The High Court Considers Implied Terms and Penalty Clauses
In Hayfin Opal Luxco 3 SARL & another v Windermere VII Cmbs Plc & others, the High Court dealt with implied terms and penalty clauses.
This case involved complex dealings between two financial institutions, but the High Court's judgment does have implications for contracts of employment.
Implied Terms
Where terms are missing from a contract of employment, or clauses are incomplete, it is sometimes necessary for the courts to supply the missing words in the event of a dispute. The judge in this case provided some guidance on the approach the courts would take to such questions:
- Additional words will only be supplied if it is necessary to do so because the contract is incomplete or commercially incoherent without them.
- This test will be applied strictly - the courts will not consider whether it is reasonable to supply the missing words.
- The absence of the missing words must have been inadvertent at the time the contract was entered into, and if asked at the time the parties would have readily agreed to the words being inserted.
The judge went on to confirm that "there may be cases in which an analysis of the express terms of a contract leads to a clear conclusion that something is missing, and in such a case the court may be able to supply the missing words or terms."
Penalty Clauses
Contractual arrangements between employer and employee will sometimes require payment of a specified sum if the main terms of the contract are breached. For example, an employee may be required to stay in employment for a period after completing some expensive training and, if they leave early in breach of their obligations, to repay a specified sum to the employer.
Where the specified sum is out of all proportion to the innocent party's legitimate interests in enforcing the terms of the main agreement, it will be deemed a penalty and will not be enforceable. This proportionality test was recently confirmed by the Supreme Court.
In this case, the High Court has confirmed that the proportionality test will still apply, even where the specified sum would only be called upon in extreme circumstances and was intended to act merely as a deterrent.
The High Court also indicated that 'whether a clause is a penalty cannot depend upon the ability of the contract-breaker to pay the specified amount, or the source from which payment will be made'.
Best Practice
In order to avoid litigation which focuses on whether a term should have been explicitly written into a contract of employment, it is important to ensure that contracts are clear, specific and well drafted from the outset.
Contracts of employment can become outdated and should therefore be reviewed at regular intervals in order to incorporate any changes to the terms under which an individual is employed. A policy of requiring the employee to sign new terms and conditions on internal promotion can be useful in this regard.
In light of the recent changes in the law surrounding penalty clauses, contracts of employment and settlement agreements should be reviewed to establish whether any amendments are required.