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Penalty decider: High Court allows enforcement of arbitration award which includes a contractual penalty

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Nettleton Sophie
Sophie Nettleton

Senior Associate

London

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14 April 2016

In Pencil Hill Ltd v US Città Di Palermo S.p.A (Unreported) QBD (Merc) (Manchester), 19 January 2016, the High Court rejected an application to block enforcement of a Swiss arbitration award, part of which comprised a penalty. The court held that the public policy in enforcing foreign arbitral awards under the 1958 Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York Convention) far outweighs that in refusing to enforce penalty clauses. Relevant to the decision was the Swiss law requirement to reduce excessive penalties. The Tribunal in this case had already reduced an award which it considered “disproportionate and unfair”. The decision is a further reminder of the very limited circumstances in which the English courts will refuse to enforce an arbitral award under the New York Convention on public policy grounds. 

Pencil Hill Ltd (Pencil Hill) sold the financial rights in footballer Paulo Dybala to US Città Di Palermo S.p.A (Palermo) for EUR 10 million. Under an agreement dated 27 April 2012 (the April Agreement), Palermo agreed to pay Pencil Hill EUR 6.72 million in two instalments of EUR 3.36 million. A further EUR 1 million was due under an agreement made in August 2012 (the August Agreement).

If Palermo failed to pay any of the instalments, all remaining amounts would become due together with a penalty equal to double the sum outstanding. Palermo failed to pay the sum of EUR 6.72 million. Disputes were referred to a three-member Tribunal of the Court of Arbitration for Sport (the CAS) for resolution “according to Swiss Private law”.

The Swiss award

The CAS made an award in favour of Pencil Hill and directed Palermo to pay EUR 9.4 million plus interest, comprising: (i) the EUR 1 million due under the August Agreement; (ii) the EUR 6.72 million due under the April Agreement; and (iii) a reduced additional sum of EUR 1.68 million in place of the penalty (the Award). The reduced additional sum represented 25% of the penalty claimed.

The Tribunal applied Article 163.3 of the Swiss Code of Obligations and held that the original penalty of EUR 6.72 million was disproportionate and unfair. The reduced penalty was upheld on appeal by the Swiss supervising court.

Would the English court enforce the penalty?

Pencil Hill sought to enforce the Award against Palermo in the English courts. Palermo argued that the penalty clause in the April Agreement was “sufficiently injurious” to justify the court’s refusal to enforce the penalty element of the Award as contrary to public policy under s103(3) of the Arbitration Act 1996 (the Act). Palermo cited the recent decision of the Supreme Court in Makdessi1 in support of its argument that the rule against penalties is a matter of public policy. Even after the reduction of the amount of the penalty, there remained a penalty which the English court should not enforce.

A balancing act – New York Convention versus public policy

His Honour Judge Bird acknowledged that the English courts have a general duty to enforce a New York Convention award, subject only to certain limited exceptions, including public policy (s103(3) of the Act).

Counsel for Pencil Hill argued that the court was required to find a balance between, on the one hand, the desirability of finality in international arbitration, and, on the other, public policy considerations concerning penalties. In the hierarchy of these public policy considerations, the public policy imperative to refuse to enforce penalty provisions was not sufficient to tip the balance against enforcement. Central to this argument was the decision of the Swiss supervisory court to uphold the adjustment of the penalty, thus confirming that the “penalty” was no longer “excessive”.

English court enforces award – governing law a vital factor

HHJ Bird held that the Award should be enforced in its entirety, since the public policy of upholding international arbitration awards outweighs the public policy of refusing to enforce penalty clauses. The judge summed up the challenge of raising a public policy exception with reference to the authorities, acknowledging that:

  • “considerations of public policy can never be exhaustively defined, but they should be approached with extreme caution”;2 and 
  • in order to exercise the public policy exception, the award in question must “fundamentally offend the most basic and explicit principles of justice and fairness” (per Professor Merkin).

The judge found the authorities to be clear on the limits of raising public policy arguments to block enforcement. While the rule against penalties does represent an important public policy, the judge was not persuaded that it protects “a universal principle of morality” (Westacre Investments Inc v Jugoimport-SPDR Holding Co Ltd3 applied) or that the rule is so “injurious to the public good” that enforcement should, without more, be refused.

Of key importance to HHJ Bird’s decision was the position under the governing law as applied by the Swiss supervisory court. Although Swiss law, as applied by the CAS, classified the clause as a penalty, the effect of the reduction of the payment obligation was that it was no longer regarded by the governing law as objectionable.

The judge held that the role of the English court was not to adjudicate upon the underlying contract. Accordingly, the decision of the supervisory Swiss court, being “the court chosen by the parties applying the law chosen by the parties”, should be respected.

COMMENT

The decision is a useful reminder of the difficulties involved in raising public policy exceptions to the enforcement of arbitral awards.

Despite the acknowledgment of the Supreme Court in Makdessi that the rule against penalty clauses is a matter of public policy, Palermo were unable to demonstrate that it outweighed the broader public policy consideration in favour of the enforcement of foreign arbitral awards.

A further tension revealed in HHJ Bird’s judgment is between domestic public policy considerations and the freedom of the parties to resolve their disputes according to their chosen governing law. In this case, the Swiss governing law chosen by the parties provided the means of transforming a penalty clause into a non-objectionable clause as a matter of Swiss law. For HHJ Bird, the application of domestic public policy exceptions in this case would have infringed the parties’ choice.  

This decision is a not a green light to the enforcement of awards containing penalty clauses in the English courts. Central to the judge’s reasoning was the fact that Swiss law required a penalty clause to be reduced and that the supervisory Swiss court had confirmed that the clause was no longer objectionable as a matter of Swiss law. English law does not allow the courts to intervene to reduce the effect of a penalty clause so as to make it enforceable. It is unclear how this might tip the balance between competing public policy considerations in other enforcement scenarios, so parties should continue to exercise caution when drafting clauses which may be construed as penalties as a matter of English law. 

Footnotes:

1 www.allenovery.com/publications/en-gb/Pages/New-penalty-test.aspx  

2 Deutsche Schachlbau und Tiefbohrgeselischaft mbH v Ras al-Khaimah National Oil Co [1987] 2 Lloyds Rep 246, per Sir John Donaldson MR.

3 [2000] QB 288.  

Further information

This case summary is part of the Allen & Overy Litigation and Dispute Resolution Review, a monthly publication.  For more information please contact Sarah Garvey sarah.garvey@allenovery.com, or tel +44 20 3088 3710.​