Practical Law

For almost 60 years (most recently in Cadogan Petroleum Holdings Ltd v Global Process Systems), courts have been asked to consider what happens to money already paid by way of instalments in relation to a contract if the contract is rescinded and the seller retains the property that is the subject matter of the contract.

In summary, the cases have held that if the pre-payment of an instalment is not intended to be a forfeitable deposit, the seller’s right to retain the instalment is conditional upon completion of the contract and the transfer of title to the seller. In order to determine whether it is a forfeitable deposit, one has to construe the terms of the actual contract as a whole.

Cadogan Petroleum v Global Process Systems

In Cadogan Petroleum v Global Process Systems, the court had to address the question once again. Was it right that the seller was able to retain $7.5 million that had already been paid by the buyer as part payment for the manufacture of plant and equipment for a large gas plant where, due to the buyer’s breach, the seller was able to rescind the contract and keep all the equipment? In addition, the seller claimed further sums that were due and payable before the contract was rescinded but which had not been paid.

What did the court decide?

On the basis of the terms of the contract, the court held that at the time that the contract was rescinded, the seller had accrued rights in respect of the:

• Instalments already paid.
• Instalments that were due and payable, but which had not been paid by the buyer.

Therefore the seller was entitled to keep it all – the sums paid and the equipment – as well as being entitled to recover sums that should have been paid by the date of rescission.

The court also considered whether the fact that the seller was able to retain the instalments paid and recover the instalments due and payable, as well as retain all of the equipment, amounted to an unenforceable penalty. The court had recently considered a similar question in Cavendish Square Holdings BV v El Makdessi.

In Cavendish, the court held that a clause which, as a result of the breach, entitled the innocent party to withhold monies that were due and payable, was capable of amounting to a penalty. However, in Cadogan the right to forfeit did not arise purely as a result of the breach. The money had already been paid and/or was already due and payable.

While some cases have suggested otherwise, the court in Cadogan held that the law on penalty clauses only properly arose when the entitlement happens on breach. The rule did not apply to sums that were due and payable on events other than breach. The right to pay the monies arose in Cadogan before and independently of the breach. Further, the law on penalties does not apply to deposits or clauses providing for forfeiture of sums already paid. Unfortunately, the judge in Cadogan was not referred to the earlier Cavendish judgment.

The consequences of this?

In my view, Cadogan may be too narrow an interpretation. It does not appear to sit happily with other cases.

Given the fine dividing line and the fact that we now appear to have two first instance decisions that are, arguably, inconsistent with each other, I guess that certainty will have to wait until another day when the Court of Appeal comes to decide the matter. Until such time, I guess you pay your money and you take your chances (although, with the Tour de France still not too distant a memory, my money is on Cav).

However, perhaps in the meantime, the real answer is do not allow events to occur that enable the other party to rescind the contract, or draft the contract so that it clearly provides otherwise.