Enforceability: Supreme Court Decision

As indicated in part 1 of the series, there remain some doubts as to whether the forfeiture option is enforceable as a matter of English law.

In short:

  • English law does not allow the enforcement of penalty clauses;
  • the law as to whether a remedy for breach of contract was penal had, until recently, centred on whether the remedy constituted a genuine pre-estimate of the loss suffered by the innocent party;
  • the Supreme Court (in the case of Cavendish Square Holding BV (Appellant) v Talal El Makdessi (Respondent)) has recently moved away from the genuine pre-estimate test and has distilled a revised test based on legitimate interests; and
  • under the revised test, the key question will be whether the relevant provision imposes a detriment on the contract breaker out of all proportion to any legitimate interest of the innocent party.

Prior to the Supreme Court’s decision in Cavendish Square there was a high level of concern among lawyers that the forfeiture option would not be enforceable on the basis that it constitutes a penalty clause i.e. the value of the forfeited participating interest is not necessarily a genuine pre-estimate of the loss of the non-defaulting parties.

The Supreme Court’s decision in Cavendish Square does not address these concerns entirely. However, the decision does perhaps move the balance back towards the non-defaulting parties who clearly have considerable legitimate interests in the removal of the defaulting party from the joint venture. There are also a number of other aspects of the decision which may be useful for non-defaulting parties in advancing their position.

Ultimately, until such time as the courts rule on the enforceability of the forfeiture option, we anticipate that arguments as to the enforceability of forfeiture provisions will remain a part of the default process and that this will be a factor encouraging parties to reach agreement as to terms of withdrawal by defaulting parties rather than proceeding with forced forfeitures.

Read more on this case and its application to JOA defaults.

Conclusions

In the current environment, we anticipate further defaults as companies come under increasing financial pressure. These defaults will raise challenges for defaulting parties, non-defaulting parties and farm-in partners, which will need to be carefully considered and managed. This will involve detailed consideration of JOA provisions, but also thinking outside the JOA and increasingly an ability to engage constructively with defaulting party financiers, administrators and liquidators.

Looking to the medium and longer term, present experience provides valuable insights into the practical application of the default provisions of the AIPN JOA and lays the foundation for improvements to be made; something which is not to be forgotten as and when the outlook for oil and gas improves.