The High Court in London has recently enforced a Swiss seated arbitration award made by the Court of Arbitration for Sport (CAS) which included a sum of €1,680,000 awarded pursuant to a penalty clause despite the general unenforceability of penalty clauses under English law.

Background

By a contract dated 27 April 2012, US Citta Di Palermo SpA (Palermo) agreed to pay Pencil Hill Ltd (Pencil Hill) a total of €6,720,000 in two installments of €3,360,000 on fixed dates for certain financial rights deriving from the ‘registration rights’ of Argentinian international and current Juventus FC footballer Paulo Dybala. Clause 4 of the contract provided:

“In the case [Palermo] fails to pay any of the installment agreed, then, all the remaining amounts shall become due and as penalty [Palermo] will have to pay an amount equal to the amount pending IE [Palermo] will pay the double of the pending amount at the moment of the fail on payment.”

Palermo did not pay the €6,720,000 and on 4 July 2013, Pencil Hill filed an arbitration request at CAS claiming, amongst other things, €6,720,000 pursuant to the contractual penalty clause. The arbitration proceeded and on 26 August 2014, CAS published its award and directed Palermo to pay to Pencil Hill €9,400,000 plus interest including €1,680,000 pursuant to the penalty clause. In reducing the amount of the penalty, the Arbitral Panel referred to Article 163.3 of the Swiss Code of Obligations which provides that “the judge must reduce a contractual penalty considered excessive”.

On 3 November 2014, Palermo appealed the Award to the Tribunal Federal in Lausanne, the Swiss court with supervisory jurisdiction over the arbitration. The Tribunal Federal upheld the reduced penalty and thereafter Pencil Hill sought to enforce the award in England.

Palermo argued before His Honour Judge Bird in the High Court that he should refuse to allow the enforcement of €1,680,000 of the award on the basis that to do so would be contrary to the English public policy against enforcing penalty clauses2 . Pencil Hill, on the other hand, argued that the granting of permission to enforce an award under the New York convention involves a balance between the desirability of finality in international arbitration and public policy considerations concerning penalties. Pencil Hill went on to argue that there is a hierarchy of public policy considerations and the public policy represented by the English law imperative to refuse to enforce penalty provisions was not sufficient to tip the balance against enforcement.

The judgment

In concluding that the award should be enforced in its entirety, His Honour Judge Bird made the following observations:

  • There is a strong leaning towards the enforcement of foreign arbitral awards and the circumstances in which enforcement may be refused are narrow.
  • The public policy against enforcement of penalty clauses does not protect a ‘universal principle of morality’, such as against the enforcement of contracts for terrorism, drug trafficking, prostitution or paedophilia and enforcement would not be so clearly ‘injurious to the public good’ that enforcement should not, without more, be refused.
  • The parties chose a governing law which empowers its courts to interfere with a penalty by reducing it. The governing law applied by the CAS and the Tribunal Federal recognised the payment obligation as a penalty. CAS exercised its power to reduce and vary the payment obligation so that it was no longer considered ‘excessive’. The Tribunal Federal upheld the CAS’ decision and the altered obligation was no longer regarded by the governing law as objectionable.
  • In the eyes of Swiss law, the variation of the payment obligation changed the nature of the obligation. What had been a penalty, an excessive payment, was changed into a non penalty, by a non excessive payment. The position then was not that Swiss law upheld a penalty, rather it was that Swiss law removed a penalty and replaced it with an obligation to pay a sum it regarded as neither exorbitant nor unconscionable.

HFW perspective

The judgment in Pencil Hill Ltd v US Citta Di Palermo SpA is undoubtedly pro arbitration. It also suggests that penalty clauses which are determined to be unobjectionable under the law of the contract, are unlikely to result in the non-enforcement of awards by the English Courts under the New York Convention. However, the judgment does not establish a general principle that the English public policy against the enforcement of penalty clauses can never provide sufficient grounds to refuse to enforce an award under the New York Convention.

Indeed, the balancing exercise performed by His Honour Judge Bird, coupled with the weight he afforded to the fact that the CAS reduced the amount of the penalty so as to ensure that it was neither exorbitant nor unconscionable, suggests that a sufficiently egregious or punitive penalty, or perhaps even one that had not been properly considered by the Tribunal in question, could result in the refusal to enforce an award under the New York Convention. As such, parties remain well advised to carefully consider the nature, scope and extent of liquidated damages clauses when drafting their contracts. This is especially true where there is a reasonable prospect that in the event of a dispute, any award would have to be enforced in England and Wales or other common law jurisdictions which have similar public policy prohibitions on the enforcement of penalty clauses, such as Hong Kong.