On 19 January 2016, the English High Court in Pencil Hill Ltd v US Citta Di Palermo SpA enforced an arbitral award issued by the Swiss based Court of Arbitration for Sport (“CAS”) despite the award relying, in part, on a penalty clause in the contract (such clauses are unenforceable under English law). The Court rejected a challenge to the award, which had advanced as its grounds that enforcement of a penalty clause is contrary to public policy. The Court held that the more pressing public policy consideration was to ensure the enforcement of international arbitral awards pursuant to section 103 of the Arbitration Act 1996 (“the Act”), other than in circumstances where to do so would violate some universal principle of morality.
In April 2012, Italian football club Palermo, entered into a written contract with Pencil Hill relating to the sale of certain financial rights deriving from the registration rights of Argentinian international footballer Paulo Dybala, who was at that time contracted to Italian football club Juventus. Under the terms of the contract, Palermo agreed to pay EUR 6,720,000 in two equal instalments on certain fixed dates. In the event that Palermo missed a payment, the parties agreed that all monies would fall due and Palermo would be required to pay double the amount outstanding.
Palermo failed to make any payments under the contract and Pencil Hill filed an arbitration request at the CAS claiming the outstanding EUR 6,720,000 and the same amount again, pursuant to the penalty clause. The CAS awarded Pencil Hill EUR 9,400,000 plus interest, which accounted for the money outstanding and 25% of the penalty claimed. The CAS elected to use its discretion to reduce the size of the penalty awarded, referring to the Swiss Code of Obligations (Article 163.3) which provides that penalty clauses considered excessive, must be reduced. The award was upheld on appeal by the Swiss Supreme Court and Pencil Hill subsequently sought to enforce the award in England.
His Honour Judge Bird, sitting as a High Court judge in the Manchester District Registry of the Mercantile Court, disagreed with the submissions of Palermo and held that the pressing public policy issue was the need to ensure enforcement of international arbitral awards. It was noted that the exception to this requirement, as outlined in the Act, emerges where enforcement or recognition would be “contrary to public policy” and this is most likely in circumstances where enforcement or recognition would infringe a “universal principle of morality” and be “injurious to the public good” (e.g., enforcement of contracts for terrorism, drug trafficking, prostitution or paedophilia). The judge did not consider the enforcement of this penalty clause to fall within this narrow bracket.
The judgment also attributed importance to the parties’ decision to choose Swiss governing law, which allows courts to interfere with penalty clauses by reducing them. Similarly, it was important that, having recognised the relevant clause as a penalty, the CAS tribunal reduced the payment obligation so that it was no longer considered excessive. Further, this reduction was upheld by the curial court as legal and sufficient to render the clause no longer objectionable under the governing law. This reduction ordered by the CAS tribunal served, in actuality, to remove the penalty clause and replace it “with an obligation to pay a sum it regarded … as neither exorbitant or excessive”.
It should be remembered that the penalty clause in this case was governed by foreign law and this judgment should not be taken to suggest a general softening in the English law rule against penalties (as reinforced in the recent Supreme Court ruling in Cavendish Square Holding BV (Appellant) v Talal El Makdessi).
It was important in this case that the reduction of the penalty awarded by the CAS tribunal served to render the penalty clause neither exorbitant nor unconscionable, effectively removing its penal element. Although in upholding the award, the judgment reiterated the pro-arbitration approach of the English courts; there remains the question of how an English court may approach the public policy arguments in the enforcement of an award affirming a penalty clause where a similar reduction had not been secured, or where the appropriate tribunal had not properly considered the punitive nature of the penalty clause in question.