Illegality, Liquidated Damages and Penalties

A. Introduction

1. What makes a contract illegal? Contravention of statute, common law, public policy.

2. Consequences of illegality. Void, voidable or simply unenforceable?

● Depends upon the construction of the express provisions of the statute by various principles,
e.g. the literal rule, golden rule, mischief rule
● The consequence of not observing the statute varies from cases to cases

3. Examples from the Conveyancing and Property Ordinance (Cap.219):-

Section 3

(1) Subject to section 6(2), no action shall be brought upon any contract for the sale or other disposition
of land unless the agreement upon which such action is brought, or some memorandum or note
thereof, is in writing and signed by the party to be charged or by some other person lawfully authorized
by him for that purpose.

● Oral contract to buy and sell land is not enforceable unless it is reduced to writing, with
exceptions

(2) This section applies to contracts or other dispositions whenever made and does not affect the law
relating to part performance or sales by the court.

Section 4(1)

A legal estate in land may be created, extinguished or disposed of only by deed.

● Transfer of land title at law must be done by deed; otherwise, no legal estate at law

Section 60

(1) Subject to subsections (2) and (3), every disposition of property made, whether before or after the
commencement of this section, with intent to defraud creditors, shall be voidable, at the instance of any
person thereby

(2) This section does not affect the law of bankruptcy for the time being in force.

(3) This section does not extend to any estate or interest in property disposed of for valuable
consideration and in good faith or upon good consideration and in good faith to any person not having,
at the time of the disposition, notice of the intent to defraud creditors.
B. Examples of illegality situations

(a) Contracts involving the Commission of a Legal Wrong

(i) Amounting to a legal wrong

● A contract is illegal if the mere making of it is a legal wrong: e.g. if legislation prohibits the
making of the contract

1. Contracts “smacking” of maintenance or champerty

Maintenance: Supports litigation in which he has no legitimate concern without just cause or excuse

Champerty: An aggravated form of maintenance - a contract by which one person (third party of the
litigation) agrees to finance another’s litigation in return for a share in the proceeds, the former having
no genuine or substantial interest in the outcome [also see Chitty Chapter 16 from para 54]

● England: criminal and tortious liability for champerty have been abolished; but the champertous
agreement remains, as a general rule, illegal

To be champertous,

1) wanton or officious intermeddling with the disputes of others (the requirement of maintenance)
2) to which must be added the notion of a division of the spoils

In Hong Kong, alleged champerty is not uncommon in cases of personal injury where the “claims agent”
would fund the litigation in return for some percentage of the settlement or damages.

Issues surrounding the champerty: how about the case of client losing the case?

-- Losing party, who has no money, pays the cost? Or the claims agent who funded the litigation from
the shadows?

The court, since 2009, has established the provision that the court has the power to order a non-party to
pay (but need to prove that someone has funded the litigation) ← it may not be always clear when it is
funded, e.g. involving mere oral understandings

Winnie Lo v HKSAR FACC No.2 of 2011 (23 February 2012)

Facts: Cheung tells Wong that she will fund litigation brought on behalf of Wong's child. Wong does not
have to pay for anything, but is to give Cheung 25% of anything damages obtained. Cheung then
engages a solicitor Lo to act on behalf of Wong in the action, but instructs Lo that she should look to
Cheung (not Wong) for payment of any fees.

-- Challenging that the law of maintenance or champerty is too vague → too uncertain for criminal law,
which is against the Basic Law

Ribeiro PJ stated:-

'C.2 Are the offences of maintenance and champerty legally uncertain?

Applying the foregoing principles, it is in my view clear that the offences of maintenance and champerty
possess the required legal certainty to qualify as measures duly “prescribed by law” for Article 39
purposes.

In Unruh v Seeberger, this Court noted that these offences are traceable in English law back to at least
the 13th century. It was pointed out that their core definitions, applicable equally to maintenance and
champerty as crimes, as torts and as the basis for rendering contracts unenforceable as against public
policy, have remained essentially unchanged throughout this time.

The kernel of the offence of maintenance has always involved a defendant’s “officious intermeddling” in
litigation in which he has no legitimate interest. And the crux of champerty has always involved a
defendant who takes a share of the proceeds of the litigation maintained. Thus:-

(a) In 1913, in Neville v London Express Newspapers Ltd, Lord Finlay LC put it as follows:-

“The essence of the offence is intermeddling with litigation in which the intermeddler has no concern,
unless the case falls under some of the heads of exception to which I have above adverted. It was
considered that it is against public policy that litigation should be promoted and supported by those
who had no concern in it. ... Champerty is a form of maintenance, and occurs when the person
maintaining another takes as his reward a portion of the property in dispute.”

(b) In the House of Lords in 1994, the essentials were described by Lord Mustill in Giles v Thompson, in
the following terms:-

“It is sufficient to adopt the description of the policy underlying the former criminal and civil sanctions
expressed by Fletcher Moulton LJ in British Cash and Parcel Conveyors Ltd v Lamson Store Service Co Ltd
[1908] 1 KB 1006, 1014: ‘It is directed against wanton and officious intermeddling with the disputes of
others in which the [maintainer] has no interest whatever, and where the assistance he renders to the
one or the other party is without justification or excuse.’ This was a description of maintenance. For
champerty there must be added the notion of a division of the spoils.”

As the Court noted in Unruh v Seeberger, the scope of these two offences has progressively been
narrowed over the years by the courts carving out common interest and similar exceptions to liability to
reflect changed public policy considerations. As Dixon J pointed out in Stevens v Keogh:-

“The law of maintenance is founded not so much on general principles of right and wrong or of natural
justice as on considerations of public policy (per Lord Esher): Alabaster v Harness [1895] 1 QB 339.
Notions of public policy are not fixed but vary according to the state and development of society and
conditions of life in a community. The exceptions or justifications which allow a person or body of
persons to maintain a litigant in a suit do not form a closed category ...”
While this process led Fletcher Moulton LJ to remark that it was “far easier to say what is not
maintenance than to say what is maintenance,” this does not mean that the offence should be regarded
as constitutionally uncertain. Rather, the process of development is an instance of the courts clarifying
and modifying a law with ancient origins to meet the needs of modern conditions, applying the
traditional methods of the common law. In so doing, the courts have unobjectionably narrowed, and not
extended, criminal liability.

In Unruh v Seeberger, this Court held that the traditional legal policies underlying maintenance and
champerty continue to apply, with the mischief aimed at continuing to be “officious intermeddling” in
litigation in the case of maintenance. It acknowledged the continued relevance of the traditional
concerns underlying champerty, namely, the tendency of an agreement to share the spoils of litigation
to encourage the perversion of justice; to endanger the integrity of the judicial process or to involve
trafficking in the outcome of litigation. It emphasised the need to consider the totality of the facts in
ascertaining liability and the importance of considering countervailing policies and recognizing that
other approaches may be more suitable in a particular case.

Doctrinal issues undoubtedly remain to be addressed and clarified. Questions may, for instance, arise as
to the extent to which the elements of maintenance and champerty as criminal offences might differ
from their elements in the civil context. It was held, for example, in Neville v London Express
Newspapers Ltd, that special damage must be proved as an element of the tort of maintenance. Is there
a similar requirement in the criminal offence? That question does not require to be decided in the
present case. But if and when it falls to be resolved by the courts, that would provide another
illustration of the common law at work. The existence of such debatable issues surrounding a settled
core does not make the offence legally uncertain. In my view, the appellant’s legal uncertainty argument
must fail.'

Contingency or conditional fees

Conditional fee agreements: pay the legal adviser at different rates depending on the outcome of the
litigation

-- UK: may be lawful to agree on these provisions → subjected to the legislation

-- HK: see the LRC report

2. Contracts to commit a criminal offence

Contacts for a deliberate commission of a crime is always illegal.

-- Cf. The need for criminal intent vs. good faith criminal offenders

3. Contracts to commit a civil wrong

(1) Both parties may have the intent to do wrong - a deliberate attempt to commit a civil wrong will
render the contract illegal.

(2) Where one party may be innocent -

Clay v Yates (1856) 1 H & N 73. P agrees to print D's book. P does not see D's Preface until later, during
proof stage. P refuses to go on with printing because Preface libellous, but asks payment for work done.
(Defamatory preface → client refused to pay for the printed material; client intended to print the
defamatory preface, while the printer was innocent)

Pollock CB: 'Then with respect to the other point, I entertain no doubt. I told the jury that if the plaintiff
agreed to print the dedication and the treatise, and so undertook to print that which he knew to be
libellous, and afterwards said that he would not print both; in such case he could not recover. I think his
right to recover rests entirely on this ground, that he had been furnished with the treatise without the
dedication. The dedication was afterwards sent, but he had no opportunity of reading it until after it was
printed; he then discovered that it was libellous, and refused to permit the defendant to have it. I think
that if a contract is bona fide entered into by a printer to print a work consisting of two parts, and at the
time he enters into the contract he has no means of knowing that one part is unlawful, and he executes
both, but afterwards suppresses that which is unlawful, there is an implied undertaking on the part of
the person employing him to pay for so much of the work as is lawful. For these reasons I think that the
rule ought to be discharged.'

Martin B: 'With respect to the other point, I agree that as soon as a printer discovers the objectionable
nature of the work which he is employed to print, he ought to stop, and that he would not be entitled
to recover for work done, after he made the discovery. But I cannot doubt that in this case, although
the contract has never been performed, yet as the work was commenced on the retainer of the
defendant, and in ignorance that part of it was unlawful, a duty arises to pay the plaintiff for that part
which he has performed. It is like one of those transactions where a person accepts goods not made
according to contract, in which case the law implies a promise to pay for them; though perhaps the
better expression would be, “a duty arises to pay for them,” for the true ground of the right to recover
is, that such a state of circumstances has arisen that in point of law there is a duty to pay.'

-- Enforceable provided that upon the time when the legality is questioned and discontinues to perform
the contract. (try to rescind?)

-- Treitel: imaginary situation where the claimant printed the dedication without knowing the facts that
it was libellous -

(i) Pollock CB test: would not recover the part of the charges on the dedication

(ii) Martin B test: would be able to recover (a more preferable view)

(3) Where both parties are innocent -

Cf. where S sells car to B, neither party knowing that car has been stolen from X.

-- The contract is not illegal (Clairon Ltd v National Power Association), even though both parties might
be liable to tort (of conversion)

4. Use of subject matter for unlawful purpose

Langton v Hughes (1813) 1 M & S 593 [Spanish juice, ginger and isinglass soled to beer brewer, which
the seller knew it was illegal to add these ingredients due to a statute]

-- Later cases suggested that the extent to which the seller participates is relevant

-- A question of fact: whether the subject matter is tailormade?

5. Contracts which may be performed in a manner which is legal, but which may also be performed in a
manner which is illegal

Unlawful method of performance

St John Shipping Corp v Joseph Rank Ltd [1957] 1 QB 267

-- The test for determining whether an otherwise lawful contract is illegal because its performance
involved a breach of statute: did. The statute intend only to penalise conduct or also to prohibit
contracts?

Ashmore, Benson Pease & Co v A W Dawson Ltd [1973] 1 WLR 828

Facts: P contracts for D to carry P's goods on D's lorries. P knows that goods to be carried are beyond the
maximum load permitted by statute to be carried on D's lorries. P had often used D's lorries to carry
similar heavy loads without incident in the past. But on this occasion D's lorry overturned due to being
over-loaded. P sues D for breach of contract.

[Brief summary: Lorry broke down because of overload; P knew that the lorries would overload; both
parties knew or reasonably to have known that the lorries were to carry weights to be illegal; P sued for
breach of contract]

-- The contract is unenforceable - D got off, when both parties are liable by the same crime (wrong), D
would have a stronger position (a defence) (The court usually rules in favour of D) [in pari delicto, potior
est conditio defendentis]

-- Where the contract could be executed legally and illegally → need to check the intention of the
parties

Lord Denning MR: 'Although I have these misgivings, I am prepared to accept the judge's finding that the
contract was lawful when it was made. But then the question arises: was it lawful in its performance?
The judge's attention does not seem to have been drawn to this point. Yet there are authorities which
show that illegality in the performance of a contract may disable a person from suing on it, if he
participated in the illegality. This was pointed out by Atkin LJ in Anderson Ltd v Daniel [1924] 1 KB 138,
149 in a passage which was quoted by Devlin J in St John Shipping Corporation v Joseph Rank Ltd [1957]
1 QB 267, 282:-

“The question of illegality in a contract generally arises in connection with its formation, but it may also
arise, as it does here, in connection with its performance. In the former case, where the parties have
agreed to do something which is prohibited by Act of Parliament, it is indisputable that the contract is
unenforceable by either party. And I think that it is equally unenforceable by the offending party where
the illegality arises from the fact that the mode of performance adopted by the party performing it is
in violation of some statute, even though the contract as agreed upon between the parties was
capable of being performed in a perfectly legal manner.”

That passage was further approved by Jenkins LJ in B and B Viennese Fashions v Losane [1952] 1 All ER
909, 913, where he said: “that illegality in the performance of a contract may avoid it although the
contract was not illegal ab initio.”

In this case the parties entered into the performance of the contract when Dawson's driver took the
articulated vehicle (the 30-tonner) up to Ashmore's works to pick up this load. Mr. Bulmer, the transport
manager, came along and saw it. Mr. Jones, his assistant, was there. Both saw this 25-ton tube bank
being loaded on to the articulated lorry. Mr. Bulmer must have known that this was illegal: and Mr.
Bulmer's knowledge would affect Ashmore’s. Mr. Jones was asked: “Mr. Bulmer would know the specific
loads for articulated lorries, would he not? (A.) Like the back of his hand, yes.” Then as to these
particular lorries, Mr. Jones was asked: “Mr. Bulmer would have had all the knowledge in the world and
would have known what weight these lorries were permitted to carry but you didn't know?” “Well,” said
Mr. Jones, “I would say he would have a good idea what they would carry, yes.”

Now Mr. Bulmer was not called to give evidence. The reason was because he left the employment of
Ashmore’s some years ago and had gone to Zambia. But he had given a statement in which he had said:
“Identical loads to the one in question have been carried on similar vehicles belonging to G. Stiller
(Haulage) Ltd., Middleton St. George, Darlington, completely without incident.”

On that evidence I think that Mr. Bulmer must have known that these articulated lorries of Dawsons
were only permitted to carry 20 tons. Nevertheless, realising that 25 tons was too heavy — much too
heavy — for them, he was content to let them carry the loads because it had happened before without
trouble. He was getting the transport done cheaper too by £30 saved on each trip by each load. Not only
did Mr. Bulmer know of the illegality. He participated in it by sanctioning the loading of the vehicle with
a load in excess of the regulations. That participation in the illegal performance of the contract debars
Ashmore’s from suing Dawsons on it or suing Dawsons for negligence. I know that Dawsons were
parties to the illegality. They knew, as well as Mr. Bulmer, that the load was overweight in breach of
the regulations. But in such a situation as this, the defendants are in a better position. In pari delicto,
potior est conditio defendentis [Translation: Where 2 persons are equally culpable, the defendant is in
the stronger position]. I would therefore allow the appeal and enter judgment for the defendants.'

Subsequent commission of the civil wrong

-- May subsequently become illegal

-- May not be illegal because one if the parties commit a fraud on the other - however, the fraud may
amount to a repudiatory breach

6. Contracts to indemnify against liability for unlawful acts

(1) A contract to indemnify a person against criminal liability is illegal if the crime is one which can only
be committed with guilty intent. (Colburn v Patmore (1834) 1 CM & R 73)

(2) Cf. Osman v F Ralph Moss Ltd [1970] 1 Lloyd’s Rep 313

Motorist had been convicted of driving while uninsured. Driver was morally innocent, as he was told by
the insurance agent that he was properly insured. Held that the fine could be included in the damages
recoverable from the agent for breach of contract.

⇒ Yet, if the person is wholly innocent, the court may allow the person to recover an indemnity against
criminal liability.

(3) Where an act amounts both to a crime and to a civil wrong, a promise to indemnify the wrongdoer
against civil liability incurred as a result of the act is often illegal.

-- Gray v barr [1971] 2 QB 554

A husband shot and killed his wife’s lover in circumstances amounting in the view of the CA to
manslaughter (although in the criminal proceedings he had been acquitted).

Held: Husband could not recover under an insurance policy (even if it covered the occurrence) the
damages which he had had to pay to the lover’s estate.

⇒ However, a promise to indemnify a person against civil liability can be enforced, even though the act
giving rise to that liability is criminal, if the crime is one of strict liability or is in fact committed without
mens rea.

See Treitel § 11-025.

(4) To indemnify a person against civil liability may be illegal if the wrong is intentionally and knowingly
committed. Cf. Valid when the liability incurred innocently or negligently.

E.g.

1) A contract to indemnify a person against liability for deceit is illegal (Brown Jenkinson & Co Ltd v
Percy Dalton (London) Ltd [1957] 2 QB 621)
2) A person who publishes what he knows to be a libel cannot recover an indemnity from the
person who instigated the publication (W H Smith & Sons v Clinton (1909) 99 LT 840)
a) Contrast: innocent publisher → can recover an indemnity (Daily Mirror Newspapers Ltd
v Exclusive News Agency (1937) 81 SJ 924
 b) Contrast: A contract to keep a communication (even where it contained a malicious
libel) confidential and to indemnify the maker against any liability resulting from its
disclosure was valid (Weld-Blundell v Stephens [1919] 1 KB 520)
3) An agent can recover indemnity from principal if he is made liable in conversion for selling a
third party’s property on principal’s instructions (Adamson v Jarvis (1827) 4 Bing 66)

7. Company acting through a guilty agent.

Safeway Stores Ltd v Twigger [2010] EWCA Civ 1472

Facts: A company admitted its liability for breach of certain of the provisions of the Competition Act
1998, and the principal loss was the fine imposed. Tried to recover from the former directors and
employees who were assumed to have been responsible for the infringements.

Stone & Rolls Ltd v Moore Stephens [2009] 1 AC 1391 (HL)

→ Treitel: As a general rule, a company will not be prevented from claiming an indemnity where the
liability of the company arises because of vicarious liability, or because the acts of its agents are
attributed to the company, at least where that are “independent” shareholders who have been
“hijacked by a fraudulent but dominant managing director”.

Quoted from Moulin Global Eyecare v CIR HCAL No. 29 of 2010 (15 February 2011). (CFI, now overruled
by CA and CFA)

Stone & Rolls and victims

Stone & Rolls concerned a one-man company (S & R) run by S. S & R was to S’ alter ego.

Facts: S fraudulently induced banks to lend money to S & R on the basis of false commercial documents.
S then siphoned off the monies which S & R received to associated third parties. The banks having
obtained judgment against S & R, the company went into liquidation. S & R’s liquidators sued the
company’s auditors for negligently failing to detect (and warn the company of) S’ fraud.

By way of defence, the auditors argued that S’ knowledge of his own fraud should be attributed to S & R.
Given such attributed knowledge on S & R’s part, the company must be deemed as having itself
defrauded the banks. The company would in effect be relying on the consequences of its own fraudulent
act as the basis for an action against the auditors. That (the auditors submitted) was impermissible. It
violated the maxim ex turpi causa non oritur actio (“a claim based on a plaintiff’s own wrongful act does
not give rise to a cause of action”).

S & R’s liquidators countered with the Hampshire Land principle. Since the fraudster S was in control of S
& R at the relevant time, it was contended that S’ knowledge of his own fraud should not be attributed
to S & R.
The Court of Appeal held in the auditors’ favour.

Rimer LJ (with whom Keene LJ and Mummery LJ agreed) stressed that S & R was a one-man company.
He pointed out (at para. 73 of the Court of Appeal’s judgment) that, given the identity between S & R
and S, it was “not a case in which the company was the target, or the victim, if its agent’s dishonesty”.
On the contrary, the company must be regarded as having itself been the fraudster.

S & R had argued that the company was itself a victim of S’ fraud since, as a result of what S had done, S
& R was left “holding the baby” in that by S’ acts it became exposed to a claim by the banks.

But the Court of Appeal thought that S & R was no more than a “secondary victim”. Inevitably, any
company used to perpetrate a fraud on a third party would be a secondary victim, once the fraud has
been discovered and the fraudster has dissipated the fruits of the crime. The Court of Appeal reasoned
that, in judging whether a company is to be regarded as a primary or secondary victim of a fraud, one
needs to consider the effect of the fraud itself and not “the adverse consequences to the company when
and if the fraud is found out”. See the judgment of the Court of Appeal at paras. 48-74.

The House of Lords upheld the Court of Appeal by a majority (Lords Phillips, Brown and Walker). Lords
Scott and Mance dissented.

Lord Phillips did not think that Hampshire Land was relevant to the outcome of the case on a true
analysis. He held that the auditors’ duty to warn of fraud was owed to the company. Since S and the
company were effectively the same, even if the auditors were in breach of their duty, such breach could
not be actionable. This is because the auditors cannot be held liable for having failed to warn the
company (that is, S) of a fraud which the company (that is, S) must have been fully aware.

Lord Walker “limited [his] ground of decision ... to the proposition that one or more individuals who for
fraudulent purposes run a one-man company ... cannot obtain an advantage by claiming that the
company is not a fraudster, but a secondary victim” (at para. 174). By the expression “one-man
company,” Lord Walker meant “a company which has no individual concerned in its management and
ownership other than those who are, or must (because of their reckless indifference) be taken to be,
aware of the fraud or breach of duty with which the court is concerned” (at para. 161).

Lord Brown upheld the Court of Appeal’s judgment “on this basis and this basis alone -- the one-man
company or sole actor basis” (at para. 201).

Cf. Moulin Global Eyecare v CIR per Lord Walker (CFA)

Rules of attribution → attribute the knowledge of certain persons to the company

Lord Walker (CFA) - the constitution or memorandum of the company → the responsible agent (their
illegal mindsets of the agent → that might be attributed to the company) [But have exceptions]

“The decision of the Court of Appeal in Bilta has achieved a welcome clarification of the law in this area.
The general effect of the authorities discussed above can in my view be summarized in some short
propositions.

(1) Questions of attribution are always sensitive to the factual situation in which they arise, and the
language and legislative purpose of any relevant statutory provisions: Tesco at pp 169-170, 194-195,
203;Meridian at pp 507, 511-512; Tesco No 2 at pp 1042-1043; PCW at p 1145; Group Josi at p 1169;
Duke at para 615; McNicholas at paras 48-50; Morris at paras 116-124; Safeway at paras 29, 44-46; Bilta
at paras 33-35, 45.

(2) The “directing mind and will” concept in Lennard, although still often referred to in judgments, has
been greatly attenuated by recognition of the importance of the factual and legislative context: El Ajou
at pp 151, 154, 159; Meridian at pp 507-509 and 511; and numerous later cases. It might be better if it
were to fade away as a general concept.

(3) In some cases acts of directors and employees will be attributed to the corporate employer without
their state of mind being so attributed: Duke at para 625, 641; MAN at para 154, illustrated by eg
Belmont No 2 at p 398 in juxtaposition with Belmont at pp 261-262.

(4) The underlying rationale of the fraud exception is to avoid the injustice and absurdity of directors or
employees relying on their own awareness of their own wrongdoing as a defence to a claim against
them by their own corporate employer: Gluckstein v Barnes at pp 247 and 249; Houghton at pp 14 and
19;Belmont at pp 261-262; Beach at para 22.30; Duke at paras 619 to 622; McNicholas at para 56;
Morris at para 114; Bilta at paras 36 to 45.

(5) The exception applies even if the wrongdoing consists of a transaction formally approved by the
whole board of directors, and completed under the company seal: Belmont No 2 at p 398. In other
words the exception can apply even when the primary rules of attribution are in play.

(6) But the exception does not apply to protect a company where the issue is whether the company is
liable to a third party for the dishonest conduct of a director or employee: El Ajou at p 702 (see para 75
above); Meridian at p 511 (see para 79 above); Duke at para 629; Morris at para 114; Bilta at para 34.

(7) The supposed distinction between primary and secondary victims, although sometimes a useful
analytical tool, is ultimately much less important than the distinction between third party claims against
a company for loss to the third party caused by the misconduct of a director or employee, and claims by
a company against its director or employee (or an accomplice) for loss to the company caused by the
misconduct of that director or employee: Bilta at paras 45 and 77.

(8) In cases concerned with insurance the terms of the policy are likely to be decisive, especially where a
company has obtained cover against the risk of breach of duty, including fraud, by directors or
employees:Arab Bank at p 283, and the comments on that case in Morris at paras 122-124. Internal
fraud was the “very thing” from which the insurance cover was intended to protect the company.

(9) The fraud exception does not appear to have been even raised as a defence, still less successfully
relied on, in a claim by a company against its auditors for failure to detect internal fraud (as in Duke and
MAN) with the sole exception of the extreme “one-man” company case of Stone & Rolls (see that case at
paras 175 and 176). Again, internal fraud was the “very thing” from which the auditors had a duty to
protect the company.
(10) Criminal law cases are of little assistance in determining issues of attribution in civil law cases,
because of the reluctance of the court, especially in the earlier cases, to treat offences as carrying strict
liability: Odyssey at p 64; Tesco is an example, but Tesco No 2 and Safeway show the more modern
approach.”

8. Promises to pay money on the commission of an unlawful act

A contract may be illegal if it provides for the payment of money to a person in the event of his doing an
unlawful act.

9. Contracts which become legal or illegal as a result of subsequent changes in the law

(1) For conducts that are made illegal - can be dealt with by the doctrine of frustration.

(2) For conducts made lawful - future contracts may still be contrary to public policy even though the
conduct in question has ceased to be a legal wrong; existing contracts: changes in the law made after
action are generally disregarded.

10. Contracts contrary to public policy

Fender v St john Mildmay [1938] AC 1: a contract is “illegal” (i.e. void or unenforceable) for this reason
only if its harmful tendency is clear, if injury to the public is its probable and not merely its possible
consequence.

-- Note that courts are reluctant to, but may still, apply the doctrine of public policy to new classes of
contracts, because the Parliament (or LegCo in HK) and its delegates have become more active in this
field.

(1) Agreement to get married

1) Not enforceable anymore; 19th century, yes, can sue for damages
2) A promise by a married person to marry one who knew him to be already married was
unenforceable

Q: How about prenuptial agreements, whereby in the event of the divorce and settlement?

A: The general position of the court is to split the assets equally between the divorcees; but if there is a
prenuptial agreement, the court may take into account of this factor; but the court will have the
ultimate jurisdiction to decide.

(2) Agreement or arrangement between parties to divorce proceedings

 ● Invalid if it was made with a corrupt intention, e.g. with the intention to deceive the court

(3) Agreement inconsistent with parental responsibility

1) Invalid; both parties have the responsibility to take care of their child if they were married at the
time of the child’s birth
2) If they were not married → mother has the responsibility; but may “share” the responsibility by
a “parental responsibility agreement” [severely restricted → protect the interest of the child]
○ To arrange for some or all of it to be met by one or more persons acting on his behalf,
i.e. vicariously performed but not transferred

(4) Agreements in restraint of marriage

1) May be invalid: if it unjustifiably restricts the freedom to marry

2) May be valid: if they are limited in duration or otherwise reasonable - health concern or moral
well-being

(5) Marriage brokerage contracts

1) In return for money consideration to procure the marriage of another

2) Equity prevented the enforcement of these contracts
3) A contract by which a marriage bureau simply undertakes to make efforts to find a spouse for a
client has been held invalid

(6) Contracts promoting sexual immorality

1) A promise by a man to pay a woman to be his mistress is illegal

2) Pearce v Brooks: a contract to hire out a brougham to a prostitute for the purposes of her
profession is illegal
3) Contrast a contract to let a room to a prostitute who practises her profession elsewhere
4) Contracts for prostitution; the Supreme Court of Canada has held that such contracts are not
illegal

(7) Contracts amounting to interference in the course of justice

1) May be illegal because they pervert the course of justice, e.g. being paid for false evidence,
bribing the witness
2) Thus they are unenforceable

(8) Agreement not to resort to the Courts at all

● Unenforceable: under the Basic Law, everyone is guaranteed the access to the courts

Q: How about the arbitration/mediation clauses?

A: Valid as they only provide that the parties can resort to arbitration before going to court. The
jurisdiction of the court is not ousted. But when the arbitration clause completely exclude the
jurisdiction of the court, then it may be illegal and unenforceable.

(9) Sale of public offices

● Some of the contracts are prohibited by statute while others are illegal at common law,
probably against public policy

(10) Bribery and lobbying

11. Contracts in restraint of trade (e.g. restrictive covenants in employment contracts)

General rule

-- All covenants in restraint of trade are prima facie unenforceable at common law

-- Enforceable only if they are reasonable when it is reasonably associated with the interests of the
parties and of the public

Definition of restraint of trade

Esso Petroleum Co Ltd v Harper’s Garage (Stourport) Ltd [1968] AC 269 (HL)

Facts:

Lord Reid: “would not attempt to define the dividing line between contracts which are and contracts
which are not in restraint of trade”

Lord Wilberforce: “no exhaustive test can be stated”; “the doctrine of restraint of trade is one to be
applied to the factual situations with a broad and flexible rule of reason.”

Lord Pearce suggested that the law should at draw a line to regulate the commercial dealings between
the parties and said that the doctrine of restraint of trade:

‘‘… does not apply to ordinary commercial contracts for the regulation and promotion of trade during
the existence of the contract, provided that any prevention of work outside the contract, viewed as a
whole, is directed towards the absorption of the parties’ services and not their sterilisation.’’

Petrofina (Great Britain) Ltd v Martin [1966] Ch 146 (CA)

Facts:

Diplock LJ: ‘‘A contract in restraint of trade is one in which a party (the covenantor) agrees with any
other party (the covenantee) to restrict his liberty in the future to carry on trade with other persons not
parties to the contract in such manner as he chooses.’’

Lord Denning MR: ‘‘Every member of the community is entitled to carry on any trade or business he
chooses and in such manner as he thinks most desirable in his own interests, so long as he does nothing
unlawful: with the consequence that any contract which interferes with the free exercise of his trade or
business, by restricting him in the work he may do for others, or the arrangements which he may make
with others, is a contract in restraint of trade. It is invalid unless it is reasonable as between the parties
and not injurious to the public interest.’’

Criteria for the application of the doctrine

(1) There is no distinction in principle between partial and total constraints

(2) The doctrine is not confined to a limited number of contracts (Nordenfelt v Maxim Nordenfelt Guns
& Ammunition Co [1894] AC 535); however, there are certain types of covenants that traditionally
applies: (i) non-competition between ex-employee and ex-employer; (ii) trader sold the business who
agreed not to compete with the purchaser of it

(3) Contracts of a kind which have gained general commercial acceptance and have not been
traditionally subject to the doctrine will generally not be subjected to it, subjected to special features in
the contracts; “absolute exemption for any restriction or regulation is never obtained” (Esso Petroleum
Co Ltd v Harper’s Garage (Stourport) Ltd per Lord Wilberforce)

(4) The doctrine applies to restraints which operate during the continuance of the contract

(5) Whether a particular provision operates in restraint of trade is to be determined not by the form the
stipulation takes but by its effect in practice (Stenhouse Australia Ltd v Phillips [1974] AC 391), i.e. a
matter of substance; a trade extends to a man’s profession or calling (Hepworth Manufacturing Co Ltd v
Ryott [1920] Ch 129)

Time of application

-- Time for testing the validity of the restriction: when the restriction was imposed; “The question of
whether the… agreement is unenforceable on restraint of trade grounds must be tested by reference to
the state of affairs at the date of the agreement.” (Watson v Prager [1991] 1 WLR 726)

-- Therefore, the claimant need not have a continuing business interest at the time of trial to enforce the
covenant (Towry EJ Ltd v Bennett [2012] EWHC 224 (QB))

The test of reasonableness

(1) While all restraints of trade to which the doctrine applies are prima facie unenforceable, all are
enforceable if reasonable.

Nordenfelt v Maxim Nordenfelt & Co [1894] AC 535 per Lord Macnaghten:

‘‘It is a sufficient justification, and indeed it is the only justification, if the restriction is reasonable -
reasonable, that is, in reference to the interests of the parties concerned and reasonable in reference to
the interests of the public, so framed and so guarded as to afford adequate protection to the party in
whose favour it is imposed, while at the same time it is in no way injurious to the public.’’

(2) The court is entitled to consider whether or not a covenant of a narrowed nature would have
sufficed for the covenantee’s protection (Office Angels Ltd v Rainer-Thomas and O’Connor [1991] IRLR
214) ⇒ no more than necessary? Whether there is “a real functional correspondence between the
prescribed area and the area in which the claimant operates”?

(3) Even if the restraint is unlimited in time (Hitchcock v Coker) or in space (Nordenfelt v Maxim
Nordenfelt Guns & Ammunition Co), it will be upheld if is reasonable, but the absence of a limit “is a
remarkable feature prima facie needing justification” (Commercial Plastics Ltd v Vincent [1965] 1 QB
623)

1) Duration
a. Bridge v Deacons [1984] AC 705: a restraint of 5 years’ duration upheld, “there appears
to be no reported case where a restriction which was otherwise reasonable has been
held to be unreasonable because of excessive duration”
b. Scully (UK) Ltd v Lee [1998] IRLR 259: a non-solicitation clause of two years in an
employment contract was unreasonable because of excessive duration
2) Area
a. SW Strange Ltd v Mann [1965] 1 WLR 629: where the employer’s business is exclusively
for credit, the customer not dealing directly with an employee, it will often be difficult to
establish the reasonableness of any area restriction since a mere covenant not to deal
with customers on the books of the employer is likely to be sufficient
b. Commercial Plastics Ltd v Vincent [1965] 1 QB 623: A covenant [related to the
employment of an ex-employee abroad) was struck down inter alia on the ground that it
was worldwide, whereas on the facts the plaintiffs did not require protection outside
the UK
c. Scully (UK) Ltd v Lee [1998] IRLR 259: Held reasonable to impose a worldwide restraint
on disclosing confidential information on an employee employed in the UK – the
reasoning of the court being that business has become global and that national
boundaries did not constrain the dissemination of confidential information

What are the legitimate interests of the parties?

(1) “Interest of the covenantee” related to the proprietary interest of an employer in his trade secrets,
trade connections; of the buyer in the goodwill of the enterprise purchased
(2) However, this understanding does not prevail in all types of contracts; particularly when the doctrine
applies to a whole range of covenants other than the traditionally recognised

(3) Where an employer specifically states the interest to be protected, he is not entitled to justify the
covenant by some other additional interest not specified (A. Schroeder Music Publishing Co Ltd v
Macaulay [1974] 1 WLR 1308)

The burden of proof

(1) No more than reasonable or necessary to impose the restraint: the party seeking to rely on it
(typically the employer) (Morris v Saxelby)

-- Traditional covenant → attention predominantly on the interests of the parties: ‘‘... their Lordships are
not aware of any case in which a restraint, though reasonable in the interests of the parties, has been
held unenforceable because it involved some injury to the public.’’ (Att-Gen of Commonwealth of
Australia v Adelaide SS Co [1913] AC 781 (PC))

(2) If (1) has been proven, then proving that it is contrary to public interest: the party attacking it
(typically the employee) (Morris v Saxelby)

-- Outside traditional categories → perhaps shifted to interests of the public as the parties should be
able to take care of themselves

-- Public interest (Texaco Ltd v Mullberry Filling Station Ltd [1972] 1 WLR 814 per Ungoed-Thomas J):

1) “Whether the restraint is, in our industry and society as at present organised with reference to
which our law operates, unreasonable in the public interest as recognised and formulated in
such principle or proposition of law”
2) “Unreasonable limitation of liberty to trade”? “The liberty of the subject”?
3) ⇒ under this line of argument, is public interest different from that of individuals?

-- Chitty suggests the solution might be to assign a government department to be responsible for making
economic decisions with a limited review being carried out by the courts

Construction

-- The same principles with construing other written terms

-- Covenants in restraint of trade must be clear and definite (Davies v Davies (1887) 36 Ch D 359)

-- Clarke v Newland [1991] 1 All ER 397

1) [T]he question of construction should be approached in the first instance without regard to the
 question of legality or illegality;
2) that the clause should be construed with reference to the object sought to be obtained;
3) that in a restraint of trade case the object is the protection of one of the partners against rivalry
in trade;
4) the clause should be construed in its context and in the light of the factual matrix when the
agreement was made.

Employer-employee relationship

-- Always subjected to the doctrine of restraint of trade; post-termination restraints if reasonable are
therefore enforceable

Home Counties Dairies Ltd v Skilton [1970] 1 WLR 526 (CA)

Facts: The defendant employee, a milkman, entered into a covenant whereby he agreed that for a
period of one year from the termination of his employment that he would not serve or sell ‘‘ milk or
dairy produce’’ to any customer of his ex-employer.

→ Too wide so that it would preclude him from working for a grocery shop selling butter and cheese
where ex-employer’s customers might visit?

1) Rejected as being commercially unreasonable

2) Need to be understood from the intention of the parties, i.e. to restrict the employee’s activities
only when engaged in the same type of business as the employer’s
3) Thus reasonable to protect the customer-connection of the employer

-- Whether a provision operates in the restraint of trade is to be determined not by the form the
stipulation wears but by its effect in practice

Examples of provisions which in essence is restraining the liberty of trade:

1) Deprivation of pension if ex-employer competed with ex-employer (not merely entitlement of

pension but to restrict competition) (Bull v Pitney-Bowes Ltd [1967] 1 WLR 273)
2) Restraining an ex-employee from approaching other members of the employer’s workforce
(Sales (1988) 104 LQR 600

-- Onus of proof of reasonable necessity on the plaintiff (employer)

Wyatt v Kreglinger & Fernau [1933] 1 KB 793

A retired employee was granted a pension on condition that after retirement from the employment he
should be at liberty to engage in any other trade than the wool trade, otherwise the pension would
cease. There was no specific covenant by the employee not to engage in the wool trade nor any limit of
time or space.
→ The transaction was void; against public policy to deprive the community of valuable skill?

-- The clause would not become reasonable just because the other party agreed to it (Chafer Ltd v Lilley
[1947] LJR 231)

-- The court will not imply a term to save the covenant (Townends Group Ltd v Cobb [2004] All ER (D) 421
(Nov))

-- The court will not re-write the covenant in restraint of trade where the contract provides that the
covenant, if unenforceable, should be rewritten with such minimum amendment as renders it
enforceable (Townends Group Ltd v Cobb [2004] All ER (D) 421 (Nov))

-- Restraint that should apply “for as long as permitted by law” was too uncertain (Days Medical Aids Ltd
v Pihsiang Machinery Manufacturing Co Ltd [2004] EWHC 44 (Comm)

“Adequate protection”

(1) Employer not entitled to protect himself against mere competition against ex-employee (Bowler v
Lovegrove [1921] 1 Ch 642); additional skills acquired rendering him a more formidable competitor →
should not be restrained by the employer

● Famous actor could retain his pseudonym after terminating contract

● Unenforceable covenant to require ex-employee to disclose and assign inventions discovered
later

(2) Breach of confidence

Printers & Finishers Ltd v Holloway [1965] 1 WLR 1: ex-employees are barred from using info which ‘‘...
can fairly be regarded as a separate part of the employee’s stock of knowledge which a man of ordinary
honesty and intelligence would recognise to be the property of his old employer and not his own to do
as he likes with.’’

-- Impermissible to copy customer lists or deliberately memorise such information even if it is in public
domain (Robb v Green [1985] 2 QB 1)

-- Employer can only protect information that constitutes a trade secret but not of mere confidentiality
nor information which the employee was prevented from disclosing due to the duty of fidelity (acting in
good faith and loyalty)

(3) More on trade secrets and connection with customers

-- Can use a covenant to restrict an ex-employee from accepting a position in which he would be likely
to utilise information as to secret processes or other trade secrets which have been acquired in the
course of his employment (Haynes v Doman [1899] 2 Ch 13)
-- May also prohibit the employee:

1) from setting up on his own, or accepting a position with one of the employer’s competitors
(Commercial Plastics Ltd v Vincent)
2) to destroy the employer’s trade connection by misuse of his acquaintance with the clients
(Baines v Geary (1887) 35 Ch D 154)
3) from soliciting the former employer’s customers (SW Strange Ltd v Mann [1965] 1 WLR 629)

Morris v Saxelby [1916] AC 688: ‘‘In fact the reason, and the only reason, for upholding such a restraint
on the part of an employee is that the employer has some proprietary right, whether in the nature of
trade connection or in the nature of trade secrets, for the protection of which such a restraint is -
having regard to the duties of the employee - reasonably necessary.’’

Faccenda Chicken Ltd v Fowler [1987] Ch 117

The duty of fidelity which an employee owes to an employer during the continuance of the employment
obliges an employee to maintain confidential information which could not be made the subject of a valid
restraint on the determination of the employment relationship. [Why not continue after termination?
Only for harmonious working relationship?]

* Additional: Where identifying what confidential information is actually → non-competition clause with
reasonable time and space preferred

Neill LJ: “It is not necessary, however, for us for the purpose of this judgment to travel this ground again.
It is sufficient to set out what we understand to be the relevant principles of law. Having considered the
cases to which we were referred, we would venture to state these principles:

(1) Where the parties are, or have been, linked by a contract of employment, the obligations of the
employee are to be determined by the contract between him and his employer: cf. Vokes Ltd. v. Heather
(1945) 62 R.P.C. 135 , 141.

(2) In the absence of any express term, the obligations of the employee in respect of the use and
disclosure of information are the subject of implied terms.

(3) While the employee remains in the employment of the employer the obligations are included in the
implied term which imposes a duty of good faith or fidelity on the employee. For the purposes of the
present appeal it is not necessary to consider the precise limits of this implied*136 term, but it may be
noted: (a) that the extent of the duty of good faith will vary according to the nature of the contract (see
Vokes Ltd. v. Heather, 62 R.P.C. 135 ); (b) that the duty of good faith will be broken if an employee
makes or copies a list of the customers of the employer for use after his employment ends or
deliberately memorises such a list, even though, except in special circumstances, there is no general
restriction on an ex-employee canvassing or doing business with customers of his former employer:
see Robb v. Green [1895] 2 Q.B. 315 and Wessex Dairies Ltd. v. Smith [1935] 2 K.B. 80.
(4) The implied term which imposes an obligation on the employee as to his conduct after the
determination of the employment is more restricted in its scope than that which imposes a general duty
of good faith. It is clear that the obligation not to use or disclose information may cover secret
processes of manufacture such as chemical formulae  (Amber Size and Chemical Co. Ltd. v. Menzel
[1913] 2 Ch. 239  ), or designs or special methods of construction (Reid & Sigrist Ltd. v. Moss and
Mechanism Ltd. (1932) 49 R.P.C. 461 ), and other information which is of a sufficiently high degree of
confidentiality as to amount to a trade secret. The obligation does not extend, however, to cover all
information which is given to or acquired by the employee while in his employment, and in particular
may not cover information which is only "confidential" in the sense that an unauthorised disclosure of
such information to a third party while the employment subsisted would be a clear breach of the duty of
good faith. This distinction is clearly set out in the judgment of Cross J. in Printers & Finishers Ltd. v.
Holloway [1965] 1 W.L.R. 1; [1965] R.P.C. 239 where he had to consider whether an ex-employee should
be restrained by injunction from making use of his recollection of the contents of certain written printing
instructions which had been made available to him when he was working in his former employers' flock
printing factory. In his judgment, delivered on 29 April 1964 (not reported on this point in [1965] 1
W.L.R. 1 ), he said [1965] R.P.C. 239 , 253:

"In this connection one must bear in mind that not all information which is given to a servant in
confidence and which it would be a breach of his duty for him to disclose to another person during his
employment is a trade secret which he can be prevented from using for his own advantage after the
employment is over, even though he has entered into no express covenant with regard to the matter in
hand. For example, the printing instructions were handed to Holloway to be used by him during his
employment exclusively for the plaintiffs' benefit. It would have been a breach of duty on his part to
divulge any of the contents to a stranger while he was employed, but many of these instructions are
not really 'trade secrets' at all. Holloway was not, indeed, entitled to take a copy of the instructions
away with him; but in so far as the instructions cannot be called 'trade secrets' and he carried them in
his head, he is entitled to use them for his own benefit or the benefit of any future employer."

*137 The same distinction is to be found in E. Worsley & Co. Ltd. v. Cooper [1939] 1 All E.R. 290 where it
was held that the defendant was entitled, after he had ceased to be employed, to make use of his
knowledge of the source of the paper supplied to his previous employer. In our view it is quite plain that
this knowledge was nevertheless "confidential" in the sense that it would have been a breach of the
duty of good faith for the employee, while the employment subsisted, to have used it for his own
purposes or to have disclosed it to a competitor of his employer.

(5) In order to determine whether any particular item of information falls within the implied term so as
to prevent its use or disclosure by an employee after his employment has ceased, it is necessary to
consider all the circumstances of the case. We are satisfied that the following matters are among those
to which attention must be paid:

(a) The nature of the employment. Thus employment in a capacity where "confidential" material is
habitually handled may impose a high obligation of confidentiality because the employee can be
expected to realise its sensitive nature to a greater extent than if he were employed in a capacity where
such material reaches him only occasionally or incidentally.

(b) The nature of the information itself. In our judgment the information will only be protected if it can
properly be classed as a trade secret or as material which, while not properly to be described as a trade
secret, is in all the circumstances of such a highly confidential nature as to require the same protection
as a trade secret eo nomine. The restrictive covenant cases demonstrate that a covenant will not be
upheld on the basis of the status of the information which might be disclosed by the former employee if
he is not restrained, unless it can be regarded as a trade secret or the equivalent of a trade secret: see,
for example, Herbert Morris Ltd. v. Saxelby [1916] 1 A.C. 688 , 710 per Lord Parker of Waddington
and Littlewoods Organisation Ltd. v. Harris [1977] 1 W.L.R. 1472 , 1484 per Megaw L.J.

We must therefore express our respectful disagreement with the passage in Goulding J.'s judgment at
[1984] I.C.R. 589 , 599E, where he suggested that an employer can protect the use of information in his
second category, even though it does not include either a trade secret or its equivalent, by means of a
restrictive covenant. As Lord Parker of Waddington made clear in Herbert Morris Ltd. v. Saxelby [1916] 1
A.C. 688 , 709, in a passage to which Mr. Dehn drew our attention, a restrictive covenant will not be
enforced unless the protection sought is reasonably necessary to protect a trade secret or to prevent
some personal influence over customers being abused in order to entice them away.

In our view the circumstances in which a restrictive covenant would be appropriate and could be
successfully invoked emerge very clearly from the words used by Cross J. in Printers & Finishers Ltd. v.
Holloway [1965] 1 W.L.R. 1 , 6 (in a passage quoted later in his judgment by Goulding J. [1984] I.C.R.
589 , 601):

"If the managing director is right in thinking that there are features in the plaintiffs' process which can
fairly be regarded as trade secrets and which their employees will inevitably carry away with *138 them
in their heads, then the proper way for the plaintiffs to protect themselves would be by exacting
covenants from their employees restricting their field of activity after they have left their employment,
not by asking the court to extend the general equitable doctrine to prevent breaking confidence beyond
all reasonable bounds."

It is clearly impossible to provide a list of matters which will qualify as trade secrets or their equivalent.
Secret processes of manufacture provide obvious examples, but innumerable other pieces of
information are  capable  of being trade secrets, though the secrecy of some information may be only
short-lived. In addition, the fact that the circulation of certain information is restricted to a limited
number of individuals may throw light on the status of the information and its degree of
confidentiality.

(c) Whether the employer impressed on the employee the confidentiality of the information. Thus,
though an employer cannot prevent the use or disclosure merely by telling the employee that certain
information is confidential, the attitude of the employer towards the information provides evidence
which may assist in determining whether or not the information can properly be regarded as a trade
secret. It is to be observed that in E. Worsley & Co. Ltd. v. Cooper [1939] 1 All E.R. 290 , 307D, Morton J.
attached significance to the fact that no warning had been given to the defendant that "the source
from which the paper came was to be treated as confidential."

(d) Whether the relevant information can be easily isolated from other information which the employee
is free to use or disclose. In Printers & Finishers Ltd. v. Holloway [1965] R.P.C. 239 , Cross J. considered
the protection which might be afforded to information which had been memorised by an ex-employee.
He put on one side the memorising of a formula or a list of customers or what had been said (obviously
in confidence) at a particular meeting, and continued, at p. 256:
"The employee might well not realise that the feature or expedient in question was in fact peculiar to his
late employer's process and factory; but even if he did, such knowledge is not readily separable from
his general knowledge of the flock printing process and his acquired skill in manipulating a flock
printing plant, and I do not think that any man of average intelligence and honesty would think that
there was anything improper in his putting his memory of particular features of his late employer's plant
at the disposal of his new employer."

For our part we would not regard the separability of the information in question as being conclusive, but
the fact that the alleged "confidential" information is part of a package and that the remainder of the
package is not confidential is likely to throw light on whether the information in question is really a trade
secret.

These then are the principles of law which we consider to be applicable to a case such as the present
one. We would wish to leave open, however, for further examination on some other occasion the
question whether additional protection should be afforded to an employer *139where the former
employee is not seeking to earn his living by making use of the body of skill, knowledge and experience
which he has acquired in the course of his career, but is merely selling to a third party information which
he acquired in confidence in the course of his former employment.”

(4) Nature of connection with customers

-- Employment of a confidential nature?

-- Established relationships: solicitors and legal executives, medical and dental practitioners, actors,
commercial managers and agents, canvassers and travellers, shop assistants and salesmen, bookmaker’s
assistants, estate agents, designers and technicians

-- Customers who are no longer interested in dealing with the employer? (John Michael Design Plc v
Cooke [1987] 2 All ER 332)

(5) Only protect the business in which the employee was employed to do (Bromley v Smith [1909] 2 KB
235)

(6) Limits to time and space

-- Longer the duration of the restriction and the greater the area it covers → harder to prove reasonable

Space:

1) Whether or not a covenant of a narrower nature would have protected the covenantee’s
interests
2) That in defining the restricted area there is “a real functional correspondence between the
prescribed area and the area in which the claimant operates”
Determining the breach of the covenant - construction of the contract, terms

***Application***

Cantor Fitzgerald v Boyer and others HCA No. 1160 of 2011 (29 February 2012).

Reyes J: 'The starting point is the principle that an employee will not be forced to work for a particular
employer.

Nonetheless, the law may enforce a restrictive covenant which prevents an employee from engaging in
certain acts once that employee leaves an employer. The law will enforce a restrictive covenant where
the covenant is no wider than is reasonably necessary to protect the legitimate business interests of
an employer. What is reasonably necessary is a question of fact to be assessed in light of all
circumstances, including the work which the employee undertook while working for the employer.

....

Clause 15.1.1 of Boyer’s contract restricts him from poaching certain Cantor Fitzgerald group employees
for a period of 12 months after termination. That covenant (if reasonable) would expire at the close of
29 May 2012.

I am prepared to assume that it is reasonable for the protection of the Plaintiffs’ legitimate interests that
Boyer be restrained from poaching certain employees. But I am unable to hold that the period of 12
months stipulated by the covenant is reasonable.

There is simply no cogent evidence justifying a period of 12 months.

Mr. Cooney says that a period of 12 months is reasonable because “it takes time to locate a suitable
replacement broker and a broker takes time to nurture”. But no hard evidence (for example, statistics
analysing the length of time actually taken by Cantor Fitzgerald to hire brokers over the years) has
been adduced to back up that assertion. Even supposing the assertion to be true, it is unclear how the
premise logically justifies the imposition of a 12 month restriction on enticing brokers.

Mr. Huggins observes that, in Associated Foreign Exchange Ltd v IFE (UK) Ltd [2010] EWHC (Ch) 1178,
the Court held that a 12 month non-solicitation covenant in the context of foreign exchange trading was
prima facie too long. In Tullett Prebon v BGC [2010] IRLR 648, on the other hand, a 6 month non-
solicitation clause in the context of inter-dealing broking was upheld as no more than reasonably
necessary. Case law itself thus supports the view that, typically, the Courts treat a 12-month duration for
a non-solicitation covenant as prima facie too long.

Mr. Huggins has fairly drawn my attention to Cantor Fitzgerald International v Bird [2002] IRLR 867
where counsel did not take the point that a provision similar to cl.15.1.1 here was unreasonable in
duration. But I am unable to deduce anything from the fact that the 12 month duration in that case was
not challenged by counsel.
Consequently, in my view, the covenant in cl.15.1.1 is unenforceable. I note that I am not entitled to re-
write cl.15.1.1 by substituting a shorter duration of (say) 6 months for the 12 months stipulated in the
clause.

Clause 15.1.2 of Boyer’s contract enjoins him from commencing employment with certain classes of
persons (including Ainslie, McGonegal and von Parpart) in “a business ... in competition” with the Cantor
Fitzgerald group for 12 months after termination.

For reasons already canvassed, there are difficulties with cl.15.1.2.

For instance, the clause is too wide, as there is again no evidence to justify a restriction of 12 months.

In any event, as discussed in connection with cl.9.7, there is ambiguity as to precisely what constitutes
“a business ... in competition”. As a start-up at the relevant time, it is hard to see how Mansion House
could in fact be regarded as being in serious competition with the well-established Cantor Fitzgerald
group at the time when Boyer joined. [Facts]'

C. Effects of illegality

(1) Generally, the clause which is illegal or against public policy is unenforceable. The contract is said to
be “wholly unenforceable” only when the sole subject-matter of the contract is illegal.

(2) The guilty party therefore cannot rely on the contract to sue for damages or breach - it is
unenforceable to the guilty party ⇒ however, he may sue the other party on the ground of tort

Saunders v Edwards [1987] 1 WLR 1116 (Claim damages in tort (deceit) despite the contract being
tainted by illegality, i.e. attempt to evade stamp duty)

Innocent party

-- In general, no right to enforce the contract due to the ignorance or mistake of law

-- Ignorance or mistake of facts → seems to be divergent in the rulings and the test is inconclusive

Techniques to get around

1) Breach of collateral contract

○ Strongman (1945) Ltd v Sincock [1955] 2 QB 525: D employed a firm to furnish his
house. Made a promise to obtain the necessary licences but only part of the licences
were obtained. Renovation work would be illegal without licences
○ Could not enforce the contract even though in good faith; but claimed damages on
breach of collateral warranty
○ P in good faith and D not careless?
 2) Tort for misrepresentation
3) Restitution (e.g. unjust enrichment)

-- These techniques or causes of action do not hinge upon the illegal contract

Locus poenitentiae (Penitence)

(1) The action of feeling or showing sorrow and regret for having done wrong and try to redeem

(2) Assuming that there is an illegal contract,

1) If the wrong has already been committed (wholly or substantially effected), then it is too late to
repent
2) The doctrine of locus poenitentiae is only relevant when the contract is executory but not
executed; it is yet to be performed
○ It is when the illegal purpose has not been carried through that one can retract

(3) It is then essential to ask whether a contract tainted by illegality is void ab intio or unenforceable at
court.

(4) In general, the requirements of applying locus poenitentiae are:

1) The illegal purpose has been wholly or substantially effected

2) The plaintiff must genuinely repent and the repudiation must be voluntary

It seems that for illegal contracts, they are generally unenforceable but not void. They continue to exist
but prevent the parties to seek remedies in reliance on it.

The case law suggests that the contract can become enforceable again when the party withdraws from
the illegal purpose.

Taylor v Bowers (1876) 1 QBD 291

A delivered his goods to B to put them out of reach of his creditors. B, by a fictitious bill of sale, without
A’s assent assigned them to a third party, who was aware of A’s illegal purpose. A sought to repudiate
the transaction and recover the goods from the third party. A could recover the goods.

(1) The fraudulent purpose had not been carried out.

(2) A did not rely on the illegal transaction between himself and B.

(3) C had no better title than B as he knew how the goods were obtained.

Tribe v Tribe [1996] Ch 107

Facts: A father transferred to his son shares in a company in order to protect them against the possible
claims of his creditors, the shares to be held by his son on trust for him until he had settled the claims.
(Attempt to defraud the creditors.) Eventually, he settled with his creditors and sought to recover the
shares from his son who refused to re-transfer them. The court held that the father could recover his
shares.

(1) The illegal purpose has not been carried into effect in any way. The father no longer relied on a
contract that was tainted by illegality.

(2) Yet, the reason of withdrawal was not a change of mind but rather simply that it was no longer
needed.

(3) Chitty: an extreme if not wrong application of the doctrine of locus poenitentiae.

(4) Bailment? Did not truly transfer the title? Perhaps in contracts of services, the doctrine may or may
not apply. There may be an alternative route.

Bigos v Bousted [1951] 1 All ER 92

A agreed to supply B with lira, which was against the exchange control legislation. A failed to do so and B
brought an action to recover the securities deposited in connection with the illegal agreement.

(1) Action was unsuccessful, as B did not repent to repudiate the contract but merely because the other
party failed to carry out his side of the bargain.

Tinsley v Milligan [1994] 1 AC 340 (HL) (Two women cohabit in premises purchased with their monies
contributed in equal shares. But premises in T's name alone because M wished to claim social security
and had to show she did not own property. The couple fight. M claims her share of premises and asks
for order of sale.)

LORD BROWNE-WILKINSON: “My Lords, I agree with the speech of my noble and learned friend, Lord
Goff of Chieveley, that the consequences of being a party to an illegal transaction cannot depend, as the
majority in the Court of Appeal held, on such an imponderable factor as the extent to which the public
conscience would be affronted by recognising rights created by illegal transactions. However, I have the
misfortune to disagree with him as to the correct principle to be applied in a case where equitable
property rights are acquired as a result of an illegal transaction.

Neither at law nor in equity will the court enforce an illegal contract which has been partially, but not
fully, performed. However, it does not follow that all acts done under a partially performed contract are
of no effect. In particular it is now clearly established that at law (as opposed to in equity), property in
goods or land can pass under, or pursuant to, such a contract. If so, the rights of the owner of the legal
title thereby acquired will be enforced, provided that the plaintiff can establish such title without
pleading or leading evidence of the illegality. It is said that the property lies where it falls, even though
legal title to the property was acquired as a result of the property passing under the illegal contract
itself....

... There was originally a difference of view as to whether a transaction entered into for an illegal
purpose would be enforced at law or in equity if the party had repented of his illegal purpose before it
had been put into operation, i.e. the doctrine of locus poenitentiae. It was eventually recognised both
at law and in equity that if the plaintiff had repented before the illegal purpose was carried through,
he could recover his property: see Taylor v Bowers, 1 QBD 291 ; Symes v Hughes, LR 9 Eq 475 . The
principle of locus poenitentiae is in my judgment irreconcilable with any rule that where property is
transferred for an illegal purpose no equitable proprietary right exists. The equitable right, if any, must
arise at the time at which the property was voluntarily transferred to the third party or purchased in the
name of the third party. The existence of the equitable interest cannot depend upon events occurring
after that date. Therefore if, under the principle of locus poenitentiae, the courts recognise that an
equitable interest did arise out of the underlying transaction, the same must be true where the illegal
purpose was carried through. The carrying out of the illegal purpose cannot, by itself, destroy the pre-
existing equitable interest. The doctrine of locus poenitentiae therefore demonstrates that the effect of
illegality is not to prevent a proprietary interest in equity from arising or to produce a forfeiture of such
right: the effect is to render the equitable interest unenforceable in certain circumstances. The effect of
illegality is not substantive but procedural. The question therefore is, "In what circumstances will equity
refuse to enforce equitable rights which undoubtedly exist."

Severance of consideration and the blue pencil test

(1) The general rule is laid down in Pickering v Ilfracombe Ry (1868) LR 3 CP 235:

“... where you cannot sever the illegal from the legal part of a covenant, the contract is altogether void;
but, where you can sever them, whether the illegality be created by statute or by the common law, you
may reject the bad part and retain the good.”

E.g. a lease where the tenant should pay “all parliamentary taxes” - only included what he might lawfully
pay; landlord’s property tax been treated as a separate covenant thus did not affect the validity of the
whole clause

(2) Two principles present throughout the judgments:

(i) The court will not make a new contract by rewriting the existing one.

-- Severability of the unreasonable part → the blue pencil test (by running through the offending part)

-- “The severed parts are independent of each other and can be severed without the severance affecting
the meaning of the remaining part” (Business Seating (Renovations) Ltd v Broad [1989] ICR 729)

-- Will not strike words if it would “alter the scope and intention of the agreement” (Attwood v Lamont
[1920] 3 KB 571) ← non-interventionist approach by not rewriting the contract; the construction of the
contract
Severable: a covenant not to disclose trade secrets and engage in a business (Carionum Co Ltd v Le
Couch (1913) 109 LT 385)

Inseverable: a restrictive covenant which contained several departments, not severable in respect of
different sorts of business (Attwood v Lamont); a covenant not to engage in a business in any one of
several capacities (British Reinforced Concrete Engineering Co Ltd v Schelff [1921] 2 Ch 563)

More examples:

Goldsoll v Goldman [1914] 2 Ch 603 (D sold imitation jewellery business to P. Covenanted not to
compete with P as a dealer in real or imitation jewellery in any part of the UK, the USA, Russia or Spain.)

 Unreasonable as it excluded competition outside the UK but was otherwise reasonable

 “Real or” and other listed places outside the UK could be severed

Severance of a condition - Marshall v NM Financial Management Ltd [1997] 1 WLR 1527 (A provision in a
contract for the payment of commission to a self-employed sales agent after termination. Payment of
the commission was conditional on the ex-agent not competing with the defendant for a period of one
year.)

 The court held that the anti-competition covenant was in restraint of trade
 The question before the court was whether the plaintiff as the party ‘‘who has been freed from
an invalid restraint of trade can enforce the remainder of the contract without it’’.
 The court held that he could since the ‘‘whole or substantially the whole [of the] consideration
was not the restraint but the provision of the services that earned the commission.

(ii) The court will not sever the unenforceable parts of a contract unless it accords with public policy.

D. Liquidated damages and penalties

Dunlop Pneumatic Tyre Ltd v New Garage and Motor Co Ltd [1915] AC 79 (HL)

Lord Dunedin:-

“I shall content myself with stating succinctly the various propositions which I think are deducible from
the decisions which rank as authoritative:-

1. Though the parties to a contract who use the words “penalty” or “liquidated damages” may prima
facie be supposed to mean what they say, yet the expression used is not conclusive. The Court must
find out whether the payment stipulated is in truth a penalty or liquidated damages. This doctrine may
be said to be found passim in nearly every case.

2. The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the
essence of liquidated damages is a genuine covenanted pre-estimate of damage (Clydebank
Engineering and Shipbuilding Co v Don Jose Ramos Yzquierdo y Castaneda).

-- The test for a genuine pre-estimate of damages is objective; it does not turn upon the honesty of the
parties.

-- An overpayment of liquidated damages does not automatically render it a penalty clause - a generous
margin is appreciated.

Murray v Leisureplay Plc [2005] EWCA Civ 963 per Arden LJ:

“The real question is whether the sums for which the parties have provided to be paid on breach differ
substantially from the sums that would be recoverable at common law and whether there is shown to
be no justification for that.”

She suggested a series of questions to be considered:

(i) To what breaches of contract does the contractual damages provision apply?

(ii) What amount is payable on breach under that clause in the parties’ agreement?

(iii) What amount would be payable if a claim for damages for breach of contract was brought under
common law?

(iv) What were the parties’ reasons for agreeing to the relevant clause?

(v) Has the party who seeks to establish that the clause is a penalty shown that the amount payable
under the clause was imposed in terrorem, or that it does not constitute a genuine pre-estimate of loss
for the purposes of the Dunlop case, and, if he has shown the latter, is there some other reason which
justifies the discrepancy between (i) and (ii) above?

3. The question whether a sum stipulated is penalty or liquidated damages is a question of construction
to be decided upon the terms and inherent circumstances of each particular contract, judged of as at
the time of the making of the contract, not as at the time of the breach (Public Works Commissioner v
Hills and Webster v Bosanquet).

4. To assist this task of construction various tests have been suggested, which if applicable to the case
under consideration may prove helpful, or even conclusive. Such are:

(a) It will be held to be penalty if the sum stipulated for is extravagant and unconscionable in amount
in comparison with the greatest loss that could conceivably be proved to have followed from the
breach....

(b) It will be held to be a penalty if the breach consists only in not paying a sum of money, and the sum
stipulated is a sum greater than the sum which ought to have been paid (Kemble v Farren). This though
one of the most ancient instances is truly a corollary to the last test. Whether it had its historical origin
in the doctrine of the common law that when A. promised to pay B. a sum of money on a certain day
and did not do so, B. could only recover the sum with, in certain cases, interest, but could never recover
further damages for non-timeous payment, or whether it was a survival of the time when equity
reformed unconscionable bargains merely because they were unconscionable—a subject which much
exercised Jessel M.R. in Wallis v. Smith —is probably more interesting than material.

(c) There is a presumption (but no more) that it is penalty when “a single lump sum is made payable by
way of compensation, on the occurrence of one or more or all of several events, some of which may
occasion serious and others but trifling damage” (Lord Watson in Lord Elphinstone v Monkland Iron and
Coal Co).

On the other hand:

(d) It is no obstacle to the sum stipulated being a genuine pre-estimate of damage, that the
consequences of the breach are such as to make precise pre-estimation almost an impossibility. On the
contrary, that is just the situation when it is probable that pre-estimated damage was the true bargain
between the parties (Clydebank Case, Lord Halsbury; Webster v Bosanquet Lord Mersey).’

-- The Dunlop case was applied in Philips Hong Kong Ltd v A-G of Hong Kong [1993] 1 HKLR 269 (PC).

P contracted with the government to carry out obligations pursuant to a construction project. P sought a
preliminary ruling in the High Court as to whether the liquidated damages clause for the delay was a
penalty.

Lord Woolf restate the law in the Dunlop case.

(1) JG Collins Insurance Agencies Ltd v Elsley (1978) 83 DLR (3d) 1 (SCC): “It is now evident that the
power to strike down a penalty clause is a blatant interference with freedom of contract and is
designed for the sole purpose of providing relief against oppression for the party having to pay the
stipulated sum. It has no place where there is no oppression.”

(2) AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170 (High Court of Australia):

“But equity and the common law have long maintained a supervisory jurisdiction, not to rewrite
contracts imprudently made, but to relieve against provisions which are so unconscionable or
oppressive that their nature is penal rather than compensatory. The test to be applied in drawing that
distinction is one of degree and will depend on a number of circumstances, including (1) the degree of
disproportion between the stipulated sum and the loss likely to be suffered by the plaintiff, a factor
relevant to the oppressiveness of the term to the defendant, and (2) the nature of the relationship
between the contracting parties, a factor relevant to the unconscionability of the plaintiff's conduct in
seeking to enforce the term. The courts should not, however, be too ready to find the requisite degree
of disproportion lest they impinge on the parties' freedom to settle for themselves the rights and
liabilities following a breach of contract. The doctrine of penalties answers, in situations of the present
kind, an important aspect of the criticism often levelled against unqualified freedom of contract, namely
the possible inequality of bargaining power. In this way the courts strike a balance between the
completing interests of freedom of contract and protection of weak contracting parties: see generally
Atiyah,The Rise and Fall of Freedom of Contract (1979), esp. Ch. 22.”
Deposits and part-payments

Polyset Ltd v Panhandat Ltd FACV No.28 of 2000 (25.2.2002) per Ribeiro PJ

Deposits and part payments

56. Many types of contract call for one of the parties to pay money to the other in advance of the
contract’s performance. Contracts for the sale and purchase of land are a prime example. Completion
usually takes place some time after execution of the contract and payment of sums made in anticipation
of such completion. The issue which arises concerns cases where completion does not occur due to the
default of the party who made the payments. The innocent party of course has his remedy in damages
for breach of the contract. However, the question which the courts have had to answer is whether the
innocent party is entitled in any event to forfeit the payments received, particularly where the breach
has caused him no loss or only loss which is exceeded in value by the payments made.

57. It was in providing a solution, which involved distinguishing between deposits and mere advance
payments, that the nature and legal incidents of a deposit came to be defined. The character of the
payment depends on the parties’ intentions to be ascertained by construing their agreement: Mayson v
Clouet [1924] AC 980, 985. If they are found to have merely been intended as advance payments on
account of what is due under the contract, they are in principle recoverable by the payer, subject to the
innocent party’s right to set off his claim for damages: Dies v British and International Mining and
Finance Corp Ltd [1939] 1 KB 724 at 743, 745-6.

58. Such recoverability has been explained on the basis that such advance payments are impliedly
conditional on the contract being completed. In McDonald v Dennys Lascelles Ltd (1933) 48 CLR 457,
Dixon J put it in these terms :-

“When a contract stipulates for payment of part of the purchase money in advance, the
purchaser relying only on the vendor’s promise to give him a conveyance, the vendor is entitled
to enforce payment before the time has arrived for conveying the land; yet his title to retain the
money has been considered not to be absolute but conditional upon the subsequent
completion of the contract.” (p.477)

59. His Honour added :-

“The right so to recover it is legal and not equitable. It arises out of the nature of the contract
itself.” (p.479)

60. The general recoverability of advance payments has also been explained on the basis that the payer
acquires a restitutionary claim upon a total failure of consideration where the contract is terminated
before the other party has performed any part of the contractual duties in respect of which payment
was made: Stocznia Gdanska SA v Latvian Shipping Co [1998] 1 WLR 574, 588.

61. The explanations overlap. Where the contractual intention is that advance payments are conditional
on completion of the contract, it will commonly be the case that failure to complete results in a total
failure of consideration.

62. Not all part payments are recoverable. In some contracts, the payments may be intended to be
unconditional, for instance, where they are intended to be spent by the payee to help finance his
performance of the contract. Shipbuilding contracts like the contracts in Stocznia Gdanska SA v Latvian
Shipping Co (above) and in Hyundai Heavy Industries Co Ltd v Papadopoulos [1980] 1 WLR 1129, are
examples. A similar result was also reached in a case involving the sale of land, parts of which were
conveyed in stages to the purchaser: Mussen v Van Dieman’s Land Co [1938] Ch 253. In such situations,
the right to the instalments accrues unconditionally to the payee. The part performance which he
renders also means that the case is not one involving total failure of consideration.

The nature of a deposit

63. Since the decision in Howe v Smith (1884) 27 Ch D 89, the legal nature of a deposit has been clear.
Cotton LJ stated it as follows :-

“What is the deposit? The deposit, as I understand it, ... is a guarantee that the contract shall
be performed. If the sale goes on, of course, not only in accordance with the words of the
contract, but in accordance with the intention of the parties in making the contract, it goes in
part payment of the purchase-money for which it is deposited; but if on the default of the
purchaser the contract goes off, that is to say, if he repudiates the contract, then ... he can have
no right to recover the deposit.” (p.95)

64. Fry LJ put it in the following terms:-

“Money paid as a deposit must, I conceive, be paid on some terms implied or expressed. In this
case no terms are expressed, and we must therefore inquire what terms are to be implied. The
terms most naturally to be implied appear to me in the case of money paid on the signing of a
contract to be that in the event of the contract being performed it shall be brought into
account, but if the contract is not performed by the payer it shall remain the property of the
payee. It is not merely a part payment, but is then also an earnest to bind the bargain so
entered into, and creates by the fear of its forfeiture a motive in the payer to perform the rest
of the contract.” (p.101)

65. His Lordship explained that the practice of taking such an earnest for performance was of great
antiquity and concluded :-

“... that the expression used in the present contract that the money is paid ‘as a deposit and in
part payment of the purchase-money,’ relates to the two alternatives, and declares that in the
event of the purchaser making default the money is to be forfeited and that in the event of the
purchase being completed the sum is to be taken in part payment.” (p.102)

66. It follows that if, on the true construction of the contract, the parties intend the advance payment as
a deposit, they are taken to have agreed that it is to be forfeited in the event that the payer fails to
complete. Five years after Howe v Smith, the House of Lords treated this proposition as beyond dispute:
Soper v Arnold (1889) 14 App Cas 429, 435.

67. Given their nature as a guarantee of performance, deposits have been regarded as subject to
forfeiture regardless of whether non-performance by the party in breach has caused, or was thought
likely to cause, the innocent party any, or as much, loss. Thus, in Hinton v Sparkes (1868) LR 3 CP 161,
the vendor was held entitled to enforce an IOU in respect of a £50 deposit on the ground that such
deposit could be forfeited when the purchaser failed to complete purchase of a public house, even
though the actual loss suffered by the vendor was only £10, this being the deficiency arising on re-sale of
the property to another buyer. In Howe v Smith itself, the £500 deposit was validly forfeited
notwithstanding that the vendor managed to re-sell the property at the original price and so suffered no
loss.

68. The object of a deposit is therefore not to provide compensation for loss resulting from the breach
of a contract. The mechanism for such compensation is the claim for damages. Having forfeited the
deposit for failure to complete, the vendor remains entitled at common law to sue for damages,
giving credit for the forfeited deposit where such damages exceed its amount. This is reflected in
standard clauses in modern contracts for the sale and purchase of land which provide (as does Clause
26(a), discussed further below) for the vendor to forfeit the deposit and additionally to recover, inter
alia, any deficiency arising on resale of the property, with such deficiency treated as liquidated damages,
giving credit for the forfeited deposit: Shuttleworth v Clews [1910] 1 Ch 176. This is, for instance, how
the standard covenant set out as clause 10 in Part A of the Second Schedule to the Conveyancing and
Property Ordinance, Cap 219, is structured.

69. The focus of a deposit’s operation is on the period elapsing between its payment and completion of
the contract’s performance. In entering into the contract, the vendor agrees to take his property off the
market and to commit himself to the purchaser on the latter’s promise that the acquisition will duly be
completed and the vendor duly paid at the completion date. The forfeitable deposit is tendered to
encourage the vendor to make the necessary commercial act of faith. It is, as the authorities show, an
“earnest”, that is, a thing of value given to signify serious intent on the purchaser’s part. It is also the
quid pro quo for the vendor depriving himself of the ability to deal commercially with the property, and
so of making any potentially greater profits, while awaiting completion. Unlike the vendor, the
purchaser is able to profit by re-selling the property during this period, in reliance on the contract. If, at
the end of the period, completion does take place, the purpose of the deposit is spent and it becomes
absorbed as part of the purchase monies. If, on the other hand, completion does not occur as promised,
the deposit’s forfeiture follows, whether or not the vendor has suffered any loss in consequence.

Deposits and liquidated damages

70. In the light of the approach adopted by the Court of Appeal and of the submissions of Mr Denis
Chang SC appearing for the respondent, it is necessary next to distinguish between deposits and
liquidated damages.

71. The law generally permits the parties to fix their contractual liabilities by agreement. They can, for
instance, agree that if certain breaches occur, the party in breach is to pay to the other party a definite
sum by way of liquidated damages. The law recognizes that such an agreement may be in both parties’
best interests where, for instance :-
 “... undoubtedly there is damage and undoubtedly damages ought to be recovered, [but] the
nature of the damage is such that proof of it is extremely complex, difficult, and expensive.”
(per Earl of Halsbury LC, in Clydebank Engineering and Shipbuilding Company v Don Jose Ramos
Yzquierdo Y Castaneda [1905] AC 6 at 11).

72. This is however subject to certain limits. Damages are generally compensatory and the courts,
both in equity and at common law, will refuse to enforce stipulations for liquidated damages if in
substance they would operate as “a penalty to be held over the other party in terrorem” (per Lord
Halsbury in the Clydebank case, at p 10), that is, as a “punishment irrespective of the damage sustained”
(ibid, per Lord Davey at p.15).

73. In Dunlop Pneumatic Tyre Company Limited v New Garage and Motor Company Limited [1915] AC
79, Lord Dunedin encapsulated the difference as follows :-

“The essence of a penalty is a payment of money stipulated as in terrorem of the offending

party; the essence of liquidated damages is a genuine covenanted pre-estimate of damage”
(p.86).

74. His Lordship stressed that :-

“[the] question whether a sum stipulated is penalty or liquidated damages is a question of

construction to be decided upon the terms and inherent circumstances of each particular
contract, judged of as at the time of the making of the contract, not as at the time of the
breach” (pp 86-87).

75. His Lordship listed (pp 87-88) various tests which would indicate, in some cases conclusively,
whether a provision was a valid liquidated damages clause or a penalty. Thus, the clause will be struck
down if the sum stipulated “is extravagant and unconscionable in amount in comparison with the
greatest loss that could conceivably be proved to have followed from the breach” or if the sanction
prescribed for a failure to pay money is payment of a sum greater than that which ought to have been
paid. A clause is to be presumed (but not necessarily held) to be a penalty if “a single lump sum is made
payable by way of compensation, on the occurrence of one or more or all of several events, some of
which may occasion serious and others but trifling damage”.

76. Clauses prescribing liquidated damages therefore spring from entirely different intentions and
pursue different objectives compared with deposit clauses. Stipulations for liquidated damages focus on
the loss considered likely to result from foreseeable breaches and aim to quantify in advance the
damages payable. In the Clydebank case, for example, liquidated damages at a weekly rate were
stipulated to cover the event of delay in the delivery of torpedo boats ordered by the Spanish
government. In the Dunlop case, the clause required such damages to be paid at a stated rate for each
tyre re-sold by a distributor in breach of certain agreed terms, including a price-maintenance clause.
Such provisions are obviously not concerned with providing an earnest or guarantee of performance to
cater for a period intervening between contract and completion. Nor are they concerned with a vendor
extracting a commercial quid pro quo for withdrawing his asset from the market during that period.
They establish an agreed measure of damages payable after breach.

77. Quite apart from the differences in the aims of the two devices, the legal consequences which attach
to a liquidated damages clause differ in one important respect. As noted above, a clause permitting
forfeiture of a deposit upon the purchaser’s breach does not preclude the vendor from claiming
damages in respect of any loss suffered over and above the value of the forfeited deposit. In contrast,
where a breach is covered by a liquidated damages clause, the amount prescribed by that clause
represents the agreed sum of damages payable, regardless of the quantum of actual loss.

78. This applies where the actual loss is in fact less than the liquidated damages amount (provided of
course the clause represents a genuine pre-estimate of loss and has not been invalidated as a penalty).
Thus, in Philips Hong Kong Ltd v Attorney General of Hong Kong [1993] 1 HKLR 269, Lord Woolf, giving
the advice of the Privy Council, stated :-

“Except possibly in the case of situations where one of the parties to the contract is able to
dominate the other as to the choice of the terms of a contract, it will normally be insufficient to
establish that a provision is objectionably penal to identify situations where the application of
the provision could result in a larger sum being recovered by the injured party than his actual
loss. Even in such situations so long as the sum payable in the event of non-compliance with the
contract is not extravagant, having regard to the range of losses that it could reasonably be
anticipated it would have to cover at the time the contract was made, it can still be a genuine
pre-estimate of the loss that would be suffered and so a perfectly valid liquidated damage
provision.” (pp 279-280)

79. The proposition that a liquidated damages clause is definitive of the damages recoverable also holds
good where the actual loss exceeds the amount payable under the clause. For example, in Diestal v
Stevenson [1906] 2 KB 345, a contract for the sale of coal prescribed payment of one shilling for every
ton of coal not delivered. The buyer was held to this and not allowed to claim damages for the greater
loss actually caused by the seller’s non-delivery. Similarly, in Talley v Wolsey-Neech (1978) 38 P & C R
45, the vendor under a sale and purchase agreement sought to recover lost interest but failed as he was
held entitled only to recover the liquidated damages as defined by the relevant clause. Even where the
parties contract for liquidated damages in sums which they know are likely to be insufficient to cover
actual loss if the foreseen breach occurs – so that the clause could be said not to be a genuine pre-
estimate of likely loss - the clause is likely to be upheld as a valid agreement to limit liability rather than
a penalty: Cellulose Acetate Silk Co Ltd v Widnes Foundry (1925) Ltd [1933] AC 20. Such a clause does
not inflict a penalty by exceeding the compensatory function of damages.

Unreasonably excessive deposits

80. Bearing in mind the foregoing principles, the question of whether and under what circumstances a
court will intervene to prevent forfeiture of a deposit on the grounds of excessiveness falls to be
examined.

81. As indicated above, the central feature of a deposit is its susceptibility to forfeiture on the
purchaser’s failure to complete without the vendor having to offer any additional justification. With loss
being irrelevant, a windfall could obviously result where, for instance, the vendor re-sells at the same
price or even at a profit. A vendor might therefore misuse the concept of “deposit” to secure the ability
to forfeit amounts exceeding anything which may reasonably be required by way of an earnest or
guarantee of performance or as compensation for the vendor’s removal of the property from the
market pending completion.
82. The courts have made it clear that they are willing to intervene to prevent forfeiture in such a case.
In Stockloser v Johnson [1954] 1 QB 476, for example, Denning LJ stated obiter as follows :-

“Again, suppose that a vendor of property, in lieu of the usual 10 per cent deposit, stipulates for
an initial payment of 50 per cent of the price as a deposit and a part payment; and later, when
the purchaser fails to complete, the vendor resells the property at a profit and in addition claims
to forfeit the 50 per cent deposit. Surely the court will relieve against the forfeiture. The vendor
cannot forestall this equity by describing an extravagant sum as a deposit, any more than he can
recover a penalty by calling it liquidated damages.” (p.491)

83. But how is unreasonable excessiveness to be tested? One may begin with a negative proposition.
Given the differences between liquidated damages and deposits in terms of their underlying purpose,
nature and legal incidents, it is clear in principle that the test used to invalidate a liquidated damages
clause would not be the right test to apply in deciding whether forfeiture of a deposit is permissible.
Since a deposit is not intended as a mechanism for quantifying damages flowing from a foreseen breach,
it is inapt to apply a test which asks whether the deposit amount represents a genuine pre-estimate of
loss.

84. The importance of this difference was emphasised by the Privy Council in Linggi Plantations v
Jagatheesan [1972] 1 MLJ 89, where Lord Hailsham, delivering the judgment of the Board, stated (at
p.91):-

“It needs to be pointed out that the law relating to the forfeiture of deposits has always been
treated as entirely distinct and separate from the learning introduced into English law by the
distinction between liquidated damages based on a genuine pre-estimate of the loss likely to be
suffered in event of a breach and a penalty where equity came to the rescue of the obligee on a
bond or other contractual provision imposing a penalty under a contract where the penalty
exceeded the actual damage. The latter combination of rules derives from the Chancellor’s
jurisdiction in equity to relieve an obligee from the harshness of the common law. But the law
relating to deposits, as Fry LJ pointed out in Howe v Smith, has a much longer pedigree, being
imported from the civil law at least as early as Bracton, and, assuming the deposit or earnest to
be reasonable, forfeiture of a deposit was not normally the subject of equitable relief. This
appears clearly from the judgment of Jessel MR in Wallis v Smith (1882) 21 Ch D 243 at page 258
when he said:

‘I come now to the last class of cases. There is a class of cases relating to deposits.
Where a deposit is to be forfeited for the breach of a number of stipulations, some of
which may be trifling, some of which may be for the payment of money on a given day,
in all those cases the judges have held that this rule (that is the rule relating to relief
against penalty) does not apply, and that the bargain of the parties is to be carried out.’

It is also implicit in the decision in Howe v Smith which is the source of all modern learning as to
the nature of deposits, and it has been followed again and again ever since.”

85. This distinction unfortunately escaped the Court of Appeal as each of the judgments in that court
seeks to uphold the forfeiture on the basis that 35% of the purchase price was not a penalty but
represented a genuine pre-estimate of loss, taking into account the long completion period and the
possibility that the property market might fall sharply in a time of volatility. This proposition was also at
the heart of Mr Chang’s submissions to this Court. With respect, that was not the correct test.

86. In the passage from Linggi Plantations cited above, Lord Hailsham spoke of a deposit’s forfeiture not
being subject to relief “assuming the deposit or earnest to be reasonable”. His Lordship added (at
p.94) :-

“No doubt, as Cotton LJ says in Howe v Smith at page 95, there may be cases when equity would
relieve a purchaser who has paid a deposit and then defaulted, although it is to be said that the
last word is probably not yet spoken on this subject. See Stockloser v. Johnson. It is also no
doubt possible that in a particular contract the parties may use language normally appropriate
to deposits properly so-called and even to forfeiture which turn out on investigation to be
purely colourable and that in such a case the real nature of the transaction might turn out to be
the imposition of a penalty, by purporting to render forfeit something which is in truth part
payment. This no doubt explains why in some cases the irrecoverable nature of a deposit is
qualified by the insertion of the adjective ‘reasonable’ before the noun. But the truth is that a
reasonable deposit has always been regarded as a guarantee of performance as well as a
payment on account, and its forfeiture has never been regarded as a penalty in English law or
common English usage.” (p.94)

87. Lord Hailsham was therefore indicating two possible routes that a court might take when faced with
an excessive deposit. First, taking his cue from Denning LJ in Stockloser v Johnson, he suggests that
some form of (as yet undefined) equitable relief may be available. Secondly, he indicates, no doubt as a
matter of common law, that the court might regard the language of “deposit” used in a contract as
“purely colourable” because of the unreasonably excessive quantum of the deposit. In such cases, the
court might regard “the real nature of the transaction” as involving “the imposition of a penalty, by
purporting to render forfeit something which is in truth part payment”. The reference to “penalty”
here is obviously not a reference to the doctrine of penalties applicable to liquidated damages clauses.
Lord Hailsham is suggesting that what is colourably called a “deposit” but not a true deposit would not
be subject to forfeiture but may instead be treated as a part payment which, as we have seen, is
generally recoverable.

88. It is the latter of these two approaches that the Privy Council adopted as the basis of its decision in
Workers Trust and Merchant Bank Ltd v. Dojap Investments Ltd [1993] AC 573.

(a) The issue was whether a deposit representing 25% of the purchase price in a contract for the
purchase of land from a bank at auction in Jamaica (where 10% deposits were customary) could
properly be forfeited.

(b) Lord Browne-Wilkinson, giving the Board’s advice, regarded the ancient rule that deposits
may be forfeited without reference to any loss as anomalous in the context of the court’s
tendency to render penalties unlawful. This rule was considered established but his Lordship
pointed to the risk of abuse :-

“However, the special treatment afforded to deposits is plainly capable of being abused if the
parties to a contract, by attaching the label ‘deposit’ to any penalty, could escape the general
rule which renders penalties unenforceable.” (p.579)
 (c) Citing the Stockloser and Linggi Plantations cases, Lord Browne-Wilkinson firmly asserted the
court’s power to intervene in such cases :-

“It is not possible for the parties to attach the incidents of a deposit to the payment of a sum of
money unless such sum is reasonable as earnest money. The question therefore is whether or
not the deposit of 25 per cent in this case was reasonable as being in line with the traditional
concept of earnest money or was in truth a penalty intended to act in terrorem.” (p.579)

(d) The Privy Council therefore imported a test of reasonableness. It made the validity of a
deposit clause conditional on it specifying a sum which “is reasonable as earnest money” or
“reasonable as being in line with the traditional concept of earnest money”. The trial court in
Jamaica had held that the 25% deposit was reasonable on the footing that “it was of common
occurrence for banks in Jamaica selling property at auction to demand deposits of between 15
% and 50%”. However, this was held to be an incorrect application of the “reasonableness”
test. Lord Browne-Wilkinson stated :-

“In order to be reasonable a true deposit must be objectively operating as ‘earnest money’ and
not as a penalty. To allow the test of reasonableness to depend upon the practice of one class of
vendor, which exercises considerable financial muscle, would be to allow them to evade the law
against penalties by adopting practices of their own.

However although their Lordships are satisfied that the practice of a limited class of vendors
cannot determine the reasonableness of a deposit, it is more difficult to define what the test
should be. Since a true deposit may take effect as a penalty, albeit one permitted by law, it is
hard to draw a line between a reasonable, permissible amount of penalty and an unreasonable,
impermissible penalty. In their Lordships' view the correct approach is to start from the position
that, without logic but by long continued usage both in the United Kingdom and formerly in
Jamaica, the customary deposit has been 10 per cent. A vendor who seeks to obtain a larger
amount by way of forfeitable deposit must show special circumstances which justify such a
deposit.” (p.580)

(e) It was held that no such special circumstances existed and therefore, that “since the 25 per
cent. deposit was not a true deposit by way of earnest, the provision for its forfeiture was a
plain penalty” (at p 582). The bank was ordered to return it subject to its deduction of damages
compensating it for actual loss suffered as a result of the purchaser’s breach.

89. The “reasonableness” of a deposit is therefore to be tested against the customary or conventional
level of deposits generally taken as an earnest of performance. In Jamaica and in the United Kingdom,
this was found to be 10% of the purchase price in contracts for the sale and purchase of land. As many
cases show, 10% is also the conventional level for deposits in relation to such contracts in Hong Kong:
see, for example, Gladflow Ltd v Grandland Development Ltd [1993] 2 HKLR 494; Dawson Enterprises Ltd
v Talisteam Ltd [1995] 1 HKLR 93; and China Pride Investment Limited v. Silverpole Limited [1994] 2 HKC
341.

90. In the light of the foregoing authorities, the proper approach to unusually large deposits may be
stated as follows.
 (a) Where (in the absence of fraud or vitiating factors other than excessiveness) the amount of
an agreed deposit matches or is less than the conventional amount, its forfeiture will not attract
judicial scrutiny, whether or not the innocent party has suffered any loss as a result of the other
party’s breach.

(b) Where the deposit exceeds the conventional amount, that is, 10% in Hong Kong, forfeiture is
only permitted if the party seeking to forfeit can show that exceptional circumstances justify the
higher amount.

(c) Such exceptional circumstances must relate to a true deposit’s purpose as an earnest of
performance and as compensation for the vendor’s withdrawal of his asset from the property
market pending completion, providing an objective justification for the higher sum.

(d) If such justification is not forthcoming, the courts will not recognize the amount as a true
deposit but will treat it as an advance payment towards what was payable under the contract
and recoverable as such, subject to the innocent party’s entitlement to deduct damages for any
actual loss suffered as a result of the other party’s breach.

91. The “reasonableness” test propounded in Workers Trust is plainly not the same as the “genuine pre-
estimate of loss” test for penalties in the liquidated damages context. When Lord Browne-Wilkinson
uses the language of “penalty” when contrasting a true deposit with excessive sums whose forfeiture is
impermissible, he is, like Lord Hailsham in Linggi Plantations, indicating the consequence of judicial
intervention in such cases and not eliding the two tests.

92. The Workers Trust reasonableness test was referred to in Demondrille Nominees Pty Ltd v Shirlaw
(Federal Court of Australia, No. AG 24 of 1996, ACT Registry, 20 June 1996), where Beaumont J
commented that a “deposit” amounting to two-thirds of the purchase price was “so substantially in
excess of the usual 10 per cent permissible by way of a true deposit, [it] would not be enforceable as a
deposit in terms of its liability to forfeiture”.

93. In Union Eagle Ltd v Golden Achievement Ltd [1997] AC 514, the Privy Council implicitly
acknowledged the “reasonableness” test, citing Workers Trust. The land contract in question provided
for the forfeiture of the deposit “as and for liquidated damages (and not a penalty)”, prompting counsel
for the purchaser to argue that the clause was to be construed, not as a deposit clause, but as one for
liquidated damages and that the amount deposited was not a genuine pre-estimate of loss and so a
penalty. Lord Hoffmann rejected this argument, holding the deposit to be forfeitable :-

“Mr Lyndon-Stanford's third point was that the purchaser was in any event entitled to the
return of his deposit because it was not a genuine pre-estimate of damage. He accepted that, in
the normal case of a reasonable deposit, no inquiry is made as to whether it is a pre-estimate of
damage or not: Howe v Smith (1884) 27 Ch D 89; Workers Trust & Merchant Bank Ltd v Dojap
Investments Ltd [1993] AC 573. But he said that this deposit was not franked under that rule
because clause 12 described it ‘as and for liquidated damages (and not a penalty)’. Their
Lordships do not think that these words deprived the deposit of its character as a deposit, an
earnest of performance, which was liable to forfeiture on rescission.” (p.518)

94. Different views were expressed in the Hong Kong Court of Appeal in China Pride Investment Ltd v
Silverpole Ltd [1994] 2 HKC 341, regarding the effect and application of Worker’s Trust. It was
recognized that the conventional deposit was 10% in relation to land contracts in Hong Kong. In the
case before it, a 20% deposit had been paid by the purchaser. The question addressed by two of the
Court’s members was as to whether the vendor was entitled to forfeit that sum.

(a) Having noted that a deposit in a conventional amount would not attract judicial intervention,
Godfrey JA stated in relation to a deposit “which exceeds the conventional size, or in a case in
which there cannot be said to be any conventional size of ‘deposit’”, as follows :-

“In my judgment, the rule in such cases must be that the law will uphold the provision for the
forfeiture of the 'deposit' if, but only if, the amount of the 'deposit' is of no more than a
reasonable size in relation to the loss likely to be suffered by the vendor as the result of a failure
on the part of the purchaser to perform his contract. If the amount of the 'deposit' exceeds this
then, as it seems to me, it loses the benefit of the anomalous rule which precludes the
purchaser, in the ordinary case of the conventional 'deposit', from asserting that the provision
for forfeiture of the 'deposit' is penal in nature and ought not to be upheld. The court will, then,
in my judgment, uphold provisions for the forfeiture of a 'deposit' in two cases: (1) where it is
shown that the deposit did not exceed a conventional percentage of the purchase price; or (2)
where it was of no more than a reasonable size in relation to the loss likely to be suffered by the
vendor; in any other case, it will treat the provision for forfeiture of the 'deposit' as penal and
will leave the vendor to his ordinary remedy for the purchaser's breach of contract, ie a claim
for damages to be assessed.” (pp 358-359)

(b) Applying this approach to the 20% deposit, Godfrey JA held that the higher amount was
reasonable and subject to forfeiture because the contract was a subsale and the vendor would
stand to lose considerably if it went off.

(c) In tying the Workers Trust concepts of reasonableness and “exceptional circumstances” to
the quantum of loss likely to be suffered by the vendor as a result of the purchaser’s breach,
Godfrey JA was in effect borrowing the “genuine pre-estimate of loss” test relevant to
liquidated damages and applying it to unusually large deposits.

(d) Nazareth JA expressed no view as to whether the deposit was forfeitable.

(e) Penlington JA disagreed with Godfrey JA’s conclusion. However, although his Lordship also
considered various factors which might be advanced in support of an unusually large deposit, he
too appears to have accepted the applicability of a “genuine pre-estimate of loss” test. His
Lordship stated :-

“It is not necessary here for us to decide whether or not the 20% deposit was in fact a genuine
pre-estimate of liquidated damages. Miss Eu has argued forcefully that while it represents
double the conventional 10% deposit, the property was unusual -- a large number of carpark
spaces. Another similar property in the area was on the market at a lower price. The vendor
regarded this contract as a very good deal -- it stood to make $ 9,200,000 in profit. Even in Hong
Kong, that is enough to entitle a vendor to require a larger deposit than normal to make sure
the purchaser went through with the deal. Godfrey JA finds that the fact that this was a subsale
and the vendor was no doubt anxious to see that it went through as planned so it could
 complete its purchase from the head vendor is a 'special circumstance' as referred to in
Workers Trust. I would myself not have found that was a special circumstance here and I would
have considered the deposit was not a genuine estimate of damage and its purported forfeiture
would have been a penalty. However, that is a matter for argument when the point has to be
decided.” (p.362)

(f) With respect, Workers Trust gives no warrant for measuring the deposit amount or
“exceptional circumstances” said to justify a larger deposit against the level of the vendor’s
potential loss. To elide the deposit and liquidated damages doctrines is to run directly contrary
to Lord Hailsham’s caveat in Linggi Plantations cited in paragraph 84 above. “Exceptional
circumstances” are those which bear upon the true purpose of a deposit. They do not involve
asking whether the amount is reasonable as a genuine pre-estimate of loss flowing from the
purchaser’s breach. The China Pride Investment decision should not be followed on this point.

A genuine pre-estimate of loss?

95. I might add, although the matter does not fall to be decided, that even if the test for a forfeitable
deposit should involve applying the doctrine of penalties relevant to liquidated damages, I would find it
extremely difficult to accept that the sum of HK$40.25 million represents a genuine pre-estimate of loss
flowing from the purchaser’s failure to complete.

(a) As Lord Dunedin stated in the Commissioner of Public Works v Hills [1906] AC 368, referring
to the Clydebank case :-

“The general principle to be deduced from that judgment seems to be this, that the criterion of
whether a sum - be it called penalty or damages - is truly liquidated damages, and as such not to
be interfered with by the Court, or is truly a penalty which covers the damage if proved, but
does not assess it, is to be found in whether the sum stipulated for can or can not be regarded
as a ‘genuine pre-estimate of the creditor's probable or possible interest in the due
performance of the principal obligation.’ The indicia of this question will vary according to
circumstances. Enormous disparity of the sum to any conceivable loss will point one way, while
the fact of the payment being in terms proportionate to the loss will point the other. But the
circumstances must be taken as a whole, and must be viewed as at the time the bargain was
made.” (pp 375-376)

(b) His Lordship later stressed again in the Dunlop case (cited in paragraph 73 above), that the
question is one of construction to be decided upon the terms and inherent circumstances of
each particular contract, judged as at the time of the making of the contract and not as at the
time of the breach.

(c) Thus, in the Clydebank case, it was inherent in the contract to deliver torpedo boats to the
Spanish government that a delay in their delivery would cause loss since the purchaser would be
deprived of the use of such vessels. Such loss represented the Spanish government’s “probable
or possible interest in the due performance” of the contract, justifying a genuine attempt to
agree the quantification of damages for such loss.

(d) Similarly, in the Dunlop case, a breach by the tyre distributor of agreed terms including a
 price-maintenance term would inherently mean that the tyre manufacturer’s system for
organizing and regulating the operation of its distribution network was damaged. As Lord
Dunedin stated, “damage as a whole from such a practice would be certain” but quantifying it in
relation to each tyre sold in breach would be exceedingly difficult (at p 88). This justified a
genuine attempt at setting a level of liquidated damages to be charged on each tyre sold in
breach.

96. When, however, the present contract for the sale of the Causeway Bay shops was made, the
property market had been steadily climbing. It was anyone’s guess whether, nine months later, the
value of the property in question would be even higher, would fall drastically, or be much the same. I
find it extremely difficult to see how it can be said, on the basis of the terms and the inherent
circumstances of this particular contract, judged as at the time of its making, that non-completion by the
purchaser nine months later would be likely to cause loss, let alone cause loss which should genuinely
be estimated at the sum of HK$40.25 million. Depending on the state of the market, non-completion
might occasion no loss at all or loss ranging from the very serious to the trifling. [Facts]

97. It is noteworthy that the standard covenants for sale and purchase agreements set out in the
Conveyancing and Property Ordinance, the only provision for the payment of liquidated damages relates
to a deficiency upon re-sale of the property after rescission. Loss is inherent in such a case and the
clause aims to avoid debates as to the recoverable quantum of the deficiency.

98. It should also not be overlooked that the parties had in fact agreed to a further $11.5 million being
handed over to the vendor on identical terms. The vendor has, no doubt wisely, decided not to assert a
claim to that amount. Objectively, however, there is no basis for distinguishing between that sum and
the $40.25 million which is claimed, making it even more difficult to see how such sums, totalling $51.75
million and equivalent to 45% of the purchase price, could be regarded as a genuine pre-estimate of
loss.

Applying the principles

106. As discussed above, the fundamental point urged by the vendor and accepted by the Court of
Appeal is that the sum was reasonable in that it represented a genuine pre-estimate of loss given the
long, nine-month completion period and the fact that the property market was then very volatile, having
risen dramatically in the months preceding the agreement. Reliance on the concept of “genuine pre-
estimate of loss” has already been criticised as an invocation of the wrong test. Nonetheless, the vendor
is entitled to contend that the same factors, that is, the length of the pre-completion period and the
market’s volatility bear logically on the need for a larger than usual deposit.

107. In my view, there is force in such a submission. While I would not accept that a lengthier
completion period justifies a larger percentage by way of an earnest of performance, I would be inclined
to accept that a vendor may legitimately demand a larger quid pro quo for keeping his property off the
market during the more prolonged period. A question of degree enters into this question and while I
would have been prepared to accept that a deposit higher than the usual 10% deposit could be justified,
I consider a deposit 3½ times the norm to fall substantially beyond the ambit of reasonableness so that
its forfeiture by the vendor is impermissible. [With respect to facts]
108. It was suggested in submissions that a court’s refusal to permit forfeiture of an agreed deposit on
the ground of excessiveness is objectionable in that it leads to commercial uncertainty. This criticism
must be kept in perspective.

(a) If a vendor wishes to be certain of being permitted to forfeit a deposit (in the absence of
fraud or other factors which vitiate the entire contract), he can achieve this by limiting its
amount to the customary 10%.

(b) If he is concerned with certainty in relation to compensation for loss should the vendor
refuse to complete in circumstances where the property market has fallen, he may incorporate
the standard clause permitting him to claim any deficiency on a re-sale, as well as the expenses
of re-sale and any interest paid or lost, as liquidated damages.

(c) If, as in the present case, the vendor chooses to contract on the basis of a deposit which is
several times larger than the conventional sum, he would be well-advised to consider it
extremely likely, if not certain, that forfeiture of his deposit is impermissible.

(d) Uncertainty only arises where the vendor requires a deposit which exceeds the conventional
10% by a sum which may or may not be considered reasonable. It becomes a matter for the
vendor to decide whether the stipulated additional amount is worth the risk of losing the right
to forfeit the deposit. He may decide to accept the risk, ready to put forward grounds for
justifying the higher amount. Or he may decide to eliminate the risk by remaining within
conventional bounds.

109. It was also suggested in submissions that a large deposit may be justified because the purchaser
may be a single-purpose company with no assets to satisfy a damages judgment. It should however be
noted that what the law forbids is the forfeiture of an excessive deposit. It does not prohibit the parties
agreeing to a deposit followed by additional part payments towards the purchase price which, although
recoverable by the purchaser in the event of non-completion, may function as security by being set-off
against any claim that the vendor may have for damages in such event.