The COVID-19 pandemic continues to rumble on and whilst the Government has introduced various protective measures for business over the past 2-3 years, many expect a tidal wave of companies to fail or downsize once those protections come to an end.
Many industries will be impacted by corporate customers taking damage limitation measures, but the business-to-business telecommunications sector may feel the pinch in particular. As customers seek to potentially downsize to save their businesses, they may look to cut over-heads. One such cut could be to their telecommunications contracts, whether that be to the line rentals and associated services, or to the lease agreements for the hardware.
The vast majority of business-to-business telecommunications agreements (“B2B agreements”) will be on a fixed-term basis. In a good number of cases, providers will likely have built in a clause that permits the provider to charge an early termination fee (“ETC”) in the event that the customer terminates the fixed-term agreement early. Most B2B agreements will also have a liquidated damages clause, which allows the provider to levy a fee in the event that it has to terminate the B2B agreement for breach of contract.
But are these early termination clauses enforceable? We explore the legal position below.
It is a settled principle in English Law that penalty clauses are unenforceable. The test for whether a clause amounts to a penalty underwent a fairly recent review in the Supreme Court.
In the combined appeals of Makdessi v Cavendish Square Holdings BV and Parking Eye Ltd v Beavis  UKSC 67;  A.C. 1172 (“Parking Eye”) the Supreme Court stated that there were two key questions that must be explored before a contractual clause is held to be a penalty:
- In what circumstances is the penalty rule engaged?
- What makes a contractual clause penal?
When is the penalty rule engaged?
The Supreme Court explained that there is a fundamental difference between having the jurisdiction to review the fairness of a contractual term and having the power to regulate remedies for breach of contract.
The penalty rule’s sole purpose is to regulate the remedies awarded for breach of a contractual term, or in other words, what an innocent party can claim when the contract breaker breaches its primary obligations. What the penalty rule does not do, is regulate the primary obligation itself. Lords Neuberger and Lord Sumption helpfully explained the position as follows:
“Thus, where a contract contains an obligation on one party to perform an act, and also provides that, if he does not perform it, he will pay the other party a specified sum of money, the obligation to pay the specified sum is a secondary obligation which is capable of being a penalty…”
In other words, if a contractual term requires a party to pay a specified sum to the other party in the event of a breach of contract, the clause is capable of being a penalty.
What makes a contractual term penal?
The leading authority for the penalty rule up to Parking Eye was Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co. Ltd A.C. 847 (“Dunlop”).
Delivering his judgment in Dunlop, Lord Dunedin stated that when considering whether a contractual clause was a penalty, the court would need to consider whether the clause under scrutiny was a genuine pre-estimate of loss, or whether the sums being claimed were unreasonable when considering what would be payable when applying the ordinary common law rules of damages.
The Supreme Court suggested that the courts had been applying the test formulated in Dunlop too rigidly, essentially creating a “quasi-statutory code”. The Justices therefore considered all pervious authorities on the test in great detail and concluded that the true test for whether a contractual clause was a penalty is:
“…whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation. The innocent party can have no proper interest in simply punishing the defaulter. His interest is in the performance or in some appropriate alternate to performance.”
In the Parking Eye appeal, the Supreme Court held that a penalty parking charge of £85 was not out of all proportion and that the company had a legitimate interest in trying to prevent breaches of the parking terms & conditions.
What does this mean for early termination clauses in B2B telecommunication agreements?
The new test provides that if a telecommunications provider wishes to claim liquidated damages for breach of contract, which from experience in most cases is the sum likely to have been charged under the remaining term of the fixed-term B2B agreement, it will need to demonstrate that it has a legitimate commercial interest in claiming the liquidated damages. Whether the commercial interests relied upon are legitimate or not will be determined on a case-by-case basis.
At the time of writing there appears to be little authority that offers any guidance as what would be accepted as a legitimate commercial interest in B2B agreements. One potentially relevant authority is Blu-Sky Solutions Limited v Be Caring Limited  EWHC 2619 (“Blu-Sky”), however, it should be stressed that this dispute concerned the somewhat unusual situation where a cancellation charge was claimed prior to connection.
The above being said, there are comments from the judgment that may provide some guidance, in particular paragraph 25 of HHJ Stephen Davies’s judgment, where he states:
“I am satisfied that the charges of £225 per connection impose on the defendant a detriment out of all proportion to any legitimate interest of the claimant in the performance of the primary obligation. It is not to recover its actual costs. It is almost 8 times the amount of any actual loss of profit suffered by the claimant. Its only purposes are either to frighten the defendant into entering into the MNS contract with EE and doing what was necessary to secure the PAC codes and take up the connections if it was to think of changing its mind (so that the claimant can obtain its profit) or to obtain compensation out of all proportion to its only actual loss if not.”
It therefore seems from the above, that a telecommunications provider attempting to enforce a liquidated damages clause, will need to persuade the court that the sum claimed reflects the likely costs incurred and actual profits lost as a result of the breach of contract (much like the old “pre-estimate” of loss test in Dunlop).
Termination by the customer
We have established above that a liquidated damages clause may amount to a penalty, but the question is, does the same rule apply to an ETC when the customer terminates the agreement early, for example when changing providers? According to the High Court, it does not.
In the case of Berg v Blackburn Rovers Football Club & Athletic Plc  EWHC 1070 (Ch) (“Berg”), the court had to consider whether a clause that provided for a fee to be paid to the dismissed manager was a penalty clause or not. The court held that it was not, with Judge Pelling QC stating that:
“A sum of money payable under a contract on the occurrence of an event other than a breach of contractual duty is not a penalty.”
The determinative factor in this case was that the termination of the contract by the Defendant was not a breach of contract, but rather the Defendant simply exercising its right to terminate the contract early.
Although this judgment pre-dated Parking Eye, the ruling does appear to align with the analysis in the latter. When considering the first of the two questions discussed above, the Supreme Court considered the difference between a clause that creates a secondary obligation upon breach of a primary obligation, and a conditional primary obligation. In the case of the latter, the Supreme Court held that it was not penalty clause.
Arguably, therefore, the reasoning in Berg remains valid, as a customer who wishes to end a contract early, other than in cases of an alleged breach of contract by the provider, is invoking a conditional primary obligation i.e. it can only invoke the clause successfully if it pays the ETC.
This appears to be good news for telecommunications providers seeking to recover an ETC from a customer who terminated the fixed-term B2B Agreement early. Whilst each case would fall to be determined by its own facts, in simple scenarios where the customer simply chose to change provider or downsize, it would appear that an ETC in this scenario would be enforceable.
Notwithstanding the legal principles discussed above, telecommunications providers will also need to be alive to clause C1.8 of Ofcom’s General Conditions of Entitlement.
Clause C1.8 states that a regulated provider must ensure that conditions or procedures for contract termination do not act as a disincentive for “Relevant Customers” against changing their provider. In the context of B2B agreements, relevant customers are defined as Microenterprise Customers/Small Enterprise Customers (10 employees or less) and Not-For-Profit Customers.
Arguably, an ETC could act as a disincentive for a Relevant Customer to switch providers and could therefore fall foul of clause C1.8.
A further point to consider is whether ETC and liquidated damages clauses have been effectively incorporated. Experience shows that in most cases, the clauses that govern B2B agreements are set-out in a standard set of terms & conditions. In some cases, those terms & conditions are directly signed, but in others they may only be referred to on an order form.
In Blu-Sky, the court held that the standard terms & conditions had been incorporated. In this case the standard terms & conditions had been referred to on the order form signed by the customer. The court did, however, go on to determine that the liquidated damages clause had not been incorporated effectively. The reasons for this were the settled legal principle that a clause which is particularly onerous or unusual, would not be incorporated unless it had fairly and reasonably been brought to the other party’s attention.
On the facts of Blu-Sky, the court determined that a clause that required the customer to pay an “administration charge” if they failed to commit to a connected agreement was particularly onerous, since the amount of the charge bore no relationship to any reasonable estimate of the provider’s loss resulting from the cancellation. Furthermore, the court held that the offending clause was “buried” in other lengthy sections of the standard terms & conditions and the provider had therefore not done enough to bring it the customer’s attention.
It is important to note that in reaching its decision, the court had to consider the application of a further settled legal principle, namely that a party was bound by terms & conditions contained in a document that it had signed. In Blu-Sky, the court relied on a further authority that drew a distinction between this principle and cases where the onerous clause was not included in the signed document, but was in a document elsewhere i.e. in standard terms & conditions on a provider’s website.
Whilst the facts of Blu-Sky are somewhat unusual given the nature of the liquidated damages clause being enforced, the judgment does serve as a warning to telecommunications providers that they should be taking steps to ensure that standard terms & conditions are effectively incorporated. It is not clear if a standard liquidated damages or ETC clause would be found to be onerous, but if it were, providers would again need to ensure that appropriate steps have been taken to bring those clauses to the customer’s attention.
It follows from the above that is not necessarily straight-forward to determine if an ETC or liquidated damages clause in a B2B agreement is enforceable. Each case will be determined on its own facts, but there are pre-emptive steps that providers can take to increase the chances of the clauses being enforceable.
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