On 28 April 2016 the Court of Appeal handed down its decision in Edgeworth Capital (Luxembourg) S.A.R.L. and Aabar Block S.A.R.L. v Ramblas Investments B.V. [2016] EWCA Civ 412, affirming the first instance decision of Hamblen J in the Commercial Court ([2015] EWHC 150 (Comm)) that a fee falling due under a loan agreement is not a penalty, even where the fee would appear to be excessive.

The facts
In September 2008 Ramblas entered into a suite of financing agreements in relation to its purchase of the Madrid headquarters of Banco Santander S.A. This suite included a Junior Loan Agreement (the "JLA") under which Ramblas borrowed €200 million; an Upside Fee Arrangement (the "UFA"); as well as a personal loan entered into by personal borrowers.

Edgeworth was not originally party to this suite of agreements but in December 2010 the original lender's rights and obligations under the above agreements were transferred to it. Also in December 2010 breaches of contract by the personal borrowers under the personal loan triggered the cross-default provision of the JLA. On 31 December 2010 Edgeworth therefore sought, under the terms of the JLA, full repayment of outstanding principal of the €200 million, and, in light of the termination of the JLA, the fee allegedly due under the UFA of approximately €100 million. Although Edgeworth and Ramblas settled the claim in relation to the €200 million due under the JLA, Ramblas disputed that the €100 million UFA fee was payable.

Ramblas argued, at both first instance and in the Court of Appeal, that:

  1. on a proper construction of the UFA the default under the personal loan triggering the repayment of the JLA could not be a Payment Event (as defined in the UFA) requiring Ramblas to pay the UFA fee; or
  2. if the fee did become payable, it was unenforceable as a penalty.

Both arguments were rejected at first instance and on appeal.

The construction argument
The Court of Appeal agreed with Hamblen J's first instance judgment that as the obligation to repay the JLA had been triggered (by the default by the personal borrowers under the personal loan), this gave rise to a Payment Event under the UFA such that the UFA fee became due.

From a practical point of view, it should be noted that both Hamblen J and the Court of Appeal referred to the recitals to the UFA to support this conclusion. The recitals included the statements that:

    • "In consideration for the benefits conferred on [Ramblas] by the [JLA], it is appropriate that [Edgeworth, following the assignment] should be entitled to the fees set out in the UFA"; and
    • Ramblas acknowledged "that the fees payable under [the UFA] together with the terms upon which the [JLA] have been or will be made available represent a fair return to [Edgeworth] for ... providing the [JLA] in circumstances in which the [JLA] has been made available for the benefit of" Ramblas.

This reiterates that when negotiating a loan or any contract, the parties must pay attention to the recitals and consider them as part of the contract to be negotiated, as the courts will refer to them in the event of a dispute.

The penalty argument
Between the first instance judgment and the appeal, the test for what constituted a penalty had been changed by the Supreme Court in Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67. It therefore fell to Hamblen J to determine whether or not to apply the old test – whether the amount of damages payable under the relevant clause were a "genuine pre-estimate of loss" – whilst it fell to the Court of Appeal to determine whether or not to apply the new test – to determine whether the relevant clause "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."

In fact both Hamblen J and the Court of Appeal held that the relevant test to determine whether a clause was a penalty clause – whether the old test or the new test – was not applicable. As the Court of Appeal stated, "The event which constituted an Event of Default under the JLA and caused the loan to fall due for repayment was not a breach of the JLA itself but a breach of the [personal loan] by the [personal] borrowers. As [Hamblen J] said, the fee had nothing to do with damages for breach of contract: it was payable on the happening of a specified event. Accordingly it does not fall foul of the rule against penalties."

Indeed Hamblen J observed that the UFA fee was always going to be payable; the effect of the triggering event was to advance the time for payment of the fee, but did not increase Ramblas' overall obligation. "It would be perverse", he noted, "if Ramblas was somehow placed in a more advantageous position by breaching rather than performing" the JLA.

The judgments in both the Court of Appeal and at first instance remind us of the need to ensure that the recitals to a contract are carefully drafted, as the court will refer to them when considering a dispute. The Court of Appeal has also affirmed that the rule on penalties applies only to damages for breach of contract. Therefore where a fee is payable under a contract the rule does not apply, even if the fee appears to be excessive.

One more thing ...
You may be wondering why Ramblas entered into an agreement whereby it was liable to pay a fee of almost 50% of the value of the loan. As we said at the start, Ramblas purchased the Madrid headquarters of Banco Santander in September 2008. The UFA was entered into on 12 September 2008 – 3 days before Lehman Brothers collapsed and, clearly, at a time when it was extremely difficult to obtain credit. As Hamblen J observed at first instance, there was "a clear commercial justification for a large fee being charged ... [and] that is the bargain that was made."