High Court Clarifies Validity of Transfer Notice and Enforceability of Penalty Clause in Company Articles

Citation: [2023] EWHC 3017 (Ch)
Judgment on

Introduction

In the case of Daniel Lee & Anor v GSquare Capital II LP & Ors [2023] EWHC 3017 (Ch), the High Court of Justice grappled with two significant legal issues pertaining to the validity of a transfer notice and the enforceability of a penalty clause within a company’s Articles of Association. The court’s approach, in this case, illuminates important principles regarding contract interpretation and the contemporary understanding of penalties under English contract law.

Key Facts

The case sees the claimants, Mr. Lee and the Trustees, challenging the validity of a “July 2020 Transfer Notice” and the enforceability of a penalty clause in the Articles of Association of P2U Holdings. The defendants, GSquare and P2U Holdings, sought to classify Mr. Lee as a “Very Bad Leaver,” purportedly due to a breach of restrictive covenants, thus triggering a share transfer for a nominal sum of £1. The application led the court to decide two issues: the validity of the transfer notice and whether the penalty clause was enforceable.

The legal principles under scrutiny revolved around the interpretation of company articles and the doctrine of penalties in contract law.

Validity of the Transfer Notice: The court applied established principles of contractual construction, emphasizing the need to ascertain the objective meaning behind the contract’s language, as noted in Lukoil Asia Pacific Pte Ltd v Ocean Tankers (Pte) Ltd. The specific inquiry here focused on whether the Articles required a notice to accurately specify the type of leaver an individual was for the transfer to be valid. The court concluded that such a requirement did not exist within the Articles’ language and hence decided the validity of the notice did not depend on the accurate classification of the type of leaver.

Penalty Clauses: For the penalty issue, the court relied on the Supreme Court’s judgment in Cavendish Square Holdings v Makdessi, which established the modern test for penalties. The question boiled down to whether the impugned clause is a secondary obligation imposing a detriment out of proportion to any legitimate interest in enforcing the primary obligation. Master Pester evaluated whether Article 16.3(d) was a primary obligation and whether the penalty doctrine was triggered at all.

Outcomes

The court determined that:

  1. The July 2020 Transfer Notice was valid. The requirement to transfer shares under the Articles did not necessitate the identification of the type of leaver, and even if it had, such identification did not need to be “accurate.”

  2. Article 16.3(d) of the Articles was not a penalty clause. The court found that the trigger for the transfer of shares was not predicated on breach of contract, but rather on being classified as a “Leaver.” As such, the provision was deemed a primary obligation with a price-adjustment mechanism, with the penalty doctrine not being engaged.

Conclusion

In the case of Daniel Lee & Anor v GSquare Capital II LP & Ors, the court provided clarity on the interpretation of company articles in connection with share transfers and reaffirmed the principles set out in Cavendish Square Holdings v Makdessi concerning penalty clauses. The judgment confirms that not all clauses triggered by a breach of contract are penalties, and underscores the importance of assessing whether such clauses constitute primary obligations, which are typically enforceable, as opposed to secondary ones, which might engage the doctrine of penalties. The determination highlights the courts’ reluctance to re-write parties’ commercial agreements and reinforce the sanctity of contractually agreed terms when they are clear, unambiguous, and do not amount to penalties.