Scottish court: 'bad leaver' clause not unenforceable penalty

Nigel Gray had not attempted to argue that the clause was a penalty until he appealed the case to the Inner House of the Court of Session, which happened just after the Supreme Court reconsidered the law in relation to penalties in November 2015. This case, known as the Cavendish case, was clear authority that "the law on penalty clauses applies … to a range of circumstances, in which a person is required to give up or surrender property at other than value", according to the Inner House judges.

Gray had been forced to resign from the board of Braid Group Holdings Ltd (BGHL), a logistics firm, as well as those of a number of related companies after becoming implicated in bribery offences involving BGHL. The other shareholders argued that this made him a 'bad leaver' and that, under the terms of a shareholders' agreement, they were entitled to buy back his shares in the companies at the price that he paid for them, rather than at their current market value of over £20 million.

In its majority judgment, the Inner House agreed, finding that Gray's arguments required the court to "close its eyes to the fact … that Mr Gray committed gross misconduct, namely bribery of customers' officials, which entitles the board to dismiss him and which triggers the transfer of his shares as per the articles at par value".

"The case law confirms that in petitions of this kind, after having regard to all the relevant circumstances of the case, the court has a wide discretion to do that which is considered to be fair and equitable," said Lord Malcolm, in one of the two majority judgments.

"I view these proceedings, and the related actions raised by Mr Gray, as a failed attempt to extricate himself from the agreed consequences of his gross misconduct, namely implementation of the 'bad leaver' provisions … [The 2006 Companies Act does not] provide a reason for the court to interfere with the freely negotiated terms of the parties' agreement in this regard, and thereby give a windfall benefit to [Gray]," he said.

Commercial litigation expert Craig Connal QC of Pinsent Masons, the law firm behind Out-Law.com, said that the case was one of the first to consider penalty clauses in an appeal context since the Supreme Court's decision in the Cavendish case.

"Bad leaver clauses, such as the one at issue in this case, are quite common, so the decision will be of interest to many commercial parties," he said.

"As the majority of the judges agreed in this case, whether or not a clause is an unenforceable penalty must be judged at the time that it was entered into, and not at the point that the clause becomes effective. Ultimately, there was nothing exorbitant about a clause which the parties entered into freely, of sound mind and on the basis of professional legal advice," he said.

In the Cavendish case, and another related decision handed down in November, the Supreme Court held that the long-standing rules preventing parties to commercial contracts from enforcing 'penalty' clauses for breaches remained good law. However, neither of the clauses it was required to rule on were strictly speaking penalties, or "secondary" obligations which impose "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", according to the court.

"I consider that reasoning similar to that invoked by [the Supreme Court] can be applied to the circumstances of the present case," Lord Malcolm said. "There was no question but that conduct of the kind undertaken by Mr Gray could be predicted to be, and in fact has been highly damaging, both financially and to the reputation of the business."

"It is of course tempting to be heavily influenced by the now wide disparity between subscription and market value of the shares, but the question has to be tested by reference to the state of affairs at the time of the agreement. In my view the bad leaver provisions were a legitimate and proportionate response to the issues and problems likely to arise if and when circumstances justified their implementation," he said.