CPD SEMINAR FOR TELEVISION EDUCATION NETWORK
7
TH
FEBRUARY 2015
th
56 ANNUAL ARMIDALE CLE WEEK END
LIQUIDATED DAMAGES CLAUSES IN CONTRACTS: PENALTIES OR NOT?
A paper to examine the doctrine of penalties and the implications of the High Court
decision Andrews v ANZ
By Sydney Jacobs
LL.M (Cam), Barrister, 13 Wentworth Chambers
Acknowledgment: The edited extracts below are from the loose leaf service of Thomson
Reuters, Commercial Damages , which I author, though paragraph numbers do not coincide.
The lecture covers off developments the subject of the update issued late 2014.
[1] Summary of legal and equitable jurisdiction to relieve against penalties
The law may be briefly summarised as follows:
• The rule against penalties is an exception to the general principle of the common
law that contracts fall to be enforced according to their terms; and this is the
situation unless they can be brought into the limited class that the court refuses to
enforce because of public policy: Euro London Appointments Ltd v Claessens
International Ltd [2006] EWCA Civ 385, para [17].
• Whether a clause amounts to a penalty1 depends on all circumstances at the time
of making the contract as well as on the terms of the contract itself.2
• A clause which stipulates that a sum certain in money must be paid upon one or a
series of defaults by one of the parties is known as a liquidated damages clause
and will be enforceable as long as it is a “genuine pre-estimate” of damages and is
not designed to terrorise3 the defaulting party into performance.
• The penalty doctrine in equity has not been subsumed into the common law:
Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205;
86 ALJR 1002; [2012] HCA 30 (“Andrews High Court”) at [51].
• The requirements for both jurisdictions run along parallel lines for most of the
way but diverge at a certain point: see the discussion by Gordon J in Paciocco v
Australia and New Zealand Banking Group Ltd [2014] FCA 35 paras [17] ff.
• The identification of a breach of contract is a prerequisite to engaging the
common law’s jurisdiction to relieve against penalties. Equity looks at substance,
not form, and hence the jurisdiction of equity to relieve against penalties is
engaged where a stipulation imposes an additional detriment (the penalty) on a
party (“the first party”) to the benefit of the second party, collateral to (or
2 accessory) to a primary stipulation, upon the failure of the primary stipulation:
Paciocco v Australia and New Zealand Banking Group Ltd [2014] FCA 35 paras
[22] ff; Andrews High Court at [10].
• As a matter of substance, the collateral or accessory stipulation operates “in the
nature of a security for and in terrorem of, the satisfaction of the primary
stipulation” (Andrews, High Court ).
• The primary stipulation may be the occurrence or non-occurrence of an event
which need not be the payment of money (Andrews High Court at [78]).
Australian law thus travels wider than the English concept of penalty: cf para
[191] of Fahim Imam-Sadeque v BlueBay Asset Managment (Services) Ltd [2012]
EWHC 3511 (QB); para [96] of Lancore Services Ltd v Barclays Bank Plc [2008]
EWHC 1264 (Ch).
• Such a clause will be unenforceable to the extent that it is “extravagant or
unconscionable” and out of all proportion to the to the maximum loss that might
be suffered from the breach (or failure of the primary stipulation) loss;4 and when
the purpose of the clause is to coerce a party to comply and not to redress a
breach; and thus operates in terrorem, even though there might not be a “literal
stipulation that the payment is in terrorem”: see Integral Home Loans Pty Ltd v
Interstar Wholesale Finance Pty Ltd (2007) 2 BFRA 23; Aust ContractR 90-261;
[2007] NSWSC 406 at [30]. This is a requirement at law and equity: Paciocco
(ibid) para [39] ff.
• In assessing the maximum loss that might have been suffered from the breach (or
failure of the primary stipulation), the Court may receive evidence of that
hypothetical quantum “assessed” as at the date of contract: Elberg v Fraval [2012]
VSC 342 at [99] ff citing Robophone Facilities v Blank [1966] 1 WLR 1428;
Paciocco at para [44].
• “Equity assesses the quantum of loss or compensation based on what is just and
equitable, or fair and reasonable, in all the circumstances. The loss may include
costs incurred in securing payment of the amount owing, including costs of the
proceeding: Johnes v Johnes [1814] EngR 672; (1814) 3 ER 969 at 975”: see
Paciocco at para [48].
• A clause which does not provide a mechanism for assessing the precise estimation
of damages will be unenforceable.5
• A stipulated payment is more likely to be regarded as a bargain between the
parties pre-estimating loss or compensation, and not as a penalty, when the
consequences of the breach (or failure of the primary stipulation) upon which the
payment is due are difficult or impossible to estimate: para [14] of Paciocco v
Australia and New Zealand Banking Group Ltd [2014] FCA 35.
• The party harmed by the breach or the failure of the primary stipulation may
enforce the stipulation that is found to be a penalty to the extent of that party’s
loss: Andrews High Court at [10]. The party burdened by the clause is relieved to
that degree from liability to satisfy the collateral stipulation. Equity assesses the
3 quantum of loss or compensation based on what is just and equitable, or fair and
reasonable, in all the circumstances. The loss may include costs incurred in
securing payment of the amount owing, including costs of the proceeding: Johnes
v Johnes [1814] EngR 672; (1814) 3 ER 969 at 975; Paciocco (ibid) para [46] ff.
• The penalty doctrine is not engaged if the prejudice or damage to the interests of
the second party by the failure of the primary stipulation is insusceptible of
evaluation and assessment in monetary terms. The “equity” upon which a Court
will intervene is generated by the availability of compensation to the party in
whose favour the stipulation is made: Andrews High Court.
• The party asserting the invalidity of a contractual provision as being a penalty
rather than a genuine pre-estimate of liquidated damages bears the onus of
proving that assertion: Robophone Facilities Ltd v Blank [1966] 3 All ER 128;
[1966] 1 WLR 1428 at 1447; Idameneo (No 123) Pty Ltd v Angel-Honnibal
[2002] NSWSC 1214 at [106]; McRoss Developments Pty Ltd v Caltex Petroleum
Pty Ltd (2004) 11 BPR 21,615; [2004] NSWSC 183.
• The distinction between a penalty and a genuine pre-estimate of liquidated
damages made by Lord Dunedin in the seminal case of Dunlop (see below) was a
product of equity and remains applicable. “In other words, equity will operate and
equally the law will operate so as to ensure that the only money that the second
party gets is that which would compensate for the financial prejudice occasioned
by the actual failure of the stipulation. Notions of extravagance and exorbitance
are as much a part of equity as they are of the law itself.”: Andrews High Court at
[15] summarised in Paciocco at para [32].
• While the “standard application” of the doctrine is in relation to the payment of
money, the doctrine extends to obligations to transfer property and also to the
foregoing of accrued entitlements.
[2] Penalties and the obligation to transfer property
[T]here is no distinction in principle between a provision that in a case of default the
promisor will pay a penalty of £1,000, and a provision that upon default he shall
transfer to the obligee 1,000 shares in a certain company for no consideration, and to
provisions that have the effect of authorising retention or withholding payments of, or
extinguishing a right to receive, remuneration already earned but unpaid.
Integral Home Loans Pty Ltd v Interstar Wholesale Finance Pty Ltd (2007) 2 BFRA
23; Aust ContractR 90-261; [2007] NSWSC 406; (2007) Aust ContractR 90-261; per
Brereton J at [12] (and this is consistent with what the High Court decided in the
Andrews case, viz that the penalty need not be the payment of money).
[3] Penalties and the foregoing of accrued entitlement
In order to understand the significance of Andrew High Court, one needs to start, at
the latest, with the decision of Brereton J, at first instance , in Integral Home Loans
Pty Ltd v Interstar Wholesale Finance Pty Ltd (2007) 2 BFRA 23; Aust ContractR
90-261; [2007] NSWSC 406.
4 That is because Brereton J extended the application of the doctrine of penalties to a
situation where
-one party to the contract forwent an accrued entitlement to moneys (in that case, an
entitlement to receive trail commission for originating loan contracts);
-upon the happening of an event (as opposed to upon breach of contract).
The loan originator, Integral, under two related agreements, was obliged to introduce
applications for loans and then manage them on an ongoing basis, if approved. It was
to receive both up front and ongoing trail commissions.
The relevant clauses provided:
20. Termination
20.1 Interstar may terminate this Agreement immediately upon the
happening of any of the following events:]
20.3 In the event that this Agreement is terminated by Interstar:
(c) pursuant to clause 20.1(a) or (c), then the Originator shall, with
effect from the date of termination, have no further entitlement to
receive any Originator’s Fee …
[I now interpose what Brereton J held in Round Two of the litigation , on relief,
reported at (No 2) [2007] NSWSC 592, para [10]
“Until now, Interstar has accepted that its termination of the LOMAs was pursuant to
clause 20.1(c) – which provides for termination immediately upon Integral having
engaged in any proven deceptive or fraudulent activity in relation to an application for
a settled loan, or where Interstar considers, in its reasonable opinion, that Integral has
done so. That the purported termination was under clause 20.1(c) was asserted by
Integral in its Statement of Claim [paragraph 18], and admitted by Interstar in the
defence [paragraph 18]. Moreover, the defence in paragraph 19 asserted that “the
termination was for cause within the meaning of sub-clause 20.1(c)”. The pleading
contained not the slightest hint of any suggestion that the termination was pursuant to
clause 20.1(b) – which provides for termination upon Integral breaching any term or
condition of the agreement and the breach not being rectified within 14 days after
written notice of the breach is given by Interstar to Integral. Had Interstar suggested
that the termination was reliant upon clause 20.1(b), no question of a total forfeiture
of trailer commission would have arisen, because clause 20.3(b) provides for a
continued entitlement to trailer commission, albeit subject to deduction of
replacement manager’s costs, in the case of such a termination.”
Nevertheless, HH went on to consider whether there was in fact an arguable basis for
the engagement of clause 20.3(b) by a termination under cl 20.1(b).
The crisp issue on appeal was whether Brereton J was correct in holding that cl
20.3(c) was a penalty in that it operated in terrorem of insolvency and fraud by the
5 mortgage originators by imposing an additional burden on the originators on the
occurrence of those events, wholly disproportionate to the loss Interstar would suffer.
At [10] of his reasons, his Honour said (distinguishing between penalties and
forfeiture) (although Integral did not seek relief against forfeiture):
A contractual provision may be said to be penal if its function is to
operate in terrorem to induce performance … or as a punishment for
default, in the sense that it imposes an additional or different liability
upon default; whereas a forfeiture involves loss or determination of an
interest in property or a proprietary right in consequence of failure to
observe a covenant … The distinction of a penalty is twofold: first, it is
collateral to the main promise and purpose of the contract; and
secondly, it is intended to operate as a deterrent to failure to perform
that main promise or purpose, by imposing an additional detriment on
the obligor and conferring an additional benefit on the obligee in the
event of default …
(The CA also noted that this was an important distinction to keep in mind – at [103]
of the judgment on appeal for which please see further, below).
The key paragraphs of the primary judgment are [71] and [72] which duly edited,
provide as follows:
Insofar as it has been suggested that the doctrine relating to the
unenforceability of penalties is confined to payments (and transfers,
retentions or withholdings) conditioned on a breach of obligation by
one party – and thus that a provision in a contract providing for
payment of money by one party on the occurrence of a specified event,
rather than on breach of a contractual duty, cannot be a penalty – this
must be judged according to substance and not form. It is clear that
where the right to terminate and receive a payment arises on the
happening of any number of events, only some of which are breaches
of contract, the doctrine of penalty applies where in fact the
termination is by reason of a breach. In this context, it would be
extraordinary (as Deane J observed in the passage cited from his
Honour's judgment in AMEV-UDC Finance Ltd v Austin (1986) 162
CLR 170; 60 ALJR 741; 68 ALR 185) if whether a provision was void
as a penalty depended upon whether it was conditioned on a breach of
contract as distinct from being a consequence of an election to
terminate pursuant to an event entitling a party to terminate – often
called an “event of default” – that did not involve a breach of contract.
It would be wholly inconsistent with the maxim that equity looks to the
intent, rather than to the form. The inclusion in an agreement of a list
of “events of default”, commission of which by one party will
authorise termination by the other, which events invariably include
breaches of covenants on the part of the first party, but usually also
include events which are not the subject of express covenants – such as
death, or committing an event of insolvency, or suffering execution to
be issued – is intended to confer on the other party an option to
terminate where performance of the main purpose of the contract
6 might be jeopardised. Such provisions serve to secure the interests of
the second party in receiving performance of the main promise of the
contract, to which they are collateral. In substance, they are collateral
provisions which operate to secure performance of the main purpose of
the contract by the first party. That is the classic territory of the
doctrine of penalties, …
The judgment was reversed on appeal: Interstar Wholesale Finance Pty Ltd v Integral
Home Loans Pty Ltd (2008) 257 ALR 292; [2008] NSWCA 310. The Court of Appeal
held that as a matter of construction of cl 20.3(c) of the agreement, the relevant fees
had never been fully earned; and that:
.....The right to receive them was conditioned, in part, on the
management obligations under the contract. The determination of the
contract put an end to the entitlement in the way provided for in cl
20.3(b) and (c). There was no relevant forfeiture of fully earned
property to engage the law of penalties, assuming that forfeiture of
rights (as opposed to payment of money) could so engage that law. Nor
was there any relevant breach of contract which was necessary for the
engagement of the law of penalties: [74], [79] –[104] , [92], [93], [104]
to [106].
(A special leave application to the High Court was noted as not proceeding or vacated
in [2009] HC Bulletin 6).
The judgment in the Court of Appeal is not delved into, because in Andrews v
Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205; 86 ALJR 1002;
[2012] HCA 30, the High Court convincingly approved of the approach of Brereton J,
rather than that of the Court of Appeal.
Andrews was a banking class action case which revolved around the validity of
dishonour and late payment fees that customers were charged.
In other words, the High Court held-unanimously-that the doctrine of penalties is not
restricted to circumstances of finding breach of contract. It extends to where a
“condition” of the contract has not been fulfilled and a penalty made payable as a
consequence.
The HC also held that in Interstar, the Court of Appeal had no basis for holding that
the penalty doctrine is a rule of law only and not of equity.
The HC concluded that the “… upshot is that at first instance in Interstar, Brereton J
properly understood the significance of what had been said by Mason and Wilson JJ,
when he concluded:
Their Honours' judgment does not decide that relief against a penalty is available only
when it is conditioned upon a breach of contract; to the contrary, it suggests that relief
may be granted in cases of penalties for non-performance of a condition, although
there is no express contractual promise to perform the condition – apparently on the
basis that despite the absence of such an express promise, a penalty conditioned on
failure of a condition is for these purposes in substance equivalent to a promise that
7 the condition will be satisfied.”
The intent of preliminary question and answer 2 before Brereton J was that the
assumed fact of termination under cl 20.1(c) did not result in forfeiture of Integral’s
right to receive trailer commission. It did not follow that Interstar necessarily had to
pay the trailer commission without any deduction. The form of relief was the subject
of Round Two
The limited nature of what the HC actually decided in Andrews, was noted by Gordon
J in Paciocco v Australia and New Zealand Banking Group Ltd [2014] FCA 35, paras
[22] –[23].
The facts of Andrews and what the HC held, will be explored more fully in the
seminar.
[13.15] The policy context
The dichotomy between a “genuine pre-estimate” and a “grossly disproportionate”
pre-estimate, is between compensation and deterrance. Whilst any clause which
stipulates that money must be paid will operate to a degree as a deterrant, where the
main focus is compensation, that is not objectionable. What is objectionable is where
the clause has the predominant function “to deter breach in contradistinction to any
function it has by way of compensation”: para [189] of Fahim Imam-Sadeque v
BlueBay Asset Management (Services) Ltd [2012] EWHC 3511 (QB).
The test posed by UK courts to probe which side of the dichotomy a payment falls, is
to ask whether it is “commercially justified” eg. para [95] of Lancore Services Ltd v
Barclays Bank Plc [2008] EWHC 1246 (Ch).
[13.20] Steps for considering whether a clause is void as a penalty
The following steps have been suggested by Gordon J in para [15] of Paciocco v
Australia and New Zealand Banking Group Ltd [2014] FCA 35 as useful in
considering whether a clause is void as a penalty in law or in equity:
(1) Identify the terms and inherent circumstances of the contract,
judged at the time of the making of the contract: Dunlop at 86-87 and
AMEV-UDC Finance Limited v Austin (1986) 162 CLR 170; 60 ALJR
741; 68 ALR 185.
(2) Identify the event or transaction which gives rise to the imposition
of the stipulation: Dunlop at 86-87 and Andrews High Court at [12].
(3) Identify if the stipulation is payable on breach of a term of the
contract (a necessary element at law but not in equity). This
necessarily involves consideration of the substance of the term,
including whether the term is security for, and in terrorem of, the
satisfaction of the term.
8 (4) Identify if the stipulation, as a matter of substance, is collateral (or
accessory) to a primary stipulation in favour of one contracting party
and the collateral stipulation, upon failure of the primary stipulation,
imposes upon the other contracting party an additional detriment in the
nature of a security for, and in terrorem of, the satisfaction of the
primary stipulation.
(5) If the answer to either question 3 or 4 is yes, then further questions
arise (at law and in equity: see Andrews High Court at [77]) including:
5.1 Is the sum stipulated a genuine pre-estimate of damage?
5.2 Is the sum stipulated extravagant and unconscionable in amount in
comparison with the greatest loss that could conceivably be proved?
5.3 Is the stipulation payable on the occurrence of one or more or all
of several events of varying seriousness?
[13.30] The seminal case: Dunlop Pneumatic Tyre Co Ltd
Any modern discussion must begin with the seminal House of Lords decision, Dunlop
Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79; [1914] UKHL
11. At the outset, it ought to be stressed that the focus of the analysis in Dunlop was
on whether payment of a fixed sum upon breach, constituted a penalty and was thus
void. The genesis of the equitable jurisdiction to intervene is set out at [13.170] of my
looseleaf service .
The propositions which Dunlop is now associated with, are focussed on the payment
of fixed sums and whether they constitute a penalty. However, it is now established
that the doctrine of penalties extends to payments which are conditioned upon
termination for an “event of default” which is not a breach of contract but which is
within the domain of the party that commits or suffers the event, such as insolvency,
death, liquidation and the like: Integral Home Loans Pty Ltd v Interstar Wholesale
Finance Pty Ltd (2007) 2 BFRA 23; Aust ContractR 90-261; [2007] NSWSC 406 at
[27], [28] (approved of in Andrews High Court . That topic is explored in more detail
in Chapter 13, but I now turn to the facts in Dunlop.
The buyers of tyres from Dunlop agreed to pay £5 for each breach of their contract.
These were the halcyon days before legislation against retail price maintenance and
the contract required the buyers to sell at a particular price. They sold at below the
price agreed. Dunlop was paid its full purchase price and hence suffered no direct
loss. The clause was upheld as compensation for Dunlop's hard-to-prove indirect loss
caused by the price war this undercutting unleashed, causing Dunlop's other agents to
seek other suppliers.
This case has come to stand for various propositions that provide a useful benchmark
to analyse developments since then as follows:
• Though the parties to a contract who use the words “penalty” or “liquidated
9 damages” may prima facie be supposed to mean what they say, the expression
used is not conclusive. The court must find out whether the payment stipulated is
in truth a penalty or liquidated damages.
• 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 pre-estimate of
damages: citing Clydebank Engineering and Shipbuilding Company Limited v
Castaneda [1905] AC 6.
• The question whether a sum stipulated is a penalty or liquidated damages is a
question 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, not
as at the time of the breach: citing Public Works Commissioner v Hills [1906] AC
368.
• To assist this task of construction various tests have been suggested which, if
applicable to the case, may prove helpful or even conclusive.
These tests are:
• It will be a penalty if the sum stipulated is an extravagant and unconscionable
amount in comparison with the greatest loss that could conceivably be proved to
have followed from the breach.
• It will 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 that ought to have been paid.
• There is a presumption (but no more) that it is a 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”: per Lord Dunedin in Dunlop Pneumatic Tyre Co Ltd v New Garage &
Motor Co Ltd [1915] AC 79; [1914] UKHL 1 at 86-88, citing Lord Watson in
Lord Elphinstone v Monkland Iron and Coal Co (1886) 11 App Cas 332.
• 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 exactly the situation when it is probable
that pre-estimated damage was the true bargain between the parties.
The High Court in para [7] of Andrews v Australia and New Zealand Banking Group
Ltd (2012) 247 CLR 205; 86 ALJR 1002; [2012] HCA 30 clearly endorsed the
approach in Dunlop , holding:
The litigation in Dunlop , where in the one court, and in the same
proceeding, legal and equitable remedies were sought by the plaintiff
and the defendant raised the penalty doctrine in its defence, illustrates
the place of the penalty doctrine in a court where there is a unified
administration of law and equity but equitable doctrines retain their
identity.
In Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656; 80 ALJR 219; 222
10 ALR 306; [2005] HCA 71, the High Court declined to revisit the principles
articulated in Dunlop Pneumatic Tyres and re-stated the principle that, in order to
strike down non-monetary consideration as a penalty, it is necessary to establish an
extravagant and unconscionable difference or oppressive disproportion between the
value of what is transferred and the price to be received. The High Court observed at
[27]:
[T]he principles of law relating to penalties require only that the money stipulated to
be paid on breach or the property stipulated to be transferred on breach will produce
for the payee or transferee advantages significantly greater than the advantages which
would flow from a genuine pre-estimate of damage.
[13.110] Courts allow some latitude to the parties before finding there is disproportion,
especially where the parties have equal bargaining power
As the cases below show:
• The courts will allow some latitude to the parties in making a genuine preestimate and will not be too ready to find disproportion.
• A mere potential that the loss recoverable in a liquidated damages clause could
exceed the maximum loss recoverable at law is insufficient to qualify the clause as
penal.
• The line between that which is a genuine pre-estimate and a penalty is one of
degree.
In so holding, the High Court in AMEV-UDC Finance Ltd v Austin (1986) 162 CLR
170; 60 ALJR 741; 68 ALR 185 retreated from its earlier position in Forestry
Commission (NSW) v Stefanetto (1976) 133 CLR 507 in which it held that a clause
need not be extravagant or unconscionable to be a penalty. It was sufficient if it
merely exceeded the greatest possible loss which might flow from the breach.
The AMEV-UDC approach has been endorsed by the High Court in subsequent cases
such as Esanda Finance Corp Ltd v Plessnig (1989) 166 CLR 131, discussed more
fully at [13.770]; and applied in a case, discussed below at [13.120] relating to the
provision of abattoir services: para [54] of Cedar Meats (Aust) Pty Ltd v Five Star
Lamb Pty Ltd [2014] VSCA 32.
“In a case like this involving commercial organisations of apparently equal bargaining
power, courts should be prepared to allow a substantially larger degree of latitude
than would be appropriate in case of a contract of adhesion.” This sentiment is
traceable back at least as far as Alfred McAlpine Capital Projects Ltd v Tilebox Ltd
[2005] BLR 271 at [48.3].
In determining whether a clause is a genuine pre-estimate, the court will look at all
the circumstances. It is well to bear in mind the underlying policy consideration in
this area of the law, namely to balance one consequence of unqualified freedom of
contract in that the weaker parties may have less bargaining power: per Mason CJ and
Wilson J in AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170; 60 ALJR 741; 68
11 ALR 185.
The test in Australia would now appear to be one requiring a court to have regard to
“all the circumstances, including the nature of the subject matter of the agreement”
(see Esanda Finance Corp Ltd v Plessnig (1989) 166 CLR 131 at 153) in order to
determine, as a matter of degree, whether a clause provided for a disproportionate
penalty or was truly compensatory.
Factors relevant to proportionality include:
(a) the relationships between the parties at the time of the contract;
(b) the genesis of the clause and discussions relating to it;
(c) the bargaining position of the parties and whether they were each fully advised
and whether, in all the circumstances, the party now seeking to impeach the
clause, appreciated the likely imposition of a penalty upon breach, but
nevertheless agreed to the clause because of some perceived benefit;
(d) whether a penalty clause was imposed upon a party with less bargaining power
in the context of a contract of adhesion; and
(e) the degree of disproportion between the stipulated sum and the loss likely to be
suffered by the plaintiff, which is relevant to the oppressiveness of the term of
the defendant.
The court should not, however, be too ready to find the requisite
degree of disproportion less they impinge on the parties' freedom to
settle for themselves the rights and liabilities following a breach of
contract.
Points (a) to (d) emerge from Multiplex Constructions Pty Ltd v Abgarus Pty Ltd
(1992) 33 NSWLR 504 at 513. Point (e) was made in AMEV-UDC Finance Ltd v
Austin (1986) 162 CLR 170; 60 ALJR 741; 68 ALR 185 at 193-194 per Mason CJ
and Wilson J, citing Thorpe v Capper (unreported, Supreme Court of Western
Australia, 2 October 1998) per Sanderson J.
[13.120] Further and or additional accommodation / alternative mode of performance
The High Court in Andrews identified an “operative distinction” between a stipulation
attracting the penalty doctrine with one giving rise consensually to an additional
obligation. In doing so, the HC considered what had been said by the New South
Wales Court of Appeal in Metro-Goldwyn-Mayer Pty Ltd v Greenham [1966] 2
NSWR 717 at 723-724 and 727.
As pointed out in Andrews High Court at [80], that operative distinction had been
earlier identified by Lord St Leonards in French v Macale (1842) 2 Drury and Warren
269 at 275-276:
[I]t appears, that the question for the Court to ascertain is, whether the
12 party is restricted by covenant from doing the particular act, although
if he do it a payment is reserved; or whether according to the true
construction of the contract, its meaning is, that the one party shall
have a right to do the act, on payment of what is agreed upon as an
equivalent. If a man let meadow land for two guineas an acre, and the
contract is, that if the tenant choose to employ it in tillage, he may do
so, paying an additional rent of two guineas an acre, no doubt this is a
perfectly good and unobjectionable contract; the breaking up the land
is not inconsistent with the contract, which provides, that in case the
act is done the landlord is to receive an increased rent.
In Metro-Goldwyn-Mayer, the contract for the hiring of films to exhibitors for public
showing entitled one screening only. The exhibitor had to pay four times the original
fee for each additional screening. Jacobs JA concluded at [723]:
There is no right in the exhibitor to use the film otherwise than on an
authorised occasion. If he does so then he must be taken to have
exercised an option so to do under the agreement, if the agreement so
provides. The agreement provides that he may exercise such an option
in one event only, namely, that he pay a hiring fee of four times the
usual hiring fee.
Thus, the penalty doctrine did not extend to the contract in issue.
As Gordon J observed in Paciocco at para [36]:
Neither Metro-Goldwyn-Mayer nor Macale has been since cited or
considered elsewhere.
[13.210] Claiming damages in the alternative
The practice prior to Andrews High Court was that where a clause was struck down as
a penalty, the plaintiff could claim damages for breach: Scandinavian Trading Tanker
Co AB v Floater Petrolera Ecuatoriana [1983] 2 AC 694; Turner v Superannuation
& Mutual Savings Ltd [1987] 1 NZLR 218; AMEV-UDC Finance Ltd v Austin (1986)
162 CLR 170; 60 ALJR 741; 68 ALR 185.
The procedure was to plead in the alternative for damages at common law.1
A party may elect to disregard the clause and sue for damages at common law.
Now that the High Court has spoken in Andrews, perhaps the procedure will no longer
be to claim damages in the alternative, but rather to claim $X as liquidated damages
alternatively such amount as compensation or damages that the court deems just.
13 [13.1215] Late payment fees on consumer credit cards
Late payment fees on consumer credit cards may constitute penalties: Paciocco v
Australia and New Zealand Banking Group Ltd [2014] FCA 35 per Gordon J. In that
case, HH first summarised the wider framework of established principles concerning
the relationship of banks and their customers, in which one must examine the
particular contractual provisions in any given case. What follows is an edited, but
otherwise verbatim extract from Paciocco at para [93] (the editing comprising mainly
of the excision of multiple authorities cited).
“The relationship between a banker and a customer is in contract. Such contracts have
been described as:
... ordinary commercial contracts to be construed and applied
according to their terms, and in accordance with a ‘basic principle of
the common law of contract ... that parties to a contract are free to
determine for themselves what primary obligations they will accept.
Unsurprisingly, the contractual terms are important; it is a contract usually with many
terms ...but from which the following core banking law principles derive:
(i) A savings or deposit account is in law a loan to the banker.
(ii) The bank borrows the money and proceeds from the customer and undertakes to
repay them on demand. The bank’s undertaking includes a promise to pay any
part of the amount due against the written order of the customer addressed to the
branch of the bank where the account is kept: Joachimson at [127]. Conversely,
the bank will not pay any part of the amount due to the customer without such an
order or some other compulsion or entitlement recognised by law;
(iii) The issue of a cheque by a customer, or the giving of a payment instruction or
withdrawal request to its bank, which would have the effect of overdrawing a
customer’s account, is construed as a request by the customer for an advance or
loan from the bank, and the bank has a discretion to approve or disapprove the
loan:
(iv) A written order by a customer which requires the bank to pay a greater amount
than the balance standing to the credit of the customer may be declined. There is
no obligation on the bank to pay a cheque unless there is a sufficient balance in
the account to pay the entire amount or unless overdraft arrangements have been
made which are adequate to cover the amount of the cheque:
(v) If a customer with no express overdraft facility draws a cheque which causes his
account to go into overdraft, the customer, by necessary implication, requests the
bank to grant an overdraft on its usual terms as to interest and other charges.”
In Paciocco , the ANZ’s Conditions of Use stated that “[t]he account holder must
make the ‘Minimum Monthly Payment’ shown on each statement of account by the
‘DUE DATE’ shown on that statement of account” and also “A fee of $35 will be
charged to your credit card account if [the amount] shown on the statement of account
is not paid within 28 days of the end of the ‘Statement Period’”.
14 A minimum monthly payment was missed.
Gordon J held at paras [114] ff:
A plain reading of the contractual documents and the applicable
Exception Fee Provisions leads to the conclusion that the Late
Payment Fee was payable upon breach by the customer of his
contractual obligation to make payment by a stated date: see [53]-[57]
above. Contrary to the submission of ANZ, the stipulation was not a
fee payable upon a further period of credit necessarily extended by the
bank to the customer because of the absence of timely payment...
Alternatively, held HH, even if not payable on breach, it was a collateral stipulation
and
At law and in equity, the collateral stipulation was, as a matter of
substance, to be viewed as security for, or in terrrorem of, the
satisfaction of the primary stipulation.
As to disproportion, HH held at paras [119] ff:
“The same fee was payable regardless of whether the customer was one day or one
week late (or longer), and regardless of whether the amount overdue was $0.01
(trifling), $100, $1,000 or even some larger amount: see [56]-[57] above. That fact
alone engaged the third rule of construction in Dunlop that there is a presumption (but
no more) that the stipulation is a penalty. Why? Because there was “a single lump
sum ... 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”: see [18(4)(c)] above. As a result, there necessarily was a degree of
disproportion between the stipulated sum and the loss likely to have been suffered by
ANZ...
That degree of disproportion cannot be considered in isolation. Other contractual
terms must be considered. In particular, it must be recalled that, in addition to the late
payment fee, the same contractual documents entitled ANZ, amongst other things, to
charge (which it did) annual interest of 12.24% on the specific outstanding amount...”
HH opined that a factor which militated in favour of the fee being a penalty was that
that the terms were imposed unilaterally by ANZ-there was no opportunity for the
customer to bargain about these matters.
Further, ANZ could produce no evidence that $35 was a genuine pre estimate of
damages, which had to be determined objectively: paras [124] to [126].
The question on this score in Paciocco devolved to this: having determined that the
$35 Late Payment Fees was prima facie a penalty at law and in equity and given that
ANZ admitted that the Late Payment Fee was not a genuine pre-estimate of damage,
to what extent (if any) did the $35 exceed the maximum loss which ANZ could
sustain in the event of late payment?
There was competing expert evidence on this point, with the Court preferring that of
15 the Paciocco interests: paras [131] ff, with HH concluding as follows at para [173]:
The circumstances do not permit the loss to be assessed with certainty:
see [46]-[47] above. The calculation or estimation of loss is difficult. It
is therefore necessary to estimate the value of the loss. I accept that
some guesswork and speculation is necessary and appropriate. Having
regard to the evidence before the Court, I am satisfied on the balance
of probabilities that ANZ suffered some loss or damage by reason of
the Late Payment Exception Fee Event and that the quantum of that
loss or damage is no more than $3. On any view, it is considerably less
than $35. I assess the loss or damage at $3. The loss or damage of $3 is
comprised of the operational (collections) costs identified by Mr Regan
rounded up to the nearest half dollar.
[13.1220] Bankerʼs honour fees and over limit fees
Terms in the contract between customer and banker that allow the bank to charge fees
if an account is overdrawn and the bank, in its discretion, approves a withdrawal eg
from an ATM or by cheque, does not necessarily constitute a penalty. Such a fee is
not payable upon a breach-it is in substance a fee for approving a loan application.
Nor is it a fee as security for a collateral stipulation: Paciocco paras [188] ff.
[13.1225] Fees for exceeding shadow limits
A shadow limit is a limit set automatically by a bank’s computer software, having
regard to factors such as a client’s historic repayment profile. When a client
overdraws their account, this is treated as a request for a loan, which is either accepted
or rejected –automatically-and if accepted, a bank fee is charged. Gordon J in
Paciocco did not consider this to be a penalty: paras [203] ff. However, as always, it
all depends on the construction of the relevant clause.
[13.1840] Obligation to reconvey land
An obligation to reconvey land the vendor could constitute a penalty. The situation in
Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656; 80 ALTR 219; 222
ALR 306; [2005] HCA 71 was as follows:
Ringrow had entered into a contract and certain related transactions including an
Option Deed and a Branded Privately Owned Sites Agreement (“POSA”) with the
respondent, British Petroleum (“BP”), to buy a service station known as BP Lansvale.
At various times during 2002, Ringrow breached the POSA by purchasing fuel from a
supplier other than BP which gave Ringrow notices of breach followed by a notice of
termination of contract.
Further, BP also gave a notice of intention to exercise its irrevocable right under the
Option Deed to buy Lansvale back and relied upon cl SC1.3 for the payment of
16 liquidated damages. Ringrow claimed in its appeal to the High Court that the option to
purchase was void and unenforceable as a penalty. Ringrow relied upon cl SC1.2,
which provided that once BP had exercised its right to acquire Lansvale then
liquidated damages would not be repayable; and that if BP relied on its right to
liquidated damages before it relied on its right to exercise the option, then it would be
securing a double remedy for the same breach. The court noted that Ringrow had paid
BP for goodwill on buying Lansvale but would not be paid for goodwill for
retransferring it once the option was exercised. Consequently, a suspicion may arise
that what was retransferred might be worth more than the price to be paid for it: at
[21]. However, the court stated that a mere suspicion in the present case was
insufficient and the comparison between the price to be paid and the value of what
was transferred calls for something oppressive or extravagant and unconscionable.
The point to note about Ringrow's case is that the High Court endorsed the
proposition that merely because a sum was out of proportion to the highest loss that
might possibly be suffered, that did not of itself render it a penalty: before the sum
might be categorised as a penalty, it had to be so out of proportion, that it could be
rightly seen as extravagant.
[13.1920] Contracts for services and the doctrine of penalties
The doctrine of penalties has been held applicable in a contract for commercial
services: Cedar Meats (Aust) Pty Ltd v Five Star Lamb Pty Ltd [2014] VSCA 32 (7
March 2014).
Five Star Lamb Pty Ltd (“FSL”) entered into an agreement with Cedar Meats (“CM”)
for CM to process and pack lamb, supplied by FSL, so that FSL could sell same, ie
CM was to provide abattoir services. The determinative point upon the appeal was
whether a particular clause constituted a penalty. The case is significant in that it is
post Andrews High Court and thus applies a more expansive view of what constitutes
a penalty, than one premised only upon a breach of contract.
Clause 7 of their agreement called for FSL to supply a minimum quantity of lamb kill
to CM for processing, and if FSL failed to supply the minimum amount, a formula
then specified the amount to be paid to CM. The Full Court held as follows at para
[43]:
... Prior to Andrews, it was generally considered to be the law that a
provision of the kind in question was incapable of being a penalty
unless it secured the performance of a contractual obligation.[39]
Andrews re-established that such a provision may still be regarded as
penal if it secures a primary stipulation even though the stipulation
does not import a contractual promise.[40] Accordingly, where it is
sought to secure the performance of a condition and, instead of
exacting a promise from the obligor to perform the condition, the
obligee exacts a promise from the obligor to pay a sum of money (or
perhaps to convey property) if the condition not be performed, the
promise is properly to be viewed as a security for the satisfaction of the
condition and so, therefore, if the sum of money (or conveyance) is
17 excessive and unconscionable, may now be treated as penal.[41]
The Court accepted FSL’s submission that, since the Agreement provided for
payments on a per head of sheep processed basis rather than on the basis of an annual
fee regardless of the number of sheep processed, it followed that the Agreement
imposed an implied obligation on FSL to deliver the agreed daily quantities to CM for
it to process. It was held that the obligation to pay as per the formula was security for
the performance of the primary obligation to deliver minimum quantities, and the
amount to be paid was extravagant and unconscionable in comparison with the
greatest loss that conceivably could be proved by CM.
It then followed that the requirement to pay as per the formula was a penalty if there
was gross disproportion in the sense discussed by the authorities. On the facts, it was
held there was gross disproportion.