Danaghers
Commercial and Corporate Lawyers
15 October 2014
e
Our ref: 14WBH3-Activ
Damages and Penalty Clauses
Danaghers
Your ref: CHM:SJH:43803
Katja Levy and Dermot Danagher*
Rockwell Olivier
Commercial and Corporate Lawyers
Lawyers
Level 8 Wesfarmers
House
In light of the
decision in Andrews v Australia and New Zealand Banking Group Ltd
40 The Esplanade
By email
to shagdorn@ro.com.au
(2012) 247 CLR 205, the approach
to theonly
construction
of terms in agreements where
PERTH WA 6000
CMeighan@ro.com.au
it is asserted the penalties doctrine is applicable and recent developments in England
and Wales of a more flexible approach to construing commercial contracts, it is
WITHOUT PREJUDICE SAVE AS TO COSTS
argued
that
theand
adoption
the commercial justification test as applied in England
Commercial
Corporateof
Lawyers
and Wales may provide a useful tool in the proper construction of commercial
agreements
in the Australian context.
Attention:
Carolyn Meighan
Danaghers
derline
Danaghers
Introduction
Dear Ms Meighan,
Commercial
and Corporate
Lawyers
Activ Foundation
ats WBHO-Carr
District
Court CIV No 3579 of 2012
On 6 February 2014, the Financial Review head-lined:
We refer to your letter dated 14 October 2014, in response to our letter and offer of
settlement dated 7 October 2014.
“English precedents put penalty on ANZ”
Having regard to the decision in Miller v Evans [2010] WASC 127 which you referred
us to, we consider that our letter of offer of settlement does fall within the principles in
Calderbank
But,
did it? v Calderbank.
Perhaps you would be so kind as to direct our attention to the specific aspects of the
judgement in Miller v Evans that you are referring to and explain to us why it is you
1
The
report
from
the Federal
Court decision
say our
offerarose
does not
fall within
the Calderbank
principles.in Paciocco v ANZ where Gordon J ruled
Yours
sincerely
that
certain
late credit card payment fees charged by the ANZ were unenforceable as
penalties. The decision was the final step in a dispute which commenced in 2011 when
38,000 customers of the ANZ bank (in representative proceedings) commenced an action in
Dermot Danagher
the Victorian District Registry of the Federal Court, seeking declarations that certain fees
Danaghers Commercial and Corporate Lawyers
charged in respect of their accounts were void or unenforceable as penalties.2
The claim was decided at first instance by Gordon J who applied the law as stated in Dunlop
Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd,3 affirmed in Ringrow Pty Ltd v BP
Australia Pty Ltd4 and applied by Allsop P in Interstar Wholesale Finance Pty Ltd v Integral
Home Loans Pty Ltd.5 Her Honour rejected the proposition that equitable jurisdiction did not
Dermot Danagher
Office location
PO Box 5769,
Level 20, Allendale Square
66 St Georges Tce
Tel: +61 8 6208 8833
77 St Georges Terrace
PERTH WA 6831
* Katja
Francis
Burt WA
Chambers,
Perth.admin@danaghers.com.au
Dermot Danagher, Solicitor Director,
Mob:
+61 Levy,
410 257Barrister,
854
PERTH
6000
dermot.danagher@danaghers.com.au
Danaghers
Commercial and Corporate
Lawyers,
Perth.www.danaghers.com.au
A summary of the argument set out in
Tel: +61 8 6208
8838
this
paper was presented at Legalwise, Contracts Conference: Developments, Clauses and Disputes
An incorporated Legal Practice - Danaghers Pty Ltd (ACN 166 214 339)
Seminar on 28 March 2014
1
[2014] FCA 35, per Gordon J.
Andrews v Australia and New Zealand Banking Group Ltd (2011) 288 ALR 611.
3
[1915] AC 79.
4
(2005) 224 CLR 656.
5
(2008) 257 ALR 292.
2
1
continue to play a role in providing relief against penalties, contrary to the finding of Allsop P
in Interstar6. She further held that the doctrine applied only to breaches of contract.7
The decision was appealed to the full court of the Federal Court and in an unusual step
several grounds of appeal were removed directly to the High Court. The resulting, High
Court decision in Andrews v ANZ Banking Group Ltd8 referred the case back to Gordon J
having clarified that breach of contract is not an essential element for relief against penalties
and confirmed that the penalty doctrine in equity has not been subsumed into the common
law.
The Penalties Doctrine - The Dunlop decision
Much of the law relating to penalties was settled by the time Lord Dunedin stated the
principles and guidelines in the decision in Dunlop Pneumatic Tyre Co Ltd v New Garage &
Motor Co Ltd.9 His Lordship distilled the test into four ‘rules’:
1.
While the words used (penalty or liquidated damages) may prima facie be supposed
to mean what they say, the task of the court is to determine whether the provision is
in truth a penalty or liquidated damages clause.
2.
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 covenanted preestimate of damage.
3.
The question whether a sum stipulated is penalty or liquidated damages is a question
of construction to be decided upon the terms and inherent circumstances of each
particular contract, judged of as at the time of the making of the contract, not as at
the time of the breach.
6
Andrews v Australia and New Zealand Banking Group Ltd (2011) 288 ALR 611 at [4].
Supra at [4] and [61].
8
(2012) 247 CLR 205.
9
[1915] AC 79 at 86 to 88.
7
2
4.
To assist this task of construction various tests have been suggested, which if
applicable to the case under consideration may prove helpful, or even conclusive.
Such are:
(a)
it will be held to be a penalty if the sum stipulated for is extravagant and
unconscionable in amount in comparison with the greatest loss that could
conceivably be proved to have followed from the breach;
(b)
it will be held to 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 which ought to
have been paid;
(c)
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; and
(d)
the fact that it is almost impossible to make a precise pre-estimate of damage
does not prejudice the sum as being a genuine pre-estimate. Indeed, this is
the very situation where it is probable the parties intended it be a pre-estimate
at the time of their bargain.
The High Court in Andrews10 started with the Dunlop formulation and summarised that “a
penalty is in the nature of a punishment for non-observance of a contractual stipulation and
consists, upon breach, of the imposition of an additional or different liability.”11 The High
Court Justices set out the (additional) settled principles relating to the doctrine of penalties:
1.
Generally, a stipulation is prima facie a penalty if as a matter of substance, it is
collateral to a primary stipulation and this collateral stipulation, upon failure of the
10
11
Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 at 234 to 236.
Citing Legione v Hateley (1983) 152 CLR 406 at 445.
3
primary stipulation imposes an additional detriment to the benefit of the non-failing
party.12
2.
The primary stipulation need not be the payment of money.13
3.
If compensation can be made to the second party for the prejudice suffered by failure
of the primary obligation, the collateral obligation will be enforced only to the extent of
that compensation.14
4.
The penalty doctrine is not engaged if the damage to the second party by the failure
of the primary condition is not susceptible of evaluation and assessment in money
terms. It is the availability of compensation which generates the “equity” upon which
the court intervenes; without it, the parties are left to their legal rights and
obligations.15
The High Court16 also considered the passages relied upon by the Court of Appeal in
Interstar, which included five propositions distilled from the history of the penalty doctrine
and that were stated in AMEV-UDC:17
1.
equity will only relieve where compensation could be made for the actual damage
suffered by the party seeking to recover the penalty;
2.
the actual damage suffered by the party was assessed in an action at common law,
such as an action of covenant or upon a special issue quantum damnificatus which
could be joined in an action on the case;
12
Waterside Workers’ Federation of Australia v Stewart (1919) 27 CLR 119 at 128-129, 131; Acron
Pacific Ltd v Offshore Oil NL (1985) 157 CLR 514 at 520.
13
Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 at 217; citing
Jobson v Johnson [1989] 1 WLR 1026 at 1034/1035, 1039; 1 All ER 621 at 628, 632 where Dillon LJ
and Nicholls LJ explained that there is no distinction in principle between a stipulation upon default for
the transfer of property and a payment of money; such a distinction would elevate form over
substance; also referring to Forestry Commission (NSW) v Stefanetto (1976) 133 CLR 507 at 519-521
per Mason J, where the principle included “use of property” and not merely transfer of property.
14
Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 at 217.
15
Peachy v Duke of Somerset (1720) 1 Str 447; 93 ER 626; approved Andrews v Australia and New
Zealand Banking Group Ltd (2012) 247 CLR 205 at 217.
16
Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 at 233.
17
AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170, per Mason and Wilson JJ at 190.
4
3.
the expression ‘actual damage’ seems to have been used in contradistinction to
‘agreed sum’ or ‘liquidated’ or ‘stipulated’ damages, not by way of opposition to
damage which was recoverable at law;
4.
there seems to have been no instance of equity regarding [awarding] compensation
over and above the amount awarded as common law damages, other than cases in
which equity would not relieve against the penalty; and
5.
relief was granted in the case of penal bonds, where there was no express
contractual promise to perform the condition though it seems such a promise could in
many cases readily be implied.
The matters stated above have largely formed the applicable principles of the penalties
doctrine, as applied in Australia, since Dunlop [1915].18
Doctrine not limited to where there has been a breach of contract
The Court of Appeal in Interstar19 said that the doctrine of penalties is limited in so far as it
will only arise from the consequences of breach of contract and so reflects the public policy
of keeping commercial parties to their bargains.20
The High Court considered the first instance decision of Brereton J in Interstar and held that
he properly understood the significance of what had been said by Mason and Wilson JJ in
AMEV-UDC21 when he concluded:22
Their Honours’ judgement 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 the condition will be satisfied.
18
Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79.
Interstar Wholesale Finance Pty Ltd v Integral Home Loans Pty Ltd (2008) 257 ALR 292.
20
Interstar Wholesale Finance Pty Ltd v Integral Home Loans Pty Ltd (2008) 257 ALR 292 at 324;
relying on AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170, per Mason and Wilson JJ at 191
and Exports Credits Guarantee Department v Universal Oil Products Co (ECGD) [1983] 1 WLR 399 at
402-404.
21
AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170, per Mason and Wilson JJ at 190.
22
(2007) 2 BFRA 23 at 53-54; [2007] Aust Contract Reports ¶90-261 at 90,037.
19
5
The court reviewed the historical nature of the penal bond and the intervention of equity,
tracing the history and in particular the meaning and effect of the term ‘condition’ and how
that term came to be referable to breaches of contract. Their honours said that: 23
The essence of the distinction is that unlike a simple contract containing an exchange
of promises, which are classified as conditions or warranties, a bond is an instrument
under seal, usually a deed poll, whereby the obligor is bound to the obligee. The
purpose of the bond was, and still is, to secure performance of the condition, but
instead of attempting to secure this result by exacting a promise from the obligor to
perform the condition, there is an acknowledgement of indebtedness – in effect a
promise to pay a sum of money if the condition is not performed.
In early common law the bond, regarded as a penal sum, secured strict performance of the
principal obligation. However, the condition may be an occurrence or event which need not
be some act or omission of the obligor, analogous to a contractual promise by the obligor.24
Having considered the nature of the bond and the history of the penalties doctrine, the High
Court concluded that it does not follow that in a simple contract the only stipulations which
engage the penalty doctrine must be those which are contractual promises broken by the
promisor.25 In concluding their reasons the Justice held “the upshot is that the restrictions
upon the penalty doctrine urged by the Court of Appeal in Interstar should not be
accepted”.26
The penalty doctrine has not been subsumed into the common law
The Court of Appeal in Interstar also held that “the modern rule against penalties is a rule of
law, not equity”27 The basis for the finding was the statement of Mason and Wilson JJ in
AMEV-UDC:28
[that it was the effect of the Judicature system which led] to the conclusion that the
equitable jurisdiction to relieve against penalties withered on the vine for the simple
reason that, except perhaps in very unusual circumstances, it offered no prospect of
relief which was not ordinarily available in proceedings to recover a stipulated sum
or, alternatively, damages.
23
Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 at 223 – 224 and
th
citing Williston, A Treatise on the Law of Contracts 4 ed. (2000) §42:15
24
Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 at 225.
25
Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 at 227.
26
Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 at 236.
27
Interstar Wholesale Finance Pty Ltd v Integral Home Loans Pty Ltd (2008) 257 ALR 292 (NSWCA)
28
AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170 at 191.
6
However, the High Court overruled this aspect of the AMEV-UDC decision and stated that
the Court of Appeal in Interstar29:
...overlooks the proposition that the only relevant effect of the Judicature system was
upon the procedures in the unified court system not upon substantive doctrine.
Thereafter, in whatever court the action was brought in respect of a penalty, a money
remedy, declaratory and injunctive relief and the taking of an account were available
in that one action.
The court also had regard to the fact that in the Dunlop30 the litigation took place in 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. The conclusion being that Dunlop
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.31 In short, the High Court stated
that the penalty doctrine in equity has not been subsumed into the common law, but remains
as a purely equitable remedy.
Having dealt with the questions of principle relating to the equitable remedy arising from the
penalties doctrine and clarifying that a breach of contract is not required before the doctrine
is engaged, the High Court framed the questions for determination by the Federal Court
when considering the fees charged by ANZ such that:
(a)
are the fees enjoyed by ANZ as security for performance by the customer of
its other obligations to the ANZ (a penalty); or
(b)
are the fees charged by the ANZ as specified in pre-existing arrangements
with the customer, and ANZ respectively, for the further accommodation
provided to the customer by its authorizing payments upon instructions by the
customer upon which the ANZ otherwise was not obliged to act, or upon
refusal of that accommodation (payment upon the exercise of an additional,
permitted, contractual right).
Payment for additional accommodation
29
Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 at 234.
Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79 at 91-93.
31
Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 at 236.
30
7
The distinction between penalties and a fee for additional accommodation was identified
much earlier. In French v Macale:32
It appears, that the question for the Court to ascertain is, whether the 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 chose to employ it in tillage, he may do so, paying
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 [emphasis added].
The High Court cited the American text authored by John Norton Pomeroy where the
principle in relation to additional accommodation was summarised and explained as follows:
33
Such being the general test by which to determine the nature of a penalty, there are
certain kinds of stipulations not unfrequently (sic) inserted in agreements which have
been judicially interpreted and held not to be penalties, and therefore not subject to
be relieved against by courts of equity. The nature and effect of these stipulations I
shall briefly explian. The first instance is that of a contract by the terms of which the
contracting party so binds himself that he is entitled to perform either one of two
alternative stipulations, at his option; and if he elects to perform one of these
alternatives, he promises to pay a certain sum of money, but if he elects to perform
the other alternative, then he binds himself to pay a larger sum of money. To state
the substance of the agreement in briefer terms, the contracting party may do either
of two things, but is to pay higher for one alternative than for the other. In such a
case equity regards the stipulation for a larger payment, not as a penalty, but as
liquidated damages agreed upon by the parties. It will not relieve the contracting
party from the payment of the larger sum, upon his performance of the latter
alternative to which such payment is annexed; nor, on the other hand, will it deprive
him of his election by compelling him to abstain from performing which alternative he
may choose to adopt.
A number of case examples are referred to by Pomeroy, including French v Macale
(described above). Others include:
Parfit v Chambre,34 where arising out of a court of arbitrators decision the defendant
was ordered to pay to the plaintiff a life annuity of £1,200 and do so within 2 months.
If the annuity was not purchased by that time, in addition to the annuity, pay a further
sum of £100 on the last day of the second month, and a like sum of £100 on the last
day of each successive month, until the annuity is purchased. The defendant failed to
purchase the annuity within the 2 month period and argued that the £100 per month
32
French v Macale (1842) 2 Drury and Warren 269 at 275-276; see also to the same effect, Hardy v
Martin (1783) 1 Cox Eq Ca 26 at 27; 29 ER 1046 at 1046-1047.
33
th
Symons SW and Pomeroy JN, A Treatise on Equity Jurisprudence (5 ed, Bancroft-Whitney
Company, San Francisco 1941) Vol II, §437, pp 211-214.
34
(1872) LR 15 Eq 36 at 39-40
8
payment was a penalty. Bacon VC held that the arrangement was not a penalty
because the defendant could have relieved himself of the obligation to pay the higher
sum by securing the annuity.
Hardy v Martin35 where the plaintiff agreed to a restraint of trade for 19 years in an
agreement to sell his partnership interest in a brandy merchant business. As security
for the restraint he provided a bond of £600 as security. The defendant brought an
action on the bond and the plaintiff took an action seeking account of the defendant’s
actual damages and an order that upon payment of those damages the defendant be
retrained by injunction from recovering the amount of the bond. The question for the
court was whether it should relieve against the bond. Lord Loughborough found that
a penalty is never considered to be the price for doing what a man had expressly
agreed not to do and found in favour of the plaintiff.
Smith v Bergengren36 where the defendant covenanted not to practice medicine in a
certain town so long as the plaintiff was in practice there, provided that at any time
after 5 years upon paying $2,000 to the plaintiff, the defendant had a right to practice
in the town. It was held that the sum was neither liquidated damages nor a penalty
but was a price fixed for what the contract permitted the defendant to do.
The High Court concluded that there is an operative distinction between the two questions,
as exemplified in the case Metro-Goldwym-Mayer:37 The MGM case concerned a contract
which permitted an exhibitor to screen certain films. The effect of relevant terms of the
contract were summarised by Jacobs JA:38
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.
Jacobs JA found that upon a proper construction, the contract provided for an additional
hiring fee if the exhibitor chose to show the film more than once so as to discourage
additional showing. He concluded that the relevant clause did not deal with damages, but
rather was in truth an option fee.
Another more recent example is the decision in Ange v First East Auction Holdings Pty Ltd39
where a contract concerning the sale of certain paintings by auction provided for withdrawal
of the paintings from sale upon payment of a withdrawal fee. The withdrawal fee was large;
however the Victorian Court of Appeal found that it was not a penalty because first the
35
(1783-1796) 1 Cox 27.
(1891) 153 Mass 236 (United States).
37
Metro-Goldwyn-Mayer Pty Ltd v Greenham [1966] 2 NSWR 717 at 723-724, 727.
38
Metro-Goldwyn-Mayer Pty Ltd v Greenham [1966] 2 NSWR 717 at 723.
39
[2011] VSCA 335.
36
9
contract permitted withdrawal upon payment of the fee and secondly because the fee,
although large, was not so extravagant and unconscionable in comparison to the greatest
loss that could conceivably be proved to have flowed from the withdrawal of the paintings
from the auction, that it amounted to a penalty. 40
As a result of the High Court decision, Manly41 suggests that clauses previously thought to
operate so as to avoid the penalty rule such as take or pay clauses, provisions in hire
purchase agreements and chattel leases which deal with payments due upon termination;
clauses providing for discounts for punctual payment, and certain interest provision in
finance documents are now open to question as being penal in their operation and thereby
unenforceable.42
Davenport has suggest that the penalty doctrine could apply to time bars to litigation and
other similar conditions.43 Davenport refers to clauses that limit the amount of time a party
may have to give notice to a counterparty before suffering some form of detriment, which are
commonly referred to as “time bars”. In his hypothetical example a notice is given by a
contractor, one day late. In the example the contractor could be subject to liquidated
damages but the employer would suffer little or no loss and avoid making payment to the
contractor. Davenport argues that the effect of the time bar is in terrorem of performance by
the contractor within the specified time period and thus unenforceable as a penalty.44
Easton argues that any stipulation providing for loss of an entitlement – whether that be, for
example, payments withheld or extensions of time – may now be susceptible to relief against
penalties. 45
40
[2011] VSCA 335 at [125 to 135].
Manly, R. SC (2013) 41 ABLR 314 “Breach no longer necessary The High Court’s reconsideration
of the penalty doctrine” at page 335.
42
Dharmananda K. and Firios L. “Penalties Arising without Breach: The Australian Apogee of
Orthodoxy” (2013) LMCLQ 145.
43
Davenport P, Andrews v ANZ and Penalty Clauses, online supplement to Adjudication in the
rd
Construction Industry (3 ed, Federation Press, 2010) pp 1-3,
http://www.federationpress.com.au/pdf/Andrews%20v%20ANZ%20and%20penalty%20clauses.pdf.
44
Davenport P, Andrews v ANZ and Penalty Clauses, online supplement to Adjudication in the
rd
Construction Industry (3 ed, Federation Press, 2010) pp 4-5.
45
Easton, P. (2013) 29 BCL 233 “Penalties percolating through the construction industry: Andrews v
Australia and New Zealand Banking Group Ltd”, p244.
41
10
According to the commentators, the Andrews decision is likely to have wide ranging
ramifications for commercial transactions including in the financial services sector,
equipment finance industry, take-or-pay clauses in long term energy and resources contracts
as well as information technology, mining and services contracts, and in the building and
engineering sector, where liquidated damages clauses are frequently employed in both
standard form and bespoke agreements.46
Liquidated damages clauses
Liquidated damages clauses are used by contracting parties to provide certainty (thereby
lowering contract prices), to minimise litigation and the inclusion of idiosyncratic loss which
may not be compensated for at law. However, arguments are often raised that such clauses
are unenforceable as they impose a penalty.
The distinction between a penalty and a genuine pre-estimate of damage was stated by Lord
Dunedin in Dunlop47 and is set out above. The principle was applied by the High Court in
Ringrow.48
In the Dunlop49 case, Lord Atkinson summarised the evidence directed to showing that even
if the sum agreed was not a precise or accurate pre-estimation of damage, it nevertheless
protected the appellant’s interest in preventing loss to its business which would arise from a
failure of the condition in the contract to maintain prices, namely price undercutting and the
resultant impact to its trading system.50
Thus, as stated by the High Court in Andrews, the critical issue, was whether the sum
agreed was commensurate with the interest protected by the bargain.51
The High Court observed that the question that was before it (is the penalties doctrine
applicable in the case) is anterior to the question as to whether or not the clause was a pre-
46
Referred to and summarised by Manly, R. SC (2013) 41 ABLR 314 “Breach no longer necessary
The High Court’s reconsideration of the penalty doctrine” at page 315.
47
Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79 at 86-87.
48
Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656 at 662-663.
49
Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79.
50
Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79 at 91-93.
51
Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 at 236.
11
estimate of liquidated damages, namely that the dispute first required identification of those
criteria by which the penalty doctrine is engaged.52
The effect is that there must be a determination as to whether or not the provision falls within
the penalty doctrine, and if so, then secondly, a determination as to whether the collateral
obligation is a genuine pre-estimate of liquidated damages or is a penalty, and accordingly
unenforceable except to the extent of compensation for the prejudice suffered by failure of
the primary obligation.
Determining whether the provision is a penalty or fee for additional accommodation
The question of whether or not a provision of a contract is a penalty or a fee paid for an
additional, permitted contractual right, has been considered in the Australia and the courts of
England and Wales subsequent to the Dunlop decision. However, notwithstanding the
changes to the doctrine arising from its decision, the High Court in Andrews provided no
further guidance as to the limits of each principle and instead left the question open to further
trial.
The approach of the courts in England and Wales
In 2010 case of Azimut-Benetti Spa before the High Court of Justice53 a luxury yacht builder
based in Italy claimed summary judgement, under a contract entered into in 2008, which
provided for the construction and sale of a very expensive yacht, described in the evidence
as a “super-yacht”. The price of the super-yacht was €38 million payable in instalments and
the delivery date was November 2011. The contract included provisions to the following
effect:
The builder may suspend construction of the yacht and or terminate the contract (by
written notice) at any time if the buyer fails to pay any instalment within 45 days of
the due date.
Upon lawful termination of the contract, the builder may retain from the instalment
payments received an amount equal to 20% of the contract price by way of liquidated
damages as compensation for its estimated losses (including agreed loss of profit)
and otherwise return the balance of sums received to the buyer.
52
53
Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 at 218.
Azimut-Benetti Spa v Healey [2010] EWHC 2234 (Comm).
12
Blair J commenced by stating that there is no dispute that the applicable law is “the classic
definition of a penalty clause [which] appears in the speech of Lord Dunedin in Dunlop:54
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 covenanted preestimate of damage...the question whether a sum stipulated is penalty or liquidated
damages is a question of construction to be decided upon the terms and inherent
circumstances of each particular contract...it will be held to be penalty if the sum
stipulated for is extravagant and unconscionable in amount in comparison with the
greatest loss that could conceivably be proved to have followed from the breach.
His honour, also noted that the test was more recently explained in Lordsvale Finance by
Colman J55:
Whether a provision is to be treated as a penalty is a matter of construction to be
resolved by asking whether at the time the contract was entered into the predominant
contractual function of the provision was to deter a party from breaking the contract
or to compensate the innocent party for breach. That the contractual function is
deterrent rather than compensatory can be deduced by comparing the amount that
would be payable on breach with the loss that might be sustained if breach occurred.
Having regard to these principles, his honour determined that the purpose of the clause was
to strike, or seek to strike, a balance between the interests of the parties should the builder
lawfully terminate upon the buyer’s breach.56 He referred to the decision of Mance LJ in
Lordsvale57 and held that there are clauses which may operate on breach, but which fall into
neither category (of genuine pre-estimate of damage or penalty) and they may be perfectly
justifiable. As Clarke LJ put it in Murray v Leisureplay,58 a particular clause may be
commercially justifiable, provided that its dominant purpose is not to deter the other party
from breach.
In coming to his conclusion that the clause was enforceable and the claimant was entitled to
summary judgement in the amount of €7.1 million (20% of the contract price), his Honour
adopted the “commercial justification” test referred to in Murray v Leisureplay (above) and
had regard to the inherent circumstances at the time of the making of the contract.59
54
Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79 at 86-87.
Lordsvale Finance Plc v Bank of Zambia [1996] QB 752 at 762.
56
Azimut-Benetti Spa v Healey [2010] EWHC 2234 (Comm) at [26].
57
Lordsvale Finance Plc v Bank of Zambia [1996] QB 752; cited with approval in Cine Bes Filmcilik
Ve Yapimcilik v United International Pictures [2003] EWCA Civ 1669 at [15]
58
[2005] EWCA Civ 963 at [106].
59
Azimut-Benetti Spa v Healey [2010] EWHC 2234 (Comm) at [4] and [29]; adopting Lord Dunedin
55
13
The basis for test appears from the speech of Lord Dunedin in the Dunlop case as cited by
Arden LJ in Murray v Leisureplay60:
Lord Dunedin in the Dunlop case makes the point that, although the issue is one of
construction, the court is not confined to the terms of the agreement and may look at
the “inherent circumstances of each particular contract, judged of as at the time of
the making of the contract, not at the time of breach...” (at 87). In my judgement, the
inherent circumstances to which the court may have regard extend beyond those
which may be adduced in evidence for the purposes of determining the true
interpretation of the agreement under the well known test in the Investors’
Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896.
But the purpose of adducing that evidence is not so that the parties can demonstrate
that they agreed to opt out of the remedies regime provided by the common law but
rather that the reasons that they had for doing so constitute adequate justification for
the discrepancy between the contractual measure of damages and that provided by
the common law.
The “well known test” referred to by Arden LJ is stated by Lord Hoffman and is, in
summary:61
(a)
“Interpretation is the ascertainment of the meaning which the document would
convey to a reasonable person having all the background knowledge which
would reasonably have been available to the parties in the situation in which
they were at the time of the contract”62;
(b)
The “matrix of facts” includes anything which would have affected the way in
which the language of the document would have been understood by a
reasonable man, provided that it is something reasonably available to the
parties;
(c)
Excluded from the admissible background are the previous negotiations of the
parties;
(d)
The meaning which the document would convey to a reasonable man is not
the same things as the meaning of its words; and
60
[2005] EWCA Civ 963 at [106].
the Investors’ Compensation Scheme Ltd v West Bromwich Building Society [1998] 1 WLR 896, per
Hoffman L
62
In BMA Special Opportunity Hub Fund Ltd and Ors v African Minerals Finance Ltd [2013] EWCA
Civ 416, Lord Justice Aikens phrased test as “the court’s job is to discern the intention of the parties,
objectively speaking, from the words used in the commercial document, in the relevant context and
against the factual background in which the document was created.
61
14
(e)
The rule that words should be given their natural and ordinary meaning
reflects the common sense proposition that we do not easily accept that
people have made linguistic mistakes in formal documents. However, if from
the background it is concluded that something must have gone wrong, the law
does not attribute to the parties an intention which they plainly could not have
had.
Relevant to the question of the ‘inherent circumstances”, Blair J had regard to the fact that
the contract was for the construction and sale of a very expensive yacht, both parties had
the benefit of expert representation in the conclusion of the contract, the terms, including the
liquidated damages clause, were freely entered into and the clause had a clear commercial
and compensatory justification for both parties (compensation for the builder and return of
balance of the purchase price for the buyer). 63
Similarly in Rainy Sky SA v Kookmin Bank64 Lord Clarke referred with approval to Investors’
Compensation Scheme Ltd v West Bromwich Building Society and said that “where a term of
a contract is open to more than one interpretation, it is generally appropriate to adopt the
interpretation which is most consistent with business common sense.”65
More recently, in E-Nik Ltd66 Mr Justice Burton considered a provision of a technology
consultancy services agreement under which the consultant claimed payment for a certain
specified minimum number of days services, notwithstanding that the project requirements of
the defendant required only half that amount. The defendant claimed that the provision was
an unenforceable penalty. His honour applied the “commercial justification” test and had
regard to the fact that the provision was commercially justifiable, it did not amount to
oppression, the contract was negotiated and freely entered into between parties of
comparable bargaining power and did not amount to a provision in terrorem.67
63
Azimut-Benetti Spa v Healey [2010] EWHC 2234 (Comm) at [29].
[2011] UKSC 50.
65
Rainy Sky SA v Kookmin Bank [2011] 1 WLR 2900 at [2911]
66
E-Nik Ltd v Department for Communities and Local Government [2012] EWHC 3027.
67
E-Nik Ltd v Department for Communities and Local Government [2012] EWHC 3027 at [25].
64
15
In relation to the application of “commercial common sense”, Lord Justice Aikens, cautioned
“first, that commercial common sense is not to be elevated to an overriding criterion of
construction, and secondly, that the parties should not be subjected to the individual judge’s
own notions of what might have been the sensible solution to the parties conundrum. I would
add, still less should the issue of construction be determined by what seems like
“commercial commonsense” from the point of view of one of the parties to the contract”.68
Commercial justification in Australia?
Manly, R. SC in his paper “Breach no longer necessary The High Court’s reconsideration of
the penalty doctrine”69, considered the decision of Mr Justice Blair in Azimut-Benetti Spa and
concluded that the decision:
Demonstrates that English courts are increasingly willing to adopt a far more flexible
approach toward the interpretation of liquidated damages clauses in commercial
contracts rather than adhering strictly to the classic Dunlop dichotomy of genuine
pre-estimate of loss versus penalty. Australian courts have not followed this
approach.
It is certainly clear enough that Australian courts have not adopted the “commercial
justification” test and that may well be understandable given the High Court’s comment in
Andrews that the pattern of remedial legislation suggests the need for caution when dealing
with the unwritten law as if laissez faire notions of an untrammelled “freedom of contract”
provide a universal legal value.70 And further, the High Court’s comments in Jireh71 in
response to the submission that it is not essential to identify ambiguity in the language of the
contract before the court may have regard to the surrounding circumstances and object of
the transaction. In Jireh their honours said:72
Acceptance of the applicant’s submission, clearly would require reconsideration by
the Court of what was said in Codelfa Construction Pty Ltd v State Rail Authority of
NSW (1982) 149 CLR 337 at 352 by Mason J, with the concurrence of Stephen J and
Wilson J, to be the “true rule” as to the admission of evidence of surrounding
circumstances. Until this Court embarks upon that exercise and disapproves or
68
BMA Special Opportunity Hub Fund Ltd and Ors v African Minerals Finance Ltd [2013] EWCA Civ
416 at [24].
69
Manly, R. SC (2013) 41 ABLR 314 “Breach no longer necessary The High Court’s reconsideration
of the penalty doctrine” at page 315
70
The court referred to Esso Australia Resources Ltd v Federal Commissioner of Taxation (1999) 201
CLR 49 at 60; Aid/Watch Inc v Federal Commissioner of Taxation (2010) 241 CLR 539 at 549.
71
Western Export Services Inc v Jireh International Pty Ltd [2011] HCA 45 (special leave refused).
72
Western Export Services Inc v Jireh International Pty Ltd [2011] HCA 45 at [3].
16
revises what was said in Codelfa, intermediate appellate courts are bound to follow
that precedent.
However, a close review of what was said in Codelfa does not appear to rule out the English
approach. The statement by Mason J, referred to above is as follows:73
The true rule is that evidence of surrounding circumstances is admissible to assist in
the interpretation of the contract if the language is ambiguous or susceptible of more
than one meaning. But it is not admissible to contradict the language of the contract
when it has a plain meaning. Generally speaking facts existing when the contract
was made will not be receivable as part of the surrounding circumstances as an aid
to construction, unless they were known to both parties, although, as we have seen,
if the facts are notorious knowledge of them will be presumed.
It is here that a difficulty arises with respect to the evidence of prior negotiations.
Obviously the prior negotiations will tend to establish objective background facts
which were now to both parties and the subject matter of the contract. To the extent
to which they have this tendency they are admissible. But in so far as they consist of
statements and actions of the parties which are reflective of their actual intentions
and expectations they are not receivable.
The ‘inherent circumstances’ to which Blair J74 and Burton J75 had regard do not appear to
infringe the ‘true rule’ stated by Mason J in Codelfa76. Such circumstances are objective
background facts that were known to both parties and did not consist of statements of
actions of the parties, reflective of their actual intentions.
Further support for inclusion of the ‘commercial justification’ rule may be drawn from the
High Court’s clarification that the penalties doctrine is a wholly equitable remedy. As
Balmford J stated in Kyriakou v Saba77:
it would be wholly erroneous to imagine that equitable partiality for intention over
form knows no bounds. There is no general equitable jurisdiction to construe
contracts so as to effectuate the actual intention of the parties if it is clear that the
parties agreed on the form of the contract.
In addition the statement of Lord Dunedin in Dunlop, provides a proper basis for the English
approach of having regard to the inherent circumstances at the time of making the contract
and consider whether the provision being questioned is commercially justifiable. His
73
Codelfa Construction Pty Ltd v State Rail Authority of NSW (1982) 149 CLR 337 at 352.
Azimut-Benetti Spa v Healey [2010] EWHC 2234 (Comm) at [29].
75
E-Nik Ltd v Department for Communities and Local Government [2012] EWHC 3027 at [25].
76
Codelfa Construction Pty Ltd v State Rail Authority of NSW (1982) 149 CLR 337 at 352.
77
[2000] VSC 318; at [23].
74
17
Lordship says, “the question of construction is to be decided upon the terms and the inherent
circumstances of each particular contract [emphasis added]”. 78
It remains the position, whatever approach to construction is adopted, that the enquiry is as
to what is the real nature of the transaction. 79
Conclusion
The decision in Andrews has in some respects reshaped the doctrine of penalties and
provides a useful summary of the previously settled aspects of the doctrine.
Clarification that there is no requirement that there be a breach of contract before the penalty
doctrine can be engaged is a significant development in the law of Australia, however, there
remains uncertainty as to when a clause will be held to be security for performance (a
penalty) or a payment for the further accommodation.
Determination of the question in each case will depend upon the application of general
principles of construction to give effect to the bargain made by the parties; determining the
meaning or legal effect of the contract as a whole (including any implied terms),80 and when
applying the penalties doctrine, having regard to equitable principles such as the
requirement that the legal form of the contractual arrangement is to be ignored in favour of
the actual substance of the agreement.81
Given the likely impact of the High Court’s decision on commercial dealings, described by
legal commentators (some of which are referred to in this paper), the adoption of the
commercial justification test as applied in England and Wales may provide a useful tool in
the proper construction of commercial agreements so as to give effect to the bargain made
by the parties and thereby provide a degree of certainty to the law in this area.
78
Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79 at 86-87.
Clydebank Engineering and Ship Building Co v Don Jose Rama Yzquierdo Y Castaneda [1905] AC
6 at 9; Esanda Finance Corporation v Plessnig (1989) 166 CLR 131 at 138.
80
Tramways Advertising Pty Ltd v Luna Park (NSW) Ltd (1938) 38 SR (NSW) 632 at 641; 55 WN
(NSW) 228 per Jordan CJ (reversed on other grounds Luna Park (NSW) Ltd v Tramways Advertising
Pty Ltd (1938) 61 CLR 286; 39 SR (NSW) 66; 12 ALJ 364.
81
Muschinski v Dodds (1985) 160 CLR 583 at 613; per Deane J.
79
18
In the meantime, from a drafting perspective, companies that impose break fees or late
payment fees should consider whether or not those fees are for the provision of further
services or otherwise represent a genuine pre-estimate of the prejudice suffered by the
company. In addition, it is suggested that including recitals in written agreements which sets
out the commercial justification for the inclusion of the relevant provisions by reference to the
inherent circumstances known to the parties to the agreement. While this is no guarantee
that the provisions will be enforceable,82 it will avoid the need for recourse to extrinsic facts
and provide a measure of certainty as to what was known by the parties at the time of entry
into the agreement, notwithstanding the passage of time.
Danaghers
Commercial and Corporate Lawyers
Dermot Danagher
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82
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The words are prima facie supposed to mean what they say, however the task of the court is to
WITHOUT
PREJUDICE
SAVE AS TO
COSTS
determine the true
effect
ofand
theCorporate
terms
of Lawyers
the agreement:
Dunlop
Pneumatic Tyre Co Ltd v New
Commercial
Garage & Motor Co Ltd [1915] AC 79 at 86-88.
Attention: Carolyn Meighan
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Danaghers
Dear Ms Meighan,
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ats WBHO-Carr
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