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Should the penalty fit the crime?

Enforcing Liquidated Damages and Time Bars in Building Contracts

Danny Arraj, Managing Partner & Veno Panicker, Partner Blackstone Waterhouse Lawyers

Impact

The recent decision of the High Court in Paciocco v ANZ1 held that late payment fees charged by a bank on a consumer credit card were not unenforceable as a ‘penalty’– nor did such fees contravene statutory prohibitions against unconscionable conduct, unjust transactions and unfair contract terms.

So what does a case about late payment fees on a credit card have to do with construction contracts?

It turns out, quite a lot!

The decision means that it will be much harder for parties to argue that a clause is unenforceable as a ‘penalty’.  This will provide greater certainty for construction contracts including provisions relating to liquidated damages and time bars.

What is Penalty

It is common for commercial agreements to include liquidated damages triggered by a breach of one party under an agreement (for example for delay in completing a project) as a way of ensuring certainty as to the recoverable amount.

Similarly, it is common for those agreements to contain time bar stipulations (to manage variations, extensions of time etc).  The purpose of such clauses is to ensure if there is a change or delay, a head contractor or developer has control over how any additional costs or options are managed.

Historically, the test for whether such clauses were enforceable were based on whether the clause provided ‘a genuine pre-estimate of the damage suffered by a breach’.

For example:

  • if the rate of liquidated damages was ‘out of all proportion’ to that measure, the clause was held to be ‘penal’ and as a result deemed void; and
  • if a notice for a Variation required within 5 days was, for example, a day late, the argument might be that such a clause could constitute a penalty.

The latter of these arguments was always a difficult position to try and argue.

Prior to this case, the often cited test was established in Dunlop – a clause could be penal 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;
  • 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; and
  • there is a presumption that the sum 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.

The key was that weight was given to whether the breach could cause damage which was comparable to the amount of liquidated damages prescribed in a contract.

The decision in Paciocco provides that a liquidated clause will be upheld even if its effect goes beyond the consequences of damages flowing from a breach of contract.  A Court will have regard to a party’s broader commercial interests and losses that may flow from non-compliance generally.  This is a significant narrowing of the scope of the penalties doctrine.

Way Forward

The Courts will be reluctant to interfere with clauses providing for liquidated damages. Similarly, strict time bar provisions will have greater certainty – as the same principles.

This decision followed other High Court2 and Supreme Court3 decisions relating to the circumstances in which a clause will be deemed unenforceable as a penalty.

A clause will be enforceable even if out of all proportion to the damages suffered by a breach of a clause – except in the most extreme of circumstances, for example where there is a disparity of bargaining power. For parties in major construction projects, this means avenues to argue a clause is void as penal will be very limited – as a Court will permit evidence if such clauses are challenged to justify the amount of agreed damages or rationale for a time bar.

For developers, this decision is a welcomed assurance that the Court will take all steps to give effect to a party’s bargain rather than try and deem a clause void as a penalty – if a consumer has difficulty arguing this point against a multi-national bank, parties with equal bargaining power, assisted by lawyers, will have almost no scope to try and argue a clause is penal in a major project agreement.

The Courts in Australia are extremely cautious about invoking the penalty doctrine in a commercial deal between commercial (and even non-commercial) parties particularly where these contracts are rigorously negotiated between parties. For builders, this Paciocco decision is an important reminder that you get what you bargained for, so if you think that a liquidated damages or time bar clause is overly strict or excessive, be sure to negotiate it before signing on the dotted line or you may be held to the terms of the contract.

The penalty need not fit the crime – damages flowing from a breach of contract are not the only criteria when considering whether a provision is penal. The Court will have regard to the wider impact on a business, including operational costs, capital costs or running costs of a business. It does not matter if these sums would not have been recoverable in an action for damages for breach of contract.

1  Paciocco v Australia and New Zealand Banking Group Limited [2016] HCA 28

2  Andrews v Australia and New Zealand Banking Group Limited (2012) 247 CLR 205

3  Grocon Constructors Pty Ltd v Juniper Developer No. 2 Pty Ltd [2015] QSC 102

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