CONTRACT LAW FUNDAMENTALS SERIES

Roman Rozenberg, Lucy Davis, Sam Prendergast & Nicholas Gallina

Contract Law Fundamentals Series Roman Rozenberg, Lucy Davis, Sam Prendergast & Nicholas Gallina September / October 2015

PART 1: I AGREED TO DO WHAT?! Introduction “[F]or a number of reasons, some to do with the work of legislatures, some to do with judicial law making, and some to do with the temper and spirit of the times, we can no longer say that, in all but exceptional cases, the rights and liabilities of parties to a written contract can be discovered by reading the contract.” - the Hon. Mr. Justice AM Gleeson AC, ‘Individualised Justice – The Holy Grail’ (1995) 69 Australian Law Journal 421, 428. 1.

Despite the passing of some two decades, these sentiments remain true and relevant today. It is without a doubt that even when a bargain is neatly reduced to writing there are a number of ways in which the law fetters the express rights and obligations of the parties.

2.

Without being exhaustive, the purpose of this paper is to explore some of those areas of law, including: (a)

Terms implied by common law (Part A);

(b)

Terms implied by statute (Part B);

(c)

Illegal, void and unfair terms (Part C); and

(d)

The penalty doctrine (Part D).

1

Part A: Terms implied by common law 3.

Implied terms serve at least two purposes. First, they fill gaps in a contract by supplying the standards of performance that have been omitted or left incomplete by the parties. Second, implied terms add unstated obligations to the express terms of the contract.

4.

There are a number of grounds on which terms might be implied into a contract.

5.

One basis for the implication of terms comes from established patterns of conduct: courts imply terms into a contract from the custom of a particular industry or from an established course of dealing. Where there is no established pattern of conduct the analysis is more difficult. Courts have conventionally drawn a distinction1 between: a.

terms implied in fact – those implied to give effect to presumed or hypothetical intention of the contracting parties; and

b.

terms implied by law – those imposed on contracting parties without regard to their intention (unless excluded by the express terms of the contract).

Terms implied in fact 6.

It is important to highlight at the outset that Courts are slow to imply terms by fact, or on an ‘ad hoc’ basis, as the implication of terms by fact is otherwise called.2

7.

As emphasized by Mason J in Codelfa Construction Pty Ltd v State Rail Authority of NSW3, in many cases what the parties have actually agreed upon represents the totality of their willingness to agree; each may be prepared to take his chance in relation to an eventuality for which no provision is made. The more detailed and comprehensive the contract the less ground there is for supposing that the parties have failed to address their minds to the question at issue. And then there is the difficulty of identifying with any degree of certainty the term which the parties would have settled upon had they considered the question.

8.

Importantly, Australian Courts have been at pains to emphasise that it is not enough that it is reasonable to imply a term; it must be necessary to do so to give business efficacy to the contract.

1

Byrne v Australian Airlines Ltd (1995) 131 ALR 422. Renard Constructions (ME) Pty Ltd v Minister for Public Works (1992) 26 NSWLR 234 at 256. 3 (1982) 149 CLR 337 at 346. 2

2

9.

In deciding whether a term should be implied in fact into a written contract, Courts usually apply the five limb test established by the Privy Council in BP Refinery (BP Refinery)4, namely: a.

it must be reasonable and equitable;

b.

it must be necessary to give business efficacy to the contract, so that no term will be implied if the contract is effective without it;

10.

c.

it must be so obvious that 'it goes without saying';

d.

it must be capable of clear expression; and

e.

it must not contradict any express term of the contract.

BP Refinery5 sets a high standard for implying a term in fact – all five requirements must be satisfied – and clear necessity is required6 for the implication to be made.

11.

Whilst it is not the case that necessity can only be established by showing that without the term in question the contract cannot be carried out at all,7 the term sought to be implied must be needed in order to make the contract work, or conversely, in order to avoid an unworkable situation.8

12.

These requirements apply in the case of formal contracts but may be slightly less strict in cases where the parties have reached agreement but have not attempted to spell out the full terms of their contract, in which case a Court may imply a term “by reference to the imputed intention of the parties if, and only if, it can be seen that the implication of the particular term is necessary for the reasonable or effective operation of a contract of that nature in the circumstances of the case”.9

Terms implied in law 13.

The circumstances in which a term will be implied in law are less clear.

14.

The significance of implying a term ‘in law’ is that the implied term will attach as an incident to all contracts of a particular class.

4

BP Refinery (Western Port) Pty Ltd v Shire of Hastings (1977) 180 CLR 266. BP Refinery (Western Port) Pty Ltd v Shire of Hastings (1977) 180 CLR 266. 6 Codelfa Construction Pty ltd v State Rail Authority of NSW (1982) 149 CLR 337 at 346. 7 Renard Constructions (ME) Pty Ltd v Minister for Public Works (1992) 26 NSWLR 234 at 257-258. 8 BP Refinery (Western Port) Pty Ltd v Shire of Hastings (1977) 180 CLR 266. 9 Byrne v Australian Airlines Ltd (1995) 185 CLR 411. 5

3

15.

For example: a.

a duty of reasonable care is implied in all contracts for the provision of professional services;10

b.

it is an implied term in a contract for work and materials that reasonable care and skill will be exercised;11

c.

mutual obligations of reasonable care apply between employer and employee12 - but the High Court recently denied the existence of an implied term of mutual trust and confidence in all employment contracts;13 and

d.

in the context of a contract of bailment, there are implied terms that: i.

the bailee will take reasonable care of the goods;14 and

ii.

the bailor providing the goods for an agreed purpose, impliedly promises that the goods are reasonably fit for that purpose.15

16.

The terms implied in law to take reasonable care often overlap with, and run in parallel to, analogous duties of care in tort which may also exist between the contracting parties.

The implied duty of good faith 17.

Much ink has been spilt in attempts to articulate the meaning of good faith in Australian law.

18.

In Esso Australia Resources Pty Ltd v Southern Pacific Petroleum Nl (Recs And Mgrs Apptd) (Admins Apptd),16 Buchanan JA gave some consideration to the content of the implied duty of good faith stating: “The content of an implied contractual duty of good faith has been variously described. In Renard Priestley JA equated good faith with reasonableness. In Garry Rogers Finkelstein J said that an obligation of good faith required a party “not to act capriciously”. Breach of the obligation has been described as seeking to prevent the performance of the contract or withholding its benefits and as seeking to further an ulterior purpose or purpose extraneous to that for which a right or power is conferred.”

10

Astley v Austrust Ltd (1999) 197 CLR 1. Zorba Structural Steel Co Pty Ltd v Watco Pty Ltd (1993)115 FLR 206. 12 Tame v New South Wales [2002] HCA 35. 13 Commonwealth Bank of Australia v Barker [2014] HCA 32. 14 Davis v Pearce Parking Station Pty Ltd (1954) 91 CLR 642. 15 Townshend v BBC Hardware Ltd [2003] QCA 572. 16 [2005] VSCA 228. 11

4

19.

The duty of good faith has also been described to include aspects of co-operation and an overlap with the well-established implied duty to co-operate stated by Griffin CJ in Butt v McDonald17 and affirmed by the High Court in Secured Income Real Estate Australia Limited v St Martins Investments Pty Ltd.18

20.

Whilst terms implied by statute are generally considered at Part B of this paper, it is important to note at this juncture, that in many instances obligations of good faith are imposed on contracting parties by operation of statute. In fact, in Bropho v Human Rights & Equal Opportunities Commission the Court noted that “a search of Commonwealth statutes discloses 154 Acts in which the term is used”. 19 Section 22 of the Australian Consumer Law is one example which provides that for the purposes of determining whether there has been unconscionable conduct in connection with goods or services, the Court may have regard to whether parties acted in good faith.

21.

In relation to implication by common law, the law of Victoria differs from other Australian states (particularly New South Wales20 and South Australia21) on the question of whether commercial contracts are a class of contract carrying an implied term of good faith as a legal incident, so that an obligation of good faith applies indiscriminately to all the rights and power conferred by a commercial contract.

22.

In Victoria, no general obligation of good faith is implied into commercial contracts as a matter of law. In Esso Buchanan JA (with whom Warren CJ and Osborne AJA agreed) did not accept the submission that a “term implied by law into commercial contracts is a term requiring the exercise of good faith in the performance of the contract”.22

23.

Although in Victoria terms of good faith do not arise in commercial contracts as an incident of the general law, the Court in Esso did accept that it may be appropriate to imply terms of good faith into commercial contracts on an “ad hoc” basis pursuant to the test in BP Refinery described above.

24.

That would, of course, require the party alleging the existence of the implied term of good faith, to establish that such a term is necessary to give business efficacy to the contract. In

17

29 (1896) 7 QLJ 68: ‘A general rule [applies] to every contract that each party agrees, by implication, to do all such things as are necessary on his part to enable the other party to have the benefit of the contract’. 18 (1979) 144 CLR 596. 19 (2004) 204 ALR 761 at 783. 20 It is generally accepted in New South Wales that a duty of good faith in the performance of obligations may be imposed on the parties by implication: Renard Constructions (ME) Pty Ltd v Minister for Public Works (1992) 26 NSWLR 234; Burger King Corp v Hungry Jacks (2001) NSWCA 187. 21 Alstom Ltd v Yokogawa Australia Pty Ltd & Anor (No 7) [2012] SASC 49. 22 Esso Australia Resources Pty Ltd v Southern Pacific Petroleum Nl (Recs And Mgrs Apptd) (Admins Apptd) [2005] VSCA 228 at [25]. 5

this regard, Buchanan JA suggested that, the necessity for such a term may be found in the need “to protect a vulnerable party from exploitive conduct which subverts the original purpose for which the contract was made.”23 Consequence of a good faith obligation 25.

If good faith is implied into a contract, certain discretionary contractual rights conferred on one party in apparently broad express terms, may be fettered by an implied term of good faith.

26.

For example, in Renard the relevant clause empowered to principal to serve a “show cause” notice whenever the contractor was in breach of the contract; and in response the contractor was obliged to “show cause” to “the satisfaction of the principal” why the principal’s termination powers should not be exercised.24

27.

In that case, there was no “materiality” threshold applicable to the nature of the breach that gave rise to the power – it could on its face be used in respect of any breach by the contractor - and in those circumstances the Court was prepared to imply a good faith obligation into the exercise of the power.25

28.

Further examples can be found in a number of authorities which considered termination for convenience clauses26 – clauses which typically confer an overwhelming power on one party to the contract to terminate at will – the use of which is often characterized as an act not in good faith.

Express exclusions of good faith 29.

There is an important caveat that applies to the authorities referred to above. Terms implied by statute aside, courts will not imply a term into a contract where it would run contrary to the express terms of that contract; it follows that an obligation of good faith will not apply to a termination for convenience clause where the wording of the clause is clear and unambiguous in providing an absolute, uncontrolled and unfettered right of termination.

23

Esso Australia Resources Pty Ltd v Southern Pacific Petroleum Nl (Recs And Mgrs Apptd) (Admins Apptd) [2005] VSCA 228 at [25]. 24 Renard Constructions (M E) Pty Ltd v Minister for Public Works (1992) 26 NSWLR 234 at 239. 25 Ibid at 257. 26 Kellogg Brown Root Pty Ltd v Australian Aerospace Ltd [2007] VSC 200; Apple Communications v Optus Mobile [2001] NSWSC 365; Thiess Contractors Pty Ltd v Placer (Granny Smith) Pty Ltd (2000) 16 BCL 130; Starlink International Group Pty Ltd v Coles Supermarkets Australia Pty Ltd [2011] NSWSC 1154. 6

30.

Examples of the kind of clauses held to be unfettered by obligations of good faith include: a.

Thiess Contractors Pty Ltd v Placer (Granny Smith) Pty Ltd,27 in which the Court held that the wording of a termination for convenience clause which allowed a party to terminate “at its option”, “at any time” and “for any reason it may deem advisable” was sufficiently unfettered and provided the party with an absolute right of termination; and

b.

Starlink International Group Pty Ltd v Coles Supermarkets Australia Pty Ltd, in which case the words allowing a party to terminate “at any time without a reason” were held to be sufficiently inconsistent with the obligations of good faith.

27

(2000) 16 BCL 130. 7

Part B: Terms implied by statute 31.

Generally, the legislature does not directly impact the parties’ freedom of contracting.28 Unlike terms implied at common law, some statutory implied terms cannot be modified or excluded by the parties. However, there are limited circumstances in which statute imposes on contracting parties to imply specific terms. Arguably the most broadly applicable statutory imposition of terms are the ‘consumer guarantees’ under the Australian Consumer Law (ACL).29 It is these guarantees that will be the focus of this part of the paper.

32.

There are also subject-matter specific implied terms. But these are beyond the scope of this presentation. If you are working in the affected areas, you should be familiar with them. For example: •

the duty of good faith implied into insurance contracts30 and franchising agreements31 which cannot be limited or excluded;

33.

•

implied terms in domestic building contracts which cannot be limited or excluded32;

•

implied terms in relation to the sale of cars;33 and

•

general terms in relation to the sale of goods,34 which can be modified or excluded.35

Consumer guarantees are not strictly implied terms as they are not dependent upon the contract.36 However, they effectively import obligations on contracting parties in relation to the supply of goods and services. Their application is far wider reaching than their name – consumer guarantees – would lead you to believe. Therefore, they should be considered in dealing with all agreements that contain any type of supply.

28

Statute also restricts what is permissible or impermissible in certain contracting arrangements such as retail leases, residential tenancies, land sales and franchising arrangements. In addition, there are other statutory obligations that affect contracting parties’ relationship and often provide alternate rights to those under the written contract such as s18 (misleading and deceptive conduct) and ss20-21 (unconscionable conduct) of the ACL. 29 Australian Consumer Law as set out in Schedule 2 of the Competition and Consumer Act 2010 (Cth) and incorporated into State / Territory legislation, such as Fair Trading and Consumer Act 2010 (Vic). 30 Insurance Contracts Act 1994 (Cth), s13(1). 31 Competition and Consumer (Industry Codes – Franchising) Regulation 2014, s6 (prescribed under s51AE of the Competition and Consumer Act 2010 (Cth)). Note, this provision also imposes an obligation of good faith on parties proposing to enter into a franchise agreement. 32 Domestic Building Contracts Act 1995 (Vic). 33 Motor Car Traders Act 1986 (Vic), see for example, s43 (cooling off), s45 (rescission) and s54 (statutory warranty). 34 Goods Act 1958 (Vic), see for example s17 (title - right to supply); s18 (conformity with description); s19(1) (fit for purpose made known); s19(b) (goods will be of merchantable quality); and s20 (correspondence to any sample). 35 Goods Act 1958 (Vic), s61. 36 Under the predecessor legislation, the equivalent provisions had force as implied terms. See for example, s71 of the Trade Practices Act 1974 (Cth). 8

When will the Consumer Guarantees apply? 34.

The words of the ACL state that the guarantees apply to ‘consumer’ transactions. However, the definition of consumer is such that it will often capture business-to-business transactions.

35.

There are three limbs to the definition:37 •

All transactions where goods / services are acquired for less than $40,000;38 OR

•

Goods / services ordinarily acquired for personal, domestic or household use or consumption (irrelevant of the price); OR

•

Vehicles or trailers acquired for use principally in the transport of goods on public roads.

36.

However, note they do not apply: •

when the goods are sold for re-sale and / or to be used up or transformed as part of manufacture or repair.39 In respect of supplies for re-supply, the consumer guarantees should still be considered as there is a statutory indemnity in favour of the re-seller in respect of their obligations under the consumer guarantees.40

•

to some specified services including insurance contracts; a contract for the transportation or storage of goods commercial purposes of the person for whom the goods are transported or stored,41 electricity, telecommunications and gas services.42

37.

The broad coverage of the consumer guarantees is enhanced by the statutory presumption that a person claiming to be a consumer is a consumer unless the contrary is established.43 Given this and the court’s interpretation, many business-to-business transactions will also be captured. This is for 2 main reasons.

38.

First, the monetary threshold is not as strict as it might seem. The Act provides means for calculating value for barter arrangements and provides that bundled goods / services are, where possible, unbundled for the purposes of calculating their value. This means that even if your contract value is over $40,000, the consumer guarantees can apply to elements of the

37

ACL, s3. There is provision under the Act for an amount of greater than $40,000 to be prescribed in relation to services. 39 ACL, s3(2). In Laws v GWS Machinery Pty Ltd [2007] NSWCV 316 the court determined that tractor tyres were not excluded from the definition because they are eventually ‘used up’ during the life of the tyre. However, note that consumers can take action directly against ‘manufacturers’. 40 ACL, s274. 41 ACL, s63. 42 ACL, s65. There is also provision for other services to be excluded by regulation. 43 ACL, s3(10). 38

9

supply, if the price (or market price) for any particular good or service is under the threshold.44 For example, if a business acquires computer hardware and installation services for the office, it is likely that each item of hardware will fall below the threshold and therefore be subject to the guarantees. 39.

Secondly, the second limb of the definition: ‘goods / services ordinarily acquired for personal, domestic or household use or consumption,’ does not have any monetary limit, and has been interpreted beneficially to those seeking relief.45 This is driven by the fact that the policy and purpose of this portion of the legislation is remedial in character.46

40.

The court has said that ‘ordinarily’ should be interpreted as ‘commonly’ or ‘regularly’ and not ‘predominantly’.47

This means that in many instances goods or services supplied for

commercial purposes, even if the particular item is almost only used for commercial purposes, will be covered by the consumer guarantees. 41.

In Bunnings Group v Laminex,48 white-foil laminate had been used in the building of Bunnings’ stores. Bunnings took action against Laminex, the manufacturer of the product, on the basis that they were goods ordinarily acquired for personal, household, domestic use or consumption.49 The white-faced foil laminate was a particular type of reflective foil laminate that was used almost exclusively for insulation in commercial premises and marketed as such. It was more expensive than general reflective foil laminate which was commonly used in domestic buildings.

42.

Young J of the Federal Court found that the white-faced foil laminates were a variant of reflective foil laminates generally and, therefore, they were ‘ordinarily acquired for person, domestic or household use or consumption’. He dismissed the respondent’s argument that the white-faced foil laminates’ distinctive additional attributes, namely washability, corrosion resistance, aesthetic appeal and suitability for use as an internal wall lining, meant that they should be classified as goods of a different kind from reflective foil laminates.

44

ACL, s3. Bunnings Group Limited v Laminex Group Limited [2006] FCA 682 at [74]. 46 These assessments were made in respect of the Trade Practices Act 1974 but they would equally apply to the ACL. See for example, Accounting Systems 2000 (Developments) Pty Ltd v CCH Australia Ltd (1993) 42 FCR 470; Webb Distributors (Aust) Pty Ltd v Victoria (1993) 197 CLR 15; and Devenish v Jewel Food Stores Pty Ltd (1991) 172 CLR 32. 47 Bunnings Group Limited v Laminex Group Limited [2006] FCA 682 at [81], cited with approval by the Court of Appeal of the Supreme Court of Victoria in Violet Homes Loans Pty Ltd v Schmidt & Anor [2013] VSCA 56. 48 Bunnings Group Limited v Laminex Group Limited [2006] FCA 682. 49 Under Trade Practices Act 1974 (Cth), ss74A and 74D. This was among a series of claims. 45

10

43.

Some other examples of goods / services found to be of a kind ordinarily acquired for personal, household, domestic use or consumption are: •

Carpet installed in a night club;50

•

Coaching with substance instruction enrolled in, in part, for business development;51

•

Loans secured against a residential property, even though accompanied by a statement that the loan would be used wholly or predominantly for business or investment purposes;52

• 44.

Patient at hospital receiving nursing services.53

Some examples of goods / services found not be of a kind ordinarily acquired for personal, household, domestic use or consumption are: •

Professional advice regarding commercial investment;54

•

Incubating machines for an ostrich farm;55

•

Commercial mortgage and guarantee;56

•

Loans made under a margin lending agreement with an acknowledgment that the funds would be wholly or predominantly used for business or investment purposes.57

45.

As you can appreciate there will be many circumstances where business-to-business transactions will be impacted by the consumer guarantees. This is potentially a powerful tool for the purchaser and should be considered carefully by the supplier.

50

Carpet Call Pty Ltd v Chan [1987] ATPR (Digest) 46-025; [1987] ASC 55-553 (in obiter). Cogan v Pau [2014] QCATA 304. The Tribunal commented that it was for personal, household, domestic use or consumption even though it was partly for business purposes. Although the transaction would have come under the consumer guarantees given the amount paid was under the monetary threshold. 52 Violet Homes Loans Pty Ltd v Schmidt & Anor [2013] VSCA 56; and Tonto Home Loans Australia Pty Ltd v Tavares; FirstMac Ltd v Di Benedetto; FirstMac Ltd v O'Donnell [2011] NSWCA 389. Both cases were considering the interpretation of the same phrase use in the Australian Securities and Investment Commission Act 2001 (Cth). 53 E v Australian Red Cross Soc (1991) FCR 310. 54 Thomas v Panourakis [2014] VSC 398. 55 Crago v Multiquip Pty Ltd [1998] ATPR 41-620. 56 Begbie v State Bank of NSW Ltd [1993] ASC 56-254. 57 Leveraged Equities Limited v Goodridge [2011] FCAFC 3; a decision made under Australian Securities and Investment Commission Act, s12CB which uses the same phrase. Although, the Court of Appeal in Violet Homes Loans Pty Ltd v Schmidt & Anor [2013] VSCA 56 considered this decision and determined similar services fell within the definition. 51

11

What are the guarantees? 46.

There are the following 9 guarantees in respect of goods and 3 guarantees in respect of services:

Guarantees for goods58 The supplier has a right to sell the goods The consumer has the right to undisturbed possession of the goods, subject to disclose securities Goods are free from any undisclosed security, charge or encumbrance Goods are of acceptable quality Goods are fit for any specified purpose61 Goods correspond to their description Goods match the sample or demo model Manufacturers will take reasonable action to ensure that repair facilities and parts for goods are reasonably available Manufacturers will comply with any express warranty they make about goods

47.

Guarantees for services59 Services are performed with due care and skill Services are fit for a particular purpose60 Services must be supplied within a reasonable time, if no time is specified

In most circumstances, the rights conferred by the guarantees are much broader than that likely offered by a supplier. This is particularly so in the following respects: •

The terms of the guarantees are very broad.

In particular, acceptable quality

encompasses fitness for common purposes, safety, defect-free and quality of appearance and finish.62 •

While the guarantees are made as to the state of goods / services at the time they are supplied, there is no time limitation in respect of latent defects.

48.

There has been significant discussion regarding the scope of these guarantees and, in particular, the meaning of ‘acceptable quality.’ ‘Acceptable quality’ was adopted from New Zealand law in favour of ‘merchantable quality’ which was the centrepiece of the consumer

58

ACL, ss51-59. There are certain exceptions that exclude the operation of the certain guarantees if the goods are sold by auction and, in respect of the title / possession of the goods, where contrary intention appears. 59 ACL, ss60-62. 60 However note that this guarantee does not apply if: the circumstances show that the consumer did not rely on (or it was unreasonable for the consumer to rely on) the skill or judgment of the supply (ACL, s61(3)); or services by a qualified architect or engineer in their area of professional expertise (ACL, s61(4)). 61 However note that this guarantee does not apply if: the circumstances show that the consumer did not rely on (or it was unreasonable for the consumer to rely on) the skill or judgment of the supply (ACL, s61(3)) 62 ACL, s54(2). 12

warranties under Trade Practices Act 1974 (Cth). To date, there have been no reported superior court decisions to provide any judicial light on the meaning of ‘acceptable quality’.63 To what extent can the remedies be limited and / or excluded? 49.

Time does not permit a detailed discussion on the remedies for breach of consumer guarantees. However, as you will likely be aware, the potential remedies are broader than necessarily under contract and expressly include the right to recover damages and losses which suffered that are reasonable foreseeable because of the failure.64

50.

It is possible that some business transactions could be structured in a way which limits the potential that the consumer guarantees would apply. For example, providing regular periodic services as a combined service, rather than a series of single transactions (which may fall under the $40,000 threshold). This could be supported by an express statement that the acquisition of services over X period is considered as a single services even if the services are paid for in advance or periodically during the provision.

However, given the broad

application and beneficial interpretation of the provisions this is unlikely to provide real certainty. 51.

There is a general prohibition on limiting or excluding the consumer guarantees and, any provision that purports to do so is void to the extent it does.65 Therefore, attempting to do so without careful consideration may leave liability uncapped.

Further, making misleading

representations about a consumer’s rights under the consumer guarantees would likely, of itself, be in breach of the ACL.66

63

The District Court of NSW remitted a matter concerning the ‘acceptable quality’ of a second hand Nissan back to the tribunal on the basis that the tribunal had erred at law by not giving the phrase a the beneficial construction it should have: Burton v Chad One Pty Limited [2013] NSWDC 301. Further, misleading statements in relation to consumer guarantees was dealt with by the Federal Court in a group of cases brought against Harvey Norman franchisees: ACCC v HP Superstore Pty Ltd [2013] FCA 1317; ACCC v Salecomp Pty Ltd [2013] FCA 316; ACCC v Moonah Superstore Pty Ltd [2013] FCA 314; and ACCC v Launceston Superstore Pty Ltd [2013] FCA 1315; Australian Consumer and Competition Commission v Camavit Pty Ltd [2013] FCA 1397; Australian Competition and Consumer Commission v Avitalb Pty Ltd [2014] FCA 222; Australian Competition and Consumer Commission v Gordon Superstore Pty Ltd [2014] FCA 452. This issue was also dealt with in: Australian Competition and Consumer Commission v Mandurvit Pty Ltd [2014] FCA 464; and Australian Competition and Consumer Commission v Hewlett-Packard Australia Pty Ltd [2013] FCA 653. However, in each of these cases, orders were made by consent and were largely focused on applicable penalties. The decisions do not contain any detailed discussion regarding the meaning of the term. 64 ACL, s259(4) re goods and s267(4) re services. 65 ACL, s64. There is a specific provision allowing suppliers of recreational services to exclude the consumer guarantees in respect of death, physical or mental injury or disease, unless the supplier’s conduct is reckless: s139A Competition and Consumer Act 2010 (Cth). There are equivalent provisions under the State and Territory acts. For exclusions to be effective they generally need to use prescribed terms. 66 ACL, s29(1)(m) and more generally s18. 13

52.

The ACL permits a supplier to limit liability in respect of goods / services that are NOT of the kind ordinarily acquired for personal, household or domestic use or consumer goods or services to:67

53.

•

Replacement or re-supply of goods (or cost of equivalent goods)

•

Repair goods (or cost of repair)

•

Resupply of services (or cost of re-supply)

One of the main effects of the provision is to allow the supplier to exclude additional liability for damage / loss flowing from the failure.

54.

It should also be noted that a similar provision exists to allow manufacturer’s to limit their liability to suppliers in respect of purchases of goods / services that are not of of the kind ordinarily acquired for personal, household or domestic use or consumer. Even though the consumer guarantees do not apply to the relationship between the supplier and manufacturer, the manufacturer indemnifies the supplier.68

55.

However, care needs to be taken to ensure: •

the goods / services in question not are of the kind ordinarily acquired for personal, household, domestic use or consumer, noting the broad interpretation of that phrase (discussed above); and

•

that reliance on the limitation is fair and reasonable (otherwise it will not apply);69 and

•

that the limitation is within the scope allowed for by the legislation as otherwise it may be ineffective altogether.70

56.

It is important to understand that there is a high likelihood that the consumer guarantees may apply to, or impact, your client’s supply agreements. Your advice to clients will be improved with a clear understanding the impact of these rights and careful navigation of any rights of exclusion or modification.

67

ACL, s64A. ACL, ss271-274. 69 ACL, s64A(3) provides that the consumer can establish that it is not fair and reasonable to rely on that term. Section 64A(4) sets out factors that should be considered in making this determination. 70 See for example, Motorcycling Events Group Australia Pty Ltd v Kelly [2013] NSWCA 361. 68

14

Part C: Illegal, void and unfair terms 57.

There are many situations where, despite the express terms of the contract having been agreed by the parties, the courts will not uphold the contract or specific terms in it.

58.

The bases upon which a court may not give effect to a particular contract or term are derived from both statute and common law.

59.

The application of the relevant principles may mean that a contract or term is held to be illegal, void or unenforceable. The precise outcome depends on the particular term and the nature of the statutory provision or common law principle being applied.

Terms impacted by statute 60.

There are numerous statutory provisions that restrict what terms the parties can agree to.

61.

The impact of statute law on contracts varies depending on the language and intent of the particular provision. The types of provisions and their effects can be summarised into 4 main categories:

Type Statutes that expressly prohibit the making of particular contracts, or the inclusion of a particular term

Examples • Contracts that restrict dealings or affect competition - s 45 of the Competition and Consumer Act 2010 (Cth) • Certain contracts entered into by councils without inviting tenders - s 186 of the Local Government Act 1989 (Vic)

Statutes that prohibit conduct associated with the formation or performance of a particular contract

•

The statute may declare a particular contract or term to be void

•

• •

Contracts entered by party to engage in unlicensed activity (where a licence is required by statute) Contracts entered into with investors without providing a valid prospectus72 Contracts of employment entered into with an unlawful non-citizen who performs work in contravention of s 235 of the Migration Act 1958 (Cth)73 Australian Consumer Law: o Unfair terms in consumer contracts: s 23 o Terms that exclude, restrict or modify consumer guarantees: s 64 o Terms that excluded, restrict or modify a

Effect The contract (or relevant term) is illegal. The question of whether it is also void and unenforceable is a question of statutory construction.71 The contract will only be illegal, void and/or unenforceable if such an effect is construed to be the intention of the legislation74

The making of the contract is lawful, but the contract or relevant term is void and unenforceable

71

Gnych v Polish Club Ltd (2015) 320 ALR 489 Equuscorp Pty Ltd (formerly Equus Financial Services Ltd) v Bassat (2007) 216 FLR 1; [2007] VSC 553 73 Australia Meat Holdings Pty Ltd v Kazi [2004] QCA 147 74 Elvidge Pty Ltd v BGC Constructions Pty Ltd [2006] WASCA 264; c.f. Master Education Services Pty Ltd v Ketchel (2008) 236 CLR 101 72

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Type

The statute may render contracts or terms void as against a third party only

Examples manufacturers liability pursuant to the ACL for safety defects: s 150 • Contracts entered into for the purpose of unauthorised gaming or wagering: s 2.4.1 of the Gambling Regulation Act 2003 (Vic) • Marine insurance policies entered into without an insurable interest: s 90 of the Marine Insurance Act 1909 (Cth) • Particular terms in retail leases (see the Retail Lease Act 2003), residential leases (see the Residential Tenancies Act 1997), domestic building contracts (see Domestic Building Contracts Act 1995), terms contracts (Sale of Land Act 1962), contracts of insurance (see Insurance Contracts Act 1984) • Certain tax avoidance arrangements are void as against the Commissioner of Taxation: s 260 of the Income Tax Assessment Act 1936 (Cth)

Effect

The validity of the contract as between the parties is not affected. However, it cannot be relied upon against the third party

Terms impacted by common law 62.

Under common law, a contract or particular term in it may be deemed to be illegal, void or unenforceable because it infringes a rule of public policy.

63.

The principles governing the denial of relief on public policy grounds were formulated by the English courts in the second half of the 18th century.

64.

“Public policy” has no fixed definition. It is generally concerned with the upholding of community standards.

65.

Generally, where a contract is affected by public policy it will be illegal only where the rule of public policy involves the commission of an offence. In other cases the contract will simply be void and unenforceable.

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Applications of public policy 66.

Since the 18th century, there have been numerous and varied examples of courts refusing to uphold contracts on grounds of public policy. Many of those contracts would probably no longer infringe public policy having regard to modern community standards. Those that are still relevant today can be broadly summarised into 6 main categories:

Type The formation or performance of the contract involves unlawful conduct The contract/term is prejudicial to good government

The contract/term is prejudicial to foreign relations The contract/term is prejudicial to the administration of justice

Unreasonable restraint of trade Ousting the jurisdiction of the courts

Examples • Contracts to engage in conduct prohibited by legislation • Contracts to engage in conduct prohibited by common law • Contracts made for an unlawful purpose (if there is a clear intention to break the law75 and the unlawful intention or purpose goes to the substance of the contract76) • Offering a person a financial inducement to refrain from standing for public office: Taylor v Taylor (1890) 11 LR (NSW) 323; 7 WN (NSW) 37 • Members of parliament promising a land agent that they would use their influence to persuade the government to settle a transaction involving the agent: Wilkinson v Osborne (1915) 21 CLR 89; 16 SR (NSW) 95; 33 WN (NSW) 2. • Trading with nationals of countries against whom Australia has declared war: Ertel Bieber & Co v Rio Tinto Co Ltd [1918] AC 260; Hirsch v Zinc Corp Ltd (1917) 24 CLR 34; [1917] VLR 680. Contracts preventing the giving of evidence in court77 or requiring a party to give particular and specified evidence in court78 • Contracts providing for maintenance or champerty of litigation (c.f. controlled access to justice provided by litigation funders79). Although these torts have been abolished in Victoria, the legislation expressly preserves the power of the court to declare contracts involving such agreements void as against public policy: see 32(2) of the Wrongs Act 1958 (Vic). • Assignment of bare causes of action: EWC Payments Pty Ltd v Commonwealth Bank of Australia [2014] VSC 207 See detailed comments below •

See detailed comments below

Restraint of trade clauses 67.

Under common law, unreasonable restraint of trade clauses are prima facie contrary to public policy and are void.

75

Hutchison v Scott (1905) 3 CLR 359 Neal v Ayers (1940) 63 CLR 524 at 528, 531 77 A v Hayden (1984) 156 CLR 532, ACT Gaming Authority v Andonaros (1991) 103 FLR 450 78 Deloitte Touche Tohmatsu v Cridlands Pty Ltd [2003] FCR 474 at [107] 79 Campbells Cash and Carry Pty Ltd v Fostif Pty Ltd (2006) 229 CLR 386 76

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68.

The common law principles are expressly preserved by section 4M of the Competition and Consumer Act 2010. Section 4M provides that the common law relating to restraint of trade shall not be interfered with where the law is capable of operating concurrently with the Act.

69.

“Restraint of Trade” is not defined in legislation or at common law. It is generally considered to cover any situation where parties agree to restrict their liberty in the future to carry on trade with other parties in such manner as the parties choose. However, the categories of restraint of trade are not closed and there is no exhaustive test of what constitutes restraint of trade.

70.

Early law provided that all restraints on freedom of trade were void because, by their very nature, they were contrary to public policy. These days, the question of their enforceability comes down to questions of reasonableness.

71.

Every restraint of trade is presumed to be void. However the presumption can be rebutted80 if the restraint is judged to be reasonable by reference to two tests.

72.

Firstly, the term must be reasonable in reference to the interests of the parties concerned. Questions the courts will ask in making this assessment include: a.

Who is the restraint sought to be enforced against? A restraint may be imposed more readily and more widely against the vendor of a business in favour of the purchaser, than against a former employee in favour of the employer.

b.

Does the party seeking to enforce the restraint have repeat customers? If it does not have repeat customers, then what interest is it seeking to protect?

c.

Does the party seeking to enforce the restraint have confidential information to protect?81 If so, a restraint may be necessary to limit that person’s ability to use that confidential information against it.

d.

What price was paid by the party to secure the restraint? For example, a purchaser of a business who has paid a great deal of money for the business will usually have a legitimate interest in ensuring that the goodwill in the business is not quickly eroded by competition by the vendor.

73.

Secondly, the restraint must be reasonable in reference to the interests of the public. The onus of showing that a contract in restraint of trade is injurious to the public lies on the party

80 81

McHugh v Australian Jockey Club [2014] FCAFC 45 [4] (Perram J, Griffiths and White JJ agreeing). Marlov Pty Ltd v Murat Col [2009] NSWSC 501 18

making that allegation.82 The onus is not easily discharged once it has been shown that a restraint clause is reasonable in the restraining party's interest.83 74.

The reasonableness of the restraint is to be decided as at the date of the contract.84 In assessing what is reasonable, the court may take into account future probabilities that could have been foreseen at that date.

Ousting the jurisdiction of the courts 75.

The basic principle is that a contract is void to the extent that it seeks to oust the jurisdiction of a court to determine a question of law, either arising under the contract or affecting rights of the parties arising under some other law.

76.

However, there are a number of exceptions and qualifications to the basic rule: a.

The parties may agree to settle a genuine dispute by way of compromise: Lieberman v Morris (1944) 69 CLR 69.

b.

The rule applies only to questions of law, not questions of fact: Dobbs v National Bank of Australasia Ltd (1935) 53 CLR 643.

c.

The parties may agree to a dispute being resolved by arbitration: Bulk Chartering & Consultants Australia Pty Ltd v T & T Metal Trading Pty Ltd (The Krasnorosk) (1993) 31 NSWLR 18. This right has been confirmed by legislation in each jurisdiction.85

d.

More recently, courts have also recognised expert determination as a legitimate form of dispute resolution. The parties may agree to have their rights and liabilities determined by an expert so that the determination, once made, identifies their contractual rights and liabilities, provided that the court retains jurisdiction as to whether the determination was made in accordance with the contract: New South Wales v UXC Ltd [2011] NSWSC 530; Straights Exploration (Aust) Pty Ltd v Murchison United NI (2005) 31 WAR 187; [2005] WASCA 241.

e.

The parties may surrender rights that are considered to be private rights (as opposed to those that are created for the benefit of the public).86

82

McHugh v Australian Jockey Club [4](e). Angel-Honnibal v Idameneo (No 123) Pty Ltd [2003] NSWCA 263 at [27] 84 McHugh v Australian Jockey Club [4](c). 85 See for example Commercial Arbitration Act 2011 (Vic), s 8(1). 86 See for example Brown v The Queen (1986) 160 CLR 171 per Dawson J at 208 (CLR). Rights which have been considered to be for the benefit of the public include a spouse’s right to claim maintenance, the right of a dependent of a deceased to seek special provision from the estate and the right to complain of discriminatory 83

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Unfair terms 77.

The current unfair terms regime came into effect on 1 July 2010. It applies to contracts made, renewed or varied after that date.

78.

At this stage, the laws only apply to consumer contracts. However, the Government has introduced a bill87 to amend the relevant sections of the Australian Consumer Law and the corresponding provision in the ASIC Act, to extend the unfair contract terms provisions to small business contracts. On Monday 14 September 2015, the Senate proposed amendments to significantly broaden the definition of small business contract and passed the bill back to the House of Representatives for consideration.

79.

A small business contract under the proposed bill (as amended by the Senate) would cover any contract where one of the parties: a.

employs fewer than 20 employees; and

b.

one of the following apply: i.

the upfront price payable under the contract does not exceed $300,000; or

ii.

the contract is for a term of more than 12 months and the upfront price payable under the contract does not exceed $1,000,000.

80.

Section 23 of the ACL provides that a term of a consumer contract is void if the term is unfair and the contract is a standard form contract.

Section 23(2) provides that the contract

continues to bind the parties if it is capable of operating without the unfair term. 81.

There are 3 requirements that must be satisfied for a particular term to be an unfair term: a.

Firstly, the contract must be a consumer contract. Section 23(3) defines a consumer contract as being “a contract for a supply of good or services, or a sale or grant of an interest in land, to an individual whose acquisition of the goods, services or interest is wholly or predominantly for personal, domestic or household use or consumption.”

b.

Secondly, the contract must be a standard form contract. Whether or not it is a standard form contract is to be determined objectively. Section 27 provides that where one party alleges that a contract is a standard form contract, it presumed to be one unless another party proves otherwise. In determining whether a contract is a standard

treatment. On the other hand, the right to invoke a limitation period has been found to be a private right which can be surrendered. 87 See the Treasury Legislation Amendment (Small Business and Unfair Contract Terms) Bill 2015, introduced to Parliament on 24 June 2015 20

form contract, a court may take into account such matters as it thinks relevant, but must take into account matters required by section 27(2). Those matters include whether one party has most of the bargaining power, whether the contract was prepared before any discussion between the parties and whether one party was required to accept or reject the terms, or given an effective opportunity to negotiate the terms. c. 82.

Thirdly, the term must be unfair, as defined by section 24.

For a term to be unfair, it must meet the three tests set out in section 24: a.

The term must cause a significant imbalance in the parties’ rights and obligations under the contract. Under the previous Victorian provisions, a significant imbalance was said to be one that is substantial in a quantitative sense;88

b.

The terms must not be reasonably necessary to protect the legitimate interests of the party advantaged by the term. There is a presumption that this test is satisfied unless the party who is advantaged by the term proves otherwise;89

c. 83.

The term must cause financial or other detriment to a consumer if it were relied on.

Section 24(2) provides that in determining whether a term of a consumer contract is unfair a court may take into account such matters as it thinks relevant, but must take into account the extent to which the term is transparent and also the contract as a whole.

84.

85.

Section 24(3) provides that a term is transparent if it is: a.

expressed in reasonably plain language;

b.

legible;

c.

presented clearly; and

d.

readily available to any party affected by the term.

There is no requirement relating to whether the term had been included in good faith, although if bad faith is involved that is a matter the court would take into account. A court is likely to find terms included in bad faith to be unfair.

86.

A court is likely to also take into account the pre-contractual conduct of the parties and alternative options available to the consumer at the time of the contract.90

88

Jetstar Airways Pty Ltd v Free [2008] VSC 539 ACL, s24(4). 90 Jetstar Airways Pty Ltd v Free [2008] VSC 539 (decided under the Fair Trading Act 1999 provisions) 89

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87.

The legislation does not specify the point in time at which the determination of unfairness should be assessed. However, to align with usual principles of contractual interpretation, it would seem that the fairness of the term should be assessed by reference to only the circumstances existing at the time the contract was entered into. Also, the sections are directed at assessing the form and language of the relevant contract, and to making prospective inquiries in relation to the effect which the term would have on the parties’ rights and the detriment which the term would cause to a party if it were applied or relied upon, indicating that the assessment of unfairness should be made at the time at which the contract is formed. This was the interpretation adopted in a recent Federal Circuit Court judgment.91

88.

Section 25 provides a number of examples of the kinds of terms that may be unfair. However, it is only intended to serve as a guide to the courts and the parties. The examples are not determinative or exhaustive. The examples provided focus on terms that permit one party, but not the other, to take various steps, such as avoid or limit performance of the contract, terminate the contract, apply penalties, assign or unilaterally vary the contract.

89.

Finally, there are a number of exceptions where the unfair terms provisions will not apply. Sections 26(1) and 28(1) of the ACL provide that the section does not apply to terms that: a.

define the main subject matter of the contract;

b.

set the upfront price payable under the contract;

c.

are required, or expressly permitted, by a Commonwealth, State or Territory law;

d.

are in a contract of marine salvage or towage, a charter party of a ship;

e.

are in a contract of the carriage of goods by ship; or

f.

are in the constitution (within the meaning of the Corporations Act 2001) of a company, managed investment scheme or other kind of body.

91

Ferme & Or v Kimberley Discovery Cruises Pty Ltd [2015] FCCA 2384 per Jarrett J 22

Part D: Penalties Introduction 90.

The penalty doctrine is a reasonably old one. Much of the modern discussion of the doctrine in Australian cases refers to House of Lords case of Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79 (Dunlop).

91.

In broad terms, a provision will be a penalty if it does not reflect a genuine pre-estimate of damages.

92.

In Dunlop, Lord Dunedin set out principles, extracted below, applicable to determining whether a provision is a penalty or not: “1. Though the parties to a contract who use the words "penalty" or "liquidated damages" may prima facie be supposed to mean what they say, yet the expression used is not conclusive. The Court must find out whether the payment stipulated is in truth a penalty or liquidated damages. This doctrine may be said to be found passim in nearly every case. 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 pre-estimate of damage [citation omitted]. 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 [citation omitted]. 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 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 [citation omitted]. (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 [citation, and a brief discussion by his Lordship (said

23

by him to be “probably more interesting than material”), omitted]. (c) There is a presumption (but no more) that it is 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" [citation omitted]. On the other hand: (d) 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 preestimation almost an impossibility. On the contrary, that is just the situation when it is probable that pre-estimated damage was the true bargain between the parties [citation omitted].” Penalties - an equitable doctrine, not limited to breach of contract 93.

In Andrews v Australia and New Zealand Banking Group Ltd [2012] HCA 30 (Andrews), the High Court: a.

clarified that the penalty doctrine is an equitable doctrine and that the doctrine has not been subsumed into the common law;92 and

b.

noted that the doctrine is not limited to breaches of contractual obligations, citing the example of the application of the doctrine to breaches of bond conditions.93

94.

The Court described at [10] the general application of the doctrines as follows: “In general terms, a stipulation prima facie imposes a penalty on a party ("the first party") if, as a matter of substance, it is collateral (or accessory) to a primary stipulation in favour of a second party and this collateral stipulation, upon the failure of the primary stipulation, imposes upon the first party an additional detriment, the penalty, to the benefit of the second party. In that sense, the collateral or accessory stipulation is described as being in the nature of a security for and in terrorem of the satisfaction of the primary stipulation. If compensation can be made to the second party for the prejudice suffered by failure of the primary stipulation, the collateral stipulation and the penalty are enforced only to the extent of that compensation. The first party is relieved to that degree from liability to satisfy the collateral stipulation.”

92 93

Andrews at [51] and [63] Andrews at [39] and [45] 24

95.

The High Court did not expressly explain the meaning of “additional detriment” but the expression appears to refer to a detriment of greater magnitude or significance than the detriment the promisor would have suffered in the absence of the provision alleged to be a penalty (see Grocon Constructors (Qld) Pty Ltd v Juniper Developer No. 2 Pty Ltd & Anor [2015] QSC 102 (Grocon) at [70]). The word “additional” should not be given too narrow a meaning because it may be that many provisions that are genuine pre-estimates of loss, and are hence enforceable, could nonetheless be said to impose an “additional detriment” on the promisor when compared to the detriment the promisor would have suffered in the absence of such provisions.94

Extravagance and unconscionability, the interest protected by a bargain, a forward looking assessment, indirect costs 96.

In Paciocco v Australian and New Zealand Banking Group Limited [2015] FCAFC 50 (Paciocco), the Full Federal Court found that a late payment fee charged by the bank not was a penalty.95 The High Court granted leave to appeal on 11 September 2015.

97.

The Full Federal Court indicated that whether a provision is extravagant or unconscionable may be assessed by reference “to the greatest loss that could conceivably be proved to have followed from the breach” and that this reflects the “obligee’s interest in the due performance of the obligation”.96

98.

The Court also stated that the assessment of whether a provision is extravagant, exorbitant or unconscionable “must be done as at the time of entry into the contract. The assessment is…forward looking.”97

99.

The decision in Dunlop is an example of the forward looking assessment used to determine whether a provision is penal. The decision also highlights the difference between, on the one hand, the interest of the obligee that is protected by a bargain, and on the other, the damage that can be proved from a particular breach.

100.

In Dunlop, a tyre manufacturer insisted that its trade purchasers not sell its products below certain prices, and that its trade purchasers (as the manufacturer’s agents) obtain similar undertakings from their trade customers. A provision, in a contract between a trade purchaser and its trade customer, required payment of £5 “for each and every tyre, cover or tube sold or

94

Grocon at [68] Paciocco at [245] 96 Paciocco at [103] 97 Paciocco at [147] 95

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offered in breach of this agreement, as and by way of liquidated damages and not as a penalty…”.98 This was alleged to be a penalty. 101.

An action was commenced to restrain the further sale by the trade customer of a tyre cover for £3 s12 d11 instead of the £4 s1 list price. The £5 payable per breach is multiple times larger than the difference between £4 s1 and £3 s12 d11. It could therefore be argued that the £5 payment is a penalty. Moreover, the damage to the appellant that could be proved from offering for sale one or even several tyre covers at below list price was arguably nothing.99

102.

The unanimous view of the House of Lords was that the £5 payment was not a penalty.100 It indicted that the sum agreed of £5 protected the appellant’s interest in preventing undercutting which if allowed to continue would disrupt its sales system.101

103.

In Paciocco the Court found that collections costs, provisioning which resulted in impairments to the bank’s profit and loss account and its balance sheet, and the need to hold additional regulatory capital because of customer failure to make payments on time, could be taken into account to determine whether the late payment fee was a penalty.102 Thus there is judicial support for the view that costs in the nature of indirect costs may be considered to ascertain whether a provision is a penalty.

Unliquidated damages recoverable from breach 104.

It would probably be going too far to say that failure to calculate unliquidated damages that will be recoverable for breach of contract may never be taken into account to assess whether a provision is a penalty. However, in the context of such an assessment, the weight that will be given to such a failure may be limited.

105.

For example, in Paciocco the bank admitted that it “did not determine the quantum of [the late payment fee] by reference to a sum that would have been recoverable as unliquidated damages.”103 The Court held that this admission did not mean the fee was penal, and stated that “the notion of a genuine pre-estimate of damages is not a description of the contractual or pre-contractual activities of the parties. Rather it is the objective reflex of a penalty: a

98

Dunlop at p81 See Paciocco at [147] 100 Dunlop at pp 90, 97, 99 and 105 101 Dunlop at p91 per Lord Atkinson and at p99 per Lord Parker of Waddington 102 Paciocco at [177], [162] and [167] 103 Paciocco at [139] 99

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payment on breach or on failure of a collateral stipulation that is not proved to be extravagant or exorbitant.”104 Genuine pre-estimate of damage, out of all proportion to the greatest loss suffered 106.

In Grocon, the Queensland Supreme Court found that a liquidated damages clause that required a builder to pay pre-agreed sums if the builder failed to reach practical completion of a residential tower complex by the contracted date for practical completion, was not a penalty.105

107.

The Court stated that Lord Dunedin’s statement of principles in Dunlop has been accepted as authoritative by the High Court and also stated that the critical statement by his Lordship is “that the essence of liquidated damages is that they are a genuine covenanted pre-estimate of damage”.106

108.

The Court also noted that it’s insufficient that an alleged penalty be “lacking in proportion” to the unliquidated damages recoverable from breach, but that it must be “out of all proportion”.107

109.

The Court also referred to the “greatest loss”, indicating that to be a penalty, an amount payable must be “extravagant and unconscionable in comparison with the greatest loss that could have been suffered from the breach.”108

$14,750 per day because an approved tag isn’t fitted to a set of keys? 110.

In Grocon, the builder sought to rely on the statement in Dunlop that a penalty is presumed 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”.109 The builder argued that this statement applied because “while some failures to achieve compliance with the requirements of the contract by the Date for Practical Completion might be expected to occasion serious damage, other failures would not” and that the daily rate of $14,750 “was extravagantly out of proportion to the damages that would be

104

Paciocco at [140] and [141] Grocon at [2] and [122] 106 Grocon at [54], [55] and [58] 107 Grocon at [61] and [64] 108 Grocon at [63] 109 Grocon at [54] and [28] 105

27

suffered for a trivial defect, such as the failure to have an approved tag attached to one set of keys.”110 111.

The Court was not persuaded by this argument and instead, based on its view of previous decisions, found that the failure to achieve practical completion (by the date for practical completion) is the failure of a single obligation, even though there may well be many matters, some very small, that could constitute non-completion.111 The decision is the subject of an appeal.

“Bank” cases versus “building” cases 112.

There are some interesting differences between bank cases like Paciocco and building cases like Grocon.

113.

In Grocon, the party that paid liquidated damages was a service provider, whereas in Paciocco, the party that paid the late payment fee was a service taker.

114.

In Grocon, the parties were of similar sophistication and the pre-contractual interactions between them could reasonably be described as a negotiation. In contrast, in Paciocco, there was a marked disparity between the sophistication of the bank and that of its customers. Moreover, there is typically little if any substantial negotiation that occurs between a large retail bank and many of its customers before they agree to banking services.

115.

In a bank type case, a late payment fee is not usually direct compensation for the value of the money that is not paid on time by a customer. This is because direct compensation for such value would typically be by additional interest.

116.

Finally, banks can argue that a fee for late payment is charged for the provision of an additional accommodation to their customers – in a similar way that a film distributor can argue that a film exhibitor who exhibits films without the distributor’s consent is to pay four times the usual fee to exhibit the film as an accommodation for an additional showing of the film (see Metro-Goldwyn-Mayer [1966] 2 NSWR 717 at 723 - 724).

Admissibility of extrinsic evidence 117.

The Court in Grocon provided guidance about admissibility of evidence as to allegedly penal provisions. It stated that, “on the question whether a clause, whose meaning has been determined, nevertheless is penal, extrinsic evidence may be used, even where the evidence

110 111

Grocon at [31] Grocon at [82], [94] and [95] 28

would not be admissible for determining the meaning of the clause.”112 The Court indicated that typically all the circumstances and evidence illuminating those circumstances will be admissible to help characterise a clause as either a penalty or a genuine pre-estimate of damages.113 118.

The Court considered the evidence about the lengthy negotiations between the parties, the sophistication of the parties and that the liquidated damages clause included a tiered regime for amounts payable. The Court also noted that during the contract negotiations, the builder had been provided “with information about the finance and other costs to which [the principal] would be subject if completion of the project, and the settlement of sales, were delayed.”114

119.

However, the Court also noted that “the general limitations on the use of evidence to construe a document apply if any question of the meaning of the clause arises…”.115

Issues for transaction lawyers 120.

When acting for a party seeking to rely on a liquidated damages provision, for example a principal in construction project: a.

during the negotiation stage, make a sensible attempt to calculate the damages that would be incurred if a breach occurs;

b.

c.

identify the damages that are likely to be incurred, for example: i.

cost of additional financing;

ii.

lost sales; and

iii.

additional certification costs for rework that needs to be carried out;

obtain written reports from any necessary experts such as accountants or engineers that document the damages likely to be incurred;

d.

tell the proposed counter party in writing what the damages that are likely to be incurred will be, explain to the counter party the basis of the calculation of the liquidated damages sums;

112

Grocon at [116]. The Court described at [113] that the reason for this approach is “that the equitable origin of the jurisdiction, and its concern unconscionability suggest the limitations on the use of extrinsic evidence may not be the same as they are when determining the meaning of a written document.” 113 Grocon at [115] 114 Grocon at [117] 115 Grocon at [113] 29

e.

consider what steps your client could take to mitigate its loss in the event of a particular breach and take this into account when assessing whether the liquidated damages sought are in fact genuine pre-estimates of loss;

f.

consider whether a tiered liquidated damages regime is appropriate; and

g.

get the parties to agree that the liquidated damages provision is a genuine preestimate of damage and is not a penalty.

121.

When acting for a party that could be asked to pay liquidated damages, for example a builder in a construction project: a.

ensure that the event that triggers liability for liquidated damages is actually within the party’s control, for example: i.

does the builder actually have the necessary control over sub-contractors and equipment suppliers, etc?; and

ii. b.

are there appropriate downstream pass throughs for liquidated damages?; and

if your client wants to push back on the liquidated damages provision, advise that this may result in lost work opportunities: in construction projects especially, a principal is usually going to suffer loss if a breach occurs, and your client’s efforts are probably better placed trying to negotiate reduced liquidated damages rather than risking loosing a contract altogether.

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