In brief - Andrews v ANZ to have significant impact on
drafting of construction contracts
Whether or not a payment is triggered by a breach of contract,
it may still be classified as a penalty. However, if the party
liable to make the payment cannot prove that it was not a genuine
pre-estimate of loss, it would not be classified as a penalty.
Landmark judgment widens definition of penalties
In September 2012 the High Court handed down a landmark
judgement in the case of Andrews
v ANZ. This decision has paved the way for a wider range
of fees to be categorised as penalties.
A penalty clause is a clause that requires a party to an
agreement to pay a sum for breach of the agreement that is not a
genuine pre-estimate of the loss suffered by the other party.
The Australian courts have long imposed the notion that penalty
clauses are unenforceable, because rather than providing relief to
the wronged party, they are used as a deterrent to stop a party
breaching the contract.
Liquidated damages clauses in construction contracts
An example of one type of clause that must be drafted with
extreme care is the liquidated damages clause. Liquidated damages
clauses are clauses that require one party to pay a certain sum to
the other party if that party breaches the contract.
For example, construction contracts often contain a clause that
requires the builder to complete the work by the date for practical
completion. The liquidated damages clause then outlines the sum
that the builder must pay to the principal each day beyond the date
for practical completion.
If the liquidated damages clause requires the builder to pay
$20,000 per day that it is late completing the work, but the
maximum pre-estimate of loss that the principal would suffer is
only $3,000, then it is likely to be a penalty clause and
This is because the $20,000 is out of proportion to the
pre-estimated loss that would be suffered by the principal as a
result of the builder's breach. It should be emphasised that
the pre-estimate of loss is to be assessed as at the time the
contract is formed, rather than the date of breach or the date on
which the loss is suffered.
Attempts to draft contract clauses to avoid them being
classified as a penalty
Prior to the Andrews decision, lawyers attempted to
avoid this problem by drafting clauses that were triggered by
something other than a breach. Although there was no certainty that
this sort of drafting would work, it gave rise to a series of
contracting strategies seeking to impose charges for the occurrence
of particular events.
An example would be if the clause stipulated that if the work
was completed by June the builder would receive $1 million, if the
work was completed by July the builder would receive $730,000 and
if completed by August the payment would be $460,000.
In practical terms, this clause still imposes a late fee but,
because the fee is not triggered by a breach, it was arguable that
it could not be classified as a penalty clause.
Distinction between penalty and fee legitimately charged for
additional service or benefit
The decision in Andrews illustrates that if payment is
conditional on the occurrence or non-occurrence of an event,
whether or not it is triggered by a breach, the payment may still
be classified as a penalty if the payment is not a genuine
pre-estimate of the loss.
Although the decision still leaves doubt as to whether clever
drafting can prevent a clause being classified as a penalty, it is
reasonable to suggest that the example given above would be
considered a penalty.
It is important to emphasise that the High Court made a
distinction between a fee legitimately charged for an additional
service or benefit and a penalty fee. This distinction is very
difficult to define and can be expected to cause confusion and
debate until further clarified by the courts. Andrews is a case
that will have a significant impact on the drafting of construction
contracts. Some commentators are suggesting that it will be used to
attack timebar and exclusion clauses, but that concept is yet to be
tested in the courts.
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