The cases of Andrews and Others v Australia and New Zealand
Banking Group Ltd (2012) (Andrews) and Re Pioneer v Energy
Holdings Pty Ltd  (Pioneer) significantly expanded the
penalty doctrine in Australia.
What should be taken from the cases is that:
a court may hold that a provision is a penalty even if it is
not triggered by a breach of contract; and
provisions requiring compensation to be provided by one party
to another should be proportionate to the potential loss
Express agreement between parties that compensation is
reasonable will not necessarily oust the doctrine of penalties.
The cases should be carefully considered when negotiating
liquidated damages or any other compensation provisions in
Provisions that incentivise parties to meet deadlines and carry
out their obligations, as opposed to compensating a party where
another party does not fulfil stipulated obligations, are more
likely to be enforceable as such provisions may avoid the issue of
In Andrews the High Court held that, contrary to the established
position, the penalty doctrine is not confined to obligations
arising from a breach of contract and extended the reach of the
doctrine to compensation arrangements, whether or not associated
with a breach of contract.
The court looked at the obligations of customers to pay fees to
ANZ upon the happening of a number of events, including overdrawing
an account. Overdrawing the account was not a breach of contract
and therefore the fees charged were not associated with a breach by
the customer. However, the court held that the fees could still be
characterised as penalties.
Pioneer was concerned with an exit mechanism in a shareholder
agreement for a joint venture project between Blue Oil Energy Pty
Ltd (Blue Oil) and Morgan Stanley Capital Group Inc. (Morgan
The agreement required Blue Oil to contribute funding to the
project and if it failed to do so, Morgan Stanley could exercise a
right to acquire all of Blue Oil's shares in Pioneer for
Morgan Stanley tried to enforce their option to acquire Blue
Oil's shares for $1.00 at a time when the shares were worth
approximately $13 million.
Blue Oil claimed that the provision was unenforceable because it
amounted to a penalty.
Morgan Stanley submitted that the provision was not intended to
punish Blue Oil and therefore did not amount to a penalty. Morgan
Stanley also argued the provision was included for 'good
commercial reason' because, unless it acquired all of Blue
Oil's shares in Pioneer, it would be left with a project that
was partially completed and of little value.
The court held that the exit mechanism needed to be
proportionate to any resulting loss and, if it was not, the
compensation provisions were punishment for default and therefore a
In coming to this conclusion, the court considered Lord
Dunedin's comments in Dunlop Pneumatic Tyre Co Ltd v New
Garage and Motor Co Ltd , where his honour stated that
an attribute of a penalty is 'if the sum stipulated for it is
extravagant and unconscionable in amount by comparison with the
greatest loss that could conceivably be proved to have followed
from the breach'.
The court compared the circumstances in Pioneer with those of
CRA Ltd v NZ Goldfields Investments , where, upon a
breach occurring, the defaulting party had to transfer its interest
in the joint venture at fair market value minus 5%. The 'good
commercial reason' for the 5% was because there was a 60-day
notice period during which the joint venture could get into
'serious commercial bother' to the burden of the remaining
The notice period in Pioneer was only 20 days and the court
noted a transfer for nominal value was significantly different to
applying a 5% discount and there were no provisions taking into
account the amount already invested in the joint venture by Blue
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The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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Peter Sise explores how your contractual clause for recovery of legal costs might not do what you think it does.
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