Blue Oil and Morgan Stanley established a joint venture company to build and operate a fuel storage and distribution facility. They also entered into a shareholders' agreement pursuant to which the construction costs were to be funded in instalments in return for the issue of shares to the participants in the joint venture company.
In April 2013 the joint venture company resolved to increase the funding by the issue of additional shares to the participants. Blue Oil failed to pay its additional amount and fell into default under the shareholders' agreement.
The shareholders' agreement provided that if Blue Oil was in default, Morgan Stanley had the option to purchase all of Blue Oil's shares in the joint venture company for $1.
The question for consideration by the Supreme Court of New South Wales was whether this option to purchase constituted a penalty or whether it was a reasonable pre-estimate of the loss that would be suffered by the party not in default. If it was determined to be a penalty, it would be unenforceable.
The shareholders' agreement expressly provided that the option to purchase for $1 was a genuine estimate of the loss and expense that Morgan Stanley would incur as a consequence of the default. The Court held that this provision was not conclusive.
Blue Oil argued that the acquisition of shares for which it had paid $13,000,000 for just $1 was unconscionable and bore no comparison with the loss that would be suffered by Morgan Stanley as a result of the default. The payment of the $1 option price was applicable irrespective of how much Blue Oil had already paid to the joint venture company. The option price payable was the same whether the default occurred in respect of the first or last payment instalment.
Morgan Stanley argued that the figure of $1 was appropriate because they would be left with a worthless partially funded facility. The Court accepted that this would be the case if the default occurred at an early stage. However, the later the breach occurred the greater the likelihood that the facility would in fact be worth a great deal.
The court held that Blue Oil's loss of all of its value in the interest in the joint venture company was out of all proportion to the breach and so constituted a penalty which was therefore unenforceable.
In the matter of Pioneer Energy Holdings Pty Ltd [2013]NSWSC 1134.
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