On 21 December 2005 the Full Court of the Supreme Court of Tasmania (the Full Court) handed down its judgement in the State of Tasmania v Leighton Contractors Pty Ltd1.
This case related to a contract dated 24 June 1999 between Leighton Contractors Pty Ltd (Leighton) and the State of Tasmania’s Department of Infrastructure, Energy and Resources (the State) for the design, construction and maintenance of a 13.65 km section of new highway which would in part bypass the town of Hagley in northern Tasmania (the Project). Complicated disputes arose between the parties in relation to delays and costs.
One of the arguments raised by Leighton was that the State wrongfully deducted approximately $1.832 million in liquidated damages under the Contract.
In a lengthy judgement handed down in November 2004, the Supreme Court of Tasmania found that the amount deducted as liquidated damages by the State was a penalty and had to be repaid to Leighton. The State’s appeal to the Full Court related solely to this finding.
Basis of Appeal
The State raised a number of grounds of appeal. In summary it was argued that the primary judge erred in fact or in law in holding that the daily rate of $8,000 for liquidated damages agreed between the State and Leighton constituted a penalty by wrongly:
| 1. | analysing the individual components of the per day amount of liquidated damages ($8,000) as those components were subjectively assessed by officers of the State, instead of engaging in an objective analysis; | |
| 2. | failing to consider or taking into account the un-contradicted evidence that the calculation of the State’s loss of use of its capital was $4,000 per day, as if the parties were not entitled to take this component into account in arriving at an enforceable sum for liquidated damages; | |
| 3. | failing to take into account certain relevant considerations namely: | |
| 3.1 | the amount payable as delay damages by the State to Leighton (which was $7,170.00 per day); | |
| 3.2 | the fact that Leighton had raised no complaint about the amount of liquidated damages during the course of negotiating the terms of the Contract; | |
| 3.3 | that the relationship between the State and Leighton was such that there was no imbalance in bargaining power between them (which the State claimed is a matter relevant to the primary judge’s finding of unconscionability). The parties had conducted extensive negotiations and detailed consideration had been given to the precise terms of the Contract. Both parties had also obtained specified legal advice on the liquidated damages clause and accepted that advice. | |
| 4. | finding that because the State was to have been reimbursed by the Commonwealth for all costs of the Project: | |
| 4.1 | the State had suffered no loss, notwithstanding the evidence that the State was solely liable to Leighton in respect of the Contract, and the State met and paid all the costs incurred in arranging for the delivery of the Project; | |
| 4.2 | the sum payable as liquidated damages was not a genuine pre-estimate of the State’s loss at the time of entering into the Contract or was unconscionable. | |
| 5 | finding that Leighton had discharged its burden of proving that the sum payable as liquidated damages was exorbitant, extravagant or alternatively unconscionable. | |
The Full Court’s decision
In upholding the State’s appeal, the Full Court found that grounds 1, 4.1 and 4.2 were sustained.
The principles to be applied
The Full Court made a number of observations about the care which should be taken in considering whether a liquidated damages clause constitutes a penalty. The Full Court commented on the many different terms used in various cases2 to characterise a liquidated damages clause as a penalty, such as ‘extravagant’, ‘exorbitant’, ‘not a genuine pre-estimate’ and ‘unconscionable’.
The Full Court observed that these words described differing conceptual approaches to the test, but encapsulated a number of matters which should be taken into account in assessing whether the clause in question is a penalty,namely:
| 1 | a comparison between: | |
| 1.1 | the amount of liquidated damages and the greatest loss which could conceivably be proven in the light of the total amount of contract as a whole; | |
| 1.2 | the sum provided and the nature of the breach; | |
| 2 | equivalence of bargaining power at the time of agreement; | |
| 3 | the potential outcomes to which the relevant clause was directed; | |
| 4 | the means used in the calculation of the sum; and | |
| 5 | the damage as assessed at the time of making the contract (ie not at the time of breach). | |
The Full Court observed that the use of varying forms of terminology is subject to two important constraints, namely:
the ‘various tests of construction are intended as conceptual guides rather than ‘closed terms’;
the parties must be permitted to determine their own bargain. The Full Court quoted with approval a recent statement of principle by the High Court3 that parties to a contract should be permitted ‘a greater latitude in determining what their rights and liabilities will be’.
In this case, the Full Court found the primary judge correctly identified the relevant principles but made an error in application.
Subjective assessment and genuine pre-estimate
In summary, at first instance the primary judge:
| 1 | considered a document prepared by the State estimating certain component parts of the loss which might be incurred by reason of delay in completion which amounted to $7,985. He found that it was reasonable to accept that this estimate formed the basis of the amount of liquidated damages specified in the Contract. | |
| 2 | examined each component comprised in the estimate and concluded that some of these components were excessive, or in some cases ‘extremely high’ and ‘extravagant’. | |
| 3 | took account of the fact that: | |
| 3.1 | the State had prepared another liquidated damages calculation for a daily rate ($3,065) which was significantly lower; | |
| 3.2 | no estimate other than the direct costs of supervising a delayed contract was prepared; | |
| 3.3 | no evidence from the consulting firm which prepared the estimate was called; | |
| 3.4 | the State was not exposed to loss of capital or payment of interest because the Project was Commonwealth funded; | |
| 4 | concluded from the above that there was no genuine pre-estimate4 and that the figure was exorbitant, disproportionate and unconscionable. | |
The Full Court disagreed with the application of principle for the following reasons:
| 1 | The evidence demonstrated that the figure of $8,000.00 was not arbitrarily chosen. A careful calculation of the amount was made. | |
| 2 | It was reasonable to provide for a contractual remedy in circumstances where: | |
| 2.1 | the Contract value was in excess of $30 million; | |
| 2.2 | delay in completion would impact on a public utility; | |
| 2.3 | quantification of the impact of delay would be ‘problematic’. | |
| 3 | In fact one calculation made by the State sought to include an interest loss equivalent of $4,000 (which did not ultimately form part of the amount of liquidated damages). | |
| 4 | The integrity of the person who compiled and reviewed the calculations was not impugned at trial. To the extent that there were errors (especially as they did not take into account the loss of public amenity amount) they could not be characterised as ‘non-genuine’. | |
| 5 | The amount payable to Leighton as delay costs was a comparable figure to the amount of liquidated damages. This was a relevant fact and should have been taken into account. | |
| 6 | Although the primary judge correctly concluded that loss of revenue by reason of delay is not of itself the reason for finding that the State could suffer no damage other than direct costs, that principle was not applied in His Honour’s assessment of the propriety of the amount of liquidated damages. The Full Court found that:
‘some component for loss of public utility or delay in access to infrastructure should have been considered not as part of the component of direct costs but as a separate matter’. | |
| 7 | The Full Court referred to Cole J’s comments in Multiplex Constructions Pty Ltd v Abgarus Pty Ltd :5 | |
| 7.1 | Public works tend not to yield a cash flow, rather any cost of capital incurred in the works is recouped over a defined period of time at a defined interest rate. Therefore delay in completion of construction would simply defer the commencement of the recoupment period so that on one view, the delay does not cause any loss. | |
| 7.2 | But, conceptually it is not correct to say that public works, because they may not yield a cash flow, cannot result in damages to the state or public authority if delay in construction occurs. | |
| 7.3 | In some instances, an appropriate measure of liquidated damages is the cost of capital tied up for the period of delay. | |
| 8 | The Full Court also referred to the Privy Council’s decision in Phillips Hong Kong Ltd v The Attorney General of Hong Kong6. The amount of damages in that case was calculated by applying a formula to the value of the contract in accordance with a Government manual of instructions for contracts of the same nature. The formula reflected the loss of return on the capital involved at a daily rate, supervisory staff costs, the daily actual cost of making any alternative provision and a sum for fluctuations. The Privy Council said it was a sensible approach because it was obvious that substantial loss would be suffered in the event of delay but the loss would be virtually impossible to calculate. | |
| 9 | In this case, the Full Court suggested that one approach which could have been adopted was to include an amount for ‘notional interest’ in the calculation, alternatively the cost of maintenance of the existing road and transfer of other resources during the delay period could have been incorporated. | |
| 10 | It was not appropriate to engage in an assessment of ‘past loss or an award of damages after the event’. The test, which is an objective one, is: ‘whether, given the nature of the contract, its complexity, value and the bargaining strength of the parties, the amount… was… a penalty as of the date of the agreement’. | |
Reimbursement by the Commonwealth
While the actual terms of the funding arrangements between the State and the Commonwealth were unclear, the Full Court noted the fact remained that the State was accountable for the expenditure of public monies regardless of the source of those funds. The State was obliged to remain accountable for and maintain diligent financial management of the expenditure and as a result it was entitled to seek reasonable compensation for delay or default.
Accordingly, the Full Court found that:
‘public utility does not at itself disentitle the State or public authority from seeking, by way of damages, compensation for loss, the components of which are incalculable’ .
Further, even taking into account the fact that the Commonwealth was to reimburse the State the cost of the works, the Court concluded that:
‘the provision of public money does not change the character of a compensatory provision into one of penalty simply because the expenditure is to be paid by another public authority’.
In reaching this conclusion the Full Court applied the long standing principle that assumption by another of payment for loss does not entitle a contractual party to avoid responsibility for breach of a term or condition.
The Full Court found that this issue is also relevant to the question of onus. The Court found that it was for Leighton, in support of the argument that the liquidated damages clause was a penalty, to affirmatively demonstrate that the Commonwealth would pay all costs of the Project, irrespective of delay or breach.
Conclusion
The decision reaffirms the importance of preparing a cogent, detailed assessment of the likely cost of any delay in completion of the works and using that as a basis for the liquidated damages calculation. It also offers support for the inclusion of the calculation of an amount of the loss of public amenity, and some suggestions for the basis upon which that amount could be calculated.
Finally, the decision reaffirms the enforceability of the liquidated damages clause (assuming it is otherwise enforceable) included in construction or infrastructure contracts on the many projects where the works are partly or fully funded by another government agency or the Commonwealth.
It is not known whether Leighton intends to appeal the decision.
Footnotes
- State of Tasmania v Leighton Contractors Pty Ltd [2005] TASSC 133
- Going back to Clydebank Engineering and Shipbuilding Co v Don Jose Ramos Yzquierdo y v Castaneda [1905] AC 6. These terms have been approved by the High Court in more recent cases such as AMEV-UDC Finance Limited v Austin (1986) 162 CLR 170
- Mason and Wilson JJ in AMEV, ibid.
- Note that this was despite a term in the Contract pursuant to which the parties agreed the amount of liquidated damages was a genuine pre-estimate.
- Multiplex Constructions Pty Ltd v Abgarus Pty Ltd (1992) 33 NSWLR 504
- Phillips Hong Kong Ltd v The Attorney General of Hong Kong (1993) 61 BLR 41
This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.
