The Andrews and Paciocco cases have
generated a lot of publicity around the law of penalties. Many
articles have been written urging suppliers and customers to
reconsider key provisions in contracts to ensure they are not
But a recent case in Queensland (IPN
Medical1) has provided clear guidance when it comes
to liquidated damages clauses.
The outcome in IPN Medical confirms that suppliers will
have a hard task trying to prove that any pre-agreed amount should
be struck out as a penalty.
On the flipside, the sting for customers is that valid
liquidated damages clauses act as a limitation of liability. The
trick is to make sure the liquidated damages clause protects all
benefits of the bargain.
IPN MEDICAL V VAN HOUTEN
Dr Van Houten simultaneously sold his medical clinic to IPN
Medical (Business Sale Contract) and was engaged
by them as a medical practitioner on a 5-year service contract
(Service Contract). The Service Contract was
attached to the Business Sale Contract.
The Business Sale Contract provided that if Dr Van Houten
breached the Service Contract and IPN Medical terminated that
contract on the basis of that breach, he would have to pay for the
remaining term of the Service Contract at a rate of $5,500 per
month for the first 36 months and then $3,000 per month for the
Dr Van Houten breached the Service Contract after seven months,
then alleged that this clause was void as a penalty.
IPN Medical made an alternative claim, alleging it had suffered
a greater loss than the amount they were entitled to under the
liquidated damages clause.
LIQUIDATED DAMAGES & THE PENALTY REGIME
In IPN Medical, the judge pointed out that there is a
long line of cases that consider the application of the penalty
regime to liquidated damages clauses. This is distinct from the
extension of the penalty regime in the Andrews cases to
circumstances where there is no underlying breach of
The relevant question has long been "does the liquidated
damages amount represent a genuine pre-estimate of loss"?
The recent Paciocco3 decision highlights
that the "genuine pre-estimate of loss" test may be too
strict or too vague. The real consideration should be whether the
pre-agreed amount is "extravagant",
"unconscionable" or "oppressive".
Justice Jackson applied this test in IPN Medical,
finding that the clause was not a penalty because there was no
evidence to suggest that the liquidated damages were
"extravagant", "unconscionable", or had a
"degree of disproportion sufficient to point to
LIQUIDATED DAMAGES AS A LIABILITY CAP
Justice Jackson dismissed IPN Medical's alternative claim to
disregard the liquidated damages clause because the pre-agreed
amount in the contract was insufficient to compensate them for
their loss. He noted that enforceable liquidated damages clauses
act as a liability cap and that a party cannot ignore the agreed
amount of damages and elect to claim a larger amount as damages for
breach of contract at common law.
Because liquidated damages may limit your claim for loss,
customers should ensure that the pre-agreed amount takes into
account all benefits designed to be protected by the contract
– ie, all reasons for which it enters into a contract and its
intended outcomes (this is known as the "scope of the
This may be wider than the immediate effect of breach.
In IPN Medical, Justice Jackson found that the
performance of the Service Contract was critical to the benefit of
the Business Sale Contract so the loss of the doctor's
services, as well as the goodwill and intellectual property
acquired in the business sale, could be factored into the agreed
WHAT IT MEANS FOR CONTRACT DRAFTING
IPN Medical's application of the Paciocco appeal
lends weight to the suggestion that Paciocco might be a go-to guide
for lawyers on penalties for the near future. In a snapshot, the
relevant threshold is high - one must prove extravagance or
For contract drafters, drafting an appropriate liquidated
damages clause is a fine craft. Drafters must be careful to ensure
that the pre-determined amount of liquidated damages is not so
overstated as to be a penalty, but not so conservative as to
deprive the beneficiary of their entitlement to compensation for
1IPN Medical Centres Pty Ltd v Van
Houten  QSC 204
2 See our other articles which discuss the
extension of the penalty regime to other performance provisions,
such as take or pay provisions and service credits.
3Paciocco v Australia & New Zealand
Banking Group Ltd  FCAFC 50
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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