There has been a question mark over the enforceability of many commonly used contractual performance incentives since the High Court's decision in Andrews v Australia and New Zealand Banking Group Limited (Andrews). The recent decision in Grocon Constructors (Qld) Pty Ltd v Juniper Developer No. 2 Pty Ltd & Anor (Grocon v Juniper) has provided some useful guidance on the application of Andrews to liquidated damages regimes.
Recap of Andrews
In Andrews, the High Court was asked to decide whether a payment, in this case certain bank fees, could be a penalty in circumstances where there was no breach of contract. Importantly, the Court was not asked to decide whether the bank fees in question were, in fact, a penalty.
Ultimately, the Court held that a payment could be a penalty even if there was no breach of contract (see our previous article What the Andrews decision means for your agency's agreements). In coming to this conclusion, the Court reversed its previous decisions and underlying reasoning on the issue, several recent Court of Appeal decisions and the generally accepted position in Australia.
Background to Grocon v Juniper
This case involved a claim for liquidated damages due to Grocon failing to achieve practical completion by the date required under the contract. Grocon applied to the court to have the liquidated damages declared a penalty, and therefore, void.
The essence of Grocon's argument was that it could have substantially performed its obligations under the contract apart from some minor defects or omissions (for example, a failure to remove minor rubbish items from the site), but those minor defects or omissions would be enough to trigger its liability for liquidated damages.
Grocon claimed that, as a result of this, the presumption that a clause is a penalty arises when a single lump sum is made payable if any one of several events occur, some of which may result in serious damage while others may result in trifling damage.
Grocon also submitted that, on an "Andrews analysis", there is a presumption that the liquidated damages clause is a penalty because it is a collateral (or accessory) stipulation, operating in the nature of security for, and in terrorem of, the satisfaction of the primary stipulation (that is, achieving practical completion).
Were the liquidated damages a penalty?
Justice Lyons took a restrictive view of the Andrews argument put forward by Grocon, stating that the Andrews analysis of primary and collateral obligations, prima facie imposing a penalty if there is additional detriment, needs to be read in the context of the Andrews decision's background. His Honour held that the additional detriment referred to in Andrews required detriment of a greater magnitude or significance than would otherwise have been suffered. It is not enough that a liability be an accessory liability for a presumption of a penalty to arise.
Principles to be applied
The Court decided the case by applying the well-established principles of distinguishing liquidated damages from penalties as set out in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd, which was accepted by the High Court in Ringrow Pty Ltd v BP Australia Pty Ltd. These are:
- Although the contract may contain the words "penalty" or "liquidated damages", the expression used is not conclusive.
- The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine pre-estimate of damage.
- The question of whether a sum stipulated is a penalty or liquidated damages is a question of construction to be decided upon the terms and inherent circumstances of each particular contract, judged at the time of the making of the contract, not at the time of the breach.
- To assist this task of construction, various tests may prove helpful:
- It will be held to be a penalty if the sum stipulated is extravagant and unconscionable in amount when compared with the greatest loss that could conceivably be proved to have flowed from the breach.
- It will be held to be a penalty if the breach consists only in not paying a sum of money and the sum stipulated is a sum greater than that sum.
- There is a presumption (but no more) that it is a penalty when"a single lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage".
On the other hand:
- It is no obstacle to the sum stipulated being a genuine pre-estimate of damage, that the consequences of the breach are such as to make precise preestimation almost an impossibility. On the contrary, that is just the situation when it is probable that pre-estimated damage was the true bargain between the parties.
Single sum for several events?
The Court disagreed with Grocon's characterisation of the liquidated damages being payable for any one of multiple events. His Honour, consistent with relevant authority, held that the liquidated damages clause is only triggered on the breach of a single event, that is, to achieve practical completion by the specified date. The fact that this breach may be a consequence of other breaches, which may be of themselves relatively insignificant, was held to be irrelevant.
What this means for agencies
Based on this decision, it appears that the principles governing liquidated damages that applied before the Andrews decision will continue to apply. Accordingly, it remains crucial that any liquidated damages regime is a genuine pre-estimate of loss, to ensure that the regime is not characterised as a penalty and therefore unenforceable.
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.