Australia: How Extravagant Are Your Liquidated Damages?

Liquidated damages are a powerful tool to both encourage contractual compliance and to provide financial protection to a party where the other party breaches the contract. In the recent case of GT Corporation Pty Ltd v Amare Safety Pty Ltd (No 2) [2008] VSC 223, one of the parties was able to enforce a generous liquidated penalties clause. The Court considered that even where a liquidated damages clause may appear extravagant, it can still be relied upon where it constitutes a genuine pre-estimate of loss.

Background

Amare Safety Pty Ltd (Amare) is a Melbourne based company which sells and distributes personal protective equipment. While Amare's sole Managing Director, Mr Geoff Pizzey, was on an overseas holiday, his then General Manager, Mr Ron Williams, entered into an agency agreement (agreement) with GT Corporation Ltd (GT) for the sale and distribution of personal protective equipment.

The agreement was on very favourable terms to GT. When Mr Pizzey returned from overseas and discovered the existence of the agreement and its terms, he was irate. Mr Pizzey thought the 'contract was a fraud' and that Mr Williams and the director of GT were 'in cahoots'. Irrespective of these protests, it was clear on the facts of the case that an agreement was entered into between GT and Amare.

Under the terms of the agreement, GT was appointed as the sole and exclusive agent of Amare in certain geographical areas. GT was also given the benefit of trade restrictions in its favour.

The agreement provided that each month GT would be paid a significant commission. Over the first two years of the agreement, the commission was equal to approximately $120,000 per annum.

Another generous term of the agreement was a liquidated damages clause in the event of a wrongful termination (clause 6.4). This clause read as follows:

Amare purported to terminate the agreement, on the basis that GT had failed to meet 'minimum standards of sales performance'. What constituted 'minimum standards of sales performance' was disputed by the parties. GT then sued Amare for several multiple breaches of the agreement. GT also claimed liquidated damages of $60,000 per annum, for wrongful termination of the agreement.

The Issues

Two of the key issues in the case were:

• Whether the purported termination was wrongful.
• If the termination was wrongful, whether clause 6.4 was a penalty and therefore unenforceable.

Amare argued that clause 6.4 was a penalty and was unenforceable. In particular, Amare argued that as the term of the agreement was five years, it would clearly be 'extravagant and unconscionable' to suggest that, after 12 months Amare would still be required to pay GT the equivalent of the commission for a full two years.

Supreme Court Decisions

In GT Corporation Pty Ltd v Amare Pty Ltd (No 1) [2008] VSC 143, the Supreme Court found that Amare breached the contract and wrongfully purported to terminate the agreement.

In GT Corporation Pty Ltd v Amare Pty Ltd (No 2) [2008] VSC 223, the Supreme Court considered whether clause 6.4 was enforceable. The Court relied principally on the High Court decision of Ringrow Pty Ltd v BP Aust Pty Ltd (2005) 224 CLR 656 (Ringrow), namely that a clause will be a penalty where:

• The sum stipulated is extravagant and unconscionable in the circumstances.
• It is not a genuine pre-estimate of loss.

The Court considered the $60,000 claim for liquidated damages in the context of the annual commission amount of $120,000, and held that clause 6.4 could be relied upon by GT, as it was a genuine pre-estimate of the loss.

The Court did not fully detail their reasoning in this regard. However, it appears that the Court may have considered the nature of the agreement and the inappropriateness of Amare's purported termination. This case may very well have been decided differently if good faith and clean hands were not in issue, particularly on the part of Amare.

The Court considered that even where a liquidated damages clause appears extravagant at face value, it can still be relied upon where it constitutes a genuine pre-estimate of loss. In this case the figure was calculated on the basis of actual annual commissions, rather than a pre-agreed fixed sum. Accordingly, it was considered to be reasonable in the context of the parties' contractual relationship.

In the two decisions, the Supreme Court awarded GT damages of $281,000 plus interest of nearly $90,000, bringing the total award of damages to nearly $370,000, not inclusive of costs.

Implications

This case highlights that liquidated damages clauses have the potential to deliver significant financial protection. Therefore, ensuring that the quantum of the liquidated damages amount is a genuine pre-estimate is a vital step.

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