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In brief - Relief against penalties to be available in wider range of scenarios

The High Court has rejected the position that relief against a penalty is only available for payments arising as a result of a breach of contract.

Decision may downplay current concepts of freedom of contract

On 6 September 2012, the High Court handed down a joint decision in the case of Andrews v Australia and New Zealand Banking Group Ltd (2012) 290 ALR 595. The case is notable because the High Court rejects the position, previously adopted by Australian courts, that relief against a penalty is only available for payments arising as a result of a breach of contract.

As a consequence, it would appear that the doctrine of relief against penalties will be available in a much wider range of scenarios in the future. The decision, with its emphasis on proportionality of compensation, supports the view that courts should not be unduly swayed by concepts of freedom of contract in circumstances where an unreasonable detriment might be suffered by a contracting party.

Applicants seek declarations that bank fees unenforceable as a penalty

The High Court judgment relates to certain grounds of appeal, from a decision of a single judge of the Federal Court, that were removed to the High Court. The ongoing Federal Court proceedings concern certain fees levied by ANZ against customers, such as fees for unauthorised overdrafts, overdrawn accounts and credit card fees that apply where users have exceeded credit limits. The contracts between ANZ and its customers allow ANZ to charge these fees. The applicants in the case are part of a representative action and seek declarations that the fees are void or unenforceable as a penalty.

The questions removed to the High Court concern the nature and scope of the jurisdiction to relieve against penalties and the question of whether relief is available only after the penalty is imposed upon a breach of contract [at 18].

Amount recoverable is a penalty if totally out of proportion to maximum loss

The famous case of Clydebank Engineering & Shipbuilding Co Limited v Don Jose Ramos Yzquierdo y Castenada [1905] AC 6 provides a much-quoted example of how the doctrine of relief against penalties often applies. Party A may enter into a contract where A agrees to build a house for B within a year for £50. A further agrees to pay B the sum of £1,000,000 in the event that A fails to complete construction on time.

When A does not complete construction on time, a breach of contract occurs. However, the £1,000,000 is a penalty because the amount recoverable is totally out of proportion to the maximum loss that B will suffer for late performance.

Relief does not depend on breach of contract occurring

In Andrews v ANZ, in which the High Court carried out a detailed examination of the long history of penalty jurisprudence, the Court confirmed that:

• The jurisdiction of the doctrine of relief against penalties is equitable.

• Because jurisdiction is equitable and not based on contract law, relief does not depend upon a breach of contract having occurred.

• It is the substance (and not the form) of a clause that matters. If a fee or any other stipulation is out of proportion to the obligation that is sought to be secured, it may be a penalty.

A "penalty" exceeds the compensation necessary to compensate the other party

The formulation used by the High Court is expressed in slightly complex terms. In essence, the Court held that a stipulation, on its face, imposes a penalty on one contracting party (the first party) if:

• first, as a matter of substance, the stipulation is collateral to a primary stipulation in favour of the other party. A stipulation is collateral if its purpose is to force the first party to satisfy the primary stipulation; and

• secondly, upon the failure of the primary stipulation, the collateral stipulation imposes upon the first party an additional detriment (the penalty) to the benefit of the other party. The detriment is "additional", and hence a penalty, if it exceeds the compensation that is necessary to compensate the other party. However, no penalty exists if the collateral stipulation is not capable of being quantified in monetary terms or if the detriment is a genuine pre-estimate of damage.

Importantly, if the collateral stipulation involves some additional accommodation by the person benefitting from it, it will not be a penalty. The High Court gives an example of where a film exhibitor has a right to hire a film for public showing at certain times but may hire the film at other times provided the exhibitor pays a hiring fee of four times the usual hiring fee. The much higher price is not a penalty because the higher payments are made in exchange for an option to purchase additional hiring rights.

Relief to be available for wider range of contract clauses

Andrews v ANZ represents a significant change in characterisation of penalties under Australian law. Going forward, relief will be available to parties to contracts and other legal instruments regarding a wider range of contractual clauses and stipulations, where they are construed as penalties.

Take care to ensure your contracts are not open to challenge

We recommend that, in commercial dealings, clients closely scrutinise any payments or other "detriments" (such as obligations to transfer property or forfeit proprietary interests) to assess whether, if enforced, they reflect a genuine pre-estimate of a party's loss or damage. Commercial dealings that are likely to be impacted include:

• Service level agreements (such as those used in the IT industry)

• Performance payment mechanisms (used in public private partnerships and facilities management contracts)

• Fees applied to non-performance of obligations under leases and franchise agreements

• Fees charged under utilities contracts and telecoms services contracts

• Amounts payable under indemnities

• Contractual restraints in construction contracts

This article has been published by Colin Biggers & Paisley for information and education purposes only and is a general summary of the topic(s) presented. This article is not specific legal advice. Please seek your own legal advice for any questions you may have. All information contained in this article is subject to change. Colin Biggers & Paisley cannot be held responsible for any liability whatsoever, or for any loss howsoever arising from any reliance upon the contents of this article.​

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