In brief - Andrews v ANZ to have significant impact on drafting of construction contracts
Whether or not a payment is triggered by a breach of contract, it may still be classified as a penalty. However, if the party liable to make the payment cannot prove that it was not a genuine pre-estimate of loss, it would not be classified as a penalty.
Landmark judgment widens definition of penalties
In September 2012 the High Court handed down a landmark judgement in the case of Andrews v ANZ. This decision has paved the way for a wider range of fees to be categorised as penalties.
The High Court held that a fee or other sum that is payable on the occurrence or non-occurrence of an event may still be characterised as a penalty, even if the event itself is not a breach of contract. (For more information please see our earlier article Andrews v ANZ revives equitable jurisdiction concerning relief against penalties.)
What is a penalty clause in a contract?
A penalty clause is a clause that requires a party to an agreement to pay a sum for breach of the agreement that is not a genuine pre-estimate of the loss suffered by the other party.
The Australian courts have long imposed the notion that penalty clauses are unenforceable, because rather than providing relief to the wronged party, they are used as a deterrent to stop a party breaching the contract.
Liquidated damages clauses in construction contracts
An example of one type of clause that must be drafted with extreme care is the liquidated damages clause. Liquidated damages clauses are clauses that require one party to pay a certain sum to the other party if that party breaches the contract.
For example, construction contracts often contain a clause that requires the builder to complete the work by the date for practical completion. The liquidated damages clause then outlines the sum that the builder must pay to the principal each day beyond the date for practical completion.
If the liquidated damages clause requires the builder to pay $20,000 per day that it is late completing the work, but the maximum pre-estimate of loss that the principal would suffer is only $3,000, then it is likely to be a penalty clause and unenforceable.
This is because the $20,000 is out of proportion to the pre-estimated loss that would be suffered by the principal as a result of the builder's breach. It should be emphasised that the pre-estimate of loss is to be assessed as at the time the contract is formed, rather than the date of breach or the date on which the loss is suffered.
Attempts to draft contract clauses to avoid them being classified as a penalty
Prior to the Andrews decision, lawyers attempted to avoid this problem by drafting clauses that were triggered by something other than a breach. Although there was no certainty that this sort of drafting would work, it gave rise to a series of contracting strategies seeking to impose charges for the occurrence of particular events.
An example would be if the clause stipulated that if the work was completed by June the builder would receive $1 million, if the work was completed by July the builder would receive $730,000 and if completed by August the payment would be $460,000.
In practical terms, this clause still imposes a late fee but, because the fee is not triggered by a breach, it was arguable that it could not be classified as a penalty clause.
Distinction between penalty and fee legitimately charged for additional service or benefit
The decision in Andrews illustrates that if payment is conditional on the occurrence or non-occurrence of an event, whether or not it is triggered by a breach, the payment may still be classified as a penalty if the payment is not a genuine pre-estimate of the loss.
Although the decision still leaves doubt as to whether clever drafting can prevent a clause being classified as a penalty, it is reasonable to suggest that the example given above would be considered a penalty.
It is important to emphasise that the High Court made a distinction between a fee legitimately charged for an additional service or benefit and a penalty fee. This distinction is very difficult to define and can be expected to cause confusion and debate until further clarified by the courts. Andrews is a case that will have a significant impact on the drafting of construction contracts. Some commentators are suggesting that it will be used to attack timebar and exclusion clauses, but that concept is yet to be tested in the courts.
This is commentary published by Colin Biggers & Paisley for general information purposes only. This should not be relied on as specific advice. You should seek your own legal and other advice for any question, or for any specific situation or proposal, before making any final decision. The content also is subject to change. A person listed may not be admitted as a lawyer in all States and Territories. © Colin Biggers & Paisley, Australia 2020.