In our July 2013 update, we considered the Victorian Supreme Court’s decision at first instance in this case regarding rules of abandonment and the penalty doctrine. On appeal, the Victorian Court of Appeal has overturned the trial judge’s decision on the effect of abandonment on accrued rights. The Court also discussed the circumstances in which the penalty doctrine will apply to a contractual clause.

Key learnings

Where a contract has been partly performed, courts will infer that abandonment operates prospectively and a party will retain any rights it has accrued, unless there is clear evidence that the parties intended to abandon those accrued rights. As a result, where a party which wishes to bring a part-performed contract to an end they should consider whether they are exposed to liability for past non-performance and, if commercially possible, make clear in the correspondence or other material documenting the end of the arrangement that any accrued rights are extinguished; otherwise, accrued rights are likely to be held to have been retained.

Parties should keep in mind that a clause is likely to be penal where it seeks to secure the performance of a condition or a primary obligation and the corresponding payment due exceeds any loss it is likely to incur in the event of non-performance. In those circumstances, the payment will be enforceable only to the extent of loss that can conceivably be proved.

Background

To recap, in 2009 the parties entered into a contract under which Cedar Meats agreed to provide Five Star with manufacturing, processing and packaging services for an “agreed daily volume” of lamb products at Cedar Meats’ abattoir.

Clause 8(a) provided that if Five Star supplied less than 75% of the agreed daily volume, it would pay Cedar Meats a fee equal to 75% of the agreed daily volume prices for the relevant days. Five Star fell short of the agreed daily volume from the outset of the contract, and eventually production ceased. However, Cedar Meats simply paid on the basis of the volume actually supplied, and did not press for payment under clause 8(a) until 2011 when Five Star announced it was planning to supply to a different processor.

In April 2013, the trial judge held that the parties had abandoned the contract, and that Cedar Meats had also abandoned its accrued rights to payment of close to $15 million under clause 8(a). This was inferred from the fact that Cedar Meats did not seek to enforce its right to payment until several months after the shortfalls and processed small quantities on an ad hoc basis in the interim on different terms. The judge also concluded that, in any event, the payments due under clause 8(a) were unenforceable as penalties.

Abandonment of accrued rights

The Court of Appeal held that, although the contract had been abandoned, the trial judge was in error in deciding that Cedar Meats had abandoned its accrued rights to payment under clause 8(a) because it had not expressly or impliedly reserved those rights.

The Court held that where a contract has been partly performed, it should be inferred that abandonment operates prospectively (that is, from the date of abandonment), with no effect on accrued rights. The court’s task is to assess the intentions of the parties on an objective basis. Where a contract has been abandoned, only clear and objective evidence will displace the presumption that the parties intend to retain their accrued rights.

In this case, the delay of Cedar Meats in enforcing its accrued rights was relevant, but was not ultimately decisive, in assessing whether those rights had been abandoned. Other factors, including evidence of Cedar Meats’ intention to keep its enforcement options open, led the Court of Appeal to find that the rights had not been abandoned.

Penalty clauses

The Court of Appeal confirmed the judge’s finding that the payments due under clause 8(a) were penal, affirming the judge’s substantive approach and application of Andrews v Australia & New Zealand Banking Group Ltd (2012) 290 ALR 595. The Court explained that a contractual promise should be viewed as a penalty where it is a security for the satisfaction of a condition or a primary obligation, and the sum of money is excessive and unconscionable when compared with the greatest loss that conceivably could be proved. Here the obligation to pay an amount equal to the agreed price for processing 75% of the forecast daily volumes delivered a windfall to Cedar Meats (ie a multiple of its anticipated lost profit). If Cedar Meats was not required to process the forecast daily volumes it was able to avoid substantial labour and other costs. This is different to many take-or-pay pricing arrangements in the resources sector where nearly all of the costs of performance are sunk and cannot be avoided if the committed volume of output is not taken. In such circumstances, the agreed amount is not wholly unenforceable. Instead, it is enforceable only to the extent of the parties’ proved loss.

To see the full judgment in this case, please click here.