Consequences for the construction industry

On Wednesday the High Court of Australia handed down its decision in Paciocco v Australia and New Zealand Banking Group Limited [2016] HCA 28 in which the majority provided that a provision will be penal if it provides an entitlement which is out of all proportion with a party's interests. Participants in the construction industry should consider the impact of Paciocco on liquidated damages clauses.

What was the issue?

Two appeals were brought before the Court concerning late payment fees charged by ANZ in connection with two credit card accounts held by Paciocco. The issues before the Court were whether the fees were unenforceable as penalties under the general law, or, whether they otherwise contravened statutory regimes.

The majority (French CJ, Kiefel, Gageler and Keane JJ) decided, in separate judgments, that the fees were not penal and that they did not contravene statutory regimes.

In considering the four tests to identify whether a provision was penal enunciated by Lord Dunedin in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79, the majority stated that those tests were not legal rules and should not be applied literally. The majority stated that the test for considering whether a provision was penal was whether the entitlement it provided was out of all proportion (or grossly disproportionate) to the party's interests in that provision not being enlivened, i.e. were the late payment fees out of all proportion to ANZ's interests in having payments made on time.

A party's 'interests' can include losses for 'commercial interests' or 'legitimate interests' which would not be recoverable as damages. Accordingly, the majority determined that it was appropriate to consider ANZ's provisioning costs, regulatory capital costs and operational costs as costs which the late payment fees should be measured against to determine whether they were out of all proportion, even though ANZ would have been able to recover only its operational costs in an action for breach of contract.

The judgments noted that even if a clause has been drafted without there having been a pre-estimate of loss it is not necessarily the case that the sum stipulated will be a penalty.

Who is affected?

Paciocco relates to late payment fees in the banking industry. However, the decision provides important guidance for Principals and Contractors in the construction and engineering industries concerning when a provision will be deemed penal and thus unenforceable.
The majority's decision that interests can include commercial or legitimate interests which would not be recoverable as damages expands the basis on which a genuine pre-estimate of loss for a liquidated damages provision can be made. Alternatively, even if no pre-estimate of loss has been undertaken, these interests can later be considered when determining whether the provision is penal.

Possible commercial or legitimate interests include reputation, goodwill, ability to win new work, relationships with clients, obligations to shareholders or stakeholders and provision of services.

The decision may justify higher rates of daily liquidated damages than the traditional genuine pre-estimated direct losses being included in construction and engineering contracts.