This week marks one year since one of the most talked about High Court decisions in recent years – Andrews & Ors v Australia and New Zealand Banking Group Ltd1.
On its face, the High Court’s decision in Andrews was as simple, as it was controversial. The High Court held that, contrary to the accepted position in England (and the remainder of the common law world), in Australia, the penalty doctrine is not confined to obligations arising from a breach of contract. The penalty doctrine can operate where a stipulation, regardless of whether or not it is activated by a breach of contract, is in substance penal.
A change that raises many questions
For at least 30 years, it was commonly assumed that the penalty doctrine applied only to stipulations activated by a breach of contract2. For this reason, there has been virtually no recent judicial consideration of whether many commonly used contractual provisions which, by reason of good drafting or otherwise, are activated by an event other than contractual breach are penal.
Following Andrews, examples of clauses which may be considered penal and unenforceable to the extent they provide for compensation greater than the loss actually sustained include:
- Time-bars in construction contracts;
- Take-or-pay clauses – e.g. in resource and energy contracts;
- Abatement regimes in long term service contracts;
- Break fees; and
- Interest rate increases for late payment.
Andrews has not only broadened the potential reach of the penalty doctrine, it has raised many difficult questions as well. Andrews was a decision about fees levied by a bank against its customers, with little or no bargaining power. Will courts be as willing to strike down commercial bargains freely made between sophisticated commercial parties?
Andrews is essentially silent on this, but in absence of any qualification by the High Court on the test to be applied, this is a possibility.
Another point to ponder is how a Court will relieve a party from a penal obligation where the obligation does not arise from a breach of contract. The general approach prior to Andrews was to hold the penal obligation unenforceable and require the other party to prove its loss as it would for any other breach of contract.
Where there is no breach of contract, how will a party prove its loss? What will be the event triggering the loss? Will principles relevant to proving contractual damages such as forseeability and remoteness apply?
Another issue is whether, in abolishing the distinction between penal and non-penal clauses based on whether they are activated by breach, the High Court has created new difficulties.
For example, in Andrews, the High Court qualified the broadness of the penalty doctrine by reference to the 1960s case of Metro-Goldwyn-Mayer Pty Ltd v Greenham3. That case stands for the proposition that where a fee is charged for an additional accommodation or service, as opposed to security for an existing obligation, it cannot be a penalty. The High Court also confirmed that the penalty doctrine doesn’t apply to loss or damage that can’t be valued in money terms4.
These qualifications may simply prompt draftspeople to attempt to draft away the penalty doctrine by ensuring that stipulations are in return for an additional service or for a loss that cannot be valued.
CURRENT JUDICIAL GUIDANCE
With so much uncertainty, practitioners and businesspeople need definitive judicial guidance quickly. Such guidance has been sparse to date. Andrews has been referred to in a handful of subsequent decisions, but as yet only one has grappled with any of the above issues in detail. That case was Kellas-Sharpe v PSAL Limited5.
In Kellas-Sharpe, the Queensland Court of Appeal considered whether the long accepted distinction between an impermissible clause which increases an interest rate payable by a borrower on default and a permissible clause which discounts the interest rate on condition of continuous prompt payment could be maintained in light of Andrews’ focus on substance over form.
The Queensland Court of Appeal refused to find the latter kind of clause penal, considering itself constrained by the long established history of judicial approval of the above distinction. The Court of Appeal did however note that the distinction was purely formulaic and may be struck down by the High Court.
Unsurprisingly, Kellas-Sharpe sought to bring the issue before the High Court. However, the High Court refused Kellas-Sharpe special leave on the ground that, in light of the lower court’s findings, a successful appeal would not disturb the orders and therefore the appeal would be futile.
Arguably this case illustrates that judges, including those in the High Court, are reticent to disturb the established commercial framework, and will avoid doing so, where possible. It is likely that until the issues thrown up by Andrews receive detailed judicial consideration, significant uncertainty will remain.