This case involved a clause in a sale contract which required the vendor to refund to the purchaser an amount equal to the amount by which the business failed to meet a turnover target of double the purchase price over two years.  The Court did not find that such a refund was disproportionate to the impact of the turnover shortfall on the business and so it was not a penalty.  Rather, the Court found that it was not unconscionable for the purchaser to enforce its contractual right to a ‘guaranteed income’.  Vendors should be mindful that such clauses in their contracts are likely to be upheld, even if (with the benefit of hindsight) they seem to operate harshly upon the vendor so care should be taken in determining triggers for such payments.

Clause 3.2 of a contract for the purchase by Complete Business Strategies Pty Ltd (CBS) of an accounting practice from AFA Wealth Pty Ltd (AFA Wealth) entitled CBS to retain $260,000 of the purchase price for two years as security against the practice failing to generate at least $2,600,000 in turnover over such period.  For every dollar deficiency in turnover, the purchase price was to be reduced by one dollar and set off against the retention amount and any amount by which the shortfall exceeded the retention amount would also be payable by AFA Wealth.  CBS recorded a shortfall of around $1,030,000 and in accordance with clause 3.2, kept the retention amount and claimed the additional $770,000.  AFA Wealth in turn claimed that clause 3.2 was a penalty and therefore void. 

AFA Wealth argued that the purchase price reduction was disproportionate to the impact of the shortfall upon the value of the accounting practice.  The accounting practice generated $1,570,000 over the two year period.  Although this was significantly more than the purchase price of $1,300,000 (which reflected the practice income in the year prior to the purchase), clause 3.2 entitled CBS to claim an additional $1,030,000 from AFA Wealth.

McMurdo J considered whether it would be unconscionable for CBS to insist upon enforcing its contractual entitlement to a ‘guaranteed income’ and found that:

  • it would be unrealistic to simply compare the $1,300,000 purchase price with the  guaranteed income of twice that amount – the purchase price had to be paid immediately whereas the income was to be received over time and CBS would incur substantial costs in conducting the business of the practice in the time; and
  • on the evidence, the amount CBS was to receive upon non fulfilment of the condition that the practice would generate the guaranteed income was not extravagant or unconscionable in comparison to the extent to which CBS might be worse off for the condition not being fulfilled.

See the case.