Liquidated damages - are they always enforceable?Dec 2015 |
The recent Supreme Court of Queensland decision of Grocon Constructors (Qld) Pty Ltd v Juniper Developer No. 2 Pty Ltd  QSC 102 provides new authority on whether liquidated damages clauses constitute unenforceable penalties in construction contracts.
The decision is welcomed by those in the construction industry, who have been looking for industry specific guidance on liquidated damages clauses since the High Court considered penalty clauses in credit agreements in Andrews v Australia & New Zealand Banking Group Ltd (2012) 247 CLR 205. In Andrews the High Court found that late payment fees on particular credit accounts were a penalty, which arguably broadened the application of the penalty doctrine.
The matter concerned a mixed commercial development at Cavill Mall, Surfers Paradise (Soul Project). Juniper Developer No. 2 Pty Ltd (Juniper) engaged Grocon Constructors (Qld) Pty Ltd (Grocon) to undertake the design and construction for the Soul Project. The terms of the contract incorporated amended AS4300-1995 general conditions of contract for design and construct.
Grocon issued proceedings against Juniper claiming an amount of $10 million for work completed under the contract, prolongation costs, variations and interest. In the same proceedings Juniper counter-claimed for (amongst other things) liquidated damages owing under the contract, in the amount of $33.6 million.
The parties applied to the court for an early determination in relation to Junipers entitlement to make the liquidated damages claim.
At the centre of the dispute was the triggering of Grocon’s liability for liquidated damages upon the failure to achieve Practical Completion by the date for Practical Completion. Under the contract Grocon was unable to obtain a certificate of practical completion until it had satisfied a number of specific requirements, some of which were, in the context of the project, relatively minor obligations, such as ensuring that keys for the works had ‘approved label inserts’. Failure to reach practical completion by the due date attracted scaled amounts of liquidated damages ranging from $14,750 to $49,000 per day.1
In its defence, Grocon alleged that the liquidated damages clause was unenforceable as it constituted a penalty.
Doctrine of penalties
A valid liquidated damages clause must be a ‘genuine pre-estimate’ of the loss likely to be suffered by the relevant breach. The doctrine of penalties has its origins in English common law and serves to protect the legal principle that private punishment for breach of contract is unenforceable, and that pressure to perform a contract is an imposition on an individual’s liberty. Whether a liquidated damages clause in a contract constitutes a penalty has been the subject of significant judicial consideration.
In formulating his decision, his Honour Justice Lyons considered the linage of cases concerning the penalties doctrine both in Australia and the UK.
His Honour considered the relatively recent High Court decision of Andrews v Australia and New Zealand Banking Group (2012) 247 CLR 205, where the court had to consider the enforceability of various fees and charges imposed by the ANZ bank, including ‘over limit’ fees which applied when a customer had overdrawn their account.
In Andrews, the court held that a stipulation imposes a penalty on a party (first party) if it is collateral to a primary stipulation in favour of a second party and this collateral stipulation, upon the failure of the primary stipulation, imposes upon the first party an additional detriment, the penalty, to the benefit of the second party. In Andrews, the late payment fees were found to be a penalty because they were payable on breach and were collateral to the main obligation; to pay the credit card bill on time.
It was Grocon’s submission that, in the context of Andrews, achievement of Practical Completion was a primary stipulation, and the liquidated damages clause contained a collateral (or accessory) stipulation which imposed upon Grocon an additional or different liability, and accordingly the penalty doctrine was enlivened.
His Honour rejected Grocons submission, finding that the existence of collateral obligation was not sufficient to constitute a penalty, and the reference to ‘additional detriment’ in Andrews is a reference to a detriment of greater magnitude or significance than the promisor would have suffered but for the penalty clause.2 Accordingly his Honour’s primary focus was on whether the collateral obligation was in the nature of a punishment.
There is a common law presumption that a liquidated damages clause is a penalty if it requires payment on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage.3 His Honour found that the presumption did not arise on these facts as the clause was activated in only one way – a breach of Grocon’s obligation to achieve Practical Completion by the Date for Practical Completion.
Finally, Grocon submitted the daily rate for liquidated damages was significantly disproportioinate to the damages that would be suffered for some trivial defects which would prevent Practical Completion, such as the failure to have an approved tag attached to one set of keys.4
His Honour held that the relevant breach was Grocon’s failure to reach Practical Completion by the Date for Practical Completion. His Honour found that, irrespective of how minor the matter/defect may be acting to prevent Grocon from reaching Practical Completion, the fact that Practical Completion was not reached meant that Juniper would be prevented from taking possession and control of the site and settling contracts of sale with purchasers of units. It was not contested by Grocon that in such circumstances the liquidated damages clause would be disproportionate to the anticipated loss. Accordingly, the penalties doctrine did not act to void the liquidated damages clause.
This decision has come as a relief for many developers who have contracts on foot with similar worded liquidated damages clauses. The Supreme Court of Queensland has provided helpful industry specific guidance on the penalties doctrine and in doing so has reaffirmed the importance of the longstanding common law principle that liquidated damages must constitute genuine pre-estimate of a party’s loss. To that end, a prescient statement appeared in the early stages of his Honour’s judgment when considering the principles articulated by Lord Dunedin in Dunlop:
 In my respectful opinion, a critical statement by his Lordship is the statement that the essence of liquidated damages is that they are a genuine covenanted pre-estimate of damage.
The decision has highlighted the importance of ensuring that the relevant liquidated damages clause is precise in its wording and requires payment on the occurrence of a specific breach, of a serious nature.
In calculating a genuine pre-estimate of a party’s loss for the purpose of prescribing the rate for liquidated damages, a party is able to consider the greatest loss which the parties might have anticipated as flowing from the breach. To that end, it would be wise to include an acknowledgement in the liquidated damages clause that the rate prescribed is a genuine pre-estimate.
Further, in this decision, his Honour allowed extrinsic evidence (beyond the four concerns of the contract) to aid in determining the meaning of the liquidated damages clause. In doing so his Honour formed the view that both parties had agreed on the definition of Practical Completion, and negotiated the rates of liquidated damages. Accordingly, this decision also serves as a warning to ensure legal advice is sought on all provisions of the contract, and that any pre-contract/tender material (and in particular the bases on which the liquidated damages rate or amount was calculated) is maintained on file in the event that it may aid in interpreting the contract or determining if the rate of liquidated damages are penal in nature.
1 For Separable Portion 3 of the Contract.
2 Grocon Constructors (Qld) Pty Ltd v Juniper Developer No. 2 Pty Ltd  QSC 102 .
3 Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd  UKHL 1.
4 Grocon Constructors (Qld) Pty Ltd v Juniper Developer No. 2 Pty Ltd  QSC 102 .