Unenforceable Penalty Clauses & Agreed Damages in Contracts
Table of Contents When negotiating a contract the parties commonly think about what should happen in the event that the other party breaches a term of the contract. They may also wish to stipulate what should happen upon the occurrence of a certain event (which may not technically constitute a “breach” of the contract). The other party might be required to pay an amount of money or provide some other non-monetary benefit as a result under the contract. Often it is difficult at the time the contract is made for a party to anticipate or foresee exactly what the damage or loss will be in the future if specified event(s) occur. Nevertheless, many contracts do specify what should happen upon the occurrence of certain events. Breach of contract If the parties agree on what will happen in the event of a breach of the contract, then the clause will either be (1) enforceable because it is a liquidated damages clause or (2) unenforceable because the clause is deemed to be a penalty. Primary contractual stipulations with secondary collateral stipulations Where a technical breach of the contract does not trigger what will happen but rather it is some other contractual stipulation / event which triggers payment, the question is “whether the party is restricted by covenant from doing the particular act [by] … payment”. This might occur for example through the imposition of a collateral contractual stipulation which imposes an additional detriment to the benefit of a party and acts as security for the performance of the primary obligation, or acts as a deterrent to non-performance of the primary obligation. Such a stipulation would be a penalty. Alternatively, the question is “whether according to the true construction of the contract, its meaning is, that the one party shall have the right to do the act, on payment of what is agreed upon as an equivalent[1]” it which case it would be enforceable. Enforceable agreed damages or liquidated damages clauses Generally, the law will enforce a clause which provides for the payment to a party of an amount (or benefit) which is a “genuine covenanted pre-estimate of damage[2]”. Unenforceable penalty clauses In summary, clauses which are in the nature of a punishment for breach of the contract or to deter non-performance of a contractual term can be characterised as penalties and therefore unenforceable. Factors which indicate an unenforceable penalty clause include where[3]: The agreed sum is “extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach”. The sum needs to be out of all proportion to the damage that would normally be awarded by a Court in the absence of the clause (i.e. it is “in terrorem”). This is the most important test and merely because no pre-estimate was made at the time the contract is entered into does not determine that the clause a penalty[4]; or The breach consists only in not paying a sum of money, and the agreed damages are more than what should be paid as a result; or A single lump sum is made payable by way of compensation on the occurrence of one or more events, some of which may occasion serious damage but others insignificant damage. General principles It is important to keep in mind the following: The circumstances and the terms of the contract as at the time the contract was made are relevant, not the circumstances at the time of the breach of contract; The fact that it was difficult or impossible to precisely estimate the likely damage at the time the contract was made does not determine that it is a penalty clause[5]; The substance and effect of the clause must be considered (not merely the way the clause has been described in the contract); and The burden of proving that the clause is a penalty and unenforceable is on the defendant (i.e. the breaching / paying party). Special rules apply where payment is accelerated and damages for loss of bargain are payable (for example which often appear in hire purchase agreements). These are treated differently and specific legal advice should be sought[6]. A party seeking to rely upon an agreed damages clause would be best advised to draft the clause with the above in mind and to keep a note of the basis for the calculation and estimate of the damages. …………………………….. [1] See Andrews v Australia and New Zealand Banking Group Limited [2012] HCA 30 and Paciocco v Australia and New Zealand Banking Group Limited [2016] HCA 28 (27 July 2016) [2] Clydebank Engineering and Shipbuilding Co. v. Don Jose Ramos Yzquierdo y Castaneda [1905] A C 6. [3] See Amev-Udc Finance Ltd v Austin (1986) 162 CLR 170 and Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79 [4] Paciocco v Australia and New Zealand Banking Group Limited [2016] HCA 28 (27 July 2016) [5] This was the fourth “test” from Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79 [6] See Melbourne Linh Son Buddhist Society Inc v Gippsreal Ltd (No 2) [2017] VSCA 198 (4 August 2017) for a recent application of the principles. contact us Contact our contract lawyers for assistance in relation to the above. Our commercial lawyers, business lawyers, and disputes lawyers provide expertise in corporate and commercial advisory services as well as litigation and dispute resolution. HEATHFIELD GROSVENOR Level 21, 133 Castlereagh Street Sydney NSW 2000 Australia T: +61 2 8005 7388 E: contact@hglaw.com.au www.hglaw.com.au The information provided in this article is provided by way of general information only. It does not constitute legal advice, and should not be relied upon as such. Specific independent legal advice should be obtained before deciding to act, or not to act, upon the views expressed or information contained in this article.
Unfair Contract Term Protections for Small Businesses
BACKGROUND Following public consultation processes, new laws[1] came into force on 12 November 2016 which extended existing consumer protection laws against unfair contract terms to “small business contracts” (e.g. business to business contracts). Under these laws, small businesses can also have an “unfair” term in a “standard form contract” declared as void in specified circumstances. In doing so they would not have to comply with the term. Findings identified in the Explanatory Memorandum to the Treasury Legislation Amendment (Small Business and Unfair Contract Terms) Bill 2015 suggest that, like consumers, small businesses are vulnerable to the inclusion of unfair terms in standard form contracts as they often lack: the resources to identify unfair terms, appreciate their significance and determine whether they can manage the associated risks; the resources to engage in negotiations over the terms of a contract; the bargaining power to successfully negotiate the terms of a contract; and/or the resources and bargaining power to resist the enforcement of unfair contract terms. The stated objective of this reform[2] is to promote fairness in contractual dealings with small businesses with regard to standard form contracts. This will reduce small business detriment and have positive impacts on the broader economy by increasing small business certainty and confidence, and providing for a more efficient allocation of risk. WHEN DOES PROTECTION TO CONSUMERS / SMALL BUSINESSES APPLY The unfair contract terms protection provisions are contained in ss23 – 28 of Schedule 2 to the Competition and Consumer Act 2010 (Cth) (Australian Consumer Law). Section 23 provides that a term of a “consumer contract” and “small business contract” is void if the term is “unfair” and the contract is a “standard form contract”. We do not examine consumer contracts which were protected prior to the amendments but examine the concepts of “small business contracts”, “standard form contracts” and when terms will be considered to be “unfair”. Small business contract In summary, in order for the contract to be a small business contract, each of the following must apply: The contract must be for the supply of goods or services or a sale or grant of an interest in land; At least one of the parties to the contract is a business that employs less than 20 people[3]; and The upfront price[4] payable under the contract is $300,000 or less, or the contract is for a duration of more than 12 months and the upfront price is $1,000,000 or less. Standard form contracts Standard form contracts are everywhere for example IT services contracts, advertising services contracts, mobile phone contracts, licences of office space, gym memberships etc. They are an efficient and effective way for businesses to contract. The Court will take into account any facts that it considers to be relevant however at the time of writing it “must” take into account the following in determining whether a contract is a standard form contract: whether one of the parties has all or most of the bargaining power relating to the transaction; whether the contract was prepared by one party before any discussion relating to the transaction occurred between the parties; whether another party was, in effect, required either to accept or reject the terms of the contract (other than certain excluded terms discussed below)in the form in which they were presented; whether another party was given an effective opportunity to negotiate the terms (other than certain excluded terms discussed below); and whether the terms of the contract (other than certain excluded terms discussed below) take into account the specific characteristics of another party or the particular transaction. Excluded terms: the protection does not extend to terms to the extent that they define the main subject matter of the contract, set the upfront price payable under the contract, or are terms required by law. Excluded contracts: the protection does not extend to contracts which are individually negotiated, or to certain types of contracts such as contracts of marine salvage or towage, a charterparty of a ship, and contracts for the carriage of goods by ship, constitutions of companies or managed investment schemes or other kinds of bodies. After 12 November 2016: The contract needs to have been entered into, renewed or rolled over after 12 November 2016. The law also applies to amendments to contracts after 12 November 2016 but not to the terms which have not been amended. Unfair terms There is a three limb test to unfairness. A term will be “unfair” if: it would cause a significant imbalance to the parties’ rights and obligations arising under the contract; it is not reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by them; and it would cause detriment to a party if it were to be applied or relied on. The Court “must” take into account the extent to which the term was transparent[5] and the contract as a whole. Make sure your print is not too fine! Some prescribed examples of the types of terms which may be unfair are as follows: a term that permits, or has the effect of permitting, one party (but not another party) to avoid or limit performance of the contract; a term that permits, or has the effect of permitting, one party (but not another party) to terminate the contract; a term that penalises, or has the effect of penalising, one party (but not another party) for a breach or termination of the contract; a term that permits, or has the effect of permitting, one party (but not another party) to vary the terms of the contract; a term that permits, or has the effect of permitting, one party (but not another party) to renew or not renew the contract; a term that permits, or has the effect of permitting, one party to vary the upfront price payable under the contract without the right of another party to terminate the contract; a term that permits, or has the effect of permitting, one party unilaterally to vary the characteristics of
Guide to Statutory Demands – What to Do When Served
Intro If a company owes one or more debts which are due and payable to a creditor and which remain outstanding, it is possible that the creditor may decide to serve a statutory demand on the debtor company. The statutory demand may require the debtor company to either pay the debt(s) in full or provide security for the debt(s) to the creditor’s reasonable satisfaction within 21 days after the demand is served on the company[1]. Requirements for a valid demand In summary the requirements for a valid statutory demand on a company are as follows: If the demand relates to a single debt the demand must specify the debt and its amount. If the demand relates to 2 or more debts then the demand must specify the total; The total debt(s) owed must be more than $2,000; The demand must require payment of the debt or the debtor company to secure or compound the debt to the creditors reasonable satisfaction within 21 days of service of the demand on the debtor company; The demand must be in writing, in the prescribed form, and signed by or on behalf of the creditor; and If there is no judgement in respect of the debt then the demand must be accompanied by an affidavit which clearly verifies that the debt is due and payable in full and the affidavit must comply with the rules. Bear in mind the available grounds to have the demand set aside, and the likely costs outcome if it is set aside (discussed below). All of the circumstances should be considered before deciding to proceed with service of a demand. Time is of the essence If you are on the receiving end of a statutory demand, legal advice should immediately be sought. If the debtor company does not take any action (i.e. comply with the demand, ensure that the demand is no longer in effect, or apply to the relevant Court) within 21 days of service of the demand, and the demand is still in effect, the creditor[2] can immediately apply for the debtor company to be wound up and the Court “must” presume that the debtor company is insolvent[3]. Extensions of time are not possible. Aside from the very harsh effects of winding up proceedings on the debtor company, the onus will be on the debtor company to then prove that it is in fact solvent. In such circumstances the debtor company will not, without the leave of the Court[4], be able to oppose the application on a ground that it might otherwise be able to do so in an application to set aside the statutory demand. Application to set aside a statutory demand If however an application is made to set aside the statutory demand within 21 days of service, supported by an affidavit, and the application to set aside the statutory demand along with the supporting affidavit is served on the person who served the demand on the debtor company within the 21 day period[5], then the application to set aside the demand would be validly issued[6]. Grounds for setting aside the statutory demand The Court must be satisfied either: that there is a “genuine dispute” between the company and the creditor about the existence or amount of the debt; that the debtor company has an offsetting claim[7]; that there is a defect in the demand “and substantial injustice will be caused unless the demand is set aside”; or that some other reason exists why the demand should be set aside[8]. If the demand is set aside then there will be no automatic presumption of insolvency and it is likely that the creditor would have to pay the debtors costs of the application to set aside[9] unless the debtor has behaved unreasonably. ……………………… [1] S.459E of the Corporations Act 2001 (Cth) (Corps Act) [2] being one of the class of persons under s.459P of the Corps Act [3] s.459C (2) (a) of the Corps Act [4] the Court can only grant leave if it is satisfied that the ground is “material” to proving that the company is solvent under s.459S of the Corps Act. [5] Sufficient time must be allowed for service in compliance with s.109X of the Corps Act. Any person receiving a statutory demand must take action immediately. [6] s.459G of the Corps Act [7] s.459H of the Corps Act [8] s.459J of the Corps Act [9] s.459N of the Corps Act