28  October, 2013

 

Legal News & Analysis – Asia Pacific – Australia – Dispute Resolution


The effectiveness of clauses which provide that a contractor’s right to an extension of time is only enlivened where the contractor has satisfied certain conditions, such as the provision of notice within a set period of time, is now well recognised in Australia.1


The recent decision of the High Court in Andrews v Australia and New Zealand Banking Group Ltd2 (Andrews) has, however, led to various articles on the potential of the doctrine of penalties to strike down such clauses. Relevantly, the High Court clarified that the doctrine of penalties did not only apply where a party who breached a contract was required to pay an agreed sum which was out of all proportion to the damage likely to be suffered as a result of the breach, but could be applied in a wider range of cases.

 

The Doctrine Of Penalties And Time Bar Provisions In Construction Contracts


Given the number of articles written on the topic in recent times, it is inevitable that the application of the doctrine of penalties to time bar clauses in construction contracts will be tested in the courts. The recent case of Love v Brienserves as a reminder, however, that whether a clause is penal in nature will still need to be assessed by looking at the contract as a whole. Accordingly, whether a particular time bar provision is unenforceable as a penalty will depend on the terms of the contract. Further, the analysis of the time bar provisions and the doctrine of penalties set out below demonstrates that, in the case of well drafted time bar clauses, they should not be readily struck down as penalties by the courts.


General Implications Of The Andrews Decision


The facts in Andrews have been widely reported. The key points from the judgment are summarised as follows:


a. The doctrine is not limited to cases of breach of contract, nor does the ‘detriment’ (penalty) have to be the payment of money.


b. A stipulation (Stipulation) is capable of being characterised as a penalty where:


1. there is a primary stipulation in favour of a second party;4
2. the Stipulation is a collateral (or accessory) stipulation which, upon the failure of the primary stipulation, imposes on the first party an additional detriment (which need not be a requirement to pay the money) to the benefit of the second party;5
3. the Stipulation is in the nature of a security for and in terrorem of the satisfaction of the primary stipulation;6
4. the prejudice or damage to the interests of the second party by the failure of the primary stipulation must be susceptible of evaluation and assessment in money terms;7


c. if compensation can be made to the second party for the prejudice suffered by failure of the primary stipulation, the collateral stipulation and the penalty are enforced only to the extent of that compensation;8


d. where, on the true construction of the contract, its meaning is that one party shall have a right to do the act, on payment of what is agreed upon as an equivalent, the penalty doctrine is not attracted.


Where a stipulation is capable of being characterised as a penalty, the first party would also need to establish that the additional detriment is ‘extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed’ or is ‘out of all proportion’.9


Love v Brien: The Importance Of Looking At The Contract As A Whole


Love v Brien10 (a judgment handed down post-Andrews), concerned a contract of sale which included Special Condition 8 requiring the buyer to apply for subdivision approval and retransfer to the seller a lot of land (Seller’s Lot), and Special Condition 9 in the following terms:


Notwithstanding anything to the contrary herein contained or implied, if as a result of failure of the condition contained in paragraph (g) of Special Condition 8, or for any reason whatsoever, the Seller’s Lot is not transferred to the Seller on or before [date] on [date] the Buyer shall pay to the Seller the sum of $500,000.00 by way of further consideration for the sale of the [Land].


Considering the contract as a whole, Beech J held that Special Condition 9 was not a penalty because his Honour did not consider that it imposed a collateral liability in the form of Special Condition 8. Rather, the two special conditions ‘are part of a contractual scheme by which the consideration payable by the buyer for the Land is in two alternatives: either $3.5 million plus the Seller’s Lot, or, if for any reason the Seller’s Lot is not transferred by the specified date, then $4 million…’.


The case highlights the importance of considering the contract as a whole (and the role of the relevant clause within it) rather than looking at the clause in isolation.

 

Application To Time Bars


A provision will only be subject to the doctrine of penalties where it is a collateral or accessory stipulation which, upon the failure of the primary stipulation, imposes on the first party an additional detriment. There is a real issue as to whether a time bar provision can be so characterised. In addition the requirement that equity only ‘intervene where compensation could be made for the actual damage suffered by the party seeking to recover the penalty’ is problematic in the case of time bar provisions.11


Is The Time Bar A Primary Stipulation In Favour Of The Principal?


In John Goss Projects v Leighton Contractors,12 McDougall J suggested a number of reasons as to why the head contractor would include a time stipulation. Firstly, it would enable the claim to be investigated promptly. Secondly, it would enable the head contractor to monitor its overall exposure to the subcontractor and, finally, it would enable the head contractor to assess its own position vis-à-vis its principal. Another rationale which has been suggested is to provide the superintendent and/or principal with ‘an opportunity to reconsider and possibly withdraw an instruction, or to mitigate its effect by giving a still further or different instruction if the first is found to provoke a claim to additional payment’.13 Therefore, looking at the stipulation in isolation, it is arguable that such a stipulation is for the benefit of the head contractor (in the case of a subcontract) or the principal (in the case of a head contract).


Whether a clause is a penalty, however, is a question of construction that must be determined as a matter of substance, viewing the agreement as a whole.14 Depending on the contract, time provisions may form an important part of a contractual regime or scheme for dealing with matters such as delays and variations. In Wormald Engineering Pty Ltd v Resources Conservations Co International15 (Wormald), Rogers CJ considered the role and effect of the last three paragraphs of clause 40.2 of AS 2124-1978 and noted that:


…it is necessary to have regard to the contract as a whole. The contract provides a carefully regulated regime… the principal feature is that the contract calls for the payment of a lump sum for the carrying out of the works. It is to be varied only in accordance with carefully constructed machinery steps. A programme of works is prepared and supervised by the superintendent. The contract lays down detailed procedures for situations which may involve a disruption of the programme, the carrying out of work not provided for in the original specifications, the omission of work which is provided for and the circumstances on which any liability over and above that contracted for as the lump sum may be incurred. The controlling person throughout is the superintendent. The controlling mechanism is the giving of notices by the contractor to the superintendent at the earliest possible time…


In Australian Development Corporation Pty Ltd v White Constructions (ACT) Pty Ltd16 (ADC), Giles CJ noted that ‘[i]mposing the notification requirement on [the contractor] was a deliberate and important part of the mechanism for determining the time by which the date for practical completion should be extended’.


Therefore, in some contracts, provisions stipulating a time for notification of claims form an important part of the contractual mechanism or regime to deal with issues such as the disruption of the programme, carrying out of extra work, omission of work and latent conditions. Such mechanisms typically set out the process by which the contractor becomes entitled to additional payments or benefits (for example, extensions of time). As such, it is arguable that the time bar provisions are not stipulations in favour of the principal (at least, not solely).


Is There A Collateral Or Accessory Stipulation Which Imposes An Additional Detriment On The Contractor?


Time bar provisions in construction contracts are often drafted in such a way that the timely notification of claims is a condition precedent to the contractor’s entitlement. That is, for example, the contractor’s right to an extension of time only accrues if notice is given within time (providing all other conditions are also met). Arguably, the failure to provide notice within time does not impose any additional detriment on the contractor since no entitlement had accrued in the first place.


Is The Prejudice Or Damage Susceptible Of Evaluation And Assessment In Money Terms?


Whether a provision is penal is to be judged as at the time of making the contract and not as at the time of breach.17 At the time a construction contract is entered into, it is uncertain how many claims may be brought during the life of the contract. Nor would the quantum and degree of complexity of those claims be known. Claims can range from small claims for minor variations to large, highly complex delay claims.


The judgments in two cases dealing with time bar provisions suggest that the courts may be reluctant to find that the prejudice or damage flowing from late notification is susceptible of evaluation and assessment in money terms.
In Wormald, Rogers CJ stated that:


[a]n action for damages for breach of the contractor’s obligation is to me not a satisfactory solution. Quantifying the damage suffered would be a matter of no little difficulty. As well, the principal would have the onus of satisfying the tribunal of fact that had proper notice been given, the variation order would not have been confirmed. There would also be lengthy argument as to whether the contractor would have formed opinion A or opinion B and to what extent the contractor would have been able to accurately forecast the likely consequence of the implementation of the variation order.


Similarly, in ADC, Giles CJ noted that ‘…to give ADC [the principal] no more than an action for damages if timely notification was not given would not be satisfactory – it would leave difficulties of proving what ADC would or might have done had timely notification been received and quantifying the damage suffered, which the parties are unlikely to have intended.’


Is the additional detriment ‘out of all proportion’?


A sum payable, or the additional detriment, will be a penalty if it is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed.18 In Ringrow Pty Ltd v BP Australia Pty Ltd,19 the High Court stated:


Exceptions from that freedom of contract require good reason to attract judicial intervention to set aside the bargains upon which parties of full capacity have agreed. That is why the law on penalties is, and is expressed to be, an exception from the general rule. It is why it is expressed in exceptional language. It explains why the propounded penalty must be judged “extravagant and unconscionable in amount”. It is not enough that it should be lacking in proportion. It must be “out of all proportion”.


The potential loss or damage suffered by the principal which might flow from the contractor’s failure to notify within time (or repeated failures to notify within time) may include the loss of ability to monitor and control costs, loss of the opportunity to reconsider and possibly withdraw an instruction (or mitigate its effect by giving a still further or different instruction), and/or the loss of the ability to investigate the claim. Conceivably, the loss or prejudice suffered by the principal is the exposure to extra costs claimed by the contractor which the principal might have been able to avoid (for example, by withdrawing the instruction). Arguably, the contractor’s loss of the ability to make a claim because it is time-barred would not be ‘out of all proportion’ to the greatest loss arising from late notification which could conceivably be proved.


The courts will also have regard to the nature of the relationship between the contracting parties as a factor relevant to the unconscionability of the conduct in seeking to enforce the time bar.20 Many construction contracts, particularly for large projects, are negotiated by commercially savvy business people and often, with legal advice. In such a situation, it is arguable that ‘[t]he courts should not…be too ready to find the requisite degree of disproportion lest they impinge on the parties’ freedom to settle for themselves the rights and liabilities following a breach of contract.’21


Implications


In the wake of Andrews, whilst there is the potential for the application of the doctrine of penalties to time bar provisions to be reviewed by courts, whether a clause attracts the penalty doctrine will still need to be assessed by looking at the contract as a whole and should prove to be a difficult contention to successfully advance.

 

Endnotes

1. See for example, Spiers Earthworks Pty Ltd v Landtec Projects Corporations Pty Ltd No. 2 [2012] WASCA 53; Jennings Construction Limited v QH & M Birt (1986) 8 NSWLR 18, Wormald Engineering Pty. Limited v Resources Conservations Co. International (1988) 8 BCL 158, Opat Decorating Service Ptd Limited v Hansen Yuncken (SA) Pty Limited (1994) 11 BCL 360, Turner Corporation (Receiver & Manager Appointed) v Austotel Pty Limited (1994) 13 BCL 378, Turner Corporation (In Provisional Liquidation) v Co-ordinated Industries Pty Limited (1994) 11 BCL 202, and Australian Development Corporation Pty Limited v White Constructions (ACT) Pty Limited (1996) 12 BCL 317.
2. [2012] HCA 30.
3. [2012] WASC 457. Note that an appeal is pending.
4. [2012] HCA 30 at [10].
5. [2012] HCA 30 at [10], [12].
6. [2012] HCA 30 at [10].
7. [2012] HCA 30 at [11].
8. [2012] HCA 30 at [10].
9. Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79 at 86-88; AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170 at 190; Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656 at [32].
10. [2012] WASC 457.
11 AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170
at 190.
12. [2006] NSWSC 798.
13. Hudson (12th Ed, 2010) at 5-051; Wormald Engineering Pty Ltd v Resources Conservations Co International (1988) 8 BCL 158 at 162.
14. O’Dea v Allstate Leasing System (WA) Pty Ltd (1983) 152 CLR 359 at 399, 368 and 375; Love v Brien.
15. (1988) 8 BCL 158 at 161.
16. (1996) 12 BCL 317 at 339.
17. Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79.
18. Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79 at 86-88; Love v Brien [2012] WASC 457 at [66].
19. [2005] HCA 71 at [32].
20. AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170 at 193-194.
21. AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170 at 193-194.

 

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