Penalties & Damages Clauses: How a Recent High Court Decision Affects Your Contracts
In the unfortunate event you are faced with a breach of contract by another party, it’s important to know that the damages clause in your contracts enables you to recover as much of the loss suffered as possible.
Damages clauses have traditionally been drafted conservatively so as to avoid the law against ‘penalties’, but a recent High Court decision has changed the legal landscape for damages and paved the way for greater scope of costs and other legitimate business interests to be calculated in damages clauses.
What is a Penalty Clause?
Most contracts contain provisions as to liquidated damages: a specified sum of money payable by a party in breach of the contract to the innocent party. A builder who fails to complete a project on time, a supplier who does not meet delivery or a breach of a confidentiality clause are a few common examples which may attract liquidated damages.
Importantly, any clause setting out liquidated damages must be a genuine pre-estimate of loss suffered by the innocent party.
The law against penalties provides that where such a clause is ‘out of proportion’ to the potential damage, or ‘extravagant and unconscionable’, it will be considered a ‘penalty’ and therefore void and unenforceable.
The Case
The recent case of Paciocco v Australian and New Zealand Banking Corporation [2016] HCA 28 concerned a claim that the late payment fees, overdraft fees and dishonour fees charged by ANZ on various banking facilities were excessive and out of proportion to the loss suffered by ANZ and were therefore invalid penalty clauses.
The disputed fees were between $20 and $35.
On appeal from decisions in both the Federal Court and Full Court, the High Court ruled that although the fees were not an estimate of ‘loss’, they were calculated having regard to the ‘legitimate business interests’ of ANZ.
The Court held that when considered against the value of an individual credit card, the fees might have appeared excessive. However, late payments resulted in flow-on consequences and gave rise to additional costs, including regulatory capital requirements, operational costs associated with debt recovery, and provisioning costs associated with the risk of outstanding debt.
The Court held that these costs increased due to customer failure to meet their contractual obligations and pay their credit card bill on time.
What does this mean for your contracts?
Damages clauses have traditionally been drafted with caution so as not to trigger the law against penalties. The High Court decision however has taken a broad view and determined that damages are not limited to loss resulting directly from a breach of the contract, but may include a wide range of legitimate business interests.
The Paciocco case has reinforced the Court’s increasing support of freedom to contract and is a timely reminder to review your commercial contracts particularly if your business uses standard form contracts. You should be carefully considering all legitimate business interests and costs arising from a breach of your contracts, including regulatory compliance and operational costs.
What Should I Do Next?
Contact us if you would like to have any advice on your commercial contracts, our lawyers at You Legal will be happy to assist you in whatever way we can.
Download Our eBook "How to Avoid a Fall from Grace: Legal Lessons for Directors"
* This blog is for general guidance only. Legal advice should be sought before taking action in relation to any specific issues.