We've previously commented on the High Court's landmark decision in Andrew v ANZ [2012] HCA 30, which concerned the law of contractual penalties in the context of various fees and charges levied by the ANZ bank on its customers.
Old ground …
The case confirms what every law student is taught in Contract Law 101:
- a provision in a contract that is considered to be a 'penalty' will be unenforceable;
- a provision will be considered to be a penalty (and therefore unenforceable) where it is in the nature of a 'punishment'; and
- since at least the 19th century, the test that the Courts have laid down in determining whether a provision is a 'punishment' – or alternatively whether it will pass muster – is to consider whether the compensation required to be paid under the provision represents a 'genuine pre-estimate' of the damages that would be suffered by the claimant: see Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79, subsequently affirmed by our own High Court in Ringrow Pty Ltd v BP Australia Pty Ltd [2005] HCA 71.
… and new
In Andrews, the High Court further expanded the application of the penalty doctrine.
More specifically, the Court held that fees or other amounts can be unenforceable penalties even where the provision requiring the payment is not triggered by a breach of contract. That is, a fee or other amount that is payable on the occurrence (or non-occurrence) of an event may still be an unenforceable penalty even where the event itself is not a breach.
For example, in the context of bank fees, such fees may still be a penalty even where they are expressed (in the relevant contract with the bank) to be invoked on the occurrence of some event – for example, the customer exceeding his or her credit or withdrawal limits – and this event is not a breach of the customer's contract with the bank. In Andrews, the High Court said that whether the dishonour, non-payment and over-limit fees were penalties was a matter for further trial in the Federal Court.
What limits apply to this expanded penalty doctrine?
The High Court did identify some limits around this expanded penalty doctrine. It found that the penalty doctrine will not be invoked where the contractual provision in question gives rise to an 'additional obligation'. That is, a provision will not be a penalty if a party is required to make the payment in question in exchange for some service, accommodation or other benefit.
The example given by the High Court (which is from the NSW Court of Appeal's judgment in Metro-Goldwyn Mayer v Greenham [1966] 2 NSWR 717) nicely illustrates this distinction. In that case, the contract in question permitted Greenham to exhibit only one screening of a film, and went on to provide that Greenham was obliged to pay an amount for each additional screening equal to four times the original contract fee.
The NSW Court of Appeal construed the relevant provision as an option to conduct further screenings in exchange for the payment of the additional amount. In other words, the required payment was not in the nature of a penalty, but rather was required to be made in exchange for an additional benefit (namely, an option to exhibit additional screenings).
What does this mean for technology contracts?
Technology contracts sometimes require a party to pay a specified amount should certain events occur. This may include, for example:
- 'liquidated damages' should the supplier fail to meet one or more milestones;
- 'service credits' should the supplier fail to meet certain specified service levels; and
- a 'payout' amount should the customer terminate the agreement for convenience before a particular time.
In the first two examples above, the payment of 'liquidated damages' and 'service credits' usually also constitutes a contractual breach (ie the supplier has failed to perform to the requisite standard under the contract), so these examples fall within the traditional penalties doctrine. A court would then need to determine whether the liquidated damages or service credits are a 'genuine pre-estimate' of the supplier's loss (otherwise they are unenforceable penalties).
In the third example, however, the obligation to pay the 'payout' amount does not arise from a breach. Rather, termination for convenience is simply a right exercised by the customer that triggers a payment obligation. Nevertheless, on the basis of Andrews, it seems that this may fall within the expanded penalty doctrine – unless the supplier can show that the customer is required to make that payment in exchange for some service or other benefit.
This leaves the enforceability (or otherwise) of termination for convenience payments in a state of some uncertainty. One thing that suppliers could do would be to expressly describe in their contracts the service or benefit that customers obtain in exchange for the termination fee (for example, discounted pricing in exchange for a committed term). However, whether that's enough to avoid the penalties doctrine remains to be seen.