Publications / Projects and Infrastructure
WHO SHOULD READ THIS
- All construction contractors and project developers operating in Australia.
THINGS YOU NEED TO KNOW
- This case clarifies for the time being that Andrews, in which the High Court held that the penalty doctrine was not limited to cases where there has been a breach of contract, will not affect liquidated damages provisions.
WHAT YOU NEED TO DO
- This case is a reminder that the penalties doctrine operates to prohibit clauses which operate primarily to punish one party or another.
The Supreme Court of Queensland has upheld the right of a principal to recover liquidated damages for late completion.
The contractor in Grocon Constructors (Qld) Pty Ltd v Juniper Developer No. 2 Pty Ltd & Anor  QSC 102 had argued that the liquidated damages (LDs) clause was a penalty and therefore unenforceable. It made this argument on two bases:
- the liquidated damages clause imposed a liability for late completion that was ‘additional or different’ from the liability that would apply in the absence of the liquidated damages clause. It therefore followed that the clause was prima facie a penalty, and
- the clause was a penalty because it imposed an identical penalty for different breaches of varying severity.
The Supreme Court rejected both of these lines of argument.
The effect of the decision is to give some comfort to principals that they can rely upon liquidated damages provisions for their intended purpose. However, there remain many bases upon which a liquidated damages provision could be invalid, and great care is called for in drafting these clauses.
‘Additional or different’ liability
A liquidated damages provision will be invalid if it is a penalty. A penalty is a consequence that is out of proportion to the act that it seeks to remedy.
Traditionally, the courts only considered that liabilities for breach of contract could be penalties. However, in the case of Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 (Andrews), the High Court held that an act (or primary obligation) does not need to be characterised as a breach in order for the consequences (or secondary obligation) of that act to be a penalty.
The secondary obligation in Andrews was a late payment fee payable upon the first party’s failure to make repayments on time (which was the primary obligation). The High Court held that the late payment fee was a penalty.
The High Court went further and said that where the failure of the primary obligation was not a breach, any secondary obligation that the contract imposed as a result would prima facie be a penalty if it was additional to or different from the obligations that would otherwise apply.
Grocon, the plaintiff contractor in Grocon v Juniper, classified the primary and secondary obligations in its contract with Juniper (to construct the 77 storey ‘Soul’ building on the Gold Coast) as follows:
- Primary Obligation: the requirement to achieve practical completion on time, and
- Secondary Obligation: the requirement to pay LDs.
Grocon argued that the requirement to pay LDs was ‘an additional or different liability, or detriment’, and therefore prima facie a penalty. Grocon’s position was that the defendant principal therefore carried the onus of proving that the provision was not a penalty.
The Court rejected this line of argument for the following reasons:
- Andrews was concerned with what happens when a contract imposes consequences for an act that is not a breach of contract. It might be expected that an act that is not a breach of contract would not usually attract special consequences; therefore the imposition of special consequences was on its face a penalty. The position is different where the act in question – such as the late attainment of practical completion – does in fact constitute a breach of contract. Even in the absence of an LDs clause, consequences would arise for breach of contract. The matter therefore falls outside the scope of the reasoning in Andrews; and
- accepting Grocon’s argument would place the burden of proof on the defendant. This outcome should be avoided.
‘Identical penalty for different breaches’ argument
Grocon also argued that the LDs clause was a voidable penalty because it sought to place the same liability on Grocon for a range of different breaches, some of which would be much more serious than others.
The LDs would apply where Grocon failed to attain practical completion by the date for practical completion. In some cases, the failure to attain practical completion would result from serious matters. However, in other cases the principal could withhold practical completion for trifling matters, including:
- a small area of paint finish being incomplete
- a small area of the Works being not cleaned, or
- a single appliance not being tested.
Grocon argued that these matters could never give rise to damages of the amount levied by the LD clause. In that respect, the clause was a penalty as it sought to extract damages ‘out of all proportion to the damages that would be suffered for a trivial defect’.
The Court rejected this argument on the basis that the matters listed by Grocon were not of themselves breaches of contract. The relevant breach in each case was the failure to reach practical completion by the date for practical completion. The relevant comparison was between the LDs rate and the principal’s greatest foreseeable loss in the event of the contractor failing to achieve practical completion in a timely way.
The decision in Grocon v Juniper will give some comfort to principals seeking to rely upon liquidated damages provisions. However it remains the case that the drafting of LDs clauses can be very difficult, and there are many opportunities for misadventure. These errors can be extremely destructive to a principal’s rights, and can severely limit the compensation recoverable for breach of contract. This is an unforgiving area of the law where a small oversight at the time of drafting the contract can have serious and long-lasting consequences.
Focus covers legal and technical issues in a general way. It is not designed to express opinions on specific cases. Focus is intended for information purposes only and should not be regarded as legal advice. Further advice should be obtained before taking action on any issue dealt with in this publication.