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Contract Law; Penalties, Unconscionable Conduct and Unfair Contract Terms

At common law and in equity there are legal principles usually protecting the perceived weaker party to a transaction or from oppressive or unfair contract terms. This includes the prohibition, for example, against penalties, unconscionable conduct or other unfair contract terms.


This publication will subsequently explore, to some degree, penalties, unconscionable conduct and unfair contract terms.


PENALTIES


The doctrine of contractual penalties is a derivative of equitable principles, which can relieve against contract terms giving rise to the incurrence of an extravagant and unconscionable in amount agreed sum of money, or other obligations, in the event of breach of contract by one party.


In Australia and until Andrews v Australia and New Zealand Banking Group Ltd [2012] HCA 30, it was widely accepted that there was a four step process in determining whether a clause was penal in nature and therefore unenforceable at a point of law. Applicably, Lord Dunedin set out the four principles to regulate the distinction between liquidated damages and penalties in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79 at 86-8:

  1. If the sum is extravagant or unconscionable in comparison to the greatest loss conceivable from the breach, it is a penalty; and

  2. If the breach is the failure to pay money, and the sum is greater than the sum that ought to have been paid, it is a penalty; and

  3. If it is a single lump sum which is payable on the occurrence of one or multiple events, some of which only warranting trifling damages, there is a presumption that it is a penalty; and on the other hand

  4. Just because the consequences of the breach are very hard or maybe impossible to estimate, it does not mean it is a penalty. Rather, there is a presumption that it is a liquidated sum.

These four principles have been cited in nearly every subsequent case in Australia, and have therefore had a considerable influence on the law in respect of penalties. Hence, these principles assist to analyse whether a clause is a penalty or a payment of money stipulated in terrorem of the offending party (being a genuine pre-estimate of damages).


Further, the decision of Re Pioneer Energy Holdings Pty Ltd [2013] NSWSC 1134 also indicated that contractual clauses should not operate to impose penalties on a party for non‐performance under a contract. Such a clause is contrary to public policy and could be construed as unenforceable at a point of law.


Relevantly, in Grocon Constructors (Qld) Pty Ltd v Juniper Developer No. 2 Pty Ltd & Anor [2015] QSC 102, Peter Lyons J held that clauses that operate to impose liquidated damages are not a penalty where the obligation to pay the liquidated damages depends purely on the failure to achieve practical completion by the date set out in the contract. In that particular case, Peter Lyons J considered Lord Dunedin's four principles in light of penalties and liquidated damages and set out that the difficulty in accurately determining a pre-estimate of damage is that it is not a determinate of whether an obligation is a penalty at law. Subsequently, this supported the view that the parties' pre-estimate was a true bargain in that case. This is not dissimilar to the notion of ‘freedom of contract’ where courts are reluctant to intervene in the bargain process unless, of course the clause is 'extravagant and unconscionable in amount' and / or 'out of all proportion' compared to a party's greatest conceivable loss as set out in both Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656 at [32] and Paciocco v Australia and New Zealand Banking Group Limited [2015] FCAFC 50 at [400].


Of particular significance in relation to the Andrews case is that the courts have conventionally held that terms resulting in agreed damages must be a ‘genuine pre-estimate’ of the loss that flows from the alleged breach of contract. In the event it is not, it is likely to be a penalty and unenforceable at law. The courts subsequently have not looked beyond the contractual formulae for the agreed damages. The impact now being that payments under contracts by certain parties will need very close consideration both at the negotiation stage and drafting stage.


UNCONSCIONABLE CONDUCT


Unconscionable conduct usually relates to transactions between stronger and weaker parties to an agreement and can often relate to undue influence and duress. It is generally prohibited by statute (see the Australian Consumer Law (ACL)) and also in equity. The term itself is usually used to seek equitable intervention to prevent enforcement, or set aside a provision in an agreement, relating to a transaction which offends the notion of equity and / or good conscience.


In regards to equity, intervention can take place where a party has taken unfair advantage of what is known as a ‘special disability’ that another party is under. A special disadvantage, for example, can include a person’s age, financial position, lack of education or otherwise and is usually used in conjunction with a number of these factors. Subsequently, the special disadvantage refers to the weaker party’s ability to make an informed judgment as to their own best interests (Bridgewater v Leahy (1998) 194 CLR 457). The stronger party then needs to have known or ought to have known (Commercial Bank of Australia Ltd v Amadio (1983) 151 CLR 447) of the special disadvantage and have exploited it (Blomley v Ryan (1956) 99 CLR 362) if equity is to intervene. Further, regardless of the absence of actual knowledge of the special disadvantage, there is still an implied requirement that the stronger party to the bargain ought to make reasonable enquiries (Micarone v Perpetual Trustee Australia Ltd (1999) 75 SASR 1). Interestingly, In O’Connor v Hart [1985] AC 1000 at 1024 and Nicholas v Jessup [1986] 1 NZLR 226 at 233, the courts are not so much concerned with the conduct of the stronger party, which may amount to unconscionable conduct, but more with the fairness of the outcome so as to intervene.


Notably the above can be highlighted in Commercial Bank of Australia Ltd v Amadio (1983) 151 CLR 447 at 461 - 3, where Mason J takes notes of passages in the judgment of Fullagar J and Kitto J in Blomley v Ryan (1956) 99 CLR 362 at 405:

It is made plain enough, especially by Fullagar J, that the situations mentioned are no more than particular exemplifications of an underlying general principle which may be invoked whenever one party by reason of some condition [or] circumstance is placed at a special disadvantage vis-a-vis another and unfair or unconscientious advantage is then taken of the opportunity thereby created.

Notwithstanding the above the equitable doctrine of unconscionable conduct is now entrenched in statute which is reflect in the ACL. Notably, s 20 of the Competition andConsumer Act 2010 (Cth) under the ACL (which is identical to its precursor, s 51AA of the Trade Practices Act) prohibits ‘unconscionability’ that is engaged in ‘within the meaning of the unwritten law' (i.e. the equitable doctrine of unconscionable conduct). Section 21 also prohibits unconscionable conduct in connection with goods or services. Lastly, s 22 sets out a range of factors a court may consider when determining whether conduct is unconscionable, which includes the strength of the parties bargaining powers, whether the conditions are necessary for the protection of the legitimate interests of the supplier, whether the consumer could understand the documents, whether undue influence or pressure was present and so on.


UNFAIR CONTRACT TERMS


Unfair terms in contracts form part of the Australian Consumer Law (ACL) and are void if found unfair where it involved what is characterised as a 'standard form contract'.


Section 24 of the ACL describes unfair as being a significant imbalance, not reasonably necessary to protect the legitimate interests by the contract term and where it would cause financial/non-financial detriment if applied/relied on.


Section 27 of the ACL describes a standard form contract as one where a party to a proceeding alleges it is a standard form contract unless it is proved otherwise. Essentially a court considers bargaining power, preparation matters and whether it was required to accept the contract prior to purchase.


Generally, a contract is unfair where, under s 24(1) of the ACL:

  • it would cause significant imbalance in the party’s rights and obligations under the standard form contract; and

  • it is not reasonably necessary to protect the legitimate interests of the party who would be advantaged by the terms; and

  • it would cause financial or non-financial detriment to a party if the terms were applied or relied on.

In relation to unfair terms under the ACL, there are a number of enforcement options ranging from dispute resolution to making a complaint with the Office of Fair Trading or Australian Competition and consumer Commission or lodging a complaint with the Queensland Civil and Administrative Tribunal, which has jurisdiction to hear matters to the value of $25,000.00. There are also other avenues available where this does not assist.


CONCLUSION


If you are facing a situation relating to the imposition of an agreed damages clause under a contract, you should reach out to an Australian Legal Practitioner that specialises in contract law, civil litigation and / or dispute resolution. Similarly, if you feel a term of a contract is unfair and / or that you were at a special disadvantage when entering a contract, you should also reach out for some help. to the contrary, should you wish to defend such a claim and need some help to do so, help may only be a call away. In the end, protection of you or your businesses legitimate interests should be paramount, especially when considering the notion of fairness.


Disclaimer: This publication is not intended to be comprehensive nor does it constitute legal advice. We are unable to ensure the information is current and there is no guarantee in relation to accuracy. You should seek legal or other professional advice before acting or relying on any of the content of this publication.


© Scott A. Green, Associate Solicitor

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