Update: The Law on Penalties 1

Briefing note July 2016

Update: The Law on Penalties

The High Court of Australia on 27 July 2016 delivered its decision in Paciocco v
Australia and New Zealand Banking Group Ltd1, its latest consideration of the
penalties doctrine.

The majority of the High Court found that in assessing whether a clause is a
penalty, the court is to have regard to the legitimate interests of the innocent
party in the enforcement of the clause. This echoes the approach taken recently
by the UK Supreme Court and emphasises the freedom of parties to conclude
bargains which include mechanisms for the protection of commercial interests in
accordance with their risk appetites and without being constrained by the
requirement to prove financial loss.

In respect of the late payment fee charged by the bank, the majority found that
the costs of provisioning for losses, regulatory capital and collection were
legitimate interests of the bank. This justified the late payment fee. It was not
determinative that the late payment fee was disproportionate to the actual loss
suffered and did not represent a genuine pre-estimate of damages.

Whilst the decision is clear, the reasoning may give rise to further debate as the
High Court delivered five separate judgments which seek to reconcile the
decision in Paciocco with the previous authorities in relation to penalties,
including the seminal decision of Dunlop 2 , the High Court's own decision in
Andrews3 and the landmark decision of the UK Supreme Court in Cavendish v
Makdessi4 (a case in which Clifford Chance (London) acted).
The law on penalties in Australia and arose where there was a breach greatest conceivable loss that
the UK heralds from the same of contract; could be proved; and
seminal case – Dunlop. Accordingly,
a clause was unlikely to be a
the relevant time for assessment
the fundamentals of the legal doctrine penalty if it reflected a genuine of the loss was at the time of
have, for many years, been aligned. pre-estimate of the loss likely to entry into the contract, not at the
Historically: be suffered on breach; time of breach.

the question as to whether a
a clause was likely to be a In recent years, the law in the UK and
clause was a penalty (and, penalty if it was "extravagant" or Australia has diverged following the
therefore, unenforceable) only "exorbitant", having regard to the Australian High Court decision in
2 Update: The Law on Penalties

Andrews and the UK Supreme Court bank on late payment by its
the distinction drawn in Dunlop
decision in Cavendish. customers were penalties. It was between liquidated damages and
held that the amount imposed by the a penalty does not mean that if
Divergence in UK and relevant clause was extravagant in no pre-estimate is made at the
Australia relation to the likely loss, having time a contract is entered into a
regard to the minimal loss that was sum stipulated will be a penalty,
In the UK, the Court in Cavendish
actually sustained by the bank. nor does it mean that a sum
affirmed that the doctrine of penalties
8 reflecting, or attempting to reflect,
only arises upon breach of contract The Full Court of the Federal Court
other kinds of loss or damage to
(and in respect of secondary overturned this decision on the basis
a party's interests beyond those
obligations). that the appropriate analysis of loss
directly caused by the breach will
flowing from the breach or failure 11
However, the Court recast the be a penalty; and
should be performed at the time of
century-old test, which centred on
the question is whether a
entering into the contract, and not
"genuine pre-estimates of loss", in provision for the payment of a
having regard to the actual loss
favour of a test focused on whether a sum of money on default is out of
sustained. The Court endorsed the
clause is "proportionate", having all proportion to the interests of
view that both the potential direct and
regard to the innocent party's the party which it is the purpose
indirect losses that could be suffered
"legitimate interests" (financial or of the provision to protect. This
by the bank (the "maximum
otherwise) in enforcement of the interest may be of a business or
conceivable loss") could be 12
relevant underlying primary obligation. financial nature.
considered when determining the
This emphasised the narrow Gageler J considered that the
amount to charge upon late payment
application of the penalties doctrine in approach endorsed in Cavendish may
by its customers.
the UK. lead to the same result, but that the
Four of the five judges of the High inquiry should be framed in terms of
In addition, it held that a clause
Court in the decision delivered on 27 whether the stipulation in issue is
intended to "deter" a breach of
July 2016 upheld the decision of the properly characterised as having no
contract would not necessarily be a
Full Court. purpose other than to punish.
13
penalty clause (in contrast to a clause
5
intended to "punish" for a breach). Whilst each judge delivered separate
judgments, each majority judge
Implications
In contrast, in Australia, no breach of
considered the approach endorsed in Each of the approaches endorsed by
contract is required to engage the
Cavendish. Keane, Kiefel (French CJ agreeing)
penalties doctrine. This was
and Gageler JJ narrow the application
established in Andrews and was not Keane J found, citing Cavendish, that
of the penalties doctrine and give
disturbed in Paciocco (although in the question to be addressed in order
greater scope for parties to determine
Paciocco French CJ and Gageler J to distinguish a penalty from a
how to protect their commercial
each commented on the divergence provision that is protective of a
9 interests without the interference of
between the UK and Australia in this legitimate interest is:
6 the courts.
respect). As Paciocco involved a
"whether the sum or remedy
breach of contract, it was not Parties are no longer constrained to
stipulated as a consequence of a
necessary for the Court to address somewhat artificial assessments of
breach of contract is exorbitant or
this issue. the losses likely to be recoverable in
unconscionable when regard is
the event of breach or required to
Paciocco does, however, provide had to the innocent party's interest
refrain from drafting clauses that deter
further guidance in relation to the test in the performance of the
parties from breaching their
to be applied in Australia in contract."
obligations. Parties with a sufficient
determining whether a clause is penal.
Kiefel J (with whom French CJ agreed risk appetite can probably afford to be
Paciocco in relation to penalties) did not more aggressive in their negotiations
7
expressly endorse the approach in and drafting than they could
At first instance, the Federal Court 10
Cavendish but, generally consistent previously.
determined that fees imposed by the with that approach, found that:
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 Update: The Law on Penalties 3

Whilst parties may have greater

certainty that clauses will not be Contacts
struck down as penalties, the
separate reasoning of the members of Sydney Perth
the majority, and the fact that each
clause must be considered by Diana Chang Jon Carson
Partner Partner
reference to the circumstances in T: +61 2 8922 8003 T: +61 8 9262 5510
which it is to operate, still leaves room E: diana.chang@cliffordchance.com E: jon.carson@cliffordchance.com
for argument between parties. Tim Grave Jenni Hill
Partner Partner
T: +61 2 8922 8028 T: +61 8 9262 5582
E: tim.grave@cliffordchance.com E: jenni.hill@cliffordchance.com
1
Paciocco v Australia and New Zealand Nadia Kalic Tracey Renshaw
Banking Group Ltd [2016] HCA 28 Counsel Partner
2
Dunlop Pneumatic Tyre Co Ltd v New T: +61 2 8922 8095 T: +61 8 9262 5505
Garage & Motor Co Ltd [1914] UKHL 1 E: nadia.kalic@cliffordchance.com E: tracey.renshaw@cliffordchance.com
3
Andrews v Australia and New Zealand
Banking Group Ltd (2012) 247 CLR Daniel Moloney Shane Stewart
205 Senior associate Senior associate
4
Cavendish Square Holding BV v T: +61 2 8922 8006 T: +61 8 9262 5507
Makdessi; ParkingEye Limited v E: daniel.moloney@cliffordchance.com E: shane.stewart@cliffordchance.com
Beavis [2015] UKSC 67; [2016] 2 All London
ER 519
5
Cavendish at [32] per Lord Neuberger Julian Acratopulo
and Lord Sumption Partner
6
Paciocco at [7]-[10] per French CJ and T: +44 207006 8708
at [119]-[127] per Gageler J E: julian.acratopulo@cliffordchance.com
7
Paciocco v Australia and New Zealand
Banking Group Ltd [2014] FCA 35 Angela Morris
8
Paciocco v Australia and New Zealand Senior associate
Banking Group Ltd [2015] FCAFC 50; T: +44 207006 4238
236 FCR 199 E: angela.morris@cliffordchance.com
9
at [270]
10
Kiefel J refers to the test at [54]
11
at [30]
12
at [29]
13
at [166]

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