Growthbuilt is a building company who had entered into 4 contracts with various developers for building projects in Surry Hills, Mosman, Balgowlah and Putney.
In turn, Growthbuilt entered into 4 subcontracts with Modern Touch so that they can manufacture, supply and install marble and granite stones for the building projects.
All 4 subcontract were in similar format with difference only in the payment terms, site address, date of commencement, liquidated damages etc
On 30 August 2016, GB terminated each of the subcontracts for the reason that Modern had failed to complete the subcontract works on time. Commencing by way of summons, GB sought to recover from Modern:
- Liquated damages under each of the 4 subcontracts from the date of completion specified in each subcontract to 30 August 2016 when the subcontracts were terminated
- Post-termination completion cost for them having to get another sub-contractor to do the works
- The cost of stone purchased for the Putney project which GB alleges Modern has wrongfully kept in their possession
On average, the liquidated damages clause under each contract were approx. $3,500 per calendar day.
Under each subcontract, Modern agreed to execute and complete the whole of the works diligently and expeditiously and to the satisfaction of GB. Clause 11 of each subcontract contained an important clause regarding extension of time and provided that the subcontractor can within 5 days of an act of prevention occurring (which was defined as an event or circumstance which results in actual delay to the works arising from an act of default of GB other than permitted under this subcontract, a breach of contract by GB or a variation direction) Modern can submit a claim for an extension of time for date for completion. GB retained absolute discretion whether to grant an extension of time, or whether to consider one at all.
Liquidated Damages Claim
In relation to GB’s liquidated damages claim, Modern raised a number of defences. One was that although the works had not been completed, they had not been completed due to GB’s fault. The other defence raised was that GB had in fact extended the time for completion which had the effect of reducing or extinguishing GB’s liquidated damages claim. The final defence raised was the application of the prevention principle. On this point, Modern sought to adduce evidence to demonstrate that Modern’s delays in completing the works by the date for completion were the result of GB’s acts or defaults. On the issue of prevention principle, the Court was asked to rule.
Prevention Principle
The essence of the prevention principle is that a party cannot require the other party to perform a contractual obligation if it itself has caused the other party’s non-performance (Spiers Earthworks Pty Ltd v Landtec Projects Corporation Pty Ltd [2012] WASCA).
In the context of construction contracts, the prevention principle may preclude the recovery of liquidated damages for delay caused by the principal contractor. An act of prevention in breach of contract by a principal which causes actual delay to the contractor will, in the absence of a contractual mechanism to grant an extension of time, have the effect of setting the time for performance of the contract ‘at large’ with no date from which liquidated damages can run (Probuild Constructions (Aust) Pty Ltd v DDI Group Pty Ltd NSWCA 2017).
The operation of the prevention principle can be modified or excluded by contract. The manner in which this is usually done is by a contractual extension of time regime (Probuild). If a contractor fails to exercise its right of extension of time where such a mechanism exists, may have the effect of negating the prevention principle from operating against the principal such that there will be no ‘at large’ operation of completion date. Whether that happens or not depends on the proper construction of the contract.
In this case, GB submitted that as Modern had not claimed any extension of time and had not pleaded it in the proceedings, any evidence by Modern contending that there were acts of prevention which caused delay was of no legal consequence and irrelevant.
GB relying on the statement of Cole J in Turner Corporation Ltd v Austotel Pty Ltd said that Modern could not rely on any preventing conduct as it had failed to exercise the contractual right to claim an extension of time that would negated the effect of that conduct. In Turner case, Cole J said:
If the builder, having a right to claim an extension of time fails to do so, it cannot claim that the act of prevention which would have entitled it to an extension of the time for practical completion resulted in its inability to complete by that time. A party to a contract cannot rely upon preventing conduct of the other party where it failed to exercise a contractual right which would have negated the affect of that preventing conduct.
Modern submitted that GB’s unilateral power in cl 11 of the subcontract to extend the dates for completion meant that the prevention principle remained an issue. In pleading this, Modern relied on the NSW CA decision in Probuild where an adjudicator’s decision to reject a set off claim for liquidated damages by a head contractor was being appealed. The NSW CA dismissed the head contractor’s appeal seeking to quash the adjudicator’s decision and considered the prevention principle.
In Probuild, the NSWCA considered a decision of Peninsula Balmain where Hodgson JA found that a principal was obliged to act honestly and fairly in deciding whether to exercise a discretionary power in a contract to grant an extension of time. This was a similar situation in the current subcontract between GB and Modern where GB retained absolute discretion whether to grant an extension of time or whether to consider granting an extension of time. The NSWCA in Probuild affirmed the decision of Peninsula on this regard and applied it in that case in the context of a clause which provided the head contractor with the discretionary power to extend time.
McColl JA concluded that Probuild was obliged to exercise the unilateral power to grant extensions honestly and fairly having regard to the underyling rationale of the prevention principle, or if necessary, because there was an implied duty of good faith in exercising the clause in question.
In addition to Probuild, Modern also referred to other cases where the Court had considered the obligation of reasonableness and good faith. Modern referred to the decision of Edelman J in Minister for Immigration and Border Protection v SZVFW (2018) where his honour observed that a contractual clause that empowers one party to act to the detriment of another has sometimes been construed as requiring the power holder to reach a decision reasonably and with fair dealing having regard to the interests of the parties and provision and purposes of the contract, objectively ascertained.
The Court in this case did not accept Modern’s submissions. It viewed the power as being described as ‘absolute discretion’ under cl 11 as excluding an obligation to act reasonably although his honour noted that there may be some room left for the obligation to act in good faith (Macquarie International Health Clinic v Sydney Local Health District 2020). The reason the Court was not persuaded by Modern’s submissions is because cl 11 of the subcontract expressly provided that GB had no obligation to extend, and had no obligation to consider whether to extend an extension of time. Although his honour notes that the obligation of good faith and to act reasonably can be implied as a matter of law as an incident of a particular type of commercial contract, the implication of such a term cannot be inconsistent with the express terms of the relevant agreement itself (Cordon Investments Pty Ltd v Lesdor Properties Pty Ltd [2012] NSWCA 184). His Honour found that there was no room for the imposition of an obligation to act in good faith on the part of GB where the express terms of cl 11 provided for no such obligation.
His Honour found that the language of ‘absolute discretion’ and ‘no obligation’ reflected a clear intention to confer a discretionary power to extend without any obligation being imposed on GB to exercise or to consider whether to exercise that power. His Honour found that the concept of the prevention principle is dealt with under cl 11 where Modern had a contractual right to seek an extension of time for completion through following the procedure set out under that clause. Such compliance would thus enable Modern to have new dates for completion in the event of default of an act of prevention by GB. This clause also made clear that if the procedure under it was not adhered to, Modern had no entitlement to an extension of time or to claim on or any right of action under law or in equity. They also make clear that GB had an absolute discretion to extend the date for completion for any reason but was under no obligation to exercise that discretion or even consider doing so, and provided for GB to be paid liquidated damages if Modern failed to complete the works by the completion date, subject to any adjustment for an extension of time. His Honour also said that the implication of terms sought by Modern were inconsistent with the express terms of the agreement where it provided that GB had no obligation to exercise or to consider exercising its contractual discretion.
In arriving that decision, his Honour stated that the terms referred to in ProBuild and Peninsula were different to the current case.
Is the liquidated damages provision of the Putney subcontract a penalty?
Modern contended that cl 12 providing for liquidated damages of $3,500 per day is unenforceable as a penalty.
The principles surrounding the doctrine of penalty were expounded by the HCA in Ringrow Pty Ltd v BP Australia where the Court accepted aspects of Lord Dunedin’s speech in Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd 1915 as expressing the law applicable in Australia.
The HCA also followed this in Andrews v Australia and New Zealand Banking Group Ltd. The essence of that speech are as follows:
- The essence of a penalty is a payment of money stipulated as in terrorem (in intimidation) of the offending party; the essence of liquidated damages is a genuine covenanted pre-estimate of damage
- The question whether something is penalty or liquidated damages is a question of construction to be decided upon the terms and inherent circumstances of each particular contract, judged of as at the time of making the contract, not as at the time of the breach
- To assist this task of construction various tests have been suggested, which if applicable to the case under consideration may prove helpful or even conclusive. Such are:
a) It will be held to be a penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be provided to have followed from the breach
b) It will be held a penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid
c) There is a presumption (but no more) that it is a penalty when ‘a single lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others trifling damage
The NSW CA in Arab Bank Australia Ltd v Sayde Developments, referred to the HCA case in Paciocco v Australia and New Zealand Banking Group where the Court summarised the propositions as follows:
- Lord Dunedine’s propositions were not ‘rules of law’ but ‘distillations of principle’.
- The essence of a penalty is that it is a collateral stipulation, the purpose (or predominant purpose) of which is to punish the borrower for breach and thus compel performance
- One way of testing whether the impugned stipulation is penal – intended to punish – is to inquire whether the sum that it stipulates to be payable on breach is to ask whether the stipulated sum is extravagant or out of all proportion to, or unconscionable in comparison with, the maximum amount of damage that might be anticipated to follow from breach.
- Damage in this sense is not limited to damages recoverable upon breach of contract, but may extend to damage, or losses, caused by the impairment of other legitimate commercial interests that were intended to be protected by the stipulation.
- The analysis is prospective, not retrospective, in the sense that it is to be made at the time and taking into account the circumstances, when the contract was made.
- Mere disproportion between the stipulated sum and the possible damage is not enough to indicate penalty; the disproportion must be such that it is unconscionable for the lender to rely on the stipulation.
The Court also referred to Murphy JA dissenting judgement in Spiers Earthworks where his Honour said: ‘in considering the question of whether a provision operates as a penalty, regard may be had to whether the provision stipulates for the payment of a rate over time, so that the total payment increases as the inconvenience caused to the innocent party by the defaulting party increases. In the absence of circumstances indicating to the contrary, a provision of that nature will ordinarily not, prima facie, be a penalty (Williamson v Murdoch (1912) 14 WALR).
The Court then had to consider whether as contended by Modern, a Jones v Dunkel inference was available to be drawn for the failure of GB to call into evidence one of the directors of GB to give evidence about one of the contracts. In discussing the principle, the Court said that the drawing of inference based on the principles of Jones v Dunkel, enables the Court to give greater significance to an already existing evidence against a party in circumstances where that party fails to adduce evidence to the contrary. However, the inference cannot be employed to fill gaps in the evidence (Manly Council v Byrne [2004] NSWCA).
In discussing the liquidated damages clause, the Court noted that Modern had agreed that the amount of liquidated damages was a genuine pre-estimate of GB’s damages. While such an agreement is not conclusive, it is not irrelevant. The Court refers to the judgement of McDougall J in Arab Bank where his honour said that the doctrine of freedom of contract remains important when considering penalty provisions.
In Ringrow, the HCA said: ‘exceptions from that freedom of contract require good reason to attract judicial intervention to set aside the bargains which the parties of full capacity have agreed. This is why the law on penalties is, and is expressed to be, an exception from the general rule. It is why it is expressed in exceptional language. It explains why the propounded penalty must be judged ‘extravagant and unconscionable in amount’. It is not enough that it should be lacking in proportion. It must be ‘out of all proportion’.
In the end the Court said that the burden of establishing that the sum stipulated under cl 12 should be characterised as ‘extravagent, out of all proportion or unconscionable’ compared to the greatest loss which may be suffered by GB rested with Modern but they had failed to discharge that onus.
