Penalties: UK's Supreme Court casts doubt on the High Court's reasoning23 March 2016
In yet another twist to the repercussions of the 2013 High Court decision Andrews v Australia and New Zealand Banking Group (Andrews), which threw the law of penalties into confusion, the United Kingdom Supreme Court (UKSC) has handed down a decision expressly disapproving Andrews.
Recap of the Andrews decision
In Andrews, the High Court was asked to decide whether a payment, in this case certain bank fees, could be a penalty in circumstances where there was no breach of contract. Importantly, the Court was not asked to decide whether the bank fees in question were, in fact, a penalty.
Ultimately, the Court held that a payment could be a penalty even if there was no breach of contract (see our previous article, What the Andrews decision means for your agency's agreements). In coming to this conclusion, it reversed its previous decisions and underlying reasoning on the issue, several recent Court of Appeal decisions and the generally accepted position in Australia. This new position was based on the Court's formulation of a threshold test for a penalty, which provided that:
"In general terms, a stipulation prima facie imposes a penalty on a party (the first party) if, as a matter of substance, it is collateral (or accessory) to a primary stipulation in favour of a second party and this collateral stipulation, upon the failure of the primary stipulation, imposes upon the first party an additional detriment, the penalty, to the benefit of the second party. In that sense, the collateral or accessory stipulation is described as being in the nature of a security for and in terrorem of the satisfaction of the primary stipulation."
In essence, the Court held there is a distinction between a collateral stipulation to secure the performance of a primary obligation, which is a penalty, and a payment in return for further services or accommodation, which is not a penalty. The decision creates great uncertainty because, although it provides a threshold test, it gives very little guidance on the criteria to be applied to determine whether a provision is in fact a penalty.
To confuse matters more, in Andrews the High Court also stated:
- the penalties doctrine is a matter of equity rather than contract
- the penalties doctrine is not engaged if the compensation to the beneficiary of the clause is not capable of assessment, and
- a penalty is not void or unenforceable, but is able to be enforced to the extent necessary to recover the loss actually suffered.
Each of these propositions are controversial and, due to the lack of guidance in the decision, creates a high degree of uncertainty in their application.
Additionally, the Andrews decision has led many to question the status of a number of commonly used commercial terms, including:
- take or pay clauses
- break fees
- termination for convenience payments
- performance-based incentives, such as loss of incentive payments for not delivering a project early
- compulsory transfer obligations
- additional interest rates for late payment indemnities, and
- time bars.
How the courts have applied Andrews
As business and the courts have grappled with the implications of the Andrews decision, the approach of most courts has been to recite the Andrews test of when a provision could be a penalty but then apply the previous law, with little analysis of whether the provisions in question actually meet the Andrews test.
What did the United Kingdom Supreme Court say about Andrews?
In its judgment in Cavendish Square Holding BV v Talal El Makdessi and ParkingEye Limited v Beavis UKSC 67 (Cavendish and ParkingEye), the United Kingdom Supreme Court considered the Andrews decision as part of its wider consideration of the doctrine of penalties applicability.
The UKSC did not agree with the decision in Andrews. This in itself does not mean that the High Court will revisit its decision, as there are numerous areas of law where Australia and England now diverge. However, the UKSC went further and questioned the correctness and underlying reasoning of the Andrews decision, including stating that:
- the decision was a "radical departure from the previous understanding of the law"
- the High Court's reasoning was not consistent with the equitable rule on which it is stated to be based
- there was no separate equitable jurisdiction for penalties since 1873, with three possible exceptions that are not applicable in these cases
- the High Court's redefinition of a penalty is difficult to apply to the case that it is directed, where there is no breach of contract, and
- the decision does not address the major legal and commercial implications of the decision's repercussions.
The UKSC summarised the impact of the decision, stating "potential assimilation of all of these to clauses imposing penal remedies for breach of contract would represent the expansion of the courts' supervisory jurisdiction into a new territory of uncertain boundaries, which has hitherto been treated as wholly governed by mutual agreement".
While the High Court is not bound by the UKSC, the UKSC's decisions have strong persuasive force. Further, given the explicit criticism of the High Court's underlying reasoning, when the next penalties case is decided by the High Court (expected to be early this year) it is likely to elicit a clear position and significant guidance.
We will keep you informed of developments in this area.