28/07/2015

Can a contract state what the damages will be if a party breaches the contract?  Will our courts enforce such a clause?

Bronnie Pty Ltd enters a contract with Chopper Services Pty Ltd relating to the hire of a helicopter.

The contract contains a so-called ‘agreed damages’ clause:

“If the Client

a)    does not timely pay any amount when due under this Agreement; or
b)    delivers written notice of cancellation at any time prior to the date of the Hire Date,

such cancellation or failure to pay shall constitute a cancellation by the Client and will immediately trigger Chopper Services right to recover as a debt all amounts outstanding under this Agreement, and to retain all monies received from the Client, as a cancellation fee.

The parties intend by this provision to agree in advance to the settlement of damages to Chopper Services that will arise from Client's cancellation.

The parties acknowledge that this Section provides for reasonable liquidated damages, and not a penalty, and bears a reasonable relation to the damages Chopper Services will sustain, which are uncertain and difficult to estimate at this time.

The relevant date for determining the timing of any notice under this Agreement is the Hire Date as stated on this Agreement even if the date of the Hire Date is changed at any time for any reason.”

Is an agreed damages clause such as this enforceable so that Bronnie loses the total hiring cost as a cancellation fee or as agreed damages?

Traditionally our courts do not allow parties to a contract to set penalties for breach if that penalty exceeds what a court might determine are fair damages.  To the extent that any required payment exceeds what is called a ‘genuine pre-estimate of loss’ it is a penalty that our courts won’t enforce.  The onus of proving the clause is a penalty rests on the defendant (in this case Bronnie Pty Ltd).

The function of an agreed damages clause is to overcome the need for the plaintiff to prove loss in a claim for damages. Unless the defendant denies breach, the clause fixes the amount recoverable by the plaintiff without the need for litigation.

Such clauses are basically enforceable.

The description of the parties in the contract as to whether the payment is liquidated damages or a penalty is not conclusive. The distinction is a question of law, not fact, and therefore the parties’ views are not relevant, though may be indicative.

Chopper Services may have some problems in enforcing the clause.

Chopper Services is claiming the whole amount of the contract and not the amount of any loss.  By claiming the whole contract amount Chopper Services is not allowing for its expenses saved as a result of Client’s cancellation.  Effectively they are saying that the whole of the contract sum is profit.

Chopper Services may need to prove that they have mitigated their loss by trying to find someone else to hire the helicopter in question on the Hire Date.  If Chopper Services can find a substitute then they’ve suffered no loss at all.

The commercial nature of the contract means that the NSW Contracts Review Act is not available to Bronnie.  Bronnie may be able to argue that the clause is unconscionable under the Australian Consumer Law ‘unconscionable conduct’ laws, notwithstanding the commercial nature of the contract.  Such an argument may depend on whether the amount is a penalty.  That is, if the amount is not a penalty then it is unlikely to be unconscionable. Even if it is not a penalty it may still be unconscionable, though the chances are not great.

Lessons to learn are that if you want to include an agreed damages clause in your contracts, you must do so very carefully and if you are asked to agree to such a clause, don‘t think that the clause is unlikely to be enforced: a well–drafted clause certainly may be.

For further information, please contact Townsends Business & Corporate Lawyers on (02) 8296 6222.