Dear all,
I hope everyone on the list is well and safe. I came across a new case on the doctrine of penalties in New Zealand in the wake of
Cavendish in the UK and
Paciocco in Australia. The case is
127 Hobson Street Ltd v Honey Bees Preschool Limited [2020] NZSC 53, involving a dispute over an indemnity for a promise to install a lift for a childcare centre. (A link to the
whole decision is here:
https://www.courtsofnz.govt.nz/assets/cases/SC-40-2019-127-Hobson-St-v-Honey-Bees-v2.pdf).
The nub of the NZSC’s decision is at [56]:
“A clause stipulating a consequence for breach of a term of the contract will be an unenforceable penalty if the consequence is out of all proportion to the legitimate interests of the innocent party in performance of the primary obligation.
When we refer in this judgment to legitimate interests in performance, that includes an interest in enforcing performance or some appropriate alternative to performance. A consequence will be out of all proportion if the consequence can fairly be described
as exorbitant when compared with those legitimate interests.“
The court goes onto say at [57] that Cavendish and Paciocco are persuasive to the extent that they suggest that the distinction cannot just be between penalties and liquidated damages: a more flexible and permissive test is needed that takes
into account other legitimate interests of the contracting parties. They end the discussion by saying, “If the impugned clause provides a consequence for breach of a primary obligation in proportion to the legitimate interests of the innocent party in performance
of that obligation, we see no good policy reason why it should not be enforced.”
At [58], they reject the argument of the NZCA in the lower proceedings that the court should also check whether the purpose of the clause is to punishment, because this requires an undesirable inquiry into the state of mind of the party.
At [59] to [66] they provide a useful discussion of what exactly a ‘legitimate interest’ in performance of the contract is. They got on to discuss in detail and adopt list member Jessica Palmer’s views on the matter (Congratulations Jessica! - always so
pleasing to see).
The court also engages in a detailed discussion of inequality of bargaining power and how it is relevant to penalties. At [89] and [90] they describe the relevance as follows:
“However, the bargaining power of the parties will be relevant to the courts’ inquiry as to the nature and extent of the innocent party’s interests in performance of the primary obligation. A court will presume that commercial parties dealing with each
other on equal terms are able to assess the appropriate proportion between the legitimate interests in performance of the primary obligation and the consequence of breach agreed to. The fact that a party was legally advised as to the nature and effect of the
transaction will also weigh in favour of upholding the bargain. But, even where there is equal bargaining power and the parties are legally advised, a court may find on the facts that the consequences provided by the impugned clause are disproportionate to
the legitimate interests.
On the other hand, where there is evidence of unequal bargaining power, or where one party is not legally advised, a court will scrutinise more closely the innocent party’s claims as to the interests protected, and also the issue of proportionality. However,
even where there is an imbalance of negotiating strength to the point that the breaching party had no ability to negotiate different contractual terms, the innocent party may still be able to show that the challenged provision protected a legitimate interest
in the performance of the primary obligation. The inequality of bargaining position simply means that the court will look closely at the claimed legitimate interest, whereas where the parties have negotiated from equal positions, the starting position is rather
different, as noted above.“
I found this case to be a welcome discussion of some of the matters which still remained outstanding after
Cavendish and Paciocco, namely what a legitimate interest in the performance of the contract is, and how inequality of bargaining power may be relevant, but the doctrine differs from unconscionable conduct or duress etc.
Kind regards,
Katy