The recent decision of the Australia High Court in Andrews v. Australia and New Zealand Banking Group Ltd. is important for the building industry.  While it dealt with a banking contract, the principles it applied are directly relevant to building contracts. 

The central decision in Andrews v. ANZ is that the doctrine prohibiting contractual penalties applies both to conduct which is a breach of contract and conduct which is permitted under the contract.  But in its review of the whole history of the law of penalties, the court draws conclusions which are of much wider consequence.  The court explains that non-monetary consequences of a contract are included in the doctrine against penalties.  That conclusion could have a dramatic impact on building contracts.  The court also clarifies the difference between a “condition” in a contract and a “condition” in a bond, and decides that these words do not have the same meaning in both settings.  Since bonds are an essential element in building projects, this decision should be well understood by those engaged in those projects.

Factual Background

The decision in Andrews v. ANZ arose from a motion to strike out certain claims in a class action relating to banking contracts.  The contracts permitted, but did not require, the bank to impose certain fees if the customer undertook, or asked the bank to undertake, various transactions. The transactions included:

  • requesting the bank to consider a withdrawal or payment which would result in an overdraft in the account; or
  • requesting the bank to honour a transaction that resulted in an overdraft.

The transactions were not contrary to the banking contract.  The fees might be payable by the customer if the bank considered the requested transaction, even if the request was denied. 

In its motion to strike, the bank argued that the rule against penalties did not apply to these amounts on the ground that the rule against penalties did not apply when, as in this case, the triggering conduct was not a breach of contracts.  The Court of Appeal agreed.  The High Court reversed that decision, holding that the fact that these fees “were not charged by the respondent upon breach of contract by its customers and that the customers had no responsibility or obligation to avoid the occurrence of events upon which these fees were charged, do not render the fees incapable of characterisation as penalties.”

The High Court also held that the doctrine against penalties applies to non-monetary conduct.  The contract may state that a party will do something (the primary event) and then stipulate a further event if the primary event does not occur (the secondary obligation).  Neither event need be a monetary one for the doctrine against penalties to apply. Thus if the primary event is the transfer property, the doctrine can apply.  If the secondary event is the transfer of property, likewise the doctrine can apply.  In either situation, if the secondary event is totally disproportionate to the real consequences of the failure to perform the primary event, the secondary event can be examined to determine if it is really a penalty.  If it is, then it is unlawful.

 The Consequences of Andrews v. ANZ  for Building Contracts

There are four important consequences of the decision in Andrews v. ANZ.

1.      Doctrine Against Penalties applies to more than Breaches of Contract

The central conclusion in Andrews v. ANZ is, of itself, extremely important for the law relating to building contracts.  All the clauses in a building contract which provide for monetary payments should be closely examined to see if they impose unlawful penalties. Even those clauses which do not give rise to a breach of contract should be examined.  If those payments are out of line with the actual detriment arising from the relevant conduct, potentially they are penalties and unlawful, whether or not they are in relation to a breach of contract.

2.      Doctrine Against Penalties applies to Non-Monetary Conduct

According to Andrews v. ANZ, this principle applies to any provision in a contract, not just those which involve monetary payments.  In the context of building contracts, this approach could have a wide and uncertain application. What sort of non-monetary consequences fall within it?  If a bidder submits an erroneous bid (the primary event), could a court hold that disqualifying the bidder (the secondary event) is unlawful as a penalty if it is shown that the error in the bid caused little harm to the owner and the disqualification of the bidder is a disproportionate “penalty”?  If an owner gives a “cure notice” and then terminates the contract, could the termination amount to a penalty if it was disproportionate to the damage suffered by the owner?  It may seem ridiculous to include those examples within the doctrine against penalties, but it is difficult to draw a clear line between what non-monetary consequences fall within that doctrine in the construction setting.

3.      Doctrine Against Penalties may not apply to Additional Obligations

The High Court expressly recognized that there may be an exception to the penalty doctrine arising from what it called a consensual “additional obligation.”  The High Court said that if the amount which the party must pay (or other secondary event) as a consequence of the conduct in question is really the result of a new contract, then the penalty doctrine may not be engaged. 

Thus, the fee for the overdraft to the banking customer might be seen as really arising from a new contract and a new and additional privilege purchased by the customer.  Similarly, a distributor of films to a theatre owner might stipulate that the theatre owner would pay four times the original single-screening fee for extra showings of the film. The High Court said that those extra fees might amount to the purchase of additional privileges which fall outside the doctrine against penalties. It did not decide whether the banking fees in question fell within this exception and left that issue to the trial judge.

How would this exception apply to building contracts? If the building contract said that for every day of delay by a contractor, the contractor shall pay the owner $500,000, is that provision a penalty or an “additional obligation.”  If instead, the contract stated that if the contractor wished to extend the period of completion, then he may apply to the owner for permission to extend, and the parties agree that a new contract containing any such permission shall be made at a cost of $500,000 per day, would that be a penalty or an additional obligation?

4.      “Conditions” in Contracts and Bonds are Different

There is a further aspect of the decision in Andrews v. ANZ which is of interest to the building industry, and that is its discussion of “conditions” in contracts and bonds. The High Court pointed out that the word has an entirely different meaning in a contract than in a bond.

As the court said, in a contract the word “condition” refers to a term of the contract which is “vital, important or material.”  By using this word, the parties have agreed that the breach of this term amounts to a repudiation and permits the other party to accept the repudiation and terminate the contract.  In other words, in a contract conduct which does not comply with a “condition” is necessarily a breach of contract, and indeed a serious one.  

In a bond, however, the word “condition” performs another function.  Like a contract, the bond seeks to “secure performance of the condition, but instead of attempting to secure this result by exacting a promise from the obligor to perform the condition, there is an acknowledgment of indebtedness –in effect a promise.” In Roman and early English law, a bond might be payable in full, no matter what damages the obligee might really suffer. That result was later modified by equity, through decisions which evolved into the doctrine against penalties, to ensure that the payment under a bond could be no more than the real loss of the obligee. 

In addition, the High Court noted that the “condition in the bond may be any occurrence or event which need not be some act or omission of the obligor, analogous to a contractual promise by the obligor.” Moreover, the condition in the bond need not be the payment of money, and could relate to the transfer or vesting of interests in land. Indeed, “the cases do not establish any general proposition as to the contractual character of the condition in a bond.”

This discussion of bonds supported the High Court’s conclusion that the doctrine against penalties relates to conduct which does not necessarily amount to a breach of contract and to consequences that do not necessarily involve monetary payments.

In the result, the decision in Andrews v. ANZ provides a good review of the law of bonds and the use of the word “condition” in bonds.  That word designates a circumstance which is the basis for the obligation in the bond. That circumstance need not be a breach of a contract.  It can be whatever conduct the bond is intended to secure.  

Conclusion:

Andrew V. ANZ results in a sweeping application of the equitable doctrine against penalties. The decision holds that the doctrine applies to all contractual conduct, including both breaches and permitted conduct and both monetary and non-monetary consequences. Whether this approach will be followed in Canada is uncertain. As a matter of logic and principle, it makes sense.  But the decision raises challenges when applied to building contracts.  And it raises difficult questions about where the boundary line is between conduct which falls within the doctrine against penalties and conduct which does not.

See Heintzman and Goldsmith on Canadian Building Contracts (4th ed.) at Chapter 6, para 2(b)(i)(B) and Chapter 9

Andrews v. Australia and New Zealand Banking Group Ltd., [2012] HCA 30

Building Contracts  –  Bonds  –  Penalties  –  Damages  –  Remedies for Breach of Contract

Thomas G. Heintzman O.C., Q.C., FCIArb                                                                  October 20, 2012

www.heintzmanadr.com

www.constructionlawcanada.com