Liquidated damages update following Ringrow v BP

General principles

As a general rule, the amount recoverable as damages for breach of contract is the sum, so far as money can do, that will place the innocent party in the position as if the breach had not occurred.  Proving the amount of loss in the event of a breach can sometimes be difficult and time consuming.

The law allows the parties to fix the sum payable for specified breaches at the time of contracting.  This is often the case for delay in completion under construction contracts.  The sum so specified is known as liquidated damages.  The benefit of having liquidated damages is that that innocent party does not have to prove the amount of the loss.  It will generally require the application of a formula, for example $2000 per day for 68 days.

In fixing that sum, the law is not prepared to allow an unmerited windfall:

  • The sum stipulated as liquidated damages will be unenforceable as being a penalty:
  • If the sum is found to be ‘in terrorem’ (intended to frighten or intimidate) the offending party; and/

or

  • If the sum is extravagant and unconscionable in comparison with the greatest loss that could conceivably be proved to have followed from the breach.
  • The sum stipulated as liquidated damages will be enforceable if it is a genuine pre-estimate of the likely loss resulting from the breach.

The law pre-Ringrow

Up until the Ringrow case, the focus on parties challenging the application of liquidated damages tended to be based on the specified liquidated damages not being a genuine pre-estimate of the loss likely to be suffered for breach – so that a comparison would take place between  that which would likely be payable and the amount specified as liquidated damages.  If the specified liquidated damages was more, the offending party would argue that it was a penalty.  That derives from a passage in the judgment in Dunlop Pneumatic Tyre Company v New Garage [1915] AC 79 that ‘the essence of liquidated damages is a genuine covenanted pre-estimate of damage’.

That often led to the offending party embarking upon a minute examination of the circumstances upon which the figure was derived.  A good example of this was in Leighton Contractors v State of Tasmania where the relevant facts were:

  • the State contracted with Leightons to construct a highway;
  • the contract provided for liquidated damages of $8000/day for delay in completion and Leightons were in considerable delay;
  • Leightons alleged that the liquidated damages were unenforceable as being a penalty, in particular that

the calculation made by the State at the time of contracting of $7,985/day made excessive allowances for the cost of its site representatives in the event of delay (which worked out at $330,000 to $430,000 a year) and that some of the figures were speculative; and

  • the trial judge, in striking the liquidated damages down as being a penalty found that there had not been a genuine pre-estimate.

The law post-Ringrow

The Tasmanian Court of Appeal overturned the trial judge’s decision (just after the Ringrow decision was handed down) on the basis that Leightons had elevated material obtained through discovery and cross examination as to a calculation of the $8000/day into the central issue and diverted the trial judge from the proper application of principle.  In particular:

  • Quantification of the impact of the delay in construction of a highway to a State would be problematic.
  • The figure of $8000/day was not arbitrarily chosen and the integrity of the person who compiled or reviewed the calculations was not impugned at trial.
  • There was other relevant evidence as to the loss likely to be suffered that was relevant to that calculation that was not afforded sufficient weight.
  • The trial judge was not engaged in an assessment of the past loss or an award of damages after the event.  The question was whether, given the nature of the contract, its complexity, value and bargaining strength of the parties, the amount of $8000/day was, in all the circumstances, a penalty as at the date of the agreement.  The test was objective as of that date.  The test was whether the sum was so disproportionate that it provided not for ‘liquidated damages’ but operated as a penalty which placed the then contracting party in terrorem.

The focus on ‘genuine pre-estimate’ was seemingly put to bed by the decision in Ringrow v BP Australia (2005) 224 CLR 656 where the High Court made it clear that:

  • the parties were not to embark upon this minute examination but to make a determination whether the sum stipulated was out of all proportion to the likely loss and again reverting to the critical proposition that an agreed sum is a penalty if (and only if) it is extravagant, exorbitant or unconscionable; and
  • as a result, mere difference between the amount that would be recoverable as liquidated damages and the amount of liquidated damages specified is not enough, let alone a suspicion of a difference.  The comparison calls for something extravagant and unconscionable. It calls for a degree of disproportion sufficient to point to oppressiveness.

It appeared to follow from the Ringrow v BP decision that it is not worthwhile challenging liquidated damages as being a penalty except in the most extreme cases.

Speirs Earthworks v Landtec [2012] WASCA 53

The decision by the Western Australian Court of Appeal last week in Speirs Earthworks Pty Ltd v Landtec Projects Corporation Pty Ltd [No2] [2012] WASCA 53 has breathed life into liquidated damages challenges.

In that case the majority of the Supreme Court was prepared to find a liquidated damages clause unenforceable as a penalty, after examining the developer’s conduct subsequent to entering into the contract.  One of the three justices disagreed and his reasons are quite compelling. The relevant facts in that case were as follows:

  • A developer had Shire Approval to develop land, stage 1 of which was to sub-divide his land into some

32 lots, subject to either upgrading a road into the sub-division or providing a bond to the Shire for the upgrade.  No lots could be sold until the Shire issued a clearance certificate to the effect that both the lots had been created and the road upgraded.

  • He let a contract using the AS2124-1986 conditions to a contractor to carry out the land sub-division (but not the road upgrade) with a date for practical completion of 6 May 2005 and liquidated damages of $13,846/week for late completion.  The developer intended to deal with the road upgrade after entering into the contract for the sub-division.
  • The contractor was late in completing the works by some months and liquidated damages were applied.
  • The contractor claimed that the liquidated damages were unenforceable as being a penalty, arguing that the road upgrade had not been carried out and no loss had been suffered.
  • In deciding on a figure for liquidated damages the developer had calculated that 32 lots would be sold at approximately $225,000 to $250,000 each and upon applying the bank interest rate it would cost him $13,896 per week if the works were delayed.
  • The contractor argued that the developer could not incur interest costs on sales due to delay in the sub- division works as the lots could not be sold without the road upgrade having first taken place.

View of the majority

McLure P, with whom Newnes JA agreed, examined the evidence and in particular found:

  • that the council had imposed the condition with respect to the road upgrade;
  • as at the date of entry into the contract the developer had not taken any steps towards securing the road upgrade;
  • after entering into the contract, the developer sought to defer the requirement of the road upgrade by providing a bond (usually given in only extreme circumstances); and
  • ultimately, the developer decided to upgrade the road when carrying out the next stage of the subdivision, some two months after the completion of stage 1.

The majority of the Court were of the view that the inference was there to be drawn that as at the date of the first contract the developer had no intention of attempting to achieve compliance with or deferral of

the relevant Shire condition as to the road upgrade, in fact had only intended to have that work done some time later.  As a result the delay in performance of the first contract was incapable of causing any relevant financial loss to the developer and therefore the liquidated damages were extravagant in amount in comparison with the greatest loss that could potentially be suffered by delaying practical completion under the first contract.

Murphy JA dissented, his reasoning being in my opinion compelling, relevantly that:

  • the contractor did not prove that the developer had no capacity to pay a bond;
  • nor did it prove that it was unlikely or even at a serious risk that the developer would not have reached an arrangement to complete the road upgrade within a reasonable period prior to the date of completion of the works by the contractor;
  • even if there was no bond provided to the Shire it was reasonable to infer that the satisfaction of the requirement to complete the road upgrade would likely be impeded by the then evident delays in completion of the first contract; and
  • as a result, the stipulated weekly sum was not shown to be grossly disproportionate to the amount which was likely to be recoverable for damages by the developer by reason of the resultant delays.

A point accepted by the whole of the Court of Appeal was that the determination as to whether the sum is extravagant or unconscionable is to be made at the time of entry into the contract.  As at the date of entry into the contract, matters relating to potential breach involve a prospective assessment  necessarily speculative in nature.

In my view, the majority of the Court of Appeal was unduly influenced by events subsequent to the entry into of the contract and had too much regard to the developer’s subjective intent.  Objectively, what developer would willingly delay carrying out a road upgrade when it was always going to cost him some

$13,846 per week during the period of delay?  I struggle to see how such sum was more than ‘the greatest loss’ that could conceivably be proved to have followed from the breach.  Unfortunately for the developer, its principal was somewhat clumsy in his evidence as to when he was intending to carry out the road upgrade, a matter his counsel could not get him to cure in re-examination.

Summary

The principle as to liquidated damages illustrated in BP v Ringrow is that, mere difference between the amount that would be recoverable as liquidated damages (ie the genuine pre-estimate) and the amount of liquidated damages specified is not enough, let alone a suspicion of a difference.  The comparison calls for something extravagant and unconscionable.  It calls for a degree of disproportion sufficient to point to oppressiveness.

The point to be taken from the Speirs case is that in preparing the genuine pre-estimate, it must be more likely than not, or at least a distinct possibility, that the events upon which it is based, will come about.