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Law of Penalties Reviewed By Paul Anderson | March 2006

In the recent High Court Decision of Ringrow Pty Limited v BP Australia Pty Limited, the High Court has had occasion to consider the operation of the law of penalties. The decision has implications beyond the scope of the immediate facts.

Facts On 27 May 1999, Ringrow Pty Limited (“Ringrow”) entered a Contract with BP Australia Pty Limited (“BP”) to buy a BP Service Station. Ringrow, or persons connected with the company, had operated a service station on the site as franchisee since 1988. On completion of the contract, the parties entered into two related transactions - an Option Deed and a Privately Owned Sites Agreement (“POSA”). A term of the POSA was that Ringrow would only purchase fuel from BP. The Option Deed only applied if the POSA “was terminated” but in such an event BP was granted an irrevocable option to purchase the service station at its market valuation as an operational service station as determined by an independent valuer. However, Clause 25.2 of the Option Deed provided that the valuer was “not to include in the determination of the market valuation any allowance for goodwill” attached to the business. The POSA had a term of five years and allowed for Liquidated Damages in the event of breach reflecting the expected return to BP under the POSA over that 5 year period of $289,531.00. The Agreement provided that if the POSA was terminated in the first year, the sum of $289,531.00 would be payable; if in the second year, 80% of that sum and so on. At various times in 2002 Ringrow purchased fuel from a supplier other than BP. This was a breach of the POSA and BP gave notice of termination of the POSA, followed by a notice of exercise of the option to purchase the service station. Ringrow argued that the option was void and unenforceable as a penalty. At first instance, Ringrow failed in the Federal Court and unsuccessfully appealed to the Full Court of the Federal Court. Ringrow then appealed to the High Court.

Legal Background A contractual provision requiring payment of liquidated damages in the event of default is acceptable if the liquidated damages specified are a genuine pre-estimate of damage likely to be suffered. Otherwise the provision may be void as imposing a penalty. The leading decision on penalties is the 1915 House of Lords decision of Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd. Both parties and the High Court accepted that this decision was a correct statement of the law.



The House of Lords as per Lord Dunedin established the following principles: • •

The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine covenanted pre-estimate of damage. The question whether a sum stipulated is a penalty or liquidated damages is a question of construction to be decided upon the terms and inherent circumstances of each particular contract, judged of as at the time of the making of the contract, not as at the time of the breach. To assist this task of construction, various tests have been suggested, which if applicable to the case under consideration, may prove helpful or even conclusive. Such are: (a)

(b) (c)

It will be held to be a penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach. It will be held to be a penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid. There is a presumption (but no more) that it is a penalty when ‘a single lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage’.

Ringrow’s Arguments Ringrow argued that there were three “penal factors” in the contractual arrangements reached by the parties: 1 2 3

The exclusion of goodwill from the resale price, even though Ringrow had paid on entry a price expressly calculated as including such goodwill. The cumulative impact of the option upon the liability to pay liquidated damages. “The indiscriminate factor”, i.e. the right to exercise the option was unrelated to the extent or gravity of any contractual default by Ringrow.

Exclusion of Goodwill from Sale Price The expert witness called by BP gave evidence to the effect that sources of goodwill other than location in relation to the particular service station were of insignificant value. The trial judge accepted this evidence. The result was that even though Ringrow had paid for goodwill on entry and was not entitled to be paid for goodwill on sale, it was not possible to say what, if any, money sum it had lost. A difference was not sufficient. In the words of Lord Dunedin, the difference had to be “extravagant or unconscionable” or the degree of disproportion had to be sufficient to prove oppressiveness. Ringrow had argued that there must be proportionality between the impugned provision and the legitimate commercial interest of the party relying upon it. If there is a manifest disproportion, the stipulation is presumptively a penalty. The High Court held that no such doctrine of proportionality existed. Instead, the Court confirmed the test proposed by Lord Dunedin, i.e. the propounded penalty, must be judged “extravagant or unconscionable”.



Cumulative Imposition of Option on Liquidated Damages In essence, Ringrow argued that there would be a penalty if BP repurchased the service station following exercise of the option and also claimed Liquidated Damages (as defined). However, BP pointed to SC1.2(e) of the POSA which provided that if BP had exercised it rights under the Option Deed, then Liquidated Damages would not be payable. Ringrow countered that BP could claim Liquidated Damages and then exercise the option, giving rise to a “double” remedy. The Court held that since there was no evidence of the value of any goodwill it could not be said that the cumulative impact of the option on the Liquidated Damages claim was oppressive or “extravagant or unconscionable.”

The Indiscriminate Factor The Court agreed that the option could be exercised after termination of the POSA for mere technical breaches. However, this was only one factor to be considered. It did not demonstrate that the disparity between what BP was to receive on retransfer of the service station and a genuine pre-estimate of damage was so great as to trigger the penalty doctrine. In the result the appeal was dismissed and the High Court confirmed existing principles to determine that the option was enforceable.

Conclusion The Court confirmed the traditional approach to penalties and emphasised the parties’ right to freedom of contract. The decision provides certainty to this area of the law and also provides valuable insights as to how the doctrine operates in practice. The decision provides a useful guide for the construction and interpretation of liquidated damages clauses and also has implications for franchisors and franchisees.

For more information please contact:

Paul Anderson Partner T: 02 8257 5742

Sydney | Level 29, Angel Place, 123 Pitt Street, Sydney, NSW 2000 | T: 02 8257 5700 | F: 02 9239 0922 Melbourne | Level 11 | 350 Collins Street , Melbourne, VIC 3000 | T: 03 8600 5000 | F: 03 8600 5099

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Law of Penalties Reviewed