Penalty Clauses in Contracts – Are They Enforceable?

A penalty clause is a term in a contract that imposes a penalty on a party that breaches a contractual obligation. It is important to know that penalty clauses are generally unenforceable under Australian law. However, it can sometimes be difficult to distinguish penalty clauses from other similar clauses that are enforceable.

What is a Penalty Clause?

A contract term that states that one party has to pay an amount upon a breach of contract may be a penalty clause. Penalty clauses are designed to deter breaches of contract, regardless of the actual harm suffered by the non-breaching party. As such, penalty clauses are unenforceable because they are considered to be a form of punishment that imposes disproportionately high financial penalty on the breaching party. However, there are very similar clauses used in contracts, called “liquidated damages” clauses, which are enforceable.

A liquidated damages clause is an agreement that a party in breach will pay the other party an amount which is a reasonable estimate of what the breach will cost the non-breaching party. For a liquidated damages clause to be enforceable, it must be a “genuine pre-estimate”. This means that the amount cannot be random, even if it is agreed between the parties. There must be a genuine effort applied to calculating how much a certain breach would cost the non-breaching party.

Identifying Penalty Clauses

Unfortunately, it can be quite difficult to distinguish between a penalty clause and a liquidated damages clause. For instance, if a contract imposes a fee for late payment of an invoice, this clause could be an unenforceable penalty clause or, it could also reflect a genuine pre-estimate of damages. It is reasonable for a late fee to be set at the cost incurred to re-issue the invoice, as it is not intended to be a penalty.

Termination fees are another example worth considering. If a termination fee is set at an unreasonably high amount, then it is not a genuine pre-estimate of the non-breaching party’s actual losses resulting from the early termination. In that case it will be considered a penalty clause and will be unenforceable. On the other hand, if the termination fee represents a reasonable estimate of the non-breaching party’s actual losses (such as the costs of finding a replacement for the terminated contract), then it may be enforceable as a valid liquidated damages provision.

To determine whether a particular term is a penalty clause, the court will consider the nature of the breach, the amount of the penalty, and the relationship between the parties. It is important to note that whether a particular contractual provision is a penalty clause or not will depend on the specific circumstances of the case. As such, parties should carefully consider the potential risks and consequences of including such provisions in their contracts.

Considerations when Drafting Contracts

When drafting a contract in Australia, it is important to ensure that the purpose of a clause is not to punish or to deter a breach by imposing an artificially high fee. In addition, consideration should be given to whether it is necessary to impose a fee for a breach, when other alternatives (such as negotiation) might achieve the desired outcome. However, these concerns should not prevent a drafter from including proportionate and necessary liquidated damages clauses in a contract, as these clauses can be vital to protect businesses against genuine losses.

When drafting a liquidated damages clause, it is wise to document the consideration that was given to calculating the amount of damages that would flow from different types of breaches. Including this documentation in the contract (or associated documentation) means that the contracting parties have all had an opportunity to consider whether the amounts imposed would constitute a reasonable pre-estimate. This will make it more likely that the clause will be enforceable.

Conclusion

Penalty clauses are generally unenforceable as they are considered to be a form of penalty on the breaching party rather than a genuine pre-estimate of loss suffered by the non-breaching party. This, however, should not prevent the inclusion of proportionate liquidated damages clauses in contracts. In such cases, it is important that the clause seeking liquidated damages to deter a breach should not impose an artificially high fee or penalty.

The information in this article is general in nature and does not constitute professional advice. If you or someone you know wants more information or needs help or advice, please contact us on (08) 8155 5322 or email [email protected].

Making a Will if capacity is in question

It is well known that a Will is a legal document which sets out how a person wants their assets to be distributed once they die.

If you are over the age of 18 you can make a Will – provided you have capacity. 

In general terms, a person making a Will (a testator) has the necessary capacity if they:

• know what a Will is;
• know of the amount and type of property they are disposing of;
• understand the moral claims to which they should give effect when deciding to whom to leave their property; and
• are not delusional or suffering from a mental illness at the time they sign their Will.

Who decides on capacity?

It is not the role of a lawyer to be an expert in assessing the capacity of their client.

However, a lawyer can be involved in carrying out a “legal” assessment of the testator’s capacity.

If there is a question about someone’s mental capacity to make a Will, then an opinion, preferably in writing, should be obtained from that person’s treating doctor. The opinion should state that the person has the required testamentary capacity to make a Will.

When should the Will be signed?

It would be ideal if the doctor could be present when the testator signs the Will, and even better if the doctor is one of the two witnesses to the Will. In all likelihood, this will not usually be possible.

Where there is the likelihood of the Will being challenged on the testator’s death on the basis of a lack of capacity, it is important to obtain contemporaneous medical evidence from the testator’s treating doctor or in some cases a geriatrician confirming the testator has capacity. It is prudent for the doctor to conduct a medical examination to determine this and then provide a written report confirming their opinion.

We feel that the testator should on the same day provide instructions to the lawyer and sign the Will.

Having a medical report stating that, in the doctor’s opinion, the testator had capacity and then on the same day the person provided instructions and signed their Will, places the testator in a strong position so far as capacity is concerned.

Could the Will be challenged?

It is important to address the issue of capacity in some circumstances because a Will can be challenged on the grounds that the testator did not have sufficient capacity when signing the Will. This arises most frequently where the testator is ill, for example, in hospital, on medication or elderly and suffering from dementia.

It is difficult to set aside a Will on grounds that the testator lacked testamentary capacity if the Will is prepared by a competent lawyer who took appropriate instructions from the testator and was satisfied that he or she had the requisite testamentary capacity to make a Will.

How your lawyer can help

If you are worried because you know someone who wants to make a Will and may not have capacity or may be in the early stages of dementia, then it is prudent to encourage them to consult a lawyer who is experienced in preparing Wills, and to do this as soon as possible.

It is also prudent to ensure the lawyer is made aware of this potential difficulty because it may be necessary for the testator to first attend their doctor’s surgery for an appointment with the doctor being able to provide a satisfactory written report so it can be taken to the lawyer’s office ahead of the testator’s appointment but on the same day.

It is then a matter for the lawyer to be in a position to actually prepare the Will on the spot for checking and signing. Then the testator will have a Will that is dated the same day as a medical report saying they had capacity to understand the Will they signed.

As you can see there is a degree of planning that is needed, so speak to your lawyer to ensure that all the plans are worked out first.

If you or someone you know wants more information or needs help or advice, please contact us on (08) 8155 5322 or email [email protected].