At a time where lots of parties are looking at their contracts to see if they are in breach, a recent judgment found that deprivation of accrued rights under a contract may amount to a penalty and therefore be unenforceable. This has big implications for commercial contracts of all kinds.
It's important to draft contracts in a way that clearly sets out the terms of your commercial agreement. It's also important that these terms are legally binding.
While the courts will consider the intention of the contracting parties, there are still some rules about what kinds of terms parties can and can't agree to, and you need to be aware of these when you're contracting.
For example, an agreement to agree may be unenforceable if the terms aren't certain enough. An unfair contract term that causes a significant imbalance in the parties' rights and obligations may also be unenforceable. Specifically, contractual terms that operate as a "penalty" will be unenforceable.
A penalty is a term that imposes a harsh monetary punishment on a breaching party – but according to the NSW Court of Appeal in Kay v Playup Australia Pty Ltd  NSWCA 33 a penalty now also includes the deprivation of accrued contractual rights.
In this case the purchaser under a share sale and purchase contract failed to make a payment by the due date.
The contract provided that this default would "immediately void ab initio (from the beginning)" all the restraints and warranties in the contract that benefited the purchaser.
But the court said that depriving the purchaser of these essential accrued contractual rights was so far out of proportion with the seller's right to get paid on a particular date, that the clause operated as a penalty and was therefore unenforceable.
So, even though commercial parties negotiate at arm's length, it's really important to keep an eye out for those unintended penalty provisions. Bargaining too hard can leave you with nothing, which is a lousy result and one you want to avoid.
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