Discussed in State of Tasmania v Leighton Contractors Pty Ltd [2005] TASSC 33

The Full Court of the Supreme Court of Tasmania has upheld an appeal by the State of Tasmania against the first instance decision of the then Chief Justice Cox in the State’s multi-million dollar dispute with Leighton Contractors.

In November 2004, Cox CJ ruled that the liquidated damages imposed under a construction contract between the parties were a penalty and therefore unenforceable. The State was ordered to repay Leighton nearly $2.5 million which had been withheld pursuant to the liquidated damages clause.

The State appealed and, shortly before Christmas last year, the Full Court overturned the decision, ruling in favour of the State.

Important principles for Commonwealth agencies:

In determining liquidated damages for delay, agencies may take account:

The value of the loss of public infrastructure.

Their need to be accountable for the expenditure of public monies.

The liquidated damages must be reasonable and in proportion to the consequences of the delay, but do not need to be a pure mathematical calculation of financial loss.

They must not be arbitrary, extravagant or unconscionable.

The dispute

The dispute arose out of a contract between the parties under which Leighton was to design, construct and maintain a section of highway.

The liquidated damages clause in the construction contract provided that Leighton had to pay the State $8,000 for every day that the project was late. The clause also contained the usual statement that the amount was ‘a genuine pre-estimate’ of the damages the State would incur as a result of the delay.

Leighton failed to finish construction in time and the State withheld from Leighton $8,000 per day for a period of about seven months.

The trial judge’s decision

At first instance, Cox CJ made the following general points on the enforceability of obligations to pay liquidated damages:

  • Whether the words ‘penalty’ or 'liquidated damages’ are used is not conclusive.
  • The essence of liquidated damages is a genuine covenanted pre-estimate of damage.
  • The question of whether a sum is a penalty or represents liquidated damages is one of construction to be decided upon the terms and inherent circumstances of each particular contract, judged at the time of the making of the contract, not at the time of the breach.

His Honour went on to consider the various tests which may assist courts to determine whether an obligation to pay liquidated damages should be enforced, including:

  • If it is virtually impossible to pre-estimate the damage arising from the breach, it is more probable that the agreed amount was a true bargain between the parties and not a penalty.
  • A sum which is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach will be a penalty.
  • If a single lump sum is payable on the occurrence of one or more or all of several breaches, some of which may cause serious but others minimal damage, a presumption arises that the sum is a penalty.

The Full Court’s decision

The Full Court agreed with Cox CJ’s enunciation of the relevant principles but held that his Honour had not applied these principles in a manner consistent with the evidence.

In reaching its decision, the Full Court highlighted the importance of the following factors (in addition to those mentioned by Cox CJ):

  • The relative bargaining power of the parties when they entered into the contract. The more unequal the respective positions of the parties, (assuming the customer was in the stronger position) the greater likelihood that the courts will find that the sum was a penalty.
  • Whether a party was subject to unreasonable pressure in performing the contract.
  • The method used to calculate the sum.

In reversing Cox CJ’s application of the above principles to the facts of the case, the Full Court held:
  • The sum of $8,000 was not chosen arbitrarily (Interestingly, the Full Court noted that Leighton had not questioned the State’s calculations of the sum during negotiations or when the contract was finalised).
  • The value of the loss of use of the public utility (the road) or delays in access to infrastructure were relevant considerations and should have been considered.
  • Even if the State was entitled to seek reimbursement of the costs of the delay from the Commonwealth (which was funding the construction), the State still had a responsibility to be accountable for how the public money was spent. As a diligent financial manager, the State was entitled to require reasonable compensation for delay.
  • ‘The test of disproportionality [between the damages and the possible loss] applies equally to public and private institutions in consideration of whether a ‘breach’ clause ought to be regarded as a penalty.’ [para 38]

The decision of the Full Court confirms that, generally speaking, the key to drafting an enforceable liquidated damages clause is to ensure that the damages reflect a logical calculation of the loss likely to be caused by the specific breach.

It is not yet known whether Leighton will seek leave to appeal the decision.

The Full Court judgment can be accessed online at http://www.austlii.edu.au/au/cases/tas/supreme_ct/2005/33.html

This publication is intended as a first point of reference and should not be relied on as a substitute for professional advice. Specialist legal advice should always be sought in relation to any particular circumstances and no liability will be accepted for any losses incurred by those relying solely on this publication.