BAUM 317020 Abolition Of Penalties BARNETT Private Law Theory LAWS50036 Legal Research

THE DOCTRINE OF PENALTIES: A CASE FOR ABOLITION
NICHOLAS BAUM
I
Introduction...........................................................................................................................5

II
The Doctrine of Penalties ...................................................................................................7

A
What is the general rule in relation to penalties? ..................................................7

B
Must the penalty be for a breach of contract? ......................................................8

C
Can the penalty be non-monetary?.........................................................................9

D
Must the penalty be unconscionable?.....................................................................9

E
What if the penalty is a genuine pre-estimate of damages?...............................10

F
What if the penalty is actually a payment?...........................................................11

G
What are the consequences of finding a penalty?...............................................11

III
The History and Purpose of the Doctrine......................................................................13

A
What is the history of the doctrine of penalties?................................................13

1
The equitable jurisdiction ...................................................................................13

2
The common law jurisdiction............................................................................14

3
Significance of history.........................................................................................15

(a)
Adaptive, not restrictive..............................................................................15

(b)
Hegemony of contract.................................................................................16

B
What is the purpose of the doctrine of penalties?..............................................17

1
Prohibition on punishment................................................................................17

2
Prevention of perverse incentives.....................................................................18

3
Protection of efficient breach............................................................................19

4
Presumed inequity in bargaining .......................................................................19

IV
Andrews v ANZ .................................................................................................................20

A
What did it change?.................................................................................................20

1
Interstar v Integral...............................................................................................20

(a)
Brereton J ......................................................................................................20

(b)
Allsop P .........................................................................................................21

2
Andrews v ANZ ..................................................................................................22

(a)
Gordon J........................................................................................................22

(b)
The High Court............................................................................................23

B
Why was the change necessary? ............................................................................24

C
What further problems remain? ............................................................................24

1
Imitating conditional bonds...............................................................................24

2
Penalties as a payment for services ...................................................................25

D
What is the significance of the change? ...............................................................25

Private Law Theory 317020
V
The Case for Abolition......................................................................................................27

A
The application of the peppercorn principle.......................................................27

1
Differences in consideration are key to market exchange.............................28

2
Lawyers are not experts at determining the wisdom of bargains.................29

3
Questioning the penalty creates excess litigation............................................29

4
Questioning the penalty creates legal uncertainty...........................................31

5
There are other protections available ...............................................................31

6
The common law respects the autonomy of parties to contract..................31

B
Law and economics.................................................................................................33

1
Signaling commitment to performance............................................................33

2
Offsetting failures in risky markets...................................................................33

3
Protecting against undetectable breaches.........................................................33

4
Allocating risk.......................................................................................................34

5
Intangible harm....................................................................................................35

C
Limited liability clauses: reverse penalties............................................................37

VI
Consequences of Abolition...............................................................................................38

D
Available alternative protections ...........................................................................38

1
Other equitable doctrines...................................................................................38

2
Legislative protections.........................................................................................39

E
Law reform options.................................................................................................40

VII
Conclusion...........................................................................................................................43

Bibliography ................................................................................................................................44

A
Articles/Books/Reports.........................................................................................44

B
Cases..........................................................................................................................46

C
Legislation.................................................................................................................47

THE DOCTRINE OF PENALTIES: A CASE FOR ABOLITION
NICHOLAS BAUM*
The High Court decision in Andrews, which recognized an expanded understanding
of the circumstances in which the doctrine of penalties is available, has somewhat
ironically reopened the debate on the abolition of that very doctrine. This article
examines the historical background in which the rule arose, the justification for the
rule, and the effect of the decision in Andrews. It argues that the doctrine has
outlived the purpose for which it was intended, and that it should now be abolished.
Finally, it explores the alternate judicial powers available that more appropriately
address the unfairness of penalties in certain circumstances.
I INTRODUCTION
In the recent High Court decision in Andrews,1
the scope of the doctrine of penalties
has been expanded beyond what has traditionally been understood as a key limitation of
its applicability, the requirement that the penalty be payable on breach of contract.
While the unanimous decision attempts to provide a clarified test for penalties, in reality
it has placed parties in the murky territory of judicial discretion. This broader form of
the doctrine, relying in part on the jurisdiction of ancient Roman and medieval English
courts, could potentially render unenforceable an expanded range of consensual
contractual arrangements.
This article will argue that the High Court, although correct in a technical legal
sense, has ignored the practical consequences of an expanded doctrine of penalties. The
manner in which the existing doctrine was being evaded, and the issue of substance and
form that this created, could instead have been resolved by the abolition of the doctrine
altogether. The reasons for the continued observance of an outdated doctrine invented
* BA (Melb), Juris Doctor candidate (University of Melbourne).
1
Andrews v Australia and New Zealand Banking Group Ltd (2012) 290 ALR 595 (‘Andrews’).

6 The Doctrine of Penalties: A Case for Abolition
by the courts of chancery in the fourteenth century no longer hold true. The freedom of
consenting parties to enter into commercial arrangements allocating risks and remedies
should instead be respected. Existing common law, equitable and legislative rules
provide sufficient protection for parties unfairly exposed to penalty payments.

II The Doctrine of Penalties 7
LAWS50039 Legal Research
II THE DOCTRINE OF PENALTIES
A What is the general rule in relation to penalties?
The doctrine of penalties is a general law rule that prevents parties to a contract
from enforcing a term that punishes a party who has failed to uphold their end of the
bargain. Ordinarily, where a party breaches a contract, the other party may bring an
action against them to recover compensation for any damage that they have suffered as
a result of the breach. Parties may include as a clause of the contract self-help remedies
to enable them to seek such damages without having to go to court, either by reference
to an agreed sum or an agreed formula. These are known as liquidated damages clauses.2
However, where such clauses go beyond replicating the common law remedy, courts
label them ‘penalties’, and will not enforce them. The classic formulation of the
difference between a legitimate remedial clause and an illegitimate one was by Lord
Dunedin in Dunlop Pneumatic:
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 the damage. 3
This formulation has been endorsed as representing the law of Australia.4
Prior to
the recent High Court decision in Andrews, it had, in nearly 100 years of litigation,
developed only a little. In Legione v Hateley, the High Court described a penalty as ‘a
punishment for non-observance of a contractual stipulation [that] consists of the
2
C J Rossiter, Penalties and Forfeiture, (The Law Book Company Limited, 1992) preface, vi.
3
Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79, 86 [2] (Lord
Dunedin) (‘Dunlop Pneumatic’).
4
Ringrow Pty Ltd and Ors v BP Australia Pty Ltd (2005) 224 CLR 656, 662 [11] (Gleeson CJ,
Gummow, Kirby, Hayne, Callinan & Heydon JJ) (‘Ringrow’).

imposition of an additional or different liability upon breach.’5
This was echoed some
two decades later by the same court in Ringrow:
The law of penalties … is attracted where a contract stipulates that on breach the
contract-breaker will pay an agreed sum which exceeds what can be regarded as a
genuine pre-estimate of the damage likely to be caused by the breach.6
To some extent foreshadowing the controversial extension of the doctrine that they
were about to undertake, the unanimous High Court in Andrews defined the concept in
more general language, avoiding references to ‘breach’:
[A] stipulation prima facie imposes a penalty on a party … if, as a matter of
substance, it is collateral (or accessory) to a primary stipulation in favour of a
second party and this collateral stipulation, upon the failure of the primary
stipulation, imposes upon the first party an additional detriment, the penalty, to the
benefit of the second party.7
B Must the penalty be for a breach of contract?
Historically, the doctrine only applied to a payment due for a breach of contract,
and this was held by Allsop P to be the state of the law in Interstar:
The intermediate appellate authorities in Australia, the persuasive view of a
unanimous House of Lords, existing High Court authority and other views
expressed in the High Court … [limit] the application of the doctrine of penalties to
circumstances of breach of contract. If a wider doctrine is to be enunciated … it is
for the High Court of Australia to enunciate it.8
5
Legione v Hateley (1983) 152 CLR 406, 445 (Mason & Deane JJ).
6
Ringrow (2005) 224 CLR 656, 662 [10] (Gleeson CJ, Gummow, Kirby, Hayne, Callinan & Heydon
JJ).
7
Andrews (2012) 290 ALR 595, 598 [10] (French CJ, Gummow, Crennan, Kiefel & Bell JJ).
8
Interstar Wholesale Finance Pty Ltd v Integral Home Loans Pty Ltd (2008) 257 ALR 292, 321 [106]
(Allsop P) (‘Interstar’).

In Andrews, the court did just that, holding that the doctrine was not so limited, and
explicitly rejecting both the decision Gordon J at first instance, and the Court of Appeal
in Interstar.9
The significance of this decision is considered below.
C Can the penalty be non-monetary?
There appears to have been some doubt as to whether the doctrine of penalties
would apply to non-monetary clauses, such as clauses requiring the transfer of
property.10
However, in Ringrow, the High Court accepted existing authority that the
doctrine ‘applies not only to cases where money is payable but also to cases where
money’s worth (including property) is transferable on a particular event.’11
The doctrine
also extends to circumstances in which non-breaching party may retain money or
property that they would otherwise be required to return to the party in breach.12
D Must the penalty be unconscionable?
It has now been accepted in Australia that the doctrine of penalties is a ‘purely
mechanical test’ 13
that affords no judicial discretion to consider whether the
enforcement of the penalty would be unconscionable in all the circumstances. In PC
Developments, Meagher J considered competing authorities on this issue, and held that the
first view, that the test simply involved considering only whether ‘the provision sought
to be impugned does or does not exceed the loss or damage which the innocent party
9
Andrews (2012) 290 ALR 595, 607 [50] 613 [78].
10
See Jobson v Johnson [1989] 1 WLR 1026.
11
JJ).
12
Interstar (2008) 257 ALR 292, 321 [104] (Allsop P); Ringrow Pty Ltd and Ors v BP Australia Pty
Ltd (2003) 203 ALR 281 (Hely J).
13
PC Developments Pty Ltd v Revell (1991) 22 NSWLR 615, 650-1 (Meagher J) (‘PC
Developments’).

could obtain if he sued for damages by breach of contract’, was the traditional view and
the one supported by greater authority.14
E What if the penalty is a genuine pre-estimate of damages?
Courts, in order to allow parties to include self-help remedies in their contracts and
thus avoid costly litigation, have created an ‘exception’ to the rule. In Dunlop Pneumatic,
Lord Dunedin said that in determining whether a stipulation is in fact a penalty, it may
be ‘helpful, or even conclusive’ if:
[T]he stipulated for amount is extravagant and unconscionable in amount in
comparison with the greatest loss that could conceivably be proved to have
followed from the breach.15
This element of the test has over time developed into a distinction between
unenforceable penalties on the one hand, and genuine pre-estimates of damages of the
other.16
Subsequent cases have adopted as a necessary component of the doctrine that a
‘mere difference is not enough,’17
and that it calls for a ‘degree of disproportion’ that
indicates oppression.18
Both Ringrow and Andrews confirmed that a genuine pre-estimate
of liquidated damages will not be penalty.19
This requirement acts as a safeguard,
protecting parties where damages may in fact have been difficult to measure at the time
of contracting.
14
PC Developments (1991) 22 NSWLR 615, 650-1 (Meagher J).
15
Dunlop Pneumatic [1915] AC 79, 86 [4] (Lord Dunedin).
16
Austin v United Dominions Corporation Ltd [1984] 2 NSWLR 612, 626 (Priestley JA)
17
JJ).
18
AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170, 193 (Mason & Wilson JJ).
19
Ringrow (2005) 224 CLR 656, 662 [11]-[12] (Gleeson CJ, Gummow, Kirby, Hayne, Callinan &
Heydon JJ); Andrews (2012) 290 ALR 595, 599 [15] (French CJ, Gummow, Crennan, Kiefel & Bell
JJ).

F What if the penalty is actually a payment?
Where the true construction of the contract is that the penalty is in fact the payment
for a right to do or not do an act, rather than a punishment, that stipulation will not be
a penalty.20
This ‘exception’ to the rule articulated in the New South Wales Court of
Appeal in Metro-Goldwyn-Mayer,21
characterizes the breach of the initial obligation as an
option, and the penalty as a payment for exercising that option.22
In Andrews, the High
Court confirmed this was available, hinting that it was an argument that could be
applied to the fees charged by the bank, although leaving the matter open to further
consideration at trial.23
G What are the consequences of finding a penalty?
While the questions of whether clauses deemed to be penalties were immediately
void, and whether there was any discretion left to the courts to choose to enforce them,
was until recently described as ‘the subject of continuing debate,’24
in Citicorp, Priestley
JA explained that:
20
French v Macale (1842) 2 Drury and Warren 269, 275 (Lord St Leonards).
21
Metro-Goldwyn-Mayer Pty Ltd v Greenham [1966] 2 SR(NSW) 717 (‘Metro-Goldwyn-Mayer’).
22
Ibid 727.
23
Andrews (2012) 290 ALR 595, 613-4, [79] – [83] (French CJ, Gummow, Crennan, Kiefel & Bell
JJ).
24

Although the origin of the present law was the relief available in equity to restrain
the enforcement of a penalty at common law […] any discretionary element in the
granting of the equitable relief against the enforcement of the penalty vanished. […]
[I]f the stipulations are penalties they are so at the same moment as the contract is
formed; agreement and enforceability are simultaneous.25
This question has not been resolved by the High Court. In AMEV-UDC, Mason &
Wilson JJ rejected the appellant’s argument that a penalty clause should be enforced to
the extent to which it was not a penalty, while leaving open the question as to whether a
penalty clause could impose a limit on common law damages.26
In Integral, Brereton J at
first instance considered AMEV-UDC conclusive on this point,27
but the High Court
statement of principle in Andrews, while not considering the issue in detail, seemed to
suggest otherwise.28
25
Citicorp Australia Ltd v Hendry (1985) 4 NSWLR 1, 39-40 (Priestley JA); cited with approval in
26
AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170, 191-3 (Mason & Wilson JJ).
27
Integral Home Loans Pty Ltd and Anor v Interstar Wholesale Finance Pty Ltd and Anor [2007]
NSWSC 406, [8], [82] (Brereton J).
28

III The History and Purpose of the Doctrine 13
III THE HISTORY AND PURPOSE OF THE DOCTRINE
A What is the history of the doctrine of penalties?
1 The equitable jurisdiction
Prior to the evolution of the modern law of contract, the principle legal device for
the enforcement of promises was the conditional bond, with a defeasance clause that
was subject to a condition.29
This form of common law bond, an agreement to pay a
principal sum of money by a certain date, or a greater sum at a later date, was initially
designed to avoid the ecclesiastical prohibition on usury (the charging of interest).30
Such bonds, when enforcing promises, were in the following form:
A agrees to pay B the sum of $100, unless A builds a house for B.
The purpose of the bond was to secure the performance of the condition, the
building of the house.31
If the obligee fulfilled the condition, the performance of the
bond was discharged. If the condition was not fulfilled, the bond was a debt liable to
paid, irrespective of the damage suffered.32
This was an extremely rigid way to enforce
promises, as anything but strict adherence to the condition would mean payment of the
debt. As Plucknett explains, the covenant (the predecessor to the contract) was a far less
developed legal instrument, which was more difficult to prove, more difficult to sue
upon, and far riskier than a deed under seal.33
29
D J Ibbetson, A Historical Introduction to the Law of Obligations, (Oxford University Press, 1999),
30.
30
J Baker, Sources of English Legal History (Oxford University Press, 2nd
edition, 2010).
31
S Williston, A Treatise on the Law of Contracts, (Thomson Reuters, 4th
ed, 2000) Volume 3, 80.
32
W H Loyd, ‘Penalties and Forfeitures’ (1915) 29 Harvard Law Review 117.
33
T F T Plucknett, A Concise History of the Common Law (Little, Brown & Co, 1956), 634 – 636.

As a result of this rigidity, equity developed a jurisdiction to intervene in such
matters, injuncting the payment of the penalty on the condition that the obligee pay
damages instead.34
In 1309, Chief Justice Beresford said:
What equity would it be to award you the debt when the document is tendered and
when you cannot show that you have been damaged by this detention? Moreover
this is not properly a debt but a penalty; and with what equity (look you) can you
demand this penalty?35
For a bond conditional on the payment of a principal sum of money, relief would be
granted where the bond exceeded the principal plus interest and costs. Where the bond
was conditional on the performance of another obligation, relief would only be granted
where there was some clear disproportion between the bond and the damages that
would be assessed if the matter was remitted to a common law court.36
Equity paid no
attention to whether the bond was expressed in language of obligation and breach, or
condition and defeasance.37
2 The common law jurisdiction
At the end of the seventeenth century, the jurisdiction to relieve from penalties was
brought into the common law by two statutes. The first, the Statute of William III 1696,38
gave the common law courts the power, having awarded judgment for payment of the
penalty, to stay enforcement if the defendant paid into court damages assessed by
34
Andrews v Australia and New Zealand Banking Group Ltd (2011) 288 ALR 611, [11]-[13]
(‘Andrews (first instance)’).
35
Y.BB. Edward II (Selden Society), ii. pp. xiii, 59, cited in T F T Plucknett, A Concise History of the
Common Law (Little, Brown & Co, 1956), 677.
36
W Newland, ‘Equitable relief against penalties’, (2011) 85 Australian Law Journal 434, 440 – 441.
37
Andrews (first instance) (2011) 288 ALR 611, [13] – [15].
38
Statute of William 1696, 8 & 9 Will 3 c 11.

reference to the alleged breach. The second, the Statute of Anne 1705,39
allowed the
defendant to plead payment of damages as a full defence to enforcement of the bond.40
These statutes were procedural steps that removed the need to bring an expensive suit
in equity following a trial at common law.41
The jurisdiction of both the common law and equity courts to relieve from penalties
was received in Australia in 1828,42
and with the introduction of the judicature system
from 1873 – 1972, the equitable jurisdiction to relieve from penalties was said to have
‘withered on the vine.’43
The historical development of the doctrine to this point was
explored carefully and methodically in Andrews at first instance.44
Gordon J ultimately
found that, despite the jurisdiction’s apparent availability to relieve penalty on breach of
a condition at its inception, this jurisdiction was no longer available.45
3 Significance of history
(a) Adaptive, not restrictive
As applied in relation to conditional bonds, the doctrine operated not within the
intent of restricting the freedom of parties, but rather adapting the operation of a legal
device that was ill-suited to enforcing promises to better reflect what the parties were
trying to achieve. Ordinary contracts were a wholly unsatisfactory way of securing the
performance of obligations in the future. Atiyah argues that the idea that a party might
39
Statute of Anne 1705, 4 & 5 Anne c 16.
40
Andrews (first instance) (2011) 288 ALR 611, 618 – 621 [18] – [25].
41
The modern equivalent sections remain in force in Victoria by virtue of the Instruments Act 1958
(Vic) s 30.
42
Andrews (2012) 290 ALR 595, 610 [61] – [63].
43
AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170.
44
Andrews (first instance) (2011) 288 ALR 611, 616 – 626 (Gordon J).
45
Ibid 636 – 637.

be bound simply by an exchange of promises was, the eyes of an eighteenth century
lawyer, ‘a very strange idea.’46
Conditional bonds were a clumsy form of contract, which
operated strictly, and overly harshly. Parties sought to enforce promises this way not
because it was convenient, but because of the certainty that a bond gave in the event
that a promise was not kept.
Where the courts of equity determined that the intention of the parties was to create
a legally enforceable promise, they were able to adapt the remedial component of the
bond. This context is very different from the modern age, where the doctrine of
penalties is no longer adapting an instrument poorly structured to enforce promises, but
rather restricting the content of those promises.
(b) Hegemony of contract
The jurisdiction was in substance developed in what is relatively close to its modern
form prior to the development of a modern law of contract centered on principles of
autonomy and commercial exchange. Atiyah characterizes the period from 1770 to 1870
as critical to developing the law of contracts as we understand them, and identifies two
key underlying principles: contracts were based upon the economic model of a free
market transaction, and were primarily an instrument for planning future economic
conduct.47
Courts in the nineteenth and twentieth centuries have struggled with the
inherent tension between what they see as this conceptual basis for enforcing contract,
and the conceptual basis for the doctrine of penalties.48
The High Court in Andrews warned that laissez-faire notions of contract were no
longer to be viewed as an all-important consideration, in light of the modern restrictions
46
P S Atiyah, The Rise and Fall of Freedom of Contract (Clarendon Press, 1979), 195.
47
Ibid 681.
48
Ibid 414 – 5.

on contract.49
Yet such notions remain critical to an understanding of modern contract
law.
B What is the purpose of the doctrine of penalties?
In Robophone, Lord Diplock described the doctrine as a ‘rule of public policy,’ and
whilst admitting that the rule was difficult to rationalize, felt that it had a role to play ‘in
these days when so often one party cannot satisfy his contractual hunger a la carte but
only at the table d’hote of a standard printed contract.’50
Lord Roskill in a later English
case suggested that the main purpose of the rule was ‘to prevent a plaintiff recovering a
sum of money in respect of a breach of contract …which bears little or not relationship
to the loss actually suffered,’ before going on to warn that ‘it is not and has never been
for the courts to relieve a party from the consequences of … an onerous or possibly
even a commercially imprudent bargain.’51
Little of the jurisprudence on penalties is
devoted to explaining the underlying reasons behind this public policy, in part because it
is difficult to identify with precision. The following are possible justifications for the
existing rule.
1 Prohibition on punishment
The primary aim of the modern doctrine appears to be to prevent parties from
punishing one another for breach of contract. In Robertson, Lord Young observed that
courts will not allow a penalty ‘because the law will not let people punish each other.’52
49
Andrews (2012) 290 ALR 595, 597 [5].
50
Robophone Facilities Ltd v Blank [1966] 1 WLR 1428, 1446 (Lord Diplock).
51
Credits Guarantee Department v Universal Oil Products Co [1983] 1 WLR 399, 403 (Lord
Roskill).
52
Robertson v Driver's Trs (1881) 8 R 555, 562 (Lord Young).

The Scottish Law Commission describes this principle as underlying the common law
approach to penalties,53
and the US Restatement on Contracts describes the basis of the
jurisdiction as to prevent ‘unjust’ punishment.54
While Posner points out there is a key
difference between the imposition of punitive damages by a court, and the award of a
punitive sum agreed to by the parties,55
the reluctance of courts to punish remains a
common theme.
2 Prevention of perverse incentives
A more subtle concern that the doctrine addresses is the creation of perverse
incentives for parties stand to benefit if the contract falls apart, who might be ‘[induced]
to provoke a breach’ in order to profit.56
Waddams notes that the real objection of the
courts is where parties seek to ‘[obtain] an unexpected windfall from a clause that was
secondary to the main purpose of the contract.’
Such an incentive arguably runs counter to the spirit of consensual agreement,
especially given the limited acceptance of an implied requirement to act in good faith in
Australian law.57
If one party stood to gain if the other party defaults on the contract,
this would lead to them encouraging and inviting breach rather than continued
performance.
53
Scottish Law Commission, Discussion Paper on Penalty Clauses, Discussion Paper No 103 (1997)
4 [1.8], 40 [5.20].
54
American Law Institute, Restatement of the Law of Contracts (1932) 339(1)(a).
55
R Posner, Economic Analysis of Law (Aspen Publishers, 7th
ed, 2007), 128.
56
Ibid.
57
See Burger King Corporation v Hungry Jack's (2001) 69 NSWLR 558.

3 Protection of efficient breach
Law and economics scholars argue that the ability to breach a contract when
continuing performance would be unprofitable is an important attribute of common
law contracting.58
The principles of compensation for breach of contract are designed
to create a situation in which parties either choose to perform the contract or pay
damages,59
with a deliberate incentive where the contract has become inefficient to
breach, compensate the other party, and reallocate resources to a more profitable
pursuit.60
A penalty clause, which induces performance in this scenario, therefore
causes parties to continue an inefficient contract, causing a misallocation of resources in
the market.
4 Presumed inequity in bargaining
Finally, as Goetz & Scott point out, the doctrine operates in part of a presumption
that there was something wrong with the bargain struck between the parties.61
This
‘rule-of-thumb’ approach acts to protect disadvantaged parties from having to pay
onerous penalties, without having to go through the difficult legal exercise of showing
that their consent to the contract was flawed. Provided that such a rule does not impose
to severe a burden on contracting generally, this artificial presumption is more beneficial
to these parties than it is harmful to society more broadly.
58
ed, 2007), 127 – 128.
59
Oliver Wendell Holmes, ‘The Path of the Law’ (1897) 10 Harvard Law Review 457, 462.
60
H R Hartzler, ‘The Business and Economic Functions of the Law of Contract Damages’ (1968) 6
American Business Law Journal 387, 388 – 97.
61
C J Goetz & R E Scott, ‘Liquidated Damages, Penalties and the Just Compensation Principle: Some
Notes on an Enforcement Model and a Theory of Efficient Breach’ (1977) 77(4) Columbia Law
Review 554, 556.

IV ANDREWS V ANZ
A What did it change?
The issue of whether the doctrine of penalties is available to relieve a party from
payment of a penalty payable for non-fulfillment of a condition, rather than breach of
an undertaking, was considered by the New South Wales Supreme Court, Federal Court
and High Court in Interstar and Andrews.
1 Interstar
In Interstar, Interstar were able to terminate the agreement if certain conditions were
not fulfilled. A failure of these conditions did not amount to a breach of contract. If
Interstar did choose to terminate, Integral were no longer entitled to receive certain
fees.62
Integral terminated the contract, and Interstar claimed that the clause removing
their right to receive certain fees was void as a penalty.63
(a) Brereton J
Interstar argued at first instance that the doctrine of penalties was limited to
circumstances in which penalty was payable on breach of contract, and as there had
been no breach of contract here, the clause could not be considered a penalty.64
Brereton J rejected this. He held that equity, having regard to substance rather than
62
Interstar (2008) 257 ALR 292, 316 [79] – [85] (Allsop P).
63
Ibid 314 [68].
64
NSWSC 406, [72] – [77] (Brereton J).

IV Andrews v ANZ 21
form, would not deny relief solely because the penalty related to the performance of a
condition rather than a promise.65
He stated:
If [the authorities limiting the doctrine to breach] were correct, the doctrine of
penalties could always be evaded by the drafting of lists of event of default upon
which termination was authorized and payment of a wholly disproportionate sum
was exigible, without including a contractual promise that those events would not
occur.66
In coming to this decision, he relied in particular on the judgment of Deane J in
AMEV-UDC,67
and of Lord Denning in Bridge v Campbell Discount Co Ltd.68
(b) Allsop P
On appeal, Allsop P conducted a detailed review of the English and Australian
appellate decisions on the doctrine,69
before concluding that it was not open to either
Brereton J or the Court of Appeal to apply the doctrine to a penalty that did not arise
from a breach of contract. He was critical of Brereton J’s use of legal authority,70
and
indicated that his decision was ‘underpinned … by a respect for the bargains of
parties.’71
At 324, he stated:
65
Integral Home Loans Pty Ltd v Interstar Wholesale Finance Pty Ltd [2007] NSWSC 406, [73]
(Brereton J).
66
Ibid.
67
AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170.
68
Bridge v Campbell Discount Co Ltd [1962] AC 600 (Lord Denning).
69
Interstar (2008) 257 ALR 292, 321 – 330, [105] – [138] (Allsop P).
70
Ibid 326, [117].
71
Ibid 334, [159].

[The] expression of view of the House of Lords is a powerful statement as to the
limits of the doctrine of penalties as arising from the consequences of breach of
contract, as to the public policy of keeping commercial parties to their bargains, and
consequently in keeping a doctrine having the consequences of voidness or
unenforceability of terms bargained for within strict and clearly identifiable limits.72
Integral successfully sought special leave to appeal this decision in the High Court,73
but the matter settled before it could be heard.74
In Andrews, the High Court indicated
that the Court of Appeal in Interstar had ‘misunderstood the scope of the penalty
doctrine.’75
2 Andrews
In Andrews, a class action was brought against the ANZ Bank claiming that various
fees known as ‘exception fees’ were void as penalties. The bank conceded that these
fees, charged for various transactions such as overdrawing an account, were not
determined by reference to a sum which would have constituted a genuine pre-estimate
of the damage the ANZ might suffer.76
(a) Gordon J
At first instance, Gordon J comprehensively explained the history and development
of the doctrine of penalties, before concluding that the established authority in
Australia,77
the established authority in the rest of the common law world,78
and ‘the
72
Interstar (2008) 257 ALR 292, 324 [112] (Allsop P).
73
Integral Home Loans Pty Ltd v Interstar Wholesale Financial Pty Ltd [2009] HCATrans 87.
74
Integral Home Loans Pty Ltd v Interstar Wholesale Financial Pty Ltd [2009] HCATrans 166.
75
76
Andrews (first instance) (2011) 288 ALR 611, 615 [3] (Gordon J); Andrews (2012) 290 ALR 595,
601 [26] (French CJ, Gummow, Crennan, Kiefel & Bell JJ).
77
Andrews (first instance) (2011) 288 ALR 611, 631 [59] (Gordon J).

IV Andrews v ANZ 23
importance and rising significance of freedom of contract since the 19th
century,’79
bound her to hold that the doctrine only applied to penalties payable upon breach.80
She
warned against applying the ‘wide dispensing power of the Court of Chancery’ in the
context of two centuries of the primacy of freedom of contract, except in certain,
narrowly established fields.81
The High Court later indicated that Gordon J had acted
‘quite properly’ in following the authority in Interstar.82
This decision was appealed to the Full Court, and the question of whether the
exception fees were capable of constituting a penalty was removed directly to the High
Court.
(b) The High Court
In a unanimous decision, the High Court accepted the submissions of the class
action that the doctrine of penalties was a rule of equity, that survived to the present
day (despite the description of Mason & Wilson JJ in AMEV-UDC that the equitable
jurisdiction had withered on the vine),83
which was not limited by reference to breach of
contract. They described the issue of substance over form as a ‘significant
consideration,’84
and pointed out that, to the extent the common law jurisdiction to
relieve from penalties may be limited to breach, under the Judicature Acts equity
prevails.85
78
Andrews (first instance) (2011) 288 ALR 611, 632 [60] (Gordon J).
79
Ibid 635 [73].
80
Ibid 636 [77].
81
Ibid 636 [78].
82
83
Ibid 611 [68].
84
Ibid 607 [49].
85
Ibid 610 [63].

B Why was the change necessary?
As identified in all of the decisions considered above, there was an inherent tension
in limiting the doctrine of penalties to breach, between protecting freedom of contract
on the one hand, and making a mockery of the law on the other. It is relatively simply
for parties, as happened in Interstar, to draft contracts in terms of ‘events of default’,
which parties have no obligation to avoid, but which give rise to rights of termination
and payment of certain penalties when they do occur. Allowing parties to do this simply
to avoid the application of the doctrine of penalties would be absurd, prioritizing one
way of writing a contract over another when the substance of each was the same.
C What further problems remain?
On the other hand, there remains the capacity to draft to avoid the doctrine, or at
least make if difficult for the doctrine to apply.
1 Imitating conditional bonds
The High Court’s framework for evaluating the application of the doctrine requires
courts to identify the relevant primary and secondary stipulations ‘as a matter of
substance.’86
Unhelpfully, they do not give a great deal of guidance for doing this.
Clever drafting may allow parties to avoid the doctrine by stating the penalty as the
primary stipulation, and the obligation that they wish to enforce as the secondary
obligation. So, rather than:
B agrees to build A a house by the end of the year. If B does not build A a house by
the end of the year, B must pay A $100.
86
Andrews (2012) 290 ALR 592, 597 [10].

IV Andrews v ANZ 25
A contract could instead be framed:
B agrees to pay A $100 at the end of the year. If B builds A a house by the end of
the year, B does not have to pay A $100.
This would replicate the historical structure of conditional bonds. While the High
Court’s focus on the substance of the transaction may still allow them the ability to
relieve from this obligation, it necessarily requires them to find that, despite the words
of the contract, the actual intent of the parties was for B to build A a house by the end
of the year.
2 Penalties as a payment for services
As considered above, the Metro-Goldwyn-Mayer ‘exception’ to the doctrine allows
penalties where they are characterized not as a payment in terrorem, but a fee for an
additional service.87
Again, taking the above example, consider the following:
B agrees to build A a house by the end of the year. B may elect to take longer than a
year to build A a house if B pays A $100.
The broad expression of the test in Andrews would allow courts to hold such a
clause unenforceable as a disguised penalty, but only where convinced, in substance,
that this was in fact a collateral payment in terrorem rather than a genuine fee.
D What is the significance of the change?
Andrews is significant when considering the doctrine of penalties as a whole because
it removes what was an important protection on the ability of parties to bargain, and
opens a veritable Pandora’s box of potential applications.
87
Metro-Goldwyn-Mayer [1966] 2 SR(NSW) 717, Andrews (2012) 290 ALR 592, 613 – 614.

Courts with an eye to respecting the ability of parties to bargain had, in limiting the
rule to breach of contract, effectively given commercial parties a loophole in which to
structure contracts containing penalties, by using a simple but effective drafting
technique. Allsop P and Gordon J were explicit in pointing to this protection as a
reason for so limiting the doctrine.88
While this undoubtedly raised a substance over
form issue, it also represented a neat compromise between the desire of the courts to
exercise a supervisory jurisdiction, and the desire of parties to have their agreements
respected. This is no longer available.
Further, while simple contracts of exchange will fall outside the doctrine, any
contract that contemplates multiple alternate events will have to consider whether these
events are more or less onerous than the others, and if so, whether there is a risk that a
court would characterize them as collateral to the less onerous options. This represents
a significant imposition, both on the substance of what parties can choose to agree to,
and on the legal costs associated with negotiating a contract.89
88
Interstar (2008) 257 ALR 292, Andrews (first instance) (2011) 288 ALR 611.
89
For specific examples of contracts that may fall within the expanded scope of the doctrine, with
reference to the building and construction industry, see P Easton, ‘Penalties percolating through the
construction industry: Andrews v Australia and New Zealand Banking Group Ltd’ (2013) 29 Building
and Construction Law Journal 233, 242 – 246.

V The Case for Abolition 27
V THE CASE FOR ABOLITION
A The application of the peppercorn principle
Ordinarily, courts do not consider the adequacy of consideration (whether the
consideration is of equal value) in judging whether a particular bargain is enforceable.
This is known as the peppercorn principle.90
Kirby P (as he then was) described the
justification for this at length in Woolworths.91
The six reasons, in summary, are:
(i) In the marketplace, different participants put different values on the
bargain they are getting – that is the point of exchange, so that both
parties are mutually better off. It is impossible for law to evaluate
whether promises are equivalent;
(ii) Judges are lawyers, cases are conducted by lawyers, and while lawyers
have the special training to answer legal questions, they do not have the
expertise to determine the wisdom of the bargain;
(iii) If courts were to open the question of the wisdom of the bargain, this
would lead to enormous amounts of litigation, vastly expanded
evidence, and difficult decisions as to the conclusions to draw from that
evidence;
(iv) Such disputes would produce a great deal of uncertainty in the law, and
it is highly desirable that such uncertainty be minimized;
(v) The law provides means to challenge the adequacy of the bargain where
some wrong or moral fault can be shown – a lack of intention, mistake,
restitution, or equitable and statutory relief; and
90
Chappell v Nestle [1960] AC 87.
91
Woolworths v Kelly (1991) 22 NSWLR 189, 193 – 4 (Kirby P).

(vi) The common law respects the liberty of parties to reach unequal
bargains to avoid paternalism, and to protect economic freedom.
Each of these reasons can be used support the abolition of the doctrine of penalties.
1 Differences in consideration are key to market exchange
A penalty is, in substance, a part of the consideration that parties bargain for when
negotiating a contract. Weinrib describes the basis of the relationship in contract as a
transfer where parties pursue their separate interests in common, under which the
promise of one party is regarded as something that belongs to the other.92
Consider:
If A agrees to give B an apple in exchange for an orange, A’s consideration is an
apple. If A agrees to give B an apple in exchange for an orange, but if A do not give
B an apple then A must give B a banana, then A’s consideration is either an apple
or a banana.
In the above situation, the court would not consider whether the apple is of
equivalent value to the orange, or if the banana was of equivalent value to the orange.
This is the ‘bargain’, which the parties choose to strike.
The point of exchange in a market in economic theory is that both parties feel they
are mutually better off. Thus A thinks an orange is more valuable than an apple or a
banana, while B thinks an apple or a banana is more valuable than an orange. Where
parties question the alternate consideration, the penalty, they are partially defeating the
purpose of the parties in engaging in the exchange. In the language of Weinrib, the
92
E J Weinrib, ‘The Juridical Classification of Obligations’ in Peter Birks (ed), The Classification of
Obligations (Clarendon Press, 1997), 45.

promise to pay the penalty in the event of a breach is just as much regarded as
something that belongs to the other party as the initial promise.
2 Lawyers are not experts at determining the wisdom of bargains
Again, lawyers are no better at determining the wisdom of entering into a contract
containing penalties than they are at determining the wisdom of entering into a simple
contract. By refusing to enforce a penalty clause, courts are essentially saying to parties
that despite their wish to enter into a contract containing penalties, they cannot do so.
This is despite the fact that parties to a transaction ought to be ‘more trustworthy
judges of their self-interest than a judge who has neither a persona stake in nor
firsthand acquaintance of the parties’ venture.’93
This argument is particularly important in addressing the idea that the doctrine of
penalties protects the idea of efficient breach. Parties who enter a contract with a
penalty clause know that they are restricting the situations in which breach will be
preferable to continued performance. They are in a sense contracting out of their right
to efficiently breach, or at least modifying it. It is patronizing and paternalistic for the
courts to dictate that they cannot do so.
3 Questioning the penalty creates excess litigation
Absent the rule on penalties, many complex legal disputes would be far simpler to
resolve, both within and out of the formal legal system. The rule against penalties leads
parties to challenge the plain words of an agreement, which would otherwise be
determinative of the dispute (either because the parties resolve the dispute more easily
93
ed, 2007), 97.

as between themselves, or because they are better able to seek summary judgment
before the court because the legal issue is simply the enforcement of the penalty clause).
This creates problems for the parties, who must instead go through a costly legal
dispute where the court must consider the difficult question of whether, in substance,
the clause is a penalty clause. It also creates problems for the system more generally,
clogging up the system with disputes that only exist because the courts are not holding
parties to their word. Enforcing penalty clauses ‘[eliminates] having to distinguish
penalties from liquidated damages, which can be tricky.’94
Consider the following example:
A runs a one-man company, which has significant cash-flow issues. A needs to
ensure that B’s obligations are met on time, because the company will otherwise
fall insolvent. If those obligations are not met on time, a trial would enable A to be
compensated for the insolvency of the company (because B is aware of the perilous
financial position of A). However, A would have to pursue such a trial at his own
time and expense.
If A was able to include a penalty for late payment, that exceeded the damage he
would potentially suffer, he could ensure that B would meet his obligations. In
particular, if B also refused to pay the penalty, it would be easier to seek summary
judgment (because the issues of proof of damage suffered would be removed). B
would also have a greater incentive to pay on time, knowing that they would be have to
pay A not just damages, but a further penalty.
Without the penalty, A may be more likely to simply walk away from the whole
situation, rather than put his own assets on the line in a difficult legal trial. This example
is imperfect, but it highlights where the ability of parties to impose self-help clauses
94
ed, 2007), 129.

unrestricted by reference to the foreseeable damages would enable them to keep
disputes out of court, with the inevitable delay and expense that results.
4 Questioning the penalty creates legal uncertainty
For the same reason that allowing parties to challenge clauses that they have agreed
to creates legal disputes, it also creates legal uncertainty. Especially following Andrews,
the doctrine puts the ‘characterisation’ of the clause in the hands of the judge, who
must decide if it fits the primary-secondary stipulation model. The decision in Metro-
Goldwyn-Mayer,95
which the High Court in Andrews endorsed,96
is difficult to distinguish
from cases in which such sums were held to be a penalty. This retained discretion leaves
parties unclear as to whether certain clauses may be unenforceable as penalties, and
hence unclear as to how to proceed in the event of a breach or anticipated breach.
5 There are other protections available
This argument will be considered below, under ‘Consequences’.
6 The common law respects the autonomy of parties to contract
Courts applying the doctrine of penalties have long recognised and understood that
it flies in the face of the traditional position of the common law to respect the freedom
and autonomy of individuals to bargain. Dickson J in the Canadian Supreme Court
described the rule as ‘blatant interference with freedom of contract …designed for the
sole purpose of providing relief against oppression.’97
95
Metro-Goldwyn-Mayer [1966] 2 SR(NSW) 717.
96
Andrews (2012) 290 ALR 595, 614.
97
Elsley v JG Collins Insurance Agencies [1978] 2 SCR 916, [47] – [54] (Dickson J).

Judges have in many instances gone out of their way to ‘read down’ the sharper
edges of the rule in light of this. In AMEV Finance, Kirby P preferred a more stringent
test to finding a penalty ‘because it tends to uphold the right of the parties to agree as
they think fit … [and] avoids questions about the authority of the courts to interfere in
the contractual freedom of parties.’98
In Ringrow, the High Court was acutely conscious
of this:
Exceptions from …freedom of contract require good reason to attract judicial
intervention to set aside bargains upon which parties of full capacity have agreed.
That is why the law on penalties is, and is expressed to be, an exception from the
general rule.
In AMEV-UDC, Mason & Wilson JJ said, in the context of considering the
proportionality of the penalty to the damages, that ‘there is much to be said for the view
that the courts should return to …allowing parties to a contract greater latitude in
determining what their rights and liabilities will be.’99
This is perhaps the key argument against the doctrine of penalties. There is a public
interest in the freedom of people ‘not to be unduly restrained by law.’100
This interest is
of course not absolute, and where there are sound reasons to impose limitations on
what can and cannot be the subject of a contract, that freedom can and should be
restricted. But without a convincing case for the rule against penalties, the common law
bias towards protecting freedoms should prevail.
98
AMEV Finance Ltd v Artes Studios Thoroughbreds Pty Ltd (1989) 15 NSWLR 564, 566 (Kirby P).
99
100
S Waddams, ‘Autonomy and Paternalism from a Common Law Perspective: Setting Aside
Disadvantageous Transactions’ in Anthony Ogus and Willem H van Boom (eds), Juxtaposing
Autonomy and Paternalism in Private Law (Hart Publishing, 2011), 171.

B Law and economics
Posner identifies a number of key advantages to allowing penalties in contracts.101
1 Signaling commitment to performance
Where a party places a high value on completing contracts, it can be difficult in a
market to signal this to other parties. Agreeing to include penalties is one way of
effectively signaling this. The penalty for non-performance acts as a monetary statement
of trustworthiness. As Posner puts it:
By signing a penalty clause I communicate credible information about my own
estimate of my reliability – information useful in determining on what terms to do
business with me.102
2 Offsetting failures in risky markets
Where a party is engaged in a market where there is a high degree of insolvency,
penalties for non-performance act not just as a safeguard, but as a way of cross-
subsidizing the price offered. By enforcing penalties against insolvent parties who fail to
perform, the price that can be offered to all market participants is brought down.103
3 Protecting against undetectable breaches
Many contracts, and especially highly technical contracts, can be breached in ways
that have significant consequences but are undetectable until those consequences occur,
sometimes years down the track. There are also situations in which the breach may not
be detectable at all. Posner provides the example of a sale of a good in which the seller
101
ed, 2007), 128.
102
Ibid.
103
Ibid.

could plausibly blame the buyer for product failures.104
Penalties have a role in deterring
these kinds of breaches, by ensuring that the performing parties takes care to meet the
requisite standard for fear of being exposed to excess risk.
4 Allocating risk
Polinsky argues that allowing parties to allocate the various risks of a contract
failing, by whatever means they consider appropriate, will always lead to the most
efficient outcome where parties have gone to the time and expense of negotiating such
a clause.105
This does not mean that it is always best for parties to choose the
appropriate remedy – many parties do not have the resources to pre-negotiate a
financial settlement for every possible outcome from a contractual arrangement,106
and
are instead better off relying on court-imposed ‘default’ rules such as the ordinary rule
as to damages in Hadley v Baxendale.107
But where parties have incurred those expenses,
Polinsky shows that it will nearly always be less efficient for the courts to intervene and
insist upon an alternate remedy.108
Consider the following example:
A wishes to enter into a contract with one of B or C to build a house. While A will
not be exposed to any significant losses if the house is not built by the end of the
year, A would prefer that the house is built by the end of the year.
104
ed, 2007), 128.
105
A M Polinsky, ‘Risk Sharing Through Breach of Contract Remedies’ (1983) 12 Journal of Legal
Studies 436, 444.
106
ed, 2007), 130.
107
Hadley v Baxendale (1854) 156 ER 145.
108
A M Polinsky, ‘Risk Sharing Through Breach of Contract Remedies’ (1983) 12 Journal of Legal
Studies 436.

B is willing to build the house by the end of the year for $100, on the condition that
if B does not complete the house by the end of the year, A does not have any
contractual recourse against B other hand a claim for nominal damages.
C is willing to build the house by the end of the year for $150, on the condition that
if C does not complete the house by the end of the year, C must pay $50 to A. A’s
losses in the event that C does not complete by the end of the year are significantly
less than $50.
The condition that C is willing to agree to would be unenforceable by virtue of the
doctrine of penalties. However, this is far from the best outcome. A cannot contract
with any real protection for their desire to have work done by a certain date unless they
will be exposed to losses as a result. Equally, C cannot seek greater profits whilst at the
same time being exposed to the risk that if they fail, the greater sum will have to be
repaid.
This example highlights the fact that where penalties are included in contracts
between commercial parties, they are inevitably priced into the terms of the contract.
Removing the ban on penalties would allow parties that are willing to be exposed to
greater risks to gain greater financial rewards, and would allow relatively risk averse
parties to secure greater certainty that their goals will be met, for a greater price.
5 Intangible harm
Goetz & Scott argue that there are many breaches of contract which, although the
economic cost is theoretically calculable, the parties premium on having the contract
performed is not.109
The rule denies compensation for ‘non-provable idiosyncratic
109
C J Goetz & R E Scott, ‘Liquidated Damages, Penalties and the Just Compensation Principle:
Some Notes on an Enforcement Model and a Theory of Efficient Breach’ (1977) 77(4) Columbia Law
Review 554, 570.

wants’,110
causing parties to suffer exposure to an inefficient breach, especially for goods
on which parties place a larger ‘subjective or fanciful’ value than the established market
value.111
Consider the following example.
A wishes to propose to his girlfriend at the top of Mt Kilimanjaro, on a trip to
Africa that they are going on in December. A orders a custom-made engagement
ring prior to the trip, which he needs to be ready before he leaves. A will suffer no
compensable harm if the ring is not ready by that date.
If A cannot include a substantial penalty in the contract with the jeweler, the jeweler
has no real incentive to have the ring completed by the necessary date, even if that date
is a term of the contract. If the jeweler falls behind, A will still be obliged to pay the full
price for the ring. However, if A is able to include a clause in the contract giving him a
substantial discount if the ring is not ready by that date, the jeweler will have a large
incentive to have the ring ready on time.
Such a clause would fall squarely within the classic definition of a penalty: a
detriment in terrorem of the primary obligation. That primary obligation is hugely
important to A for reasons that a court would struggle to compensate for. Another
examples of this may be where party wishes to protect their reputation for getting
things done on time, or to a certain standard, by including penalties in a clause with a
subcontractor, even though it would be difficult to show in court that they had suffered
any harm as a result of a loss in this reputation.
110
Review 554, 594.
111
Ibid 570.

C Limited liability clauses: reverse penalties
Finally, it should be noted that the law already allows parties to a contract to include
limited liability or exemption clauses, which ‘are penalty clauses in reverse’,112
and
arguably under Andrews could be said to constitute a penalty. A limited liability clause
operates to prevent a party who has breached a term of a contract from being liable to
pay damages greater than an agreed sum. If this sum is lower than the sum likely to be
incurred in performing the contract, a party under the protection of a limited liability
clause has an incentive to discontinue performance.
The fact that these clauses are available creates two problems for the doctrine of
penalties. Firstly, it makes a mockery of the concept that courts will not enforce
penalties because they create perverse incentives against performance. Limited liability
clauses create the same incentive, and do so for the party who is able to decide whether
or not to continue performance. Secondly, while not framed as a form of collateral,
limited liability clauses can be used in terrorem of another party’s obligations. If the party
under the protection of the limited liability clause threatens to breach the contract, and
instead pay only the agreed sum, this gives them a degree of leverage over the
counterparty’s performance.
Just as issue of substance and form in relation to penalties for breach was, prior to
Andrews, an ‘absurd paradox’,113
so too the availability of limited liability clauses as the
equal and opposite of penalty clauses leaves the law in a bizarre state. Yet limited
liability clauses form a critical part of modern contracting, allowing parties to allocate
risk effectively. To make the law of agreed remedies in contract more coherent, it is the
doctrine of penalties that should be abolished.
112
Robophone Facilities Ltd v Blank [1966] 1 WLR 1428 (Lord Diplock).
113
Bridge v Campbell Discount Co Ltd [1962] AC 600 (Lord Denning).

VI CONSEQUENCES OF ABOLITION
D Available alternative protections
There are a variety of methods, other than the doctrine of penalties, by which the
courts have granted relief against disadvantageous transactions, including mistake, fraud,
unfairness, undue influence and unconscionability. Waddam identifies the grounds on
which these relief are based: a lack of consent, other wrongdoing, a form of unjust
enrichment, and general public policy.114
Parties who are subject to penalties may seek
relief on these grounds, which are better suited to righting the wrongs at which the
doctrine is aimed. As Goetz and Scott conclude:
The behavior which requires regulating is the unfairness in bargaining. … [M]ore
selective legal doctrines, such as unconscionability, have developed remedies for
those market imperfections [once addressed by the rule] which retain practical
importance.115
1 Other equitable doctrines
A key ameliorating factor in the abolition of the doctrine of penalties is the
availability of alternate remedies to address the key wrong at which the doctrine is
aimed. Rather than treating penalties as evidence of a problem in the negotiating
process, equitable and statutory protections exist to nullify and rectify contracts where
appropriate. In Interstar, Allsop P mused that:
114
Waddams, Stephen, ‘Autonomy and Paternalism from a Common Law Perspective: Setting Aside
Disadvantageous Transactions’ in Anthony Ogus and Willem H van Boom (eds), Juxtaposing
Autonomy and Paternalism in Private Law (Hart Publishing, 2011).
115
Review 554, 594.

VI Consequences of Abolition 39
The role or place of equity and relieving parties from injustice or unconscionable
bargains or from unfair forfeitures is most effectively brought about by judging the
operation of the clause or provision in light of the principles of relief against
forfeiture, unconscionable bargains, any found obligation of good faith or such
other consideration. This approach would enable an approach to be taken to the
justice of the case by reference to an analysis of the behavior of the parties and the
circumstances at the point of asserted breach or forfeiture.116
In particular, equitable doctrines such as undue influence and unconscionable
dealing focus on the status and behavior of the parties at the time of contracting,
allowing courts to examine whether there was a problem in the consent of the party
who has otherwise agreed to pay the penalty. Rather than presuming that the penalty is
something that a consenting party would not have agreed to, these doctrines look to the
actual consent of the parties to the terms of the contract.
2 Legislative protections
In Andrews, the High Court referred to the ‘pattern of remedial legislation’ as a
reason for distrusting ‘untrammelled freedom of contract’ as a universal value in
considering the doctrine of penalties.117
But, as Peel points out, it is precisely that
remedial legislation, which was plainly not available when the doctrine was first
developed, that makes a ‘quite compelling’ case to abandon the rule against penalties.118
In particular, regimes such as the unfair contract terms law,119
which gives courts
powers to set aside terms of standard form consumer contracts where they are unfair,
are far more adapted to righting the wrong at which the doctrine of penalties is aimed
than the doctrine itself. This legislation focuses on the issue of consent in such
116
Interstar (2008) 257 ALR 292, 334 (Allsop P).
117
Andrews (2012) 290 ALR 595, 597 [5].
118
E Peel, ‘The Rule Against Penalties’ (2013) 129 Law Quarterly Review 152 156.
119
Competition and Consumer Act 2010 (Cth) Schedule 2 (Australian Consumer Law) Part 2-3.

contracts, directing judges to consider the transparency of the terms when the
document was entered into, and hence helping to ensure that terms (such as penalties)
are properly understood by parties taking on contractual obligations. While Paterson
argues that greater transparency is likely to do little to influence the behavior of
consumers in practice,120
this legislation at least directs the courts to look at the heart of
the problem – a lack of consent to exposure to penalties – not the symptom of the
problem, the actual penalty.
In Andrews, the doctrine of penalties was not the only ground on which the fees
were challenged. In a ‘prolix pleading’,121
the applicants in the class action also
contended that the fees constituted an engagement in ‘unconscionable conduct’ under
the Australian Securities and Investments Commission Act 2001 (Cth), were able to be avoided
as an unfair term under the Fair Trading Act 1999 (Vic), and were ‘unjust transactions’
under the Consumer Credit (Victoria) Code and the National Credit Code.122
While many of
these are specific to the banking industry, they are partially mirrored in national and
state-based consumer legislation.123
E Law reform options
The Scottish Law Commission in 1997 presciently envisaged an expansion of the
scope of the doctrine on the very basis that Andrews was decided, preferring substance
120
Paterson, Jeannie, ‘The Australian Unfair Contract Terms Law: The Rise of Substantive
Unfairness as a Ground for Review of Standard Form Consumer Contracts’ (2009) 33(3) Melbourne
University Law Review 934.
121
Andrews (2012) 290 ALR 595, 597 [4].
122
Ibid.
123
See for instance, Competition and Consumer Act 2010 (Cth) Schedule 2 (Australian Consumer
Law); Australian Consumer Law and Fair Trading Act 2012 (Vic).

VI Consequences of Abolition 41
over form.124
However, they also explored and left open the idea that whether or not
the penalty should be unenforceable should be judged ‘according to all the
circumstances,’ with the onus of showing why it should be unenforceable lying on the
party so contending.125
Many civil law jurisdictions are willing to enforce penalty clauses, while reserving the
right to reduce the penalty to a degree where it is grossly excessive.126
Penalty clauses
have been enforceable in Europe since Roman times,127
and are enforceable under the
German, Swiss, and French Civil Codes.128
The Principles of European Contract Law, a
restatement, provide that:
(1) Where the contract provides that a party who fails to perform is to pay a
specified sum to the aggrieved party for such non-performance, the aggrieved party
shall be awarded that sum irrespective of his actual loss.
(2) However, despite any agreement to the contrary the specified sum may be
reduced to a reasonable amount where it is grossly excessive in relation to the loss
resulting from the non-performance and the other circumstances.129
One possible reform, other than simply abolishing to doctrine, would be to
introduce (or arguably reintroduce) the notion of unconscionability into the doctrine.
124
Scottish Law Commission, Discussion Paper on Penalty Clauses, Discussion Paper No 103
(1997).
125
Ibid.
126
Hatzis, Aristides ‘Having the Cake and Eating It Too: Efficient Penalty Clauses in Common and
Civil Contract Law’ (2003) 22 Intl Rev Law & Econ 381, 399 – 401.
127
Justinian, Institutes (Inst. III, 15, 7) cited in R Zimmermann, The Law of Obligations: Roman
Foundations of the Civilian Tradition (Oxford University Press, 1990), 95 – 113.
128
Hatzis, Aristides ‘Having the Cake and Eating It Too: Efficient Penalty Clauses in Common and
Civil Contract Law’ (2003) 22 Intl Rev Law & Econ 381, 400.
129
Article 4.508 (Agreed Payment for Non-Performance) in O Lando & H G Beale, The Principles of
European Contract Law. Part I: Performance, Non-Performance and Remedies, (Martinus Nijhoff
Publishers, 1995).

Rather than simply rendering penalties unenforceable as a ‘mechanical’ exercise,130
courts would be asked to consider, first, does the clause meet the definition of a penalty
described in Andrews, and second, would it be unconscionable in all the circumstances
to allow the penalty to be enforced. A layer of discretion would allow commercial
parties to bargain with certainty, whilst protecting parties vulnerable to exploitation
such as consumers under standard form contracts.
130
See PC Developments Pty Ltd v Revell (1991) 22 NSWLR 615 (Meagher J).

VII Conclusion 43
VII CONCLUSION
While the decision in Andrews has superficially simplified the doctrine of penalties,
and attempted to address the issues of substance and form inherent in the doctrine, it
has failed to resolve the real problem – the very existence of the rule against penalties.
As the High Court has recognized, we no longer (and perhaps, have never) lived in a
world in which laissez-faire, free market notions of freedom of contract have dictated
the resolution of disputes between commercial parties. But the enhanced activity of the
legislature in intervening in these circumstances does not justify the continued and
expanded application of archaic and ill-adapted rules.
The coherence of the law is an important goal in the development of the law. Birks’
legal taxonomy is build on ‘the quest for legal rationality.’ 131
This ideal is not
undisputedly pre-eminent – there are many instances in which there are sound reasons
of policy for a legal principle that is inconsistent with the general body of law in which
it sits. But the key argument for the abolition of the doctrine of penalties is that it is, by
the admission of those courts who enforce it, fundamentally inconsistent with the
modern law of contract, and the reasons for that inconsistency are inadequate.
131
P Birks, The Classification of Obligations (Clarendon Press, 1997), preface, v.

BIBLIOGRAPHY
A Articles/Books/Reports
American Law Institute, Restatement of the Law of Contracts (1932)
Atiyah, Patrick S, The Rise and Fall of Freedom of Contract (Clarendon Press, 1979)
Baker & Milsom, Sources of English Legal History (Oxford University Press, 2nd
edition,
2010)
Birks, Peter, The Classification of Obligations (Clarendon Press, 1997)
Easton, Patrick, ‘Penalties percolating through the construction industry: Andrews v
Australia and New Zealand Banking Group Ltd’ (2013) 29 Building and Construction Law
Journal 233
Goetz, Charles j & Scott, Robert E, ‘Liquidated Damages, Penalties and the Just
Compensation Principle: Some Notes on an Enforcement Model and a Theory of
Efficient Breach’ (1977) 77(4) Columbia Law Review 554
Halsbury, The Laws of England, (Butterworths, 1st
ed, 1908)
Hartzler, H Richard, ‘The Business and Economic Functions of the Law of Contract
Damages’ (1968) 6 American Business Law Journal 387
Hatzis, Aristides ‘Having the Cake and Eating It Too: Efficient Penalty Clauses in
Common and Civil Contract Law’ (2003) 22 Intl Rev Law & Econ 381
Holmes, Oliver Wendell, ‘The Path of the Law’ (1897) 10 Harvard Law Review 457,
462
Ibbetson, David John, A Historical Introduction to the Law of Obligations, (Oxford
University Press, 1999)

Bibliography 45
Justinian, Institutes (Inst. III, 15, 7) cited in Zimmermann, Reinhard, The Law of
Obligations: Roman Foundations of the Civilian Tradition (Oxford University Press, 1990)
Lando, Ole, & Beale, Hugh G, The Principles of European Contract Law. Part I: Performance,
Non-Performance and Remedies, (Martinus Nijhoff Publishers, 1995)
Loyd, William H, ‘Penalties and Forfeitures’ (1915) 29 Harvard Law Review 117
Paterson, Jeannie, ‘The Australian Unfair Contract Terms Law: The Rise of Substantive
Unfairness as a Ground for Review of Standard Form Consumer Contracts’ (2009)
33(3) Melbourne University Law Review 934
Peel, Edwin, ‘The Rule Against Penalties’ (2013) 129 Law Quarterly Review 152
Plucknett, Theodore F T, A Concise History of the Common Law (Little, Brown & Co,
1956)
Polinsky, A Mitchell, ‘Risk Sharing Through Breach of Contract Remedies’ (1983) 12
Journal of Legal Studies 436
Posner, Richard, Economic Analysis of Law (Aspen Publishers, 7th
ed, 2007)
Rossiter, C J, Penalties and Forfeiture, (The Law Book Company Limited, 1992)
Scottish Law Commission, Discussion Paper on Penalty Clauses, Discussion Paper No 103
(1997)
Waddams, Stephen, ‘Autonomy and Paternalism from a Common Law Perspective:
Setting Aside Disadvantageous Transactions’ in Anthony Ogus and Willem H van
Boom (eds), Juxtaposing Autonomy and Paternalism in Private Law (Hart Publishing, 2011)
Weinrib, Ernest J, ‘The Juridical Classification of Obligations’ in Peter Birks (ed), The
Classification of Obligations (Clarendon Press, 1997)
Williston, S, A Treatise on the Law of Contracts, (Thomson Reuters, 4th
ed, 2000)

Zimmermann, Reinhard, The Law of Obligations: Roman Foundations of the Civilian
Tradition (Oxford University Press, 1990)
B Cases
AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170
AMEV Finance Ltd v Artes Studios Thoroughbreds Pty Ltd (1989) 15 NSWLR 564
Andrews v Australia and New Zealand Banking Group Ltd (2011) 288 ALR 611
Andrews v Australia and New Zealand Banking Group Ltd (2012) 290 ALR 595
Austin v United Dominions Corporation Ltd [1984] 2 NSWLR 612
Bridge v Campbell Discount Co Ltd [1962] AC 600
Burger King Corporation v Hungry Jack's (2001) 69 NSWLR 558
Chappell v Nestle [1960] AC 87
Citicorp Australia Ltd v Hendry (1985) 4 NSWLR 1
Credits Guarantee Department v Universal Oil Products Co [1983] 1 WLR 399
Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79
Elsley v JG Collins Insurance Agencies [1978] 2 SCR 916
French v Macale (1842) 2 Drury and Warren 269
Hadley v Baxendale (1854) 156 ER 145
NSWSC 406
Integral Home Loans Pty Ltd v Interstar Wholesale Financial Pty Ltd [2009] HCATrans 87
Integral Home Loans Pty Ltd v Interstar Wholesale Financial Pty Ltd [2009] HCATrans 166

Bibliography 47
Interstar Wholesale Finance Pty Ltd v Integral Home Loans Pty Ltd (2008) 257 ALR 292
Jobson v Johnson [1989] 1 WLR 1026
Legione v Hateley (1983) 152 CLR 406
Metro-Goldwyn-Mayer Pty Ltd v Greenham [1966] 2 SR(NSW) 717
PC Developments Pty Ltd v Revell (1991) 22 NSWLR 615
Ringrow Pty Ltd and Ors v BP Australia Pty Ltd (2005) 224 CLR 656
Robertson v Driver's Trs (1881) 8 R 555
Robophone Facilities Ltd v Blank [1966] 1 WLR 1428
Woolworths v Kelly (1991) 22 NSWLR 189
C Legislation
Australian Consumer Law and Fair Trading Act 2012 (Vic).
Competition and Consumer Act 2010 (Cth) Schedule 2 (Australian Consumer Law)
Instruments Act 1958 (Vic)
Statute of Anne 1705, 4 & 5 Anne c 16
Statute of William 1696, 8 & 9 Will 3 c 11

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