The effectiveness of time bar clauses following the high court in decision in Andrews v. Australia and New Zealand Banking Group

• Author: Philip Davenport
• Position: University of New South Wales, Sydney, Australia

1 Background

In Australia, adjudication under the Building and Construction Industry Security of Payment Act 1999 (NSW)¹ (“the NSW Act”), or equivalent legislation in Australia², is a common way that disputed payment claims under commercial construction contracts are decided. Construction contracts often contain penalty clauses. In particular, time bar clauses have been used to impose a penalty upon contractors and subcontractors. The case most often cited in adjudications as authority for the effectiveness of time bar clauses is John Goss Projects v. Leighton Contractors³ (“the John Goss case”). In that case, McDougall J considered a clause that provided that the respondent (Leighton Contractors) would not be liable upon any claim by its subcontractor (John Goss) in respect of any matter arising out of the subcontract including but not limited to variations and claims for damages unless the claim together with full particulars thereof was lodged with Leighton Contractors not later than ten business days after the date the subcontractor became aware or should reasonably have become aware of the occurrence of the events or circumstances on which the claim is based.

The subcontractor argued that the time bar clause in the contract (clause 45) was rendered void by section 34 of the NSW Act⁴. McDougall J decided that the time bar in clause 45 was effective and was not inconsistent with the NSW Act. His Honour said:

Where John Goss wishes to claim an amount over and above the Contract Amount (for example, for a variation, or for delay or disruption costs), it is required, as a precondition of such a claim, to give notice under, and complying with the terms of, cl 45. It is obvious why a head contractor in Leighton's position might stipulate for such notice. Firstly, it will enable the claim to be investigated promptly (and, perhaps, before any work comprised in it is rebuilt, or built over). Secondly, it will enable Leighton to monitor its overall exposure to the subcontractor. Thirdly, it will enable Leighton to assess its own position vis a vis its principal. No doubt, there are other good reasons for stipulations of the kind found in cl 45.

It is correct to say that cl 45 operates to bar claims if the notice provisions in it are not followed. But it does not follow that cl 45 is thereby inconsistent with the rights given under the Act, so as to attract the operation of one or other of the alternatives set out in s 34(2)⁵.

The effect of the time bar was that the subcontractor was not able to pursue a claim for in excess of $2 million. The claimant did not argue and the court did not appreciate that would offend against the penalty doctrine. Had the notice of claim been even one day late, the claimant would have been penalised to the extent of possibly $2 million.

Most major construction companies now have similar time bars in their construction contracts. In adjudication they invoke the time bars to avoid paying subcontractors what would otherwise be the subcontractors' entitlement. They also use the time bar (when the subcontractor has failed to claim an extension of time within the prescribed period) to enable them to recover liquidated damages for periods of delay that they have caused to the subcontractor.

One major contractor has general conditions of subcontract that provide that the subcontractor has no entitlement to an extension of time unless the subcontractor has given a written notice of claim within three business days after the event causing the delay first occurs. Those same general conditions provide that the subcontractor must comply with any direction of the contractor and if the subcontractor does not, before complying with the direction and within three business days of the direction, provide a written notice of a claim for additional payment and an extension of time, the subcontractor will not be entitled to any additional money or time for complying with the direction.

When the issue of a time bar arises in adjudication the respondent almost invariably cites the John Goss case as authority for the effectiveness of the time bar. To date, there does not appear to be any reported case in Australia where a claimant has defeated a time bar clause on the ground that it is a penalty.

However, following Andrews v. Australia and New Zealand Banking Group⁶ (“the Andrews case”) decided by the high court of Australia, the highest judicial body in the country, on 6 September 2012 the penalty doctrine will become a major issue in adjudication in Australia. The decision in John Goss Project v. Leighton Contractors would almost certainly not be decided the same way today if the penalty doctrine was raised.

Section 2 of this paper explains the penalty doctrine and the Andrews case. Section 3 considers the application of the penalty doctrine to the facts in the John Goss case. Section 4 describes how the penalty doctrine might impact on other provisions commonly found in construction contracts and subcontracts. Section 5 deals with a very controversial issue in construction law. That is whether when a contractor fails, within the time allowed in the contract for extension of time claims, to claim and extension of time, the contractor can be liable for liquidated damages for a period of delay caused by the principal. The issue is illustrated by the Gaymark Investments Pty Limited v. Walter Construction Group Limited⁷ (“the Gaymark case”). That case is revisited in the light of the Andrews case. Section 6 considers the implications of the Andrews case for adjudication. Section 7 is the conclusion.

2 The penalty doctrine

It has long been the law in England and Australia that a provision in a contract that would impose a penalty on a party to the contract is unenforceable. This is the penalty doctrine. A leading authority on the penalty doctrine is Gilbert-Ash (Northern) v. Modern Engineering⁸ (“the Gilbert-Ash case”). Paragraph 3 of clause 14 of the subcontract the subject of that case provided:

If the Sub-contractor fails to comply with any of the conditions of this Sub-contract, the Contractor reserves the right to withhold payment of any monies due or becoming due to the Sub-contractor.

The House of Lords held that paragraph 3 of clause 14 of the subcontract was a penalty.

Lord Salmon said:

Paragraph 3 [of clause 14] purports to confer much more on contractors than the law allows. According to the natural meaning of its language, it would enable contractors to suspend or withhold payment of very large sums of money due to the sub-contractors in the event of the sub-contractors committing some minor breach of contract causing only trivial damage in no way comparable to the amount owed to sub-contractors. The paragraph is, therefore, unenforceable since it provides for the extraction of a penalty⁹.

The penalty doctrine was the subject of the Andrews case. The Andrews case involved a class action by customers against the ANZ Bank. The argument of the bank customers was that certain fees charged by the bank were void because they were a penalty. If an “instruction” (for example a cheque or order for a periodical payment) to the bank by a customer would have the effect of overdrawing the customer's account, the bank could either honour the instruction (i.e. allow the account to be overdrawn) or dishonour it. The bank would then charge the customer an “honour fee” for honouring the instruction or an “outward dishonour fee” for dishonouring the instruction.

The customers argued that these fees were a penalty and were therefore unenforceable. They argued that the fees were imposed upon or in default of the occurrence of stipulated events but were out of all proportion to the loss or damage which might have been sustained by the bank by reason of the occurrence of the events. The bank argued that since the fees were not charged for breach of contract, they could not be a penalty. The primary judge followed the NSW Court of Appeal decision in Interstar Wholesale Finance v. Integral Home Loans¹⁰ (“the Interstar case”) and found that the fees were not a penalty. The high court said that the Interstar case was wrongly decided and, consequently, the primary judge erred in concluding that in the absence of a contractual breach the fees could not be categorised as penalties.

The penalty doctrine is described in the Andrews case as follows:

In general terms, a stipulation prima facie imposes a penalty on a party (“the first 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. In that sense, the collateral or accessory stipulation is described as being in the nature of a security for and in terrorem of the satisfaction of the primary stipulation. If compensation can be made to the second party for the prejudice suffered by failure of the primary stipulation, the collateral stipulation and the penalty are enforced only to the extent of that compensation. The first party is relieved to that degree from liability to satisfy the collateral stipulation¹¹.

The court used the term “stipulation” rather than “term” or “condition” of a contract. The court did not change the penalty doctrine. It merely enunciated what the common law of Australia is. The court considered Dunlop Pneumatic Tyre Co Ltd v. New Garage and Motor Co Ltd¹² and other cases on liquidated damages, but the decision does not change the law on liquidated damages.

In the Andrews case, the court said that there is no distinction...