ReSolution |June 2020
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Honey Bees: Supreme Court judgment creates a buzz around the penalty doctrine
By Jo-Anne Knight, Lisa Curran, Shanti Frater, Deborah Rowe & Mike Weatherall
The Supreme Court of New Zealand has confirmed the disproportionality test as the primary test for establishing whether a clause amounts to a penalty.
In this article we outline the Supreme Court’s findings following its decision in Honey Bees and what it means for parties entering into construction contracts in New Zealand.
What you need to know
• The primary test for establishing whether a clause amounts to a penalty in New Zealand is the disproportionality test.
• The bar - whether the consequence is “out of all proportion” to the legitimate interests of the innocent party in performance of the primary obligation - is a high one.
• The bar will be met if the consequence can fairly be described as “exorbitant” when compared with the legitimate interests protected.
• The disproportionality test gives greater credence to freedom of contract and the enforcement of bargains made by agreement between commercial parties.
• On this basis the possibility of a liquidated damages clause being rendered unenforceable as a penalty is limited.
Liquidated damages and the penalty doctrine
Liquidated damages clauses are common features of most construction contracts. In circumstances where a contractor is in delay, a liquidated damages clause will allow the principal to recover an agreed amount of damages for the period between the due date for completion of the contract works and the date of practical completion of the contract works. The principal does not have to prove actual loss.
Liquidated damages clauses offer both contracting parties a degree of certainty as to the contractor’s liability in the event of delay to the completion of the contract works. However, this degree of certainty has previously been limited by the possibility of liquidated damages clauses being challenged as being unenforceable penalties.