How Much Autonomy Do Franchisees Have In Operating Their Business?
One of the disadvantages of buying a franchise is the lack of independence or autonomy in operating...
The following article examines the general principles of law and practice in relation to liquidated damages, indemnity and exclusion and limitation of liability clauses. The following topics are considered in the paper
The law relating to liquidated damages and penalties is expressed in the much quoted case of Dunlop Pneumatic Tyre Co v New Garage and Motor Co Ltd [1915] AC 791.
In Dunlop2 Lord Dunedin set out the following principles when assessing a liquidated damages clause:
Deane J considered the above in O’Dea v Allstates Leasing System (WA) Pty Ltd (1983) 152 CLR 359 and explained:
” whether or not a provision of a contract imposes a penalty must be determined by reference to the true operation of that provision. That question must be determined as a question of substance which cannot be foreclosed by statements of the parties in their agreement, no matter how genuine they may be, as to their intention in stipulating the sum. The parties to an agreement may have subjectively intended to make a pre-estimate of damages in the event of breach. If, however, that pre-estimate is either extravagant or unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach or, judged as at the time of making the contract, is unreasonable in the burden which it imposes in the circumstances which have arisen, it is a penalty regardless of the intention of the parties making it.”3
In the case of Ringrow v BP Australia Pty Ltd (2005) 222 ALR 3064 the majority of the High Court accepted Dunlop as the applicable law and indicated that “the present appeal afforded no occasion for a general reconsideration of Lord Dunedin’s tests” and that it would leave any substantial reconsideration to “a future case where reconsideration or reformation is in issue”.
The facts of Ringrow5 are as follows.
The appellant entered into an agreement with the respondent for the purchase of a service station. There was a collateral agreement which contained an option enabling the respondent to buy back the service station in the event that the appellant breached the agreement. The appellant submitted that the price payable by the respondent on exercise of the option excluded any allowance for goodwill, even though the appellant had paid an entry price expressly calculated as including such goodwill. Consequently the appellant firstly submitted that the purported imposition upon the appellant by the option deed, of an obligation to transfer to the respondent the freehold of the service station was void as a penalty.
On the evidence before the Court the appellant was unable to show what, if anything its loss would be for goodwill. Consequently it was not possible for the Court to say that there was a penalty on the first basis which the appellant contended. The appellants further submissions also failed.
In considering the appellant’s arguments the High Court said5
“the principles of law relating to penalties require only that the money stipulated to be paid on breach or the property stipulated to be transferred on breach will produce for the payee or transferee advantages significantly greater than the advantages which would flow from a genuine pre-estimate of damage”.
The High Court went on to say the law of penalties was an exception from freedom of contract and that exceptions “require good reason to attract judicial intervention to set aside the bargains upon which parties of full capacity have agreed”5.
It approved the following observation of Mason and Wilson JJ in AMEV-UDC Finance Ltd v Austin6
“However, there is much to be said for the view that the courts should return to the Clydebank and Dunlop concept, thereby allowing parties to a contract greater latitude in determining what their rights and liabilities will be, so that the agreed sum is only characterized as a penalty if it is out of all proportion to damage likely to be suffered as a result of breach.”
The case of State of Tasmania v Leighton Contractors [2005] TASSC 1337 concerned a liquidated damages clause which provided that the contractor was to pay to the principle $8,000.00 per day for each day after the agreed date of construction completion until the actual date of construction completion.
The Full Court of the Supreme Court (overturning the judgment of Cox J sitting as a single judge in the Supreme Court) held that the liquidated damages clause was not a penalty.
At the initial trial evidence had been given as to the calculation of the liquidated damages daily sum. The calculation included an estimate of actual direct costs to be incurred by the Principal in the event of delay but did not include any loss by way of interest on the Principal’s outlay.
Cox J held that the clause was a penalty and concluded8:
“In the present case, it does not appear that any estimation was made in respect of the Principal’s loss other than direct costs of supervising an over-run contract and it is my view that these costs are extravagant and exorbitant as they are totally disproportionate to the likely actual costs anticipated to be incurred. Furthermore, the evidence is that the costs of the project were fully funded by the Commonwealth Government and the State has not been exposed to either its capital cost or the costs incurred after the Date for Construction Completion. In these circumstances I am of the view that the estimate of $8,000.00 for each calendar day of delay was not a genuine pre-estimate of the likely damage to the State resultant upon the late opening of the bypass and is unconscionable”.
The Full Court of the Supreme Court stated that this was an incorrect application of principle, which was not consistent with evidence.
The Full Court found9:
“The question was whether, given the nature of the contract, its complexity, value and the bargaining strength of the parties, the amount of $8,000.00 was, in all the circumstances, a penalty as at the date of the agreement. The test was objective as of that date. The test was whether as of that date, allowing for potential incurred costs, public utility or loss of amenity, diversion of resources and future dealings with, or responses by, the Commonwealth, loss of capital or its equivalent, the sum was so disproportionate that it provided not for “liquidated damages” but operated as a penalty which place the then contracting party in terrorem. The contract was for an amount of $30m with the potential for complexity, delay and potential cost variations, all matters shown at trial to be real.
In its commentary of the law in relation to penalties the Full Court stated that the use of the varying terminology is subject to important constraints. Firstly the Full Court commented that the various tests are intended as guides only10. Secondly11 the Full Court set out the view of Mason JJ and Wilson JJ in AMEV-UDC Finance Ltd v Austin referred to above and noted that it had been approved by the High Court in Ringrow.
The prevention principle is set out in the case of Peak Construction (Liverpool) Ltd v McKinney Foundations Ltd [1970] 1 BLR 114. Lord Salmon said in dealing with liquidated damages12
“A clause giving the employer liquidated damages at so much a week or month which elapses between the date fixed for completion and the actual date of completion is usually coupled, as in the present case, with an extension of time clause. A liquidated damages clause contemplates a failure to complete on time due to the fault of the contractor. It is inserted by the employer for his own protection: for it enables him to recover a fixed sum as compensation for delay instead of facing the difficulty and expense of proving the actual damage which the delay may have caused him. If the failure to complete on time is due to the fault of both the employer and the contractor, in my view, the clause does not bite. I cannot see how, in the ordinary course, the employer can insist on compliance with a condition if it is partly his own fault that it cannot be fulfilled…… No doubt if the extension of time clause provided for a postponement of the completion date on account of delay caused by some breach or fault on the part of the employer, the position would be different. That would mean that the parties had intended that the employer could recover liquidated damages notwithstanding that he was partly to blame for the failure to achieve the completion date.”
The liquidated damages clause should be a genuine pre-estimate of the likely loss. There is a presumption that a single lump sum payment is a penalty Re Newman; Ex parte Capper (1876) 4 Ch D 724.
The liquidated damages clause should be certain and should specify:
In Arnhold & Co Limited v Attorney General of Hong Kong (1989) 47 BLR 129 a liquidated damages clause that specified a maximum or minimum range was considered void due to uncertainty because there was uncertainty as to what the intermediate figures should be between the maximum and the minimum.
The contract should deal with the prevention principal. Where liquidated damages are payable as a result of delay in completion, the contract should also include an effective extension of time clause.
Where there are several liquidated damages clauses in a contract, it should be clear that each clause is to compensate for a different and separate head of damage. If the damages are cumulative it is likely that the clause will be found to be a penalty.
The case of Philips Hong Kong Ltd v Attorney-General of Hong Kong (1993) 61 BLR 41 involved a contract which provided a daily rate of liquidated damages for failure to meet various key dates together with a further daily rate of liquidated damages for delay in completing the whole work. The court held that as the losses could arise from different situations, the damages were not cumulative.
If it is the intention of the parties that the liquidated damages clause is to survive termination of the contract, this must be expressly stated, as without such an express statement the right to liquidated damages will end on termination of the contract13.
The Privy Council in Canada Steamship Lines Ltd v The King [1952] AC 192 said in respect of the interpretation of an exclusion clause14
(1) If the clause contains language which expressly exempts the person in whose favour it is made (hereafter called ‘the proferens’) from the consequence of the negligence of his own servants, effect must be given to that provision …. (2) If there is no express reference to negligence the court must consider whether the words used are wide enough, in their ordinary meaning, to cover negligence on the part of the servants of the proferens. If a doubt arises at this point, it must be resolved against the proferens ….. (3) If the words used are wide enough for the above purpose, the court must then consider whether “the head of damage may be based on some other ground than that of negligence ” ….. The ‘other ground’ must not be so fanciful or remote that the proferens cannot be supposed to have desired protection against it; but subject to this qualification …. the existence of a possible head of damage other than that of negligence is fatal to the proferens even if the words used are prima facie wide enough to cover negligence on the part of his servants.”
The effect of the rules set out in Canada Steamship Lines is that an indemnity will not be construed as applying to liability for negligence unless it is expressly stated.
In Brambles Ltd v Wail; Brambles Ltd v Andar Transport Ltd (2002) 5 VR 169 the Victorian Court of Appeal stated that the third proposition in Canada Steamship Lines is no longer law in Australia in relation to the interpretation of exclusion and limitation clauses, and that the correct approach was the position set out in Darlington Futures Ltd v Delco Australia Pty Ltd (1986) 161 CLR 500 where the High Court said that
“the interpretation of an exclusion clause is to be determined by construing the clause according to its natural and ordinary meaning, read in the light of the contract as a whole, thereby giving due weight to the context in which the clause appears including the nature and object of the contract, and, where appropriate, construing the clause contra proferentem in case of ambiguity.”15
The Victorian Court of Appeal went on to say that in the case of Schenker & Co (Aust) Pty Ltd v Maplas Equipment and Services Pty Ltd (1990) VR 834 at 846 the Full Court of the Victorian Supreme Court held that the approach set out above was equally applicable to indemnity clauses.
The majority of the High Court in Andar Transport Ltd v Brambles Ltd (2004) 206 ALR 387 treated contractual indemnity provisions as analogous to contracts of guarantee, holding that where there is an ambiguity in the contractual provision an indemnity will be construed strictly against the indemnified.
The facts of Andar16 are as follows. Brambles provided laundry delivery services which it outsourced to various contractors. Wails, who had previously been an employee of Brambles, formed a company Andar Transport Pty Ltd which was awarded a contract by Brambles. Wails was employed by Andar Transport Pty Ltd. Wails was injured on the job while using a trolley supplied by Brambles. Subject to certain issues, Wails had a claim for damages against both Brambles and Andar.
Brambles joined Andar pursuant to clause 8.2 of the contract between Brambles and Andar which provided:
Andar shall ….
8.2 indemnify Brambles from and against all actions, claims, demands, losses, damages, proceedings, compensation, costs, charges and expenses for which Brambles shall or may become liable whether during or after the currency of the Agreement and any variation renewal or extension in respect of or arising from –
8.2.1 loss damage or injury from any cause to property or person occasioned or contributed to by the neglect or default of Andar to fully, duly punctually and properly pay, observe and perform the obligations, covenants, terms and conditions contained in the Agreement and on the part of Andar to be paid, observed and performed.
8.2.2 loss, damage, injury or accidental death from any cause to property or person caused or contributed to by the conduct of the delivery round by Andar.
8.2.3 loss, damage, injury or accidental death from any cause to property or person occasioned or contributed to by any act, omission, neglect or breach or default of Andar.
The High Court found that there was no express provision in the clause that liability arising on the part of Brambles as a result of injuries suffered to employees of Andar fell within the terms of the indemnity and that where the provisions of the clause were ambiguous the provisions were required to be construed in favour of Andar.
The decision in Andar16 makes it clear that unless an indemnity clause is drafted to express all of the circumstances to which it applies, in the case of ambiguity the provisions will be construed strictly against the indemnified.
Although it is not clear whether the rules set out in Canada Steamship Lines apply in Australia17, it is still advisable to expressly refer to negligence when drafting an indemnity clause.
Consider whether reciprocal indemnities are appropriate.
Consider what should be excluded from the indemnity. It is common to exclude liabilities which arise due to the actions of the indemnified.
Consider the interaction between indemnity clauses and any exclusion of liability and limitation of liability clauses.
The law in Australia in relation to the interpretation of an exclusion or limited liability clause is set out in Darlington Futures Ltd v Delco Australia Pty Ltd (1986) 161 CLR 500 at 510, referred to above.
The contra proferentum rule provides that a clause in a contract is to be construed strictly against the person seeking to rely on the benefit of the clause. As set out above, the contra proferentum rule applies to exclusion and limitation of liability clauses only in the case of ambiguity.
In Darlington Futures Ltd v Delco Australia Ltd18, Delco and Darlington Futures entered into a contract which authorised Darlington Futures to engage in a form of futures trading on behalf of Delco for the purpose of achieving a “tax straddle”. Darlington Futures engaged in trading in breach of its mandate with Delco which provided that the trading of any positions open for more than one day needed Delco’s permission. Delco sued Darlington Futures for the losses arising from Delco’s breach of the mandate.
In it’s defence, Darlington Futures relied on two exclusion clauses set out below.
6 The client acknowledges that a guarantee or assurance of profit is impossible in commodity trading and accordingly acknowledges that it has not received any such guarantee or assurance from the agent of any of its representatives. The client has not entered into this agreement and will not be transacting any orders in reliance upon any such guarantee or assurance. The client further acknowledges that the agent will not be responsible for any loss should the client follow any of the agent’s trading recommendations or suggestions, nor for any loss, in the case of discretionary accounts, arising from trading by the agent on behalf of a client. The client finally acknowledges that the agent will not be responsible for any loss arising in any way out of any trading activity undertaken on behalf of the client whether pursuant to this agreement or not, and that the agent shall not be liable to account to the client for any profit made by the agent in any of the circumstances set out in clause 9 whether or not such circumstances result in a loss to the client.
7 Any liability on the agent’s part or on the part of its servants or agents for damages for or in respect of any claim arising out of or in connection with the relationship established by this agreement or any conduct under it or any orders or instructions given to the agent by the client, other than any liability which is totally excluded in paragraphs (a) and (b) hereof, shall not in any event (and whether or not such liability results from or involves negligence) exceed one hundred dollars.
The High Court held that clause 6 did not apply because on its construction the parties did not intend the clause to apply to unauthorised futures trading by Darlington Futures. However the High Court upheld clause 7 which limited Darlington’s liability for each unauthorised trade to $100.00.
In applying the approach of Delco19 that exclusion and limited liability clauses are to be construed in accordance with normal rules of contractual construction there is a proposition that the more serious a breach the less likely that it was the parties intention to exclude liability for such breach. In the Federal Court case of Wallace-Smith & Anor v Thiess Infraco (Swanston) Pty Ltd (2005) 218 ALR 1 the court stated:
“The more radical the breach, the clearer must be the language of an exemption clause to cover it.”20
The Federal Court also cited the following passage of Lord Wilberforce in Suisse Atlantique Societe D’Armement Maritime SA v NV Ratterdamsche Kolen Centrale [1967] 1 AC 361 at 432
“One may safely say that the parties cannot, in a contract, have contemplated that the clause should have so wide an ambit as in effect to deprive one party’s stipulations of all contractual force: to do so would be to reduce the contract to a mere declaration of intent. To this extent it may be correct to say that there is a rule of law against the application of an exception clause to a particular kind of breach.”21
Another case is that of Regal Pearl Pty Ltd v Zurich Australian Insurance Ltd [2005] NSWSC 1055. Regal Pearl was the operator of a restaurant at which a number of customers were injured when they ate prawns which contained the hepatitis A virus. Regal Pearl had purchased the prawns from Tai Kwan. Five customers commenced proceedings against Regal Pearl, in which proceedings it was found that Regal Pearl was negligent and that its owner had breached implied warranties under the Sale of Goods Act. His honour dismissed the cross-claims of Regal Pearl against Tai Kwan and the importer of the prawns Great Ocean.
Regal Pearl appealed claiming inter alia that it was entitled to be indemnified by Tai Kwan under the Sale of Goods Act in breach of contract. The Court of Appeal found that Regal Pearl was entitled to succeed on its cross-claim against Tai Kwan. Tai Kwan failed to pay the judgments against it.
Prior to the commencement of the District Court proceedings Tai Kwan sought indemnity pursuant to business insurance held with Zurich. Zurich denied indemnity to Tai Kwan relying on the following exclusion clause.
This section does not cover:
12 Contractual liability
Liability for personal injury or property damage that is accepted by any insured person under any contract, warranty or agreement requiring:
(a) insurance to be effected upon any property not owned by the insured person;
(b) the acceptance of any liability, except liability that would have existed even if the contract accepting the liability did not exist;
(c) the waiving or limitation of the insured persons rights of recovery against another party.
Zurich argued that the exclusion clause operated because in its contract to purchase the prawns from Great Ocean Tai Kwan had agreed to
i) waive liabilities which may be otherwise imposed on Great Ocean under the Sale of Goods Act,
ii) indemnify Great Ocean from all claims arising out of or in relation to any defects whether latent or patent in the goods purchased.
When Tai Kwan failed to pay the judgments against it Regal Pearl proceeded against Zurich.
Regal Pearl argued that the wording of the exclusion clause only sought to exclude liability for personal injury or property damage and that the liability of Tai Kwan to Regal Pearl was for economic loss.
The insuring clause was in the following terms:
When a limit of liability is shown in the schedule for products liability we will pay for all amounts up to the limit of liability that an insured person becomes legally liable to pay in compensation for:
1 Personal injury; or
2 Property damages
that results during the period of insurance from an occurrence within the territorial limits that happens in connection with your products.
Cooper AJ held that when combined with the definitions the insuring clause was to be read as follows:
When a limit of liability for an event which causes personal injury or property damage that is neither intended or expected by an insured person, that is caused by or arises out of any of the insured’s products, we will pay for all amounts up to the limit of liability that an insured person becomes legally liable to pay in compensation for personal injury or property damage that results during the period of insurance from an event which causes personal injury or property damage that is neither expected or intended by an insured person within the territorial limits that happens in connection with your products.
His Honour agreed with Regal Pearl and held that the exclusion clause did not apply because Tai Kwan’s liability to Regal Pearl was an indemnity for economic loss and not for personal injury or property damage.
Exclusion clauses are prohibited by some statutory provisions.
When drafting insurance contracts ensure that the wording of the exclusion clause mirrors the wording of any liability clauses. Regal Pearl v Zurich Australian Insurance Ltd [2005] NSWSC 1055
If the parties intend to exclude liability for negligent conduct, this should be done expressly.
Care should be taken when using words such as ‘indirect’ and ‘consequential loss’ in an exclusion clause. Although it is suggested” that references to “indirect loss” fall within the first limb of Hadley v Baxendale22 and references to “consequential loss” fall within the second limb of Hadley v Baxendale23, it should not be assumed that these phrases will cover all economic losses.
If the parties intend the exclusion or limited liability clause to apply to serious, fundamental wilful and total breaches of the contract, this must be expressly stated.
Consideration should be given to the statutory prohibitions to exclusion and limitation of liability clauses.
Endnotes
1 Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79.
2 Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79 at 86-88.
3 O’Dea v Allstates Leasing System (WA) Pty Ltd [1983] 152 CLR 359 at 400.
4 Ringrow Pty Ltd v BP Australia Pty Ltd [2005] 222 ALR 306 at 309.
5 Ringrow Pty Ltd v BP Australia Pty Ltd [2005].
6 AMEV-UDC Finance Ltd v Austin [1986] 162 CLR 170 at 190.
7 State of Tasmania v Leighton Contractors Pty Ltd [2005] TASSC 133.
8 State of Tasmania v Leighton Contractors Pty Ltd [2005] TASSC 133 at paragraph 11.
9 State of Tasmania v Leighton Contractors Pty Ltd [2005] TASSC 133 at paragraph 31.
10 State of Tasmania v Leighton Contractors Pty Ltd [2005] TASSC 133 at paragraph 25.
11 State of Tasmania v Leighton Contractors Pty Ltd [2005] TASSC 133 at paragraph 26.
12 Peak Construction (Liverpool) Ltd v McKinney Foundations Ltd [1970] 1 BLR 114 at 121.
13 British Glanzstoff Manufacturing Co Ltd v General Accident Fire & Life Assurance Corp Ltd [1912] SC 591.
14 Canada Steamship Lines Ltd v The King [1952] AC 192 at 208.
15 Darlington Futures Ltd v Delco Australia Pty Ltd [1986] 161 CLR 500 at 510.
16 Andar Transport Ltd v Brambles Ltd [2004] 206 ALR 387.
17 J. W. C. a. D. Yates, “Perspectives on Commercial Construction and the Canada SS Case” (2004) 20 Journal of Contract Law 239.
18 Darlington Futures Ltd v Delco Australia Pty Ltd [1986] 161 CLR 500.
19 Darlington Futures Ltd v Delco Australia Pty Ltd [1986].
20 Wallace-Smith and Another v Thiess Infraco (Swanson) Pty Ltd [2005].
21 Wallace-Smith and Another v Thiess Infraco (Swanson) Pty Ltd [2005] 218 ALR 1 at 17-18.
22 Hadley v Baxendale [1854] 9 Ex 341.
23 Hadley v Baxendale [1854] 9 Ex 341 -.
Disclaimer
The information in this article is general in nature and is not intended to address the circumstances of any person or other entity. Although we do our best to provide timely and accurate information, we do not guarantee that the information in this article is accurate or that it will continue to be accurate in the future.
If you would like more information or would like to discuss your situation
One of the disadvantages of buying a franchise is the lack of independence or autonomy in operating...
Copyright © 2021 Haarsma Lawyers