Points of interest
- Recent UK and Australian decisions are likely to be influential in the future development of liquidated damages clauses in New Zealand.
- Court of Appeal holds that depreciated replacement cost is the appropriate measure of indemnity under an indemnity-only policy following destruction.
- IRD considers the deductibility of seismic assessments.
Recent UK and Australian Liquidated Damages Cases
Liquidated damages clauses are common in construction contracts to increase certainty, reduce the prospect of litigation, and preserve relationships even in the face of a dispute over performance. The long-standing position under common law is that such clauses are generally enforceable unless they constitute a ‘penalty’.
Recent decisions from the United Kingdom and Australia demonstrating vastly different approaches are likely to be influential in the future development of the ‘penalties doctrine’ in New Zealand.
United Kingdom – A liquidated damages clause (or other clause providing specific remedies for breach) that does not constitute a genuine pre-estimate of loss may be enforceable if it is nevertheless proportionate to the innocent party's legitimate interest
In Cavendish Square Holding BV v Talal El Makdessi, the United Kingdom Supreme Court recently clarified its stance on a number of key aspects regarding the penalties doctrine, including the following:
- The penalties doctrine only applies to contractual clauses that operate upon a breach of contract (eg liquidated damages clauses) and does not apply to clauses that set out the parties’ primary obligations under the contract, or that set out obligations that are conditional on events other than a breach of contract. In deciding this point the Supreme Court rejected, and heavily criticised, the more relaxed approach recently set out by the High Court of Australia in Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205.
- A damages clause will not automatically constitute a penalty simply because it does not constitute a genuine pre-estimate of loss. Such a clause may be enforceable if it is proportionate to the innocent party’s legitimate interest in performance of the corresponding primary obligation.
- The extent to which there was any inequality of bargaining power between the parties is one relevant factor when considering whether a damages clause is a penalty. However, this factor merely raises a presumption as a starting point for the analysis, and is not determinative.
If the United Kingdom Supreme Court’s approach is adopted in New Zealand, then contractors in the construction industry are likely to have a greater degree of flexibility when drafting liquidated damages clauses. At this stage though, the outer limits of the ‘legitimate interest in performance’ test are not clear, so contractors should proceed with caution.
Cavendish Square Holding BV v Talal El Makdessi  UKSC 67
Australian courts reluctant to redraft an agreed rate of damages between parties
In December 2015, the Queensland Court of Appeal upheld a liquidated damages clause in a design and construction contract, rejecting an argument that the clause was an unenforceable penalty. It was critical to the decision that the developer was denied access to the site if practical completion was not achieved, so that the developer could not complete apartment sales and was therefore exposed to the real risk of loss.
Key points from the Queensland decision include:
- the penalties doctrine at law runs parallel to the penalties doctrine in equity – a necessary element at law, but not in equity, is that the stipulation is payable on breach of a term of contract;
- a provision will not be a penalty unless the amount payable is extravagant and unconscionable in comparison with the greatest lost that could have been suffered from the breach;
- where a liquidated damages clause provides for the payment of a sum of money by reference to a rate over a period of time then the provision would not ordinarily be a penalty; and
- the courts are reluctant to redraft an agreed rate of damages between parties, particularly commercial parties of equal bargaining power who have competent advice. McMeekin J noted at  that “at a more general level interference with clauses of this type in building contracts, clauses which are common place, will introduce uncertainty to the disadvantage of all in the industry”.
Grocon Constructions (Qld) Pty Ltd v Juniper Developer (No 2)  QCA 291
New Zealand Case
Depreciated replacement cost is the appropriate measure of indemnity under an indemnity-only policy following destruction
In a recent Court of Appeal case, an insured negotiated a settlement with its insurer following damage to its building from a series of earthquakes, for a sum representing the building’s pre-earthquake market value. However the insured came to regret the settlement and sought to reopen its claim on the basis that, when the parties entered into the settlement agreement both were mistaken about the measure of entitlement to indemnity under the policy so the settlement resulted in substantially unequal exchange of values and should be set aside under the Contractual Mistakes Act 1977. The mistake pleaded was that market value (rather than replacement cost) was the “full measure of indemnity” under the policy.
The Court held that, however the mistake was framed, it was one that the parties must be taken to have had in mind when they negotiated the settlement. There was therefore no justification for reopening the claim on the basis of mistake.
Prattley Enterprises Limited v Vero Insurance New Zealand Limited  NZCA 67
EQC and Action Group agree settlement principles – EQC must repair to ‘when new’ standard
The Earthquake Commission (EQC) and the EQC Action Group (a group of 89 homeowners) have agreed to settle the High Court proceedings against the EQC which sought declarations to clarify the extent of the EQC’s liability under the Earthquake Commission Act 1993 (EQC Act).
As part of the settlement, the EQC and Action Group have made a joint statement, which confirms that:
- EQC will reinstate earthquake damage to a condition substantially the same as “when new”, which includes complying with any applicable laws;
- if to repair an earthquake damaged part of a house means work is required on an undamaged part of the house, EQC will cover the cost of this extra work; and
- while EQC gives due consideration to the MBIE guidance on floor levels it does not use the guidance as its only benchmark to determine whether or not it has fulfilled its repair obligations under the EQC Act.
A copy of the joint statement can be found here.
Attempt to strike out “leaky schools” claim heard in Supreme Court
Carter Holt Harvey Limited’s attempt to have defective cladding claims brought against it by the Ministry of Education struck out (including on the basis of the 10-year Buildings Act limitation period) was heard in the Supreme Court on 13-15 April 2016.
A brief overview of the Court of Appeal decision that is being appealed, Carter Holt Harvey Ltd v Minister of Education  NZCA 321, can be found in our last Update.
Direct payment agreement decision to be appealed
The High Court decision, Sanson v Ebert Construction Ltd  NZHC 2014, holding that payments by a financier to a contractor under a direct payment agreement may be clawed back by liquidators of the developer will reportedly be appealed.
A brief overview of the High Court decision can be found in our last Update.
Appeal on the eligibility of a leaky building claim made beyond 10-year limit heard in Court of Appeal
An appeal against a High Court decision made in September last year, which held that apartment owners could join a leaky building lawsuit after the expiry of the 10-year limit on claims by ‘piggy backing’ on claimants within the same complex who had met the deadline, was heard in the Court of Appeal on 9 February 2016. At the time of writing, the Court of Appeal has yet to make its decision.
A copy of the High Court decision, Auckland Council v Weathertight Homes Tribunal  NZHC 2098 can be found here.
IRD considers the deductibility of seismic assessments
The IRD has released a controversial exposure draft considering the deductibility of expenditure for the purpose of obtaining a detailed seismic assessment on an earthquake-prone building. It concludes that the expenditure is capital in nature, and as such, no deduction is available. Paragraph 20 of the exposure draft sets out the rationale for this conclusion:
From a practical and business point of view, the expenditure incurred in obtaining the [detailed seismic assessment] is calculated to determine the nature, scale and, possibly, an estimate of the costs of the seismic strengthening required on an earthquake-prone building with a view to devising the best option for the building. It is directed to the future preservation or otherwise of an important capital asset. The expenditure goes to one of the taxpayer’s tangible capital assets and not to the day-to-day operations of the business. This is clearly a capital purpose.
A copy of the exposure draft is available here.
Retentions regime under the Construction Contracts Act: when trust law and insolvency collide
Amendments to the Construction Contracts Act requiring retentions to be held on trust come into force at the end of March 2017. Speaking at the annual conference of the Restructuring, Insolvency and Turnaround Association of New Zealand (RITANZ) in May, Russell McVeagh partners Polly Pope and Andrew Butler considered some of the issues that will arise on the insolvency of a party holding retentions, including:
- If retention money is commingled with other funds, and there is a shortfall in the account, how might equitable tracing principles assist?
- If retention money has not been held on trust, is the payee’s priority position preserved? In particular, what will the effect of the statutory requirement that funds ‘must be held on trust’ be if it turns out the payer has breached its obligations and has not done so? So far, commentators on the amendments seem to agree that this would have the consequence that a subcontractor would lose their priority interest. However, Polly and Andrew discussed whether there might be some scope for debate on this point.
If you would like further information on these issues, or how to comply with the new retention requirements, please click here to email Polly Pope.
This publication is intended only to provide a summary of the subject covered. It does not purport to be comprehensive or to provide legal advice. No person should act in reliance on any statement contained in this publication without first obtaining specific professional advice.