AMEV-UDC Finance Ltd v Austin

162 CLR 170
68 ALR 185; 1986 - 1104A - HCA

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(Judgment by: Mason J, Wilson J)

Between: AMEV-UDC Finance Ltd
And: Austin

Court:

Judges: Gibbs CJ

Mason J
Wilson JDeane J
Dawson J

Hearing date: 19 February 1986
Judgment date: 4 November 1986

Canberra

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Judgment by:
Mason J
Wilson J

This appeal from the New South Wales Court of Appeal raises an important question concerning the recovery of compensation by a lessor under a hiring contract which contains a provision for the payment by the hirer of a stipulated sum or sums in the event of the owner exercising a contractual power to terminate the contract on the hirer's non-payment of instalments of rent, when that provision is unenforceable because it is a penalty.  The precise question may be stated in this way:  Is the owner restricted to recovery of the instalments of rent unpaid at termination plus interest or is he entitled to recover his actual loss, that is, the difference between the capital component of the rent payable after termination, plus interest to the date of termination and the market value of the hired goods on or at that date?

The appellant, which is a finance company, sued the respondents on two guarantees dated 27 May 1981 and 13 November 1981 whereby the respondents guaranteed the due and punctual payment by Lithotone Printing Pty Limited ("Lithotone") of the rental and of every other sum payable by that company under two hiring agreements (called "Lease Agreements") bearing the same dates respectively as the guarantees.  The Lease Agreements were between the appellant as owner and Lithotone as lessee.  They related to certain printing equipment. The equipment was leased to Lithotone at a rental of $4,685.75 per month commencing on 27 May 1981 under the first agreement and at a rental of $800.28 per month commencing on 13 November 1981 under the second agreement. The first agreement provided for a lease of 60 months, the second for 48 months.  The appellant terminated the agreements, pursuant to an express power which each conferred, after the lessee failed to pay within seven days of the due date an instalment of rent payable under each agreement.

The amount sued for by the appellant under the guarantees was $291,857.40. According to par.13 of the statement of claim it consisted of (a) arrears of rental as at the date of repossession of the equipment;  (b) the balance of rental due from the date of repossession to the dates when the agreements would have expired if they had not ended prematurely;  and (c) the residual values specified under the agreements;  less (d) the proceeds of sale of so much of the equipment as had been sold.  Interest under the agreements was claimed on the total.  The claim, as thus formulated, was based on the provisions of the agreements. Except as otherwise mentioned, and apart from the particulars specified in the schedules, the agreements are in identical terms.

The first such provision is cl.1 which provides: 

"1(a)

The Lessor hereby leases the goods to the Lessee and the Lessee hereby takes the goods on lease from the Lessor for the period stated in the Schedule (hereinafter called 'the period of the lease') for the Total Rent stated in the Schedule.

(b)

The full amount of the Total Rent shall become due forthwith upon the execution of this Agreement but the Lessor agrees with the Lessee that provided the Lessee shall pay to the Lessor the instalments specified in the Schedule upon the due dates therein specified or within seven days thereafter the Lessor will accept payment of the Total Rent by such instalments.  On default in the payment of any instalment on the due date and upon such default continuing for the space of fourteen days and upwards the Lessor may by notice in writing to the Lessee declare the whole unpaid balance of the Total Rent to be payable forthwith and in such event the same shall become payable by the Lessee to the Lessor accordingly."

The second relevant provision is cl.6(b), by which the lessee undertakes : 

"to pay interest at the rate of ten per centum per annum (in the May agreement, twenty per centum in the November agreement) on any monies payable hereunder which may from time to time be overdue."

Clause 7 confers on the appellant a power to terminate the agreement on the happening of various events which include failure to pay an instalment of rent within seven days of the due date.  It provides, so far as it is material: 

"7.

If:-

...

(c)

the Lessee fails to pay any instalment within seven days of the due date or any other monies payable hereunder immediately upon the Lessor making demand therefor;

(d)

the Lessee shall commit or permit or suffer to be committed any breach of the terms conditions and provisions of this Agreement;

...

then in any such case-

(i)

with or without notice the Lessor shall be entitled to take possession of the goods (but without prejudice to the Lessor's right to payment of the whole unpaid balance of the Total Rent or other monies payable under this Agreement) and for the purpose of taking possession of the goods the Lessee hereby authorises the Lessor and the agents or servants of the Lessor to enter upon any premises occupied or controlled by the Lessee, and

(ii)

the Lessee's right to use and to the possession of the goods hereunder may be terminated by the Lessor by notice in writing to the Lessee whereupon the whole unpaid balance of the Total Rent shall be payable forthwith by the Lessee to the Lessor."

Clause 10 authorizes a sale by the appellant of the goods upon termination of the agreement.  Clause 11 makes provision for a consequential alteration in the lessee's liability.  The clause is in these terms: 

"11.

If the net proceeds of such disposal (after allowing for all costs and expenses relating to the receipt by the Lessor of the goods and their disposal including storage) are less than the Residual Value stated in the Schedule hereto then the Lessee will forthwith after demand made by the Lessor pay to the Lessor by way of indemnity the amount of any deficiency (in addition to the whole unpaid balance of the Total Rent and other monies payable by the Lessee under this Agreement)."

Clause 12 provides: 

"12.

If upon the expiration of the period of the lease or any extension thereof or upon the prior termination for any reason whatsoever of the Lessee's right to use and to the possession of the goods hereunder the goods shall not be received by the Lessor within seven days of the giving of notice by the Lessor requiring the return of the goods to the Lessor's place of business or to such other place as may be agreed upon then the Lessee will forthwith pay to the Lessor on demand as and by way of ascertained and liquidated damages the Residual Value stated in the Schedule hereto together with the whole unpaid balance of the Total Rent and any other monies payable under this Agreement and interest thereon at the rate of ten per centum per annum (in the May agreement, twenty per centum in the November agreement) from the date of demand until payment."

The residual value specified in the schedules to the two agreements were $64,350 and $9,150 respectively.

The appellant determined the hiring under cl.7(ii) of each agreement on the ground mentioned in par.(c) of that clause, namely that in each case the hirer had failed to pay one instalment of rent within seven days of the due date. The two notices under cl.7(ii) were dated 28 April 1982. The relevant part of the first notice was in these terms: 

"... NOW the Company in pursuance of the rights and powers conferred upon it by the said Lease Agreement exercises its option in accordance with Section 7(ii) of the said Lease Agreement and terminates the Lessee's right to use and to possession of the goods and accordingly the whole of the unpaid balance of the total rent is payable forthwith by the Lessee to the Lessor.  Further pursuant to Section 6(b) of the said agreement the Lessor claims interest from the Lessee at the rate of 10 per centum per annum upon the moneys payable which are at the date hereof overdue.  The total rent due with interest at the date hereof is $230,825.00 and the Company demands payment thereof forthwith.  The Lessor also gives notice that it intends to claim on you for any deficiency in relation to the residual value as stated above ..."

It seems that the second notice was in identical terms, save for the specific amount claimed and the rate of interest which was applicable.

Lithotone did not comply with the notice of demand.  A winding-up order was made against it on 30 April 1982.  The appellant repossessed the equipment under the first agreement on 2 August 1982 and under the second agreement on or about 6 May 1982.  The appellant sold the equipment which was the subject of the second agreement for $22,500, an amount higher than the residual value of $9,150.  The appellant was unable to sell the equipment which was the subject of the first agreement, but it was not claimed that the value of the equipment was less than the residual value of $64,350.

The appellant's statement of claim does not precisely state the nature of its claim.  In par.10 it is alleged that upon the giving of the notice of termination the whole of the unpaid balance of the total rent became payable. This is a reference to cl.7(ii).  However, in par.15, where the appellant formulated its claim against the respondents, the claim made is for "payment of the damages sustained by (the appellant) as a result of (Lithotone's) breaches of the Lease Agreements, together with interest thereon and costs". Despite the way in which par.15 is expressed, the primary judge stated that the appellant sued for moneys payable under the agreements and, alternatively, for damages. In saying this, his Honour no doubt had it in mind that as part of their defence to the action the respondents pleaded that cll.6(b) and 7 of the agreements, which obliged Lithotone to pay the whole of the balance of the total rent due under the agreements upon their early termination, with interest thereon, created liabilities which amounted to penalties and were therefore unenforceable.  Moreover, in its reply the appellant pleaded that if equitable relief was granted to the respondents on the basis that their liabilities are penalties then, as a condition of such relief, the respondents should be required to do equity by:

(a)

accepting liability to compensate the appellant for the actual loss which it suffered arising from the termination of the agreements;  or

(b)

accepting liability to pay to the appellant an amount equal to the rental under the agreements for the period after termination when the goods remained on Lithotone's premises.

Whether the appellant's primary claim for moneys payable under the agreements was based on cll.11 or 12, in addition to cl.7(ii), was not made clear.  It seems to have been assumed, both at first instance and in the Court of Appeal, that this branch of the appellant's case was based on cl.7(ii) alone. The confusion may be ascribed to the deficiencies in the statement of claim, which led, in the ultimate analysis, to the absence of any issue in relation to the penal character of cll.11 and 12.

At first instance the defence that cl.7(ii) gave rise to a penalty, in so far as it imposed a liability on Lithotone to pay the whole of the balance of the total rent, was upheld.  Rogers J. correctly regarded the recent decision of this Court in O'Dea v. Allstates Leasing System (WA) Pty. Ltd. (1983) 152 CLR 359 as authority for the proposition that, where a lessee is under no present obligation to pay the entire rent, a provision requiring him to pay the whole of the balance of the rent for the unexpired term, without rebate for accelerated payment of future instalments, on his breach of the agreement in failing to make prompt payment of an instalment of rent, is a penalty if in the circumstances the lessor is entitled to repossess and resell the goods leased and is not bound to account to the lessee for the proceeds of sale, even if they exceed the appraisal or residual value.  The point is that such a provision cannot amount to a genuine pre-estimate of damage because it must necessarily exceed by a wide margin the greatest loss which the lessor can suffer as a result of default in payment of instalments.  The lessor would receive both the entire rental and possession of the vehicle, which would greatly exceed his damage (O'Dea, at p 379).

The provisions of the lease agreements in the present case are indistinguishable in material respects from those which were considered in O'Dea.  As in O'Dea, the clauses governing payment, when read together, created a liability to pay by instalments, with an obligation to pay the whole in the event of default in payment of an instalment.  And the effect of the agreements was that, on termination for breach, the appellant was entitled (a) to the whole of the balance of the rent, without rebate;  (b) to repossess and sell the goods;  and (c) to recover the difference, if any, between the residual value and the proceeds of sale.  The draftsman of the agreements did not attempt to take advantage of the decision of this Court in I.A.C. (Leasing) Ltd v. Humphrey (1972) 126 CLR 131 .  The comments of Walsh J. in that case, at pp 141-145, indicate that if provision is made for an appropriate rebate of future instalments of rent and for the lessee to have the benefit of any excess of the net sale price over the residual value, so long as it is the subject of a bona fide estimate, the problems encountered in the present case may be avoided.

Rogers J. held that the consequence of a finding that the amount prescribed to be paid by the provisions of an agreement is a penalty is that "the Court will grant relief against it and refuse to allow the promisee to recover more than the actual damage which he has sustained" (Philip Bernstein (Successors) Ltd v. Lydiate Textiles Ltd, noted only in (1962) 106 Solicitors' J. 669 as Sterling Industrial Facilities, Ltd v. Lydiate Textiles, Ltd, per Diplock L.J.; a statement approved by Staughton J. in Export Credits Guarantee Department v. Universal Oil Products Co. [1983] 2 All ER 205 , at p 212; (1983) 1 Lloyd's Rep 448, at p 453).  It was therefore necessary to assess the damage actually suffered by the appellant in accordance with the principles of the general law. The issue was whether the appellant was entitled to the arrears of rental to the date of termination only, as the respondents conceded, or to its actual damage, as the appellant claimed.

Rogers J. took as a starting point the principle established by the authorities that when a hiring agreement is terminated by the exercise of a power of termination conferred by the agreement and the owner retakes possession of the goods hired, he can recover damages for any breach up to the date of termination, but not for any breach thereafter, because there are no breaches thereafter.  The damage which he suffers over and above the instalments up to the date of termination is due, not to any breach of the agreement by the hirer, but to the owner's exercise of his contractual power of termination at a time when the value of the goods has decreased by an amount which exceeds the instalments which the owner has received and is entitled to receive up to that date.

However, his Honour considered that the principles on which the Court acts when, having pronounced a contractual stipulation to be a penalty, it awards to the plaintiff compensation for the loss which he has suffered, are derived from the exercise by equity of its jurisdiction to relieve against penalties.  In his view it would be inconsistent with those principles "to disregard completely the fact that the parties had agreed that a payment on account of the balance remaining unpaid of the total rent should be paid notwithstanding termination" and he pointed to the indication in cl.11 of the parties' intention that after termination there be, if necessary, an adjustment of rights by payment of moneys by the former lessee on account of the depreciation of the goods.  Accordingly, the appellant was entitled to recover the actual damage which it suffered and was not confined to the rental which accrued up to termination.  The amount awarded, $206,000, was agreed between the parties and evidently reflected both the unpaid rent to the date of termination and a component for the appellant's capital loss arising by virtue of depreciation of the equipment.

The Court of Appeal (Mahoney and Priestley JJ.A., with Hutley J.A. dissenting) allowed the respondents' appeal, set aside the judgment for $206,000 in favour of the appellant and remitted the matter to the Supreme Court for further hearing on the footing that the amount to be awarded to the appellant be limited to the sum of the instalments of rent unpaid at the date of either termination or repossession, and interest.  In the Court of Appeal the appellant did not contest the correctness of the finding that cl.7(ii) amounted to a penalty.  The issue there was whether the amount for which judgment was given could be supported on the ground advanced by Rogers J. or on the ground that the respondents had repudiated the agreements, the parties having agreed that, if either ground were made out, the amount awarded accurately reflected the amount of the appellant's loss.  Mahoney and Priestley JJ.A. found against the appellant on the question of repudiation. Hutley J.A. did not deal with that question, having no need to do so because he found for the appellant on the ground advanced by Rogers J.  Repudiation is no longer in contention as the appellant does not challenge the correctness of the Court of Appeal's finding on that matter .

Priestley J.A. considered, and Mahoney J.A. was prepared to assume, that Rogers J. was correct in having regard to the principles of equity in determining the compensation which the appellant was entitled to recover in lieu of the stipulated penalty.  However, they held that the limitation of the appellant's damages to the amount of instalments which had fallen due, but were unpaid, plus interest, accorded with those principles.  The correctness of this conclusion is the critical issue in the appeal.

Any attempt to exhume a discretionary jurisdiction to grant relief, which has not been exercised for more than a century, is bound to bring complications in its train. There is the initial problem of ascertaining the scope and mode of exercise of a dynamic jurisdiction which seems to have applied constantly changing criteria in the course of its development over more than two centuries before the introduction of the Judicature system.  And there is the secondary problem of determining whether there is any place for the exercise of the equitable jurisdiction in the framework of the law as it has developed in recent times. In the case of the doctrine of penalties these complications are accentuated by doubts which have been expressed with respect to the utility of the doctrine (see Muir, "Stipulations for the Payment of Agreed Sums" (1985) 10 Syd. L. Rev. 503, esp. at pp.526-527;  UK Law Commission, Penalty Clauses and Forfeiture of Monies Paid (1975) Working Paper No. 61;  Meagher, Gummow & Lehane, Equity:  Doctrines and Remedies (1984) 2nd ed., at pp.428-429;  Meagher, "Penalties in Chattel Leases", in Finn (ed.) Essays in Equity (1985), at pp.57-58).  And these doubts are compounded by unresolved difficulties which continue to arise in the course of its application.

The mainspring of the appellant's argument is to be found in the comments of Lord Denning in Campbell Discount Co. Ltd v. Bridge [1962] AC 600 .  In that case Viscount Simonds (at pp 613-614) and Lord Morton of Henryton (at pp 614-615) considered that a minimum payment clause was valid in its application to a termination by the hirer, being the price payable for the exercise of that right, even though it amounted to a penalty when it applied to a breach of contract on the part of the hirer.  On the other hand, Lord Denning (at pp.629-631), though agreeing with this conclusion, rejected the notion that the doctrine of penalties was confined to sums stipulated to be paid for breach of contract.  He pointed out that the jurisdiction of equity to relieve against penalties was not so confined, calling attention to equity's practice in earlier times of granting relief against penalties for non-performance of a condition in circumstances where, he suggested, the obligor gave no covenant to perform the condition.  Lord Devlin (at pp.634-635) reserved his opinion on the wider ground taken by Lord Denning.  He based his decision on the conclusion that the minimum payment clause was a penalty in its application to the hirer's breach of contract.  He concluded that the minimum payment clause was invalid in its application to termination by the hirer, because, being a sham for one purpose, it must be a sham for all purposes. Lord Radcliffe also found that the clause was a penalty in its application to the hirer's breach of contract. Although he did not commit himself on the wider ground taken by Lord Denning, Lord Radcliffe thought that it would be necessary to construct almost a new set of arguments to render the provision unenforceable in its application to events which were not breaches of contract (at pp.625-626).

Common to a number of the speeches in Campbell Discount was the view that the doctrine of penalties has no application to a stipulation which provides for the payment of an agreed sum on the happening of a specified event other than a breach of contract.  The correctness of this view has since been affirmed by the House of Lords in Export Credits, at pp 402-403;  pp 223-224 of All ER (see also I.A.C. (Leasing), at p 143).  The reason given for this limitation on the scope of the doctrine is that it has never been the function of the courts to relieve a party from a contract on the mere ground that it proves to be onerous or imprudent (Export Credits, at p 403;  p 224 of All ER). Unfortunately the proposition that the doctrine of penalties has no operation in relation to a sum agreed to be paid on the happening of an event which is not a breach of contract generates difficulties when an attempt is made to apply the proposition to the exercise of an option to terminate a contract which is conditional upon, or associated with, a breach of contract.

What is the position if the option is exercisable by the owner in a hire purchase agreement or the lessor in a chattel lease on the happening of any one of a series of events, some of which are breaches of contract on the part of the hirer and some of which are not?  If the option is exercised on the occasion of the hirer's breach of contract, it accords with principle and authority to say that the sum is payable in respect of the breach of contract and is a penalty, unless it is a genuine pre-estimate of the damage (O'Dea, at p 368;  Cooden Engineering Co. Ltd v. Stanford [1953] 1 QB 86 , at pp 96, 116; Campbell Discount; United Dominions Trust (Commercial) Ltd. v. Ennis [1968] 1 QB 54 , at pp 65, 68, 69;  cf. I.AC (Leasing), at pp 142-143).  The point is that the doctrine is concerned with matters of substance, not of form (Campbell Discount, at p 624;  O'Dea, at pp.368, 403).

A related problem arises when an agreement contains a minimum payment clause which requires the hirer to pay a stipulated sum on his exercise of an option to terminate the agreement or on the happening of other events which include his breach of contract.  Such a provision has been held to be valid in its application to termination by the hirer (Associated Distributors, Ltd v. Hall [1938] 2 KB 83 ), notwithstanding that the provision constitutes a penalty in its application to a breach of contract.  However, the status of Associated Distributors has been weakened by the comments made in Campbell Discount (see also O'Dea, at p 368).

The restricted view of the doctrine of penalties, vindicated in Export Credits, was criticized by Lord Denning in Campbell Discount (at p 629) on the ground that equity would thereby commit itself to an "absurd paradox:  it will grant relief to a man who breaks his contract but will penalise the man who keeps it".  With reference to the terms on which equitable relief would be granted against a penalty his Lordship said (at p 632): 

"When equity granted relief against a penalty, it always required the recipient of its favours, as a condition of relief, to pay the damage which the other party had really sustained.  A Quantum Damnificatus was issued to determine it.  On payment of the damage, equity granted an injunction to restrain the other party from proceeding to enforce the penalty at law.  Now that equity and law are one, the hire-purchase company should recover its actual damage, and such damage should be assessed according to the realities and not according to any fiction.  The hire-purchase company should recover the money it has advanced with interest at a reasonable rate up to the time when the hiring was terminated, less the instalments already received and the sum which the car might reasonably be expected to realise when it was delivered up to them."

Immediately before this passage, Lord Denning had stated that he was prepared, if necessary, to hold that the hiring was terminated by a repudiation which was accepted. Subsequently in Financings Ltd v. Baldock [1963] 2 QB 104 , at pp 112-113, his Lordship made it clear that the last sentence in the passage in Campbell Discount which we have quoted was relevant only to a case in which there was before termination a repudiation by the hirer of his obligation to pay future rentals and that where there was only a failure to pay instalments which did not go to the root of the contract, giving rise only to a right to terminate pursuant to an express stipulation in the contract, the owner can recover only instalments in arrear, with interest, and nothing else.  The point is that when the lessor terminates pursuant to the contractual right given to him for breach by the lessee, the loss which he can recover for non-fundamental breach is limited to the loss which flows from the lessee's breach.  The lessor cannot recover the loss which he sustains as a result of his termination because that loss is attributable to his act, not to the conduct of the lessee.  It is otherwise in the case of fundamental breach, breach of an essential term or repudiation (see Progressive Mailing House Pty Ltd v. Tabali Pty Ltd (1985) 59 ALJR 373, at p 379;  57 ALR 609 , at p 619).  In the present case, perhaps in deference to the views expressed in Shevill v. Builders Licensing Board (1982) 149 CLR 620 , it was not argued that the existence of a contractual right on the part of the lessor or owner to terminate for a breach of what is otherwise a non-essential term endowed that term with the character of a condition, though the judgment of Jordan C.J. in Larratt v. Bankers & Traders Insurance Co. (1941) 41 SR(NSW) 215, at pp 225-226 seems to support the proposition.  Such an argument was advanced in Financings Ltd v. Baldock, but was not discussed by the English Court of Appeal.  However, the point was discussed by Mahoney J.A. in Citicorp Australia Ltd v. Hendry (1985) 4 NSWLR 1, at pp 25-26.

The doctrine of penalties has pursued such a tortuous path in the course of its long development that it is a risky enterprise to construct an argument on the basis of the old decisions.  However, we can be reasonably sure that by the beginning of the seventeenth century it was established that equity would relieve against a penal bond where it was possible to compensate the obligee for the loss suffered as a result of the default (Simpson, "The Penal Bond with Conditional Defeasance" (1966) 82 LQR 392 , at p 418).  According to the opinion of Lord Somers, cited by counsel in argument in Marks v. Marks (1718) Prec. Ch 486, at p 488;  24 ER 218, at p 219, and in Astley v. Weldon (1801) 2 Bos & Pul 346, at p 349;  126 ER 1318, at pp 1320-1321: 

"... where the party might be put in as good a plight as where the condition itself was literally performed, there the Court of Chancery would relieve though the letter of it were not strictly performed, as payment of money & c. but where the condition was collateral and no recompense or value could be put on the breach of it, there no relief could be had for the breach of it."

So, where compensation was not possible, or damages could not be assessed, it seems that relief would not be granted (Tall v. Ryland (1670) 1 Chan. Cas. 183; 22 ER 753).  It was recognized during Lord Nottingham's chancellorship that in the eye of equity a penalty was regarded as an obligation by way of security or, to use the language of the later cases, a guarantee of performance (Selden Society, Lord Nottingham's Chancery Cases (Vol. II) (1961) vol. 79, at pp 7-30, esp. at p 19).  By the last quarter of the eighteenth century equity was relieving against penal bonds which were collateral to performance contracts, as well as against stipulations for the payment of agreed sums on default of the payment of money (Hardy v. Martin (1783) 1 Cox 26;  29 ER 1046;  Sloman v. Walter (1783) 1 Bro CC 418;  28 ER 1213;  Muir, at pp 507-508).

Hardy v. Martin is an interesting illustration.  There the plaintiff and the defendant had been partners as brandy merchants.  The plaintiff, on quitting the business and selling the lease and goodwill of the shop to the defendant for 300, entered into a penal bond for  600 not to sell, for nineteen years, any quantity of brandy less than six gallons within five miles of the cities of London and Westminster or to permit any person to do so in his name. When, upon a breach, an action was brought and a verdict given for payment of the penalty, the plaintiff filed a bill praying that an account might be taken of the actual damage sustained by the defendant and an issue directed (quantum damnificatus) for that purpose.  An injunction was granted to restrain the defendant from taking out execution for the penalty under the bond, an issue was directed on damages and the jury subsequently gave a verdict for the plaintiff at law (the defendant in equity) with damages of 1s.

The basis of the decision in Hardy v. Martin is to be found in Sloman v. Walter where Thurlow L.C. said, at p 419; p 1214 of ER:  

"The rule, that where a penalty is inserted merely to secure the enjoyment of a collateral object, the enjoyment of the object is considered as the principal intent of the deed, and the penalty only as accessional, and, therefore, only to secure the damage really incurred, is too strongly established in equity to be shaken."

Lord Thurlow invoked this general principle in order to displace the rule of interpretation, applied before the enactment of the Statute 8 & 9 Wm. III c.11 s 8 (1696), that stipulations for the payment of an agreed sum otherwise than on default of the payment of money were to be considered as liquidated damages (see Muir, at pp.506-507).  In both Hardy v. Martin and Sloman v. Walter the parties had imprudently described the amount agreed to be paid as a penalty. At that time much depended on the terms which the parties used, for the distinction between a penalty and liquidated damages was thought to be in a substantial degree a matter of intention.  This was emphasized eighteen years later by Lord Eldon ChJ. in Astley v. Weldon.  He pointed out (at pp 350-351; p 1321 of ER) that the decision in Sloman v. Walter was justified on the footing that the parties described the sum as a penalty.  He stated that there was little to commend the view that, if the sum be "enormous and excessive considered as liquidated damages, it shall be taken to be a penalty though agreed to be paid in the form of contract".  He thought that there was no reason why an agreement such as that made in Hardy v. Martin should not be enforced, except perhaps if the agreement be entered into "in the form of a bond with a penalty" (at p 352; p 1322 of E.R.).  And he regretted that the principle stated by Lord Somers, quoted above, had not been adhered to.

Astley v. Weldon and Kemble v. Farren (1829) 6 Bing 141;  130 ER 1234, were both cases concerning contracts for theatrical performances by which the performer was required to comply with many covenants and a large sum was fixed by the contract as being payable on any breach.  In Kemble v. Farren the sum was described as liquidated damages;  in Astley v. Weldon it was not given a description.  In granting relief in each case the court applied the presumption that where a sum was payable on a number of contingencies, one of which was the non-payment of a smaller sum, a penalty was intended, even though the breach relied on was failure to perform, rather than non-payment of money.  Kemble v. Farren marked a turning point because Tindal C.J. refused to give effect to the declaration by the parties that the stipulated sum was liquidated damages and determined its true character as a penalty.  In the result the verdict awarded by the jury in favour of the plaintiff for an amount less than the stipulated sum was allowed to stand.  The plaintiff had sued at common law for the stipulated sum and, pursuant to the Statute 8 & 9 Wm. III c.11 s 8 (1696), had recovered a verdict for his actual damage, subject to a motion for increasing the damages to the stipulated sum if the Court thought he was entitled to recover the whole of that sum as liquidated damages.

As early as the seventeenth century the common law courts had themselves begun to relieve against penalties, thereby avoiding the need for proceedings in equity.  The practice of the common law courts in this respect was regulated by the Statute 8 & 9 Wm. III c.11 s 8 (1696) (actions for penalties for non-performance of covenants or agreements) and Statute 4 & 5 Anne c.3 ss 12, 13 (1705) (actions on money bonds).  The refusal of the common law courts to enforce penalties was to lead to the emergence of the principle that a penalty provision is unenforceable, a matter to be discussed later because it is fundamental to the disposition of this appeal.  The English statutory provisions have been replaced in New South Wales by ss 33 and 34 of the Imperial Acts Application Act 1969 (NSW) which fulfil a similar function. Astley v. Weldon and Kemble v. Farren are instances of the exercise of jurisdiction by the common law courts in accordance with the 1696 statute.

Although the subsequent history of the doctrine of penalties in the nineteenth century throws little light on the way in which the jurisdiction to relieve was exercised, the judgment of Sir George Jessel M.R. in Wallis v. Smith (1882) 21 ChD 243, at p 256 et seq., is illuminating.  His Lordship, who was given to expounding the virtues of freedom of contract (see p 266), like Lord Eldon Ch.J. in Astley v. Weldon, rejected the idea that the mere magnitude or extravagance of the sum agreed upon was indicative of its character as a penalty.  For him the concept of a penalty was a sum of money agreed to be paid for breach of a covenant or promise in respect of which the damage was ascertainable and was "much less than the sum named as payable upon the breach", to use the words of Coleridge J. in Reynolds v. Bridge (1856) 6 El & Bl 528, at p 541;  119 ER 961, at p 966.

Wallis v. Smith was a staging post on the way as the doctrine became more closely identified with sums agreed to be paid on breaches of contract, a development which was fully reflected later in the landmark decisions of the House of Lords in Clydebank Engineering and Shipbuilding Company v. Don Jose Ramos Yzquierdo y Castaneda [1905] AC 6 and Dunlop Pneumatic Tyre Company, Limited v. New Garage and Motor Company, Limited [1915] AC 79 .  In both these decisions, in conformity with the doctrine's historic antecedents, the concept is that an agreed sum is a penalty if it is "extravagant, exorbitant or unconscionable" (Clydebank, at pp.10-11, 17;  Dunlop, at p 87).  This concept has been eroded by more recent decisions which, in the interests of greater certainty, have struck down provisions for the payment of an agreed sum merely because it may be greater than the amount of damages which could possibly be awarded for the breach of contract in respect of which the agreed sum is to be paid (see Cooden Engineering Co. Ltd v. Stanford, at p 98).  These decisions are more consistent with an underlying policy of restricting the parties, in case of breach of contract, to the recovery of an amount of damages no greater than that for which the law provides.  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 an 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 (see Robophone Facilities Ltd v. Blank [1966] 1 WLR 1428 , at pp 1447-1448;  [1966] 3 All ER 128 , at pp 142-143;  UK Law Commission, at pars.33, 42-44).

From this review of the doctrine of penalties, brief though it is, the following points emerge:

(1)

equity would only relieve where compensation could be made for the actual damage suffered by the party seeking to recover the penalty;

(2)

the actual damage suffered by the party was assessed in an action at common law, such as an action of covenant, or upon a special issue quantum damnificatus which could be joined in an action on the case (Simpson, fn. 11, at p 418);

(3)

the expression "actual damage" seems to have been used in contradistinction to "agreed sum" or "liquidated" or "stipulated" damages, not by way of opposition to damage which was recoverable at law;

(4)

there seems to have been no instance of equity awarding compensation over and above the amount awarded as common law damages, other than cases in which equity would not relieve against the penalty;  and

(5)

relief was granted, in the case of penal bonds, where there was no express contractual promise to perform the condition (see Hardy v. Martin), though it seems such a promise could in many cases readily be implied .

The advent of the Judicature system, with its emphasis on the disposition of all issues in one proceeding, hastened the demise of equity's separate jurisdiction to relieve against penalties.  Although it is not possible to identify when the principle that a penalty is unenforceable became an established rule of law, the Judicature system reinforced the principle.  That system strengthened the development which had been taking place in the common law courts since the seventeenth century, whereby all relevant relief could be obtained in the one action in which the plaintiff sued to recover a penalty. It meant that there was no need to invoke the equitable jurisdiction.  It is significant that counsel have not drawn to our attention any instance of the equitable jurisdiction to relieve against penalties having been invoked in England since the Judicature Act 1873 (UK), let alone any instance of the exercise of the jurisdiction in which compensation awarded has exceeded the amount of damages which would have been awarded at common law in lieu of the penalty.  Without exception the cases show that once the agreed sum is held to be a penalty the plaintiff recovers damages for breach of contract in lieu of the penalty.  All this leads to the conclusion that the equitable jurisdiction to relieve against penalties withered on the vine for the simple reason that, except perhaps in very unusual circumstances, it offered no prospect of relief which was not ordinarily available in proceedings to recover a stipulated sum or, alternatively, damages.

Moreover, the old cases do not deal with the question whether the jurisdiction to relieve against penalties would have been exercised so as to recompense a party for the capital loss which he sustained as a result of his termination, pursuant to a contractual right, of a contract on account of the other party's non-fundamental breach in circumstances where there was no repudiation.  The law of contract was in its infancy and the distinctions between essential and non-essential terms and between fundamental and non-fundamental breach had not at that time been fully developed.  However this may be, it would now be inconsistent with modern authority for equity to condition its relief by imposing on the obligor a liability to pay damage which flows, not from the obligor's breach of contract, but from the obligee's act in exercising his contractual right to terminate for non-fundamental breach.

This conclusion does not provide a comprehensive answer to the appellant's alternative submission that the penalty clause should be enforced to the extent to which it is not a penalty.  It is one thing to deny to a plaintiff a right to recover damages for a loss which is of his own making and cannot be sheeted home to conduct of the defendant.  It is another thing to deny to a plaintiff the right to recover pro tanto on an indemnity for capital loss arising from depreciation and deterioration of the goods leased to the defendant when the amount of the indemnity exceeds the amount which the law is prepared to allow. So, according to the argument, although the relevant provisions, cll.7(ii) and 12, were penal in character, they should be treated as valid and operative to the extent to which they provide an indemnity for the actual loss which the appellant has sustained.

The question whether a penal provision is void or unenforceable has been the subject of continuing debate. There has also been a conflict of authority on the related question whether a penalty operates to impose a limit on the common law damages which a plaintiff may recover.  The charterparty cases say that the plaintiff may ignore the penalty and sue for greater damages (Wall v. Rederiaktiebolaget Luggude [1915] 3 KB 66 ;  Watts, Watts and Company, Limited v. Mitsui and Company, Limited [1917] AC 227 ), but there is also authority the other way (Wilbeam v. Ashton (1807) 1 Camp 78;  170 ER 883;  Lord Elphinstone v. Monkland Iron and Coal Co. (1886) 11 App. Cas. 332, at p 346;  Public Works Commissioner v. Hills [1906] AC 368 , at p 376).  The point was left open by Lord Atkin in Cellulose Acetate Silk Co. v. Widnes Foundry (1925) Ltd [1933] AC 20 , at p 26, and by Diplock L.J. in Robophone Facilities Ltd v. Blank, at p 1446;  p 142 of All ER;  but cf. Financings Ltd v. Baldock, at p 121.  Since then the question has attracted different answers from the Supreme Court of Canada in Elsley v. J.G. Collins Insurance Agencies Ltd (1978) 83 DLR(3d) 1 and from Lee J. in W & J Investments Ltd v. Bunting (1984) 1 NSWLR 331.  It is unnecessary for the purposes of determining the present case to resolve the larger aspects of this controversy.

At least since the advent of the Judicature system a penalty provision has been regarded as unenforceable or, perhaps void, ab initio (Citicorp Australia Ltd v. Hendry). In all that time it has been thought that no action could be brought on such a clause, no doubt because the courts should not lend their aid to the enforcement in any way of a provision which is oppressive. However, this is not the only reason why the courts would refuse to lend their aid. In the majority of cases involving penalties, the courts, if called upon to assist in partial enforcement of the kind suggested by the appellant, would be required to undertake an unfamiliar role.  They would need to rewrite the clause so as to permit the plaintiff to recover the loss he has actually sustained.  Penalty clauses are not, generally speaking, so expressed as to entitle the plaintiff to recover his actual loss.  Instead they prescribe the payment of a sum which is exorbitant or a sum to be ascertained by reference to a formula which is not an acceptable pre-estimate of damage.  In either case the court, if it were to enforce the clause, would be performing a function very different from that which it undertakes when it severs or reads down an unenforceable covenant, such as a covenant in restraint of trade.

In the ultimate analysis, in whatever form it be expressed, the appellant's argument amounts to an invitation to the Court to develop a new law of compensation, distinct from common law damages, which would govern the entitlement of plaintiffs who insist on the inclusion of penalty clauses in their contracts.  In this respect it is perhaps worthwhile recalling that the amount of compensation which equity regarded as a just and equitable recompense for loss suffered, usually happened to be equivalent to the amount of damages recoverable at common law (Elsley, at p 13).

Instead of pursuing a policy of restricting parties to the amount of damages which would be awarded under the general law or developing a new law of compensation for plaintiffs who seek to enforce a penalty clause, the courts should give the parties greater latitude to determine the terms of their contract.  In the case of provisions for agreed compensation and, perhaps, provisions limiting liability, that latitude is mutually beneficial to the parties.  It makes for greater certainty by allowing the parties to determine more precisely their rights and liabilities consequent upon breach or termination, and thus enables them to provide for compensation in situations where loss may be difficult or impossible to quantify or, if quantifiable, may not be recoverable at common law.  And they may do so in a way that avoids costly and time-consuming litigation.  But equity and the common law have long maintained a supervisory jurisdiction, not to rewrite contracts imprudently made, but to relieve against provisions which are so unconscionable or oppressive that their nature is penal rather than compensatory.  The test to be applied in drawing that distinction is one of degree and will depend on a number of circumstances, including (1) the degree of disproportion between the stipulated sum and the loss likely to be suffered by the plaintiff, a factor relevant to the oppressiveness of the term to the defendant, and (2) the nature of the relationship between the contracting parties, a factor relevant to the unconscionability of the plaintiff's conduct in seeking to enforce the term. The courts should not, however, be too ready to find the requisite degree of disproportion lest they impinge on the parties' freedom to settle for themselves the rights and liabilities following a breach of contract.  The doctrine of penalties answers, in situations of the present kind, an important aspect of the criticism often levelled against unqualified freedom of contract, namely the possible inequality of bargaining power.  In this way the courts strike a balance between the competing interests of freedom of contract and protection of weak contracting parties (see generally Atiyah, The Rise and Fall of Freedom of Contract (1979), esp. Ch.22).

Our rejection of the appellant's arguments should not be taken as throwing any doubt on the right of the owner or the lessor to recover his actual loss on his early termination of a hire-purchase agreement or chattel lease, pursuant to a contractual right, for the hirer's non-fundamental breach, under a correctly drawn indemnity provision.  The validity of such a provision was upheld in I.A.C. (Leasing) and is supported by the comment of Gibbs C.J. in O'Dea (at p 369) that "a lessor is entitled to be compensated for the loss which he is likely to suffer on the premature termination of a hiring."  A similar suggestion was made by Willmer L.J. in Anglo Auto Finance Co. Ltd v. James [1963] 1 WLR 1042 , at p 1047;  [1963] 3 All ER 566 , at p 569. And in Shevill v. Builders Licensing Board (1982) 149 CLR 620 there were indications that, if the lease clearly provided that whenever a lessor exercised the right of re-entry conferred by the lease he was able to recover such loss as he may have suffered by reason of the premature termination of the lease, such a provision might be effective (at pp.629, 637). The assumption on which these comments are based is that the suggested provisions, unlike cl.7(ii) of the agreements in the present case, do not amount to a penalty.

It may no longer be possible to sustain all the steps in the reasoning which led to this Court's conclusion in I.A.C. (Leasing).  However, there is no reason to suppose that a provision which gives the lessor an indemnity, on his early termination for the lessee's breach, in the form of all unpaid instalments of rent, suitably discounted for early receipt, plus the residual value of the goods adjusted so as to reflect their actual value at the relevant time, would constitute a penalty.  The topic is dealt with in recent decisions which are discussed in Barnes, "Agreed Damages Clauses in Financing Contracts in the Light of Citicorp Australia Limited v. Hendry" (1986) 14 ABLR 63.

We would dismiss the appeal.