Penalties and Relief Against Forfeiture of Joint Venture Interests 219 PENALTIES AND RELIEF AGAINST FORFEITURE OF JOINT VENTURE INTERESTS Michael Lishman A common provision in an exploration joint venture agreement is one which allows non-defaulting joint venture participants to acquire the joint venture interest of a defaulting participant. These provisions often provide for the forfeiture of the defaulting joint venturers joint venture interest for either no consideration or at a percentage discount to its value. Such a provision may be a penalty and not enforceable. Questions may also arise as to the circumstances in which the defaulting joint venturer may be entitled to relief against forfeiture of the joint venture interest. This article considers leading High Court cases on penalties and relief against forfeiture and applies principles extracted from those cases to address the enforceability of such default provisions. INTRODUCTION Courts will in certain circumstances grant relief against the forfeiture of a proprietary interest which would otherwise occur on default of an obligation. Courts will also not enforce a provision of a contract on default which is in the nature of a penalty for default rather than compensation to the non-defaulting party. 1 A common provision in an exploration joint venture agreement 2 is one which allows nondefaulting joint venture participants to acquire the joint venture interest of a defaulting participant. These provisions often provide for the forfeiture of the defaulting joint venturers joint venture interest for either no consideration or at a percentage discount to its value. This article considers leading High Court cases on penalties and relief against forfeiture and applies principles extracted from those cases to address the enforceability of such default provisions. The article focuses on the Australian Mining and Petroleum Law Association s (AMPLA) Model Exploration Joint Venture Agreement. 3 (Model JVA) Clause 13 of the Model JVA contains a default clause (AMPLA Default Clause). 4 This article suggests an alternative approach to drafting clause 13. 1 2 3 4 Michael Lishman, Partner, Cochrane Lishman. This article is based on a paper submitted for assessment in Resources Joint Ventures in the LLM Programme at Melbourne University. For a discussion of both concepts see Meagher, Gummow and Lehane s Equity Doctrines and Remedies (4th ed) Ch 18. In this article, the term joint venture and joint venture agreement have been used to refer to joint ventures for the exploration for both minerals and petroleum. Accordingly, a reference to a joint venture agreement includes a joint operating agreement. AMPLA Model Exploration Joint Venture Agreement (Minerals) approved version 18 February 2008. References in this article to the AMPLA Default Clause are to clause 13 of the Model JVA.
220 Articles (2008) 27 ARELJ 1. THE AMPLA DEFAULT CLAUSE For a Breach Default Event, clause 13.1 of the AMPLA Default Clause provides that: the non-defaulting Joint Venturers may (but are not obliged to) elect to acquire, pro-rata in proportion to their Joint Venture Interests, the whole (but not part) of the Defaulting Joint Venturer s Joint Venture Interest, provided that if the Default Event is remedied or compensated in accordance with this agreement before the election is made, the right to election lapses. Clause 13.3 of the AMPLA Default Clause provides that if an election is made under clause 13.1, the non-defaulting joint venture parties may acquire the defaulting party s joint venture interest, by curing the default, assuming all future obligations of the defaulting party and paying market value less 10%, less amounts due from the defaulting joint venturer and less amounts paid to cure the default. The requirement to discount the market value by 10% applies in all cases and regardless of the stage of the joint venture. The Model JVA is intended to continue beyond the discovery of minerals, until the parties agree new terms. 5 Clause 13.4 of the AMPLA Default Clause provides: The Joint Venturers acknowledge that the consideration for the acquisition by a non- Defaulting Joint Venturer of a Defaulting Joint Venturer s Joint Venture Interest (including the assumption of all future obligations and liabilities): (a) is agreed following negotiations involving all Joint Venturers which accepted that the consideration does not constitute or give rise to a penalty, forfeiture or unjust enrichment; and (b) represents a reasonable and good faith assessment of the just and fair compensation for the Defaulting Joint Venturer in all the circumstances surrounding the Default Event. 6 The Notes which accompanied the Exposure Draft of the Model JVA said of clause 13: 7 4 members of the Reference Group 8 did not consider the provision a penalty, 4 members of the Reference Group thought that if there was a dispute the provision could be litigated while 1 member thought that the consideration for the forced transfer would be better being a royalty or Net Smelter Return. This article considers two questions. First, in what circumstances may a court grant relief against forfeiture of the joint venture interest under the AMPLA Default Clause? Second, is the AMPLA Default Clause a penalty specifically because of the inclusion of the 10% discount? 9 5 6 7 8 9 Clause 3.3 of the Model JVA. There is something of course curious about a clause in a precedent along these lines that purports to reflect the course of negotiations between parties, but has been drafted before the parties have begun to negotiate the joint venture agreement. See: AMPLA Model Exploration Joint Venture Agreement Approved Exposure Draft 3.12.06. Particular Issues for Consideration - Forced transfer on default a penalty? The group that drafted the Model JVA. A subsidiary question is whether clause 13.4 of the AMPLA Default Clause is of any assistance in answering these questions?
Penalties and Relief Against Forfeiture of Joint Venture Interests 221 2. CHARACTERISATION OF THE AMPLA DEFAULT CLAUSE CRA AND MONARCH CASES 10 How a court characterises the AMPLA Default Clause may affect the availability of relief against forfeiture or whether it is a penalty. For example, if it is characterised as essentially requiring the payment of money it will be easier for a defaulting participant to obtain relief against forfeiture (see 3. High Court and Relief Against Forfeiture below). Two cases give guidance on how an Australian court may characterise the AMPLA Default Clause. A clause similar to the AMPLA Default Clause was considered in the CRA case. The relevant clause provided: If such default persists for more than 60 days after notice in writing from the non-defaulting party to remedy it, then the non-defaulting party may, at its option require the defaulting party to sell to the non-defaulting party its Participating Interest (which includes all rights and obligations attaching to it) at its then fair market value less 5%, or acquire the interests of the defaulting party to dilute it in favour of the non-defaulting party. 11 The defendant defaulted and the plaintiffs exercised their option to acquire the defendant s interest. The defendant argued that the 5% discount to market value was an unenforceable penalty and that the price should be the fair market value. The defendant did not argue that the clause was unenforceable as a whole. 12 The defendant s arguments were not accepted by Tadgell J of the Victorian Supreme Court who characterised the clause as follows: [As] properly understood [the clause] seeks to impose no penalty of that kind at all. The essential purpose of [the clause] appears to me neither to compensate the non-defaulting party nor punish the defaulting party. That is not to say that it is unconcerned to provide a measure of inducement not to default. It is primarily directed, in my view, to dealing within accommodating a default in a fashion most conveniently suited to overcoming it in the interests of the progress of the joint venture project. 13 The context of [the clause] suggests that it is not concerned so much with the imposition of a liability as to the resolution of an impasse. 14 10 11 12 13 14 CRA Ltd and Kelian Ltd v New Zealand Goldfields Investments and Claremont Petroleum [1989] VR 873 and Monarch Petroleum NL v Citco Australia Petroleum Ltd [1986] WAR 310. CRA Ltd and Kelian Ltd v New Zealand Goldfields Investments and Claremont Petroleum [1989] VR 873 at 874 and 875. Tadgell J was not impressed with the defendant s arguments being confined to the 5% discount (rather than attacking the whole clause). He said (ibid at 877), This, I must say, smacks of blowing hot and cold. It tends to highlight the fact that the acquisition provisions in [the clause] while in a sense providing a benefit to the plaintiffs, or to the non-defaulting party, is also of benefit to the defaulting party, enabling it to recover the greater part of the value or its interest instead of, for example, forfeiting it or simply walking away from it by virtue of clause 11. Ibid at 875. Ibid at 875.
222 Articles (2008) 27 ARELJ It is not hard to accept the logic of the finding that the 5% discount was designed to recognise an actual diminution in value of that interest with the non-defaulting party opting to acquire it and persevere with the project. 15 Whilst the discount could not be an accurate reflection of any decrease in value it was, however, agreed as an acknowledgment that the fair market value otherwise objectively to be ascertained was too high a price to be paid by the non-defaulting party. 16 That price was too high because what was to be acquired was an interest in a project whose integrity had ex-hypothesis been fractured by the defaulting party s breach. 17 On its own, the CRA case is of limited value as the point at issue was limited to whether or not a 5% discount on fair market value was a penalty, in circumstances where the defendant seemed happy to accept cash for the sale of its joint venture interest. The case is therefore limited authority for how a court would consider a default clause such as the AMLPA Default Clause with a higher percentage discount. Had significant gold reserves been discovered post default but prior to exercise of the option, the defendant s arguments in CRA may have been less hot and cold. 18 The defendant may have sought to attack the enforceability of the clause as a whole. The Monarch case does not consider penalties or relief against forfeiture. The case is primarily concerned with enforceability of deeds. 19 However, the case does provide another example of how a court may characterise the AMPLA Default Clause, at least during the exploration phase of the joint venture. The Monarch case concerned a petroleum exploration joint venture. The relevant default clause provided: If a default persists for longer than sixty (60) days after receipt of notice by the defaulting Party of default hereinabove provided, in addition to other remedies provided herein and such other remedies as may be available under law, the defaulting Party shall have no rights to Available Oil and Available Gas and non-defaulting Parties shall have the right to require the defaulting Party to assign to them at defaulting Party s expense defaulting Party s entire Percentage Interest in the Contract whereupon, as from the date of default, the defaulting Party shall cease to be a party hereto and shall have no rights nor benefits nor obligations. 20 The extremely high risk nature of oil exploration was emphasised by Kennedy J who referred to the costs of offshore drilling, the low prospect of success, the need to spread risk and the scarcity of high risk capital. 21 His Honour concluded: In these circumstances, participants in oil exploration ventures cannot contemplate anything other than a commercial operation which flows smoothly and is not liable to disruption, for example, by the default of any participant. A steady flow of funds is essential. Commitments must be made a long time ahead and it is important that programmes be adhered to. Any default by one participant places a heavy burden upon the 15 16 17 18 19 20 21 Ibid at 876. Ibid at 877. Ibid at 877. Ibid at 12. Monarch Petroleum NL v Citco Australia Petroleum Ltd [1986] WAR 310 at 352. Ibid at 317. Ibid at 319.
Penalties and Relief Against Forfeiture of Joint Venture Interests 223 other participants The acquisition of a defaulter s interest is not seen as being beneficial in the exploration stage of a venture. On the contrary, it involves an additional financial commitment without necessarily any return on it. If there is eventually any return, it will frequently only be revealed after the expenditure of further funds to which the defaulting party should have contributed, but to which it did not contribute. 22 If the approach to the purpose of a default clause taken in Monarch and CRA is followed then the primary purpose of the AMLPA Default Clause is not merely to secure the repayment of money, but rather to allow the non-defaulting participants to take out the defaulting party and to move on with the exploration. As will be seen, this conclusion may have significant consequences as to whether or not relief against forfeiture will be available to the defaulting participant. 3. HIGH COURT AND RELIEF AGAINST FORFEITURE Relief against forfeiture can be available in respect of the forfeiture proprietary interests on default such as under mortgages and leases. If a mining or petroleum joint venture interest is categorised as contractual (and the titles held under the joint venture statutory and not proprietary) then relief against forfeiture may not apply. The answer to this question depends on the characterisation of the joint venture interest and the nature of the title interests that the joint venture has. That is the subject for another article. Christensen and Duncan 23 note that the cases which have considered relief against forfeiture deal with the forfeiture of interests in land and, in particular, mortgages and leases. Christensen and Duncan conclude that In Australia, the question must therefore be an open one and much might depend on the nature of the interest forfeited. 24 In the United Kingdom, according to Willoughby, 25 relief against forfeiture of a joint venture interest was thought to be available based on the judgment of Lord Wilberforce in Shiloh Spinners Ltd v Harding 26 on the basis that the sanction of forfeiture in the joint venture agreement was designed in part to ensure payment of calls. This article proceeds on the basis that the joint venture interest has sufficient propriety character that would allow relief against forfeiture to be granted in the appropriate circumstances. But the matter is not beyond doubt. Assuming that relief against forfeiture can be available for loss of a joint venture interest; it remains to be considered how a court may approach the AMPLA Default Clause if asked to relieve a defaulting joint venture party of loss of the interest. Proposition: for relief to be available there must be some element of fraud, accident, mistake, surprise or conduct on the party of the non-defaulting joint venture parties that renders it unconscionable for them to enforce the clause. 22 23 24 25 26 Ibid at 319. S Christensen and B Duncan: Default, Deadlock and Remedies in W D Duncan (ed) Joint Venture Laws in Australia (2nd ed, 2005) p 309. Ibid p 310. G D M Willoughby Forfeiture of Interests in Joint Operating Agreements (1985) 3 Journal of Energy and Natural Resources Law 258. Shiloh Spinners Ltd v Harding [1973] AC 6971.
224 Articles (2008) 27 ARELJ In Shiloh Spinners Ltd. v Harding Lord Wilberforce 27 referred to specific categories where relief against forfeiture may be granted: (a) fraud, accident, mistake or surprise; or (b) where the object of the transaction is essentially to secure the payment of money and the defaulting party is prepared to pay with interest. If the characterisation of the AMPLA Default Clause by a court follows the approach taken in the Monarch and CRA cases the second category is unlikely to apply. So relief against forfeiture would only apply if the default involved an element of fraud, accident, mistake or surprise. However, in Australia, the categories set out in Lord Wilberforce s speech are not the only circumstances in which relief against forfeiture may be given. 28 Legione v Hateley 29 concerned a contract for the sale of land. Prior to completion, the purchasers built a house on the land. The purchasers defaulted. Demand was made for payment and notice was served threatening rescission. The case concerns, amongst other things, estoppel and whether estoppel arose from certain discussions between solicitors for the parties. Gibbs CJ and Murphy J (who were in the minority) considered the purchasers were entitled to specific performance because of the estoppel. 30 They went on to consider whether relief against forfeiture would be available and considered Lord Wilberforce s decision in Shiloh Spinners Ltd v Harding 31 and the two categories of circumstances where relief may be available. They were of the opinion that it is unnecessary that the condition which provides for forfeiture should be a penal one before the jurisdiction of equity can be invoked. 32 So, relief against forfeiture may be available in the case of loss of a joint venture interest on default, even if the default clause is not of a penal nature. The concept of penalties and relief against forfeiture are not the same. Gibbs CJ, Mason, Murphy and Deane JJ held that there is no principle preventing the court granting relief against forfeiture to a purchaser in breach of an essential condition. 33 Mason and Deane JJ said: Generally speaking equity expects men to carry out their bargains and will not let them buy their way out by uncovenanted payment (Shiloh Spinners Ltd v Harding [1973] AC 691 at 723 per Lord Wilberforce). Nor will it remake the parties contract simply because it transpires that as things have happened one party has made a bad bargain. But if there be fraud, mistake, accident, surprise or some other element which would make it unconscionable or inequitable to insist on forfeiture of the purchaser s interest under the contract because he has not performed in strict accordance with its terms, there is no 27 28 29 30 31 32 33 Ibid at 722-3. See Tolhurst and Carter Relief Against Forfeiture in the High Court of Australia (2004) 20 Journal of Contract Law 74 at 76. Legione and Another v Hateley (1983) 46 ALR 1. Ibid at 11. Ibid at 12. Ibid at 13. Two decisions of the Privy Council which were authority for the proposition that courts will not grant specific performance where the party is in breach of a time of the essence provision were not followed: Steedman v Drinkle [1916] 1 AC 275 and Brickles v Snell [1916] 2 AC 599.
Penalties and Relief Against Forfeiture of Joint Venture Interests 225 injustice to the innocent party is granting relief against forfeiture by means of specific performance with or without compensation. 34 Importantly, Mason and Deane JJ go on to say: Whether the exceptional circumstances exist in a given case hinges on the existence of unconscionable conduct. It is impossible to define or describe exclusively all the situations which may give rise to unconscionable conduct on the part of a vendor in rescinding a contract for sale. Nonetheless, it may be said that where the conduct of the vendor, though not creating an estoppel or waiver, has effectively caused or contributed to the purchaser s 35 36 breach of contract there is a ground for exercising the jurisdiction to relieve. In Stern & Anor v McArthur & Anor 37 the respondents had entered into a contract to acquire land, the purchase price payable in instalments. The purchasers took possession of the land and built a home on it and neglected to pay 11 months of instalments. The purchasers made attempts to pay the instalments but the appellant sought payment for the full purchase price and purported to rescind the contract on a failure to complete. The purchaser successfully sought relief against forfeiture and specific performance of the contract. The High Court confirmed that the circumstances in which relief against forfeiture will be given are not limited to fraud, mistake, accident or surprise. These elements do not, however, exhaust the scope of unconscionable or unconscientious behaviour; they are referred to in this context to emphasise that a strong case must be made out to warrant departure from the general approach, which is to hold the parties to their bargain. 38 Proposition: The characterisation of the AMPLA Default Clause as more than merely securing the payment of money will limit the availability of relief against forfeiture. The characterisation of the contract in Stern as being to secure the payment of money is important. In such cases equity may relieve against forfeiture if the defaulting party is prepared to make good arrears. 39 So the characterisation of the AMPLA Default Clause is important. Is the primary purpose of the clause to secure the participants commitment to meet calls for exploration expenditure? Such a 34 35 36 37 38 39 Legione v Hateley (1983) 46 ALR 1 at 30. Ibid at 32. The approach by Mason and Deane JJ is to be contrasted with the approach taken by Brennan J where he says at 39: The respondent lost her interest in the land because she did not pay the residue of the price at the time she had promised, though she had agreed that time was of the essence of her contract. There is no equitable jurisdiction to relieve against the consequences of failure to pay the residue of the purchase price for the due date when the parties have agreed that the time of payment is of the essence of the contract (CP per Lord Wilberforce in Shiloh Spinners Ltd v Harding [1973] (1 All ER 90; [1973] AC 691 at 723). The purchaser, having lost her right to the specific performance, has lost the benefit of the expenditure which she outlaid in putting a dwelling on the land. The appellants have obtained the benefit of that expenditure, but the circumstance does not destroy or sterilise the stipulation that time should be of the essence of the contract. Stern & Anor v McArthur & Anor (1988) 81 ALR 463. Ibid per Deane and Dawson JJ. Shiloh Spinners Ltd v Harding at 722 referred to by Deane and Dawson JJ in Stern v McArthur at 489.
226 Articles (2008) 27 ARELJ characterisation would be an over simplification of the clause. In the relationship between the vendor and purchaser under an instalment contract, the vendor sells something in return for a promise to pay which is in turn secured by the fact that a legal interest in the land has not been conveyed. A hirer or lessor of equipment under a hire purchase agreement or finance lease, is seeking a certain return on its capital through structured financing of the equipment. A landlord is seeking rent on his investment in property. Joint venture participants have an interest in the AMPLA Default Clause greater than securing the payment of money. Each participant has committed to a share of cost, to take a share of risk to get a share of success. The AMPLA Default Clause enables a participant who reneges on this deal to be removed quickly from the joint venture and for the remaining parties (on their own or by the introduction of a new party) to proceed to complete the exploration. For relief against forfeiture under the AMPLA Default Clause to be available, there will have to be some element of fraud, accident, mistake or surprise or some other conduct on the part of the nondefaulting parties which would make it unconscientious for them to enforce their rights. This conclusion is supported by the recent decision of the High Court in Tanwar Enterprises Pty Ltd v Cauchi and Ors. 40 Tanwar concerned a contract for the sale of land where time was of the essence. Completion was to take place on 25 June 2001, but funds did not arrive until 26 June 2007. The vendors terminated the contract and the purchaser commenced proceedings for relief against forfeiture and for specific performance of the contract or for the return of the deposit. The High Court unanimously dismissed the purchaser s appeal. The key difference between Tanwar and Legione v Hateley was that there was no identified conduct on the part of the vendors which contributed to the default. In Legione v Hateley there had been conversations between solicitors to the effect that completion could be delayed. For relief against forfeiture to be given there must be something in the vendor s conduct which caused or contributed to the breach. 41 The principal difference between Tanwar and Stern is that the contract in Stern was like a mortgage, ie its primary purpose was to secure payment of money. 42 In addition to that, in Stern, a house had been built on the land, the land had increased in value and only a small amount was owed. 43 The High Court referred to Lord Wilberforce in Shiloh Spinners and the special heads of fraud, accident, mistake or surprise. 44 It is clear that where there are circumstances of fraud, for example, relief may be granted against forfeiture of a joint venture interest. The issue is whether there are any other circumstances not falling within the special heads in which relief against forfeiture will be given? Here, the door has been left open by Tanwar. Gleeson CJ, McHugh, Gummow, Hayne and Heydon JJ said: No doubt the decided cases in which the operation of these special heads is considered do not disclose exhaustively the circumstances which merit equitable intervention. But, at 40 41 42 43 44 Tanwar Enterprises Pty Ltd v Cauchi and Ors (2003) 201 ALR 359. Ibid Gleeson CJ, McHugh, Gummow, Hayne and Heydon JJ at 373. Ibid at 367. Ibid at 367. Ibid at 373.
Penalties and Relief Against Forfeiture of Joint Venture Interests 227 least where accident and mistake are involved, it will be necessary to point to the conduct of the Vendor as having in some significant respect caused or contributed to the breach of the essential time stipulation. Tanwar s situation falls beyond that pale. 45 The majority went on to say it should be made clear that what is said above does not support any proposition that the circumstances must be exceptional before equity intervenes. 46 The majority referred to the joint judgment of Deane and Dawson JJ in Stern referring to the judgment of Mason and Deane in Legione (as follows): Mason and Deane JJ were not saying that there must be unconscionable conduct of an exceptional kind before a case for relief can be made out. Rather, what was being said was that a court will be reluctant to interfere with the contractual rights of parties who have chosen to make time of the essence of the contract. The circumstances must be such as to make it plain that it is necessary to intervene to avoid injustice or, what is the same thing, to relieve against unconscionable - or more accurately, unconscientious - conduct. 47 The majority in Tanwar goes on to say: Thus, it remains for Tanwar to show that it is against conscience for the Vendors to set up the termination of the contracts. 48 Proposition: A windfall to the non-defaulting joint venture parties is not enough to get relief against forfeiture. In respect of an exploration joint venture, a particular question arises. For enforcement of the AMPLA Default Clause to be against conscience, does there have to be some conduct on the part of the non-defaulting participant which makes it unconscientious to enforce the clause or is the mere prospect of a significant windfall to the non-defaulting parties enough? It seems that the answer is that mere windfall is not enough. In Tanwar the majority held: The second matter which Mason and Deane JJ emphasised in Legione was the possibility that a case might be made out in the Supreme Court that the vendors were seeking to reap the benefits of the very valuable improvements to the property which the purchasers had effected whilst in possession under the contract. It is not clear from their Honours remarks whether the reaping of the benefit of the improvements as a consequence of termination of itself would be sufficient to deny insistence by the vendors upon their rescission. It is not readily apparent how that circumstance alone could be sufficient. The contract in Legione had permitted the purchasers to enter into possession and any improvements they made were at risk of the operation of the contractual provisions for termination. 49 4. HIGH COURT AND PENALTIES The principal High Court cases on penalties fall into two categories: those involving what are essentially finance transactions and those that are not. The first category includes O Dea & Ors v 45 46 47 48 49 Ibid at 373. Ibid at 373. Ibid at 373. Ibid at 373. Ibid at 374.
228 Articles (2008) 27 ARELJ All States Leasing System (WA) Pty Ltd and Ors, 50 AMEV-UDC Finance Ltd v Austin & Anor 51 and Esanda Finance Corp Ltd v Plessnig & Anor. 52 Whilst the arrangements in the finance cases have been carefully structured, no doubt for tax, accounting and other reasons, at their heart the relationship is one of lender and borrower. The financier can acquire capital at a certain cost and earns profit by making that capital available to the customer at a higher cost. The expected return to the financier can be calculated to the cent and, therefore, so can the loss to the financier flowing from a default and loss of the deal. So by their very nature, these types of financing arrangements are susceptible to an argument that where the financier gets a return on default that is greater than its expected return on the contract, the clause that allows that is a penalty. 53 It is for that reason that these cases are not helpful in considering whether the AMPLA Default Clause is a penalty. In that respect, the earlier case of Forestry Commission of New South Wales v Stefanetto 54 and Ringrow Pty Ltd v BP Australia Pty Ltd 55 are of more interest. Nonetheless, there are still some relevant principles to be derived from the finance cases. Proposition: In assessing whether or not the AMPLA Default clause is a penalty, it is important to look at the substance of the transaction and not its form. Clauses such as clause 13.4 of the AMPLA Default clause which state that in the party s view the clause is not a penalty, will not assist. O Dea 56 involved a lease transaction structured (no doubt in part to overcome penalty issues) on the basis that the entire rental was paid on signing but recovery would be deferred so long as a lessee performed conditions in the lease and punctually paid instalments. On default, the lessor seized the vehicle and sold it for an amount exceeding its residual value. It also sought to recover the difference between the entire rent and the instalments which had been paid. The clause was held to be a penalty. Had the contract been fulfilled, the expected return to the lessor could be clearly calculated. Retaining the difference between the sale price of the vehicle and its residual value was clearly a windfall. Applying the principles articulated by Lord Dunedin in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd 57 this assessment can be easily made at the time the contract was entered into. For our purposes, what is interesting about O Dea is the suggestion of a requirement to look at the substance of the transaction rather than its form. Statements of intention (such as clause 13.4 of the AMPLA Default Clause) cannot be dressed up to overcome that substance. For example, Deane J says: In what is written above, I have omitted the statement to be found in many cases, including Lord Dunedin s judgment in the Dunlop Pneumatic Tyre case (at 86), to the effect that the question whether a sum stipulated is penalty or liquidated damages is a question of construction. Properly understood, that statement is unobjectionable; whether 50 51 52 53 54 55 56 57 O Dea & Ors v All States Leasing System (WA) Pty Ltd and Ors (1983) 45 ALR 632. AMEV-UDC Finance Ltd v Austin & Anor (1986) 68 ALR 185. Esanda Finance Corp Ltd v Plessnig & Anor (1989) 84 ALR 99. See E Peden and J W Carter Agreed Damages Clauses - Back to the Future? (2006) 22 Journal of Contract Law 198 at 196. Forestry Commission of New South Wales v Stefanetto (1976) 8 ALR 297. Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 222 ALR 306. O Dea & Ors v All States Leasing System (WA) Pty Ltd and Ors (1983) 45 ALR 632. Lord Dunedin in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79.
Penalties and Relief Against Forfeiture of Joint Venture Interests 229 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, however, 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 stipulating the sum. 58 So, a clause like clause 13.4 of the AMPLA Default Clause stating that the parties do not regard the default clause as a penalty or the use of recitals is likely to be of marginal value. Proposition: If the AMPLA Default clause is a penalty, it is unenforceable. It will not be read down by a court to allow forfeiture for a lower discount or for market value, for example. The AMEV-UDC Finance case is a useful reminder of the proposition that if a clause is a penalty it will not be enforced and will not be rewritten (or read down) to permit the recovery of actual loss. So if the purchase price under the AMPLA Default Clause at a discount of 10% of value is found to be a penalty, the court will not allow the clause to be enforced for payment of full value or a lesser discount. If a clause is a penalty, it is unenforceable. Unlike relief against forfeiture (which requires the court to exercise a discretion to grant a remedy) once the court finds a clause is a penalty, the clause is just not enforceable. Mason and Wilson JJ in AMEV-UDC Finance say: However, this is not the only reason why the courts would refuse to lend their aid. In the majority of cases involving the 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 a restraint of trade. 59 Proposition: In comparing the value of the joint venture interest with the price to be paid, regard can be had but only to the damages flowing from the default but also to the possible loss to the non-defaulting parties and the loss of benefit of the contract as a whole. The Esanda case is authority for the proposition that in judging whether an agreed sum is a penalty it is not just the loss flowing from the breach which is counted but also the loss of the benefit of the contract. In Esanda, a clause which entitled the financier to take possession of the equipment and recover a lump sum under the contract calculated as rent plus costs, less deposit and rental paid with a rebate of interest was held not be a penalty. The formula used in Esanda was probably developed after the O Dea case was decided. 60 If the non-defaulting participants terminate under the AMPLA Default Clause and seek to acquire the defaulting participants joint venture interest, their loss is not only the unpaid calls but also an obligation to fund the unpaid call (and the cost of capital attached), the additional obligations (absent bringing in another party) to fund a greater share of expenditure and the concentration of 58 59 60 O Dea & Ors v All States Leasing System (WA) Pty Ltd and Ors (1983) 45 ALR 632 at 562. AMEV-UDC Finance Ltd v Austin & Anor (1986) 68 ALR 185 at 201. See Wilson and Toohey JJ, see Esanda Finance Corp Ltd v Plessnig & Anor (1989) 84 ALR 99 at 101 for the calculation of the amount payable.
230 Articles (2008) 27 ARELJ risk. For junior exploration companies, loss of a joint venture partner may have significant consequences for the company s ability to raise capital to fund the exploration expenditure. Loss of the exploration opportunity is a real possibility. So prior to discovery, the forfeiture of the joint venture interest for no consideration could be justified. Proposition: A different conclusion may be reached on whether the AMLPA Default Clause is a penalty depending on the stage of the joint venture. The arguments above are weakened where discovery occurs and an interest in the venture can be sold or the joint venture party can more easily raise capital because of a significant appreciation in its share price. The loss of the joint venture party may not be that significant. The loss that is foreseeable to a party at the exploration stage from the joint venture agreement is different from the loss foreseeable after discovery. The AMPLA Default Clause applies the 10% discount regardless of the stage of the Joint Venture. Take the example of two listed exploration joint venturers. They are required by the ASX Listing Rules to provide quarterly reports as to both expenditure and discovery. 61 Subject to certain exceptions, the Listing Rules require immediate disclosure of price sensitive information. 62 Announcement of resource must comply with the JORC code. 63 It is at the point of discovery and announcement that the value of the discovery may be recognised and measured by a lift in the joint venturer s share price. In the period following discovery of commercially extractable minerals, forfeiture of the joint venture interest at market value less 10% could result in a gain to the non-defaulting party far in excess of any conceivable loss suffered or flowing from termination of the joint venture. Proposition: Penalty issues arise for non-monetary defaults as well as monetary defaults. Forestry Commission of New South Wales v Stefanetto 64 concerned a contract for road construction which allowed the Forestry Commission (on default of the contractor) to take over works and for that purpose, to take possession of (amongst other things) the contractor s road making machinery and plant without payment and to retain possession of the equipment until the contractor had paid any monies owed. The contractor claimed that this clause constituted a penalty. This case is of interest in that it illustrates that penalty issues can arise for non monetary defaults. In other words, for a clause to be held to be a penalty is not necessary that the default triggering enforcement of the clause is for non payment of money. Proposition: The purpose of the clause as ascertained by a court will be important. Mason J says in respect of the relevant default clause in the Forestry Commission case: The purpose of the provision is not so much to provide compensation for loss which the principal may sustain as a result of the contractor s breach of contract, but to enable the principal to complete the contract works which the contractor has engaged to execute. If the provision were limited in its operation to the attainment of this objective, it might be impossible to characterise it as a penalty, so long at any rate as the advantage which the principal might derive from the use of the contractor s materials, plant and equipment, was 61 62 63 64 Listing Rules 5.2 and 5.3 of ASX Limited. Listing Rule 3.1. Listing Rule 5.6. Forestry Commission of New South Wales v Stefanetto (1976) 8 ALR 297.
Penalties and Relief Against Forfeiture of Joint Venture Interests 231 taken into account in arriving at the contractor s entitlement or liability under, or by virtue of, the contract. 65 By analogy, the AMPLA Default Clause (applying the approach in CRA) at the exploration phase has as its objective the facilitation of completion of the exploration. This is particularly so as the non-defaulting parties are required to assume liability for past unpaid calls. Proposition: Lord Dunedin s speech in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd continues to express the law applicable in Australia on penalties. In a single unanimous judgment in Ringrow Pty Ltd v BP Australia Pty Ltd 66 the High Court said: It is therefore proper to proceed on the basis that Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd continues to express the law applicable in this country, leaving any more substantial reconsideration than that advanced, to a future case where reconsideration or reformulation is an issue. 67 The following passage in Lord Dunedin s speech in Dunlop Pneumatic Tyre was cited: 2. The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine covenanted preestimate of damage 3. The question whether a sum stipulated is penalty or liquidated damages is a question of construction to be decided upon the terms and inherent circumstances of each particular contract, judged of as at the time of the making of the contract, not as at the time of the breach 4. To assist this task of construction various tests have been suggested, which if applicable to the case under consideration may prove helpful, or even conclusive. Such are: (a) It will be held to be a penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach (b) It will be held to be a penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid (c) There is a presumption (but no more) that it is a penalty when a single lump sum is payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage. 68 In Ringrow, Ringrow entered into an agreement with BP to purchase a service station. It also entered into an option for BP to buy back the service station and entered into a privately owned sites agreement with BP. The option was exercisable if the privately owned sites agreement was breached. In breach of this agreement, Ringrow sold fuel which it had purchased from someone 65 66 67 68 Ibid at 307. Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 222 ALR 306. Ibid at 309. Ibid at 309.
232 Articles (2008) 27 ARELJ other than BP. BP terminated the contract and informed Ringrow that it intended to exercise its option. The relevant clause of the option provided the price payable was market valuation as an operational service station as determined by an independent valuer. The valuer was specifically instructed not to include any allowance for any goodwill attaching to any business conducted at [the site]. 69 The appellant argued that the exclusion of goodwill from market value tendered the clause a penalty. Proposition: The doctrine of penalties can apply to the forfeiture of a joint venture interest on default. Young and Johnston 70 say there is some uncertainty as to whether the doctrine of penalties applies at all to a joint venture default because historically the doctrine of penalties has been confined to obligation to pay money. 71 Reference by them is made to Jobson v Johnson 72 where an obligation to transfer shares on default was held to be a penalty. Young and Johnston conclude But there is no apparent reason why a joint venture interest should be treated differently to a transfer of shares. 73 The CRA case proceeded on the basis that the clause was capable of being a penalty. It was accepted by the court in Ringrow that the doctrine of penalties can apply to non monetary penalties. 74 If the exercise of an option to buy back a service station on default of an agreement to purchase petrol only from BP is analogous to an option to purchase a joint venture interest on default of a joint venture covenant, the AMPLA Default Clause could be a penalty. Proposition: It is not entirely clear whether the assessment of whether a clause is a penalty is to be made at the time the joint venture agreement is to be entered into but, as appears more likely (considering the approach taken in Ringrow) is to be made at the time of the default. The difficulty with the decision in Ringrow is that Lord Dunedin s speech seems to require the judgment as to whether a clause is a penalty or not to be made at the time that the contract is entered into and not at the time of the breach. But whilst the court said that Lord Dunedin s speech represents a correct statement of law in Australia, the analysis of the court seems to have proceeded on the basis of assessing a difference in value at the time of the default. Their Honours say: In cases like the present, on the other hand, assuming (contrary to certain submissions of the respondent) that the doctrine of penalties is capable of application at all, one relevant comparison would be the price payable by the respondent to the appellant on retransfer of BP Lansvale by the appellant, and the actual value of what is transferred. 75 A difficulty the court faced in Ringrow was the inability of the appellant to establish the existence of valuable goodwill in relation to the service station. 76 69 70 71 72 73 74 75 76 Ibid at 307. M J Young and B Johnston Commentary on Penalties, Forfeiture and Dilution [1989] AMPLA Yearbook 27. Ibid p 33. Jobson v Johnson [1989] 1 All ER 621. Young and Johnston, op cit n 70, p 33. Ibid p 311. Ibid p 311. Ibid p 312.
Penalties and Relief Against Forfeiture of Joint Venture Interests 233 Proposition: For a court to determine whether the AMPLA Default Clause is a penalty in particular circumstances it is necessary to compare the value of what is to be transferred against the price to be paid for it. So a starting point in challenging the AMPLA Default Clause would be to have evidence of the value of what was to be transferred against the price to be paid. With the AMPLA Default Clause, this may not be as difficult as for the appellant in Ringrow because embedded in the AMPLA Default Clause is a discount to market value. Whatever the value is, the defaulting joint venturer gets only 90% of it. On the other hand, the fact of a difference does not of itself make the clause a penalty. The court in Ringrow said: That a mere difference is not enough let alone a suspicion of a difference. The comparison calls for something extravagant and unconscionable in the value of what is transferred compared to the price to be received, to use Lord Dunedin s words. It calls for a degree of disproportion sufficient to point to oppressiveness, to use the words of Mason and Wilson JJ (AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170 at 193). 77 So, we are back to square one. Is a 10% discount extravagant and unconscionable or a degree of disproportion. The difficulty with applying Lord Dunedin s speech in Dunlop, is that the degree of disproportion must be judged at the time that the agreement is entered into and not at the time of the breach (which is what paragraph 3 of Lord Dunedin s speech says), unless his words are confined to consideration of a lump sum as a penalty or as a genuine pre-estimation of damage. However, that is not how the court proceeded in its analysis in Ringrow. The approach taken by the court (of suggesting a comparison of the actual value of what is transferred to the price payable) is an approach that can only be taken at the time of the breach. In the case of an exploration joint venture, the value of the joint venture interest depends upon what is discovered, in what quantities, the costs of recovery and the price for the commodity. What can be assessed at the time the joint venture agreement is entered into is that if no minerals or petroleum are discovered, a 10% discount may result in little difference between the value of what is transferred and what is paid. However, if significant minerals or petroleum are discovered, the discount could represent a very significant difference in value. If the justification for a discount is to offer some compensation for loss to the non-defaulting participants, there is little logic in using a percentage rather than a fixed amount. The logic from the CRA case seems to be that it is foreseeable that some cost or loss will be suffered from the loss of the joint venture agreement and the defaulting participant s breach. But that, as the loss is impossible to quantify at the time the joint venture agreement is entered into, a discount of 5% seems about right. Somewhere between a 5% discount and a complete forfeiture, a line would presumably be drawn as to the level of discount which would render the clause a penalty. Proposition: Proportionality between the damage to the non-defaulting parties and the consequences of enforcement to the defaulting party is not relevant. What is clear from Ringrow is that it is the relativity of the value of what is paid compared with what is transferred on enforcement of the clause (and not the relativity of the default and the benefit to the non-defaulting parties) that has to be looked at. The question is not of the proportionality between the damage suffered by the innocent party and the consequence to the defaulting party. This argument of proportionality was rejected. The court stated: 77 Ibid p 312.