Perpetual Trustee Company v Mitchell [2010] NSWSC 825

The central issue in this case was whether a default provision in the terms of a settlement agreement was a penalty, given that the lender had agreed to accept a lesser sum if certain conditions were met. Justice Davies decided that the default provision was not a penalty.

The key condition was for the payment of $800,000 by a certain date, but that if payment was not received in time, the payment of a higher amount said to represent the full amount of the mortgage debt. When the lesser amount was not paid in time (because the secured property did not settle on time), the borrower refused to pay the higher amount, alleging that it was a penalty.

Proportionality is the guiding principle in the law of penalties. Justice Davies quoted an earlier decision in which the Judge stated:

… consideration of the purpose of the law of penalties shows why this must be so. The law of contract normally upholds the freedom of parties, with no relevant disability, to agree upon the terms of their future relationships. As Mason and Wilson JJ observed in AMEV-UDC Finance Ltd v Austin:

[T]here is much to be said for the view that the courts should return to … 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.

Exceptions from that freedom of contract require good reason to attract judicial intervention to set aside the bargains upon which parties of full capacity have agreed. That is why the law on penalties is, and is expressed to be, an exception from the general rule. It is why it is expressed in exceptional language. It explains why the propounded penalty must be judged “extravagant and unconscionable in amount”. It is not enough that it should be lacking in proportion. It must be “out of all proportion”. It would therefore be a reversal of longstanding authority to substitute a test expressed in terms of mere disproportionality. However helpful that concept may be in considering other legal questions, it sits uncomfortably in the present context.

The higher amount stated in the conditions reflected the mortgage debt and for that reason it was not a penalty. Justice Davies quoted from “The Principles of Equity” by Professor Parkinson:

Where a stipulated sum is presently due and owing as a debt and the creditor grants the debtor an indulgence to pay the debt by instalments, it is not a penalty for the creditor to provide, as a condition of granting the indulgence, that the indulgence will be withdrawn if the debtor defaults in the payment of an instalment. However this principle … has no application where, having regard to the substance and notwithstanding the form of the transaction, the stipulated sum is not owing as a present debt.

The creditor’s agreement to accept a lesser amount on certain conditions was an indulgence. Recovery of the pre-existing debt following the borrower’s failure to meet the conditions was not a penalty.  

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