New Variations on the Rule Against Penalties

As a consequence of the rule against penalties, contractual clauses with a penal character are unenforceable. The rule has recently undergone significant revision in both the United Kingdom and Australia, following decisions by the highest courts in those jurisdictions. This article sets out and considers the options that those decisions put forward for the development of the rule against penalties in New Zealand. The variants are presented in terms of answers to two questions. The first is the "engagement question": which kinds of contractual clauses are capable of being subject to the rule against penalties? At first glance, the English and Australian authorities present different answers to this question. However, we argue that their answer is essentially the same – the clause must be a secondary obligation triggered by failure to perform a contractual promise. We suggest the English framing of the engagement question should be followed in New Zealand, primarily because it is clearer. The second question is the "test question”: given that a clause engages the rule, what is the test for whether the clause is penal? The new cases are in agreement that a clause is a penalty if it is out of proportion to a legitimate interest in the performance of the contract, but two competing approaches emerge as to what can qualify as such an interest. We call the narrower approach the "bargain approach"; it focuses on interests that are protected by the parties’ bargain, and we argue it is preferable for this reason. However, on the broader approach, which we call the "party purposive approach", the courts can look further to the innocent party's motives for entering into the contract. This approach has overwhelming judicial support, and is more likely to be adopted in New Zealand.