Settlement without Penalty

Every day thousands of disputes are settled by agreement. Written Terms of Settlement are entered into by those who want to be sure they have a clear enforceable agreement in relation to the relevant issues.  Often the deal done is that one party to the Terms  of Settlement (A) will pay the other (B) a sum of money.  In order to encourage payment on time there is another provision that if A doesn’t pay that sum, then A needs to pay more.   In legal circles, it is known as the default provision – what is agreed to happen if A defaults in making the promised settlement payment.  Normally the default provision includes agreement to judgment being entered by consent for the larger amount if the lesser amount is not paid on time.

The way the default provision is drafted in the context of the Terms of Settlement makes all the difference to whether it is enforceable or not.

Any clause in a contract which includes a financial penalty for not making a payment in time which is held by a court not to be a “genuine pre-estimate” of the loss suffered by the payee because the payment does not make the payment, is void as a penalty.  It cannot be enforced.  So, for example, if A has agreed to pay B $100 for a box of items, and agrees to pay $200 if the payment is a day late, and that extra $100 payment is not what A and B genuinely think represents the loss to B of having to wait an extra day, then that agreement about the $200 payment will be unenforceable.

However, if A really owes B $200 but B agrees to accept $100 if it is paid by a certain day (and only if it is paid by then) it is not void as a penalty.  There is the same effect of encouraging A to pay the $100 on time or pay $200 if late – but the crucial difference is that in this scenario B has agreed to accept less than is in fact owing to him, only on condition of payment by a certain date.

One way to avoiding the default provision being void as a penalty in if A does not pay up on time is to ensure the Terms of Settlement include the concession by A that A owes B the larger amount ($200, in this example).  This should be set out upfront as part of what is agreed.  Another clause then needs to set out that B will accept payment of a lesser amount (in this example, $100) by a certain day, but that if A does not pay by then, B can obtain judgment for the $200.

There needs to be acknowledgement, either express or implicit, that A owes B the larger amount at the time of the Terms of Settlement.

See the recent Victorian Supreme Court case of Legal Practice Management (Vic)(In Liq) v Simms Corp Hotels & Leisure Pty. Ltd. [2013] VSC 734 for a helpful discussion of relevant cases on this issue, starting with the well known High Court decision of  O’Dea v Allstates Leasing Systems (W.A.) Pty Ltd [1983] HCA 3; (1983) 152 CLR 359.


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