Law on penalties according to Honey Bees

The recent Court of Appeal decision in 127 Hobson Street Limited v Honey Bees Preschool Limited [2019] NZCA 122 (Honey Bees) confirms the law on penalty clauses in New Zealand. The case concerned a commercial lease between Honey Bees Preschool Limited (Honey Bees) and 127 Hobson Street Limited (127 Hobson). In addition to a deed of lease, the parties entered into a collateral deed (Deed) which required 127 Hobson to install a second lift at the leased premises. The Deed provided that if 127 Hobson did not install a second lift on or before 31 July 2016, it had to indemnify Honey Bees for all obligations under the lease (Indemnity). 127 Hobson did not install the lift on time and Honey Bees sought to enforce the Indemnity. 127 Hobson argued the Indemnity was an unenforceable penalty and should be disregarded.

The Court of Appeal dismissed the appeal and upheld Whata J’s decision in the High Court. A comprehensive summary of the High Court decision from our Construction team is available here.

The Court of Appeal confirmed that the penalty clause test is whether the secondary obligation imposes a detriment on a promisor out of all proportion to any legitimate interest of the promisee in the enforcement of the primary obligation (‘disproportionality test’). Applying the test to this case, the Court held that the Indemnity was not an unenforceable penalty because it was not out of proportion to Honey Bees’ legitimate interest in 127 Hobson’s performance of its obligation to install the second lift. The Indemnity protected Honey Bees’ two legitimate performance interests: the installation of the second lift by a specified time, and the provision of leasehold premises fully fit for use as a pre-school facility.

For a comprehensive summary of the Court of Appeal decision, please see our Dispute Resolution team’s recent article available here.

Penalties in a Construction Context

While the Court of Appeal has confirmed the approach to the penalty doctrine in New Zealand (subject to an appeal by 127 Hobson to the Supreme Court), we are yet to see how the Courts would apply Honey Bees in the construction context, where liquidated damages are commonly used to protect the Principal’s performance interest of requiring the Contract Works to be completed by pre-defined completion date(s). However, Honey Bees is a good reminder to pay proper attention to the scope of the liquidated damages regime in the contract, including the amount that the Principal/developer is seeking to recover for completion delays.

If you have any questions, please get in touch with one of our experts.

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