Contracting better to avoid the rule against fettering

By Margaret Michaels, Simon Forsterling, Tatiane Kelly and Bridgette Vanderwolf
17 Feb 2022
While compensation regimes may provide some protection to parties contracting with the government, the government's freedom to govern remains the ultimate trump card.

With the federal election looming, there is no better time to reflect upon your approach to government contracting and reconsider how the rule against fettering may come into play. The potential for a change of government brings great risk, none greater than that faced by parties contracting on a project that is politically sensitive or lacking bipartisan support.

An example of this risk crystallising occurred in late 2014 when the Victorian Labour Party's election victory saw the $22.8 billion East-West Link project terminated, in line with pre-election promises.

The East-West Link project highlights a key issue in government contracting: managing the tension between a government's freedom to govern and counterparties' confidence to contract.

Contracts which impose restrictions or obligations on government and its future actions should be carefully drafted because a contractual term will offend the rule against fettering if the government promises to:

  • legislate (or not legislate) in a certain way in the future; or
  • exercise an executive or statutory discretion in a certain way in the future.

The recent case Searle v Commonwealth (2019) 100 NSWLR 55 considered how the rule might be limited.

Searle v Commonwealth

The plaintiff, a Royal Australian Navy marine technician, brought proceedings against the Commonwealth for damages in breach of contract arising from the Commonwealth's failure to provide training, as per the plaintiff's employment contract, that would enable him to attain an engineering qualification. The Commonwealth submitted it lacked power to enter into a contract which had the effect of fettering the exercise of the naval command and at first instance, the Supreme Court found the contract was void.

The New South Wales Court of Appeal overturned the trial judge's decision and discussed various ways the rule against fettering may be limited. Relevantly, the judgment indicated that:

  • where a government enters into a contract under a broad power to contract; and
  • the contract itself is not specifically enforced (or specifically enforceable via the grant of an injunction or order of specific performance),

the government's prospective liability for damages in breach of contract does not in itself fetter the exercise of the government's discretion, unless the magnitude of the potential award of damages has a fettering effect.

Given the low value of damages sought in Searle v Commonwealth, it could be said that the circumstances were ideal to limit the application of the rule as above.

Avoiding the fetter

Prior to entering into Government contracts, consider the following:

  1. Compensation regimes

    An alternative to the government party agreeing to exercise or refrain from exercising a power in a certain way is to provide for what will occur where that power is not exercised in the way envisaged by the parties. This could include via compensation or an adjustment in contract price.

    Arguably, the potential remains, under an application of Searle v Commonwealth, for a compensation regime itself to be considered a fetter. However, for this to be an issue, the sum payable would need to be significant.

  2. "No fettering" clauses

    An express contractual clause specifying that there is no fetter on government powers could be included with words to the effect: "the government party is not obliged to exercise any executive or statutory right, duty or function; or: nothing in the contract has the effect of fettering the government party's discretion".

    The risk here is that such clauses may make other contractual promises illusory.

  3. Termination for convenience clauses

    Terminating for convenience might be a more commercially acceptable alternative than rendering a contract void on the grounds of offending the rule against fettering. Such clauses should clearly stipulate the rights and obligations (including any entitlement to compensation) in the event the right to terminate is exercised.

  4. Project-specific legislation

    An exception to the rule against fettering is where a contract is statutorily approved or authorised. This is because the authorising statute empowers the executive to make the contractual provision. Contracts which incorporate project-specific legislation are often used in some States and Territories for large infrastructure and mining projects. 

    There is always the potential, however, that a future government may further legislate to change the approval.

  5. Sovereign risk as counterbalance

The rule against fettering strongly favours and protects the government. However, a "trigger happy" decision to terminate a contract under the protection of this rule, impacts both a government's credit rating, its reputation and increases the cost of doing business with the government.

The impact of the rule against fettering should be front of mind when acting for or with government parties both in the negotiation and finalisation of contractual arrangements.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.