Approximately 170,000 customers of eight banks in Australia (including the 'big four') are attempting to recoup $223 million in fees they claim are 'unfair'. The fees in question are variously described as honour, dishonour, non-payment, late payment and over-limit fees.
One of the keys to this ground-breaking series of class actions is the applicants' claim against Australian and New Zealand Banking Group Ltd (ANZ) that the terms requiring payment of the fees are void or unenforceable as penalties, and that they are entitled to repayment of those fees as moneys had and received by ANZ.
In Andrews v Australia and New Zealand Banking Group Ltd  HCA 30 (Andrews), the High Court has clarified that a term of a contract that requires the payment of money (or the transfer of property) upon the occurrence or non-occurrence of some event may be a 'penalty' even if it has nothing to do with a breach of contract (overturning an earlier decision of the NSW Court of Appeal in a different case).
What is a penalty?
In general terms, a penalty is a term that is a punishment i.e. it goes beyond an obligation to compensate for the actual loss suffered. To paraphrase the High Court in Andrews:
- A penalty is in the nature of a punishment for non-observance of a contractual term and consists, upon breach, of the imposition of an additional or different liability.
- On its face, a term imposes a penalty if, as a matter of substance, it is collateral to a primary term and is in the nature of a security for performance of the primary term (ie the penalty is intended to intimidate the defaulter to perform and if they do not, it imposes an additional detriment on the defaulter to the benefit of the other party).
- If the injured party can be compensated for the prejudice suffered by the failure of the primary term, the collateral term, if a penalty, is enforced only to the extent required to provide that compensation and not further.
- The key is whether the party intended to benefit from the primary term can be compensated if the primary term fails. If the prejudice or damage to their interests is insusceptible of evaluation and assessment in money terms, the penalty doctrine is not engaged.
- Whether a stipulation is a penalty is a matter of substance, not form.
In the earlier High Court case of Ringrow Pty Ltd v BP Australia Pty Ltd  HCA 71, the court said that the 'principles of law relating to penalties require only that the money stipulated to be paid on breach or the property stipulated to be transferred on breach will produce for the payee or transferee advantages significantly greater than the advantages which would flow from a genuine pre-estimate of damage' and that a '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'.'
What the High Court proceedings were about
ANZ argued, successfully in the first instance, that the doctrine regarding relief against penalties is limited to providing relief only if the penalty is imposed upon a breach of contract and, therefore, does not apply to any of the fees except the late payment fee. This argument was based upon a unanimous decision of the NSW Court of Appeal in Interstar Wholesale Finance Pty Ltd v Integral Home Loans Pty Ltd  NSWCA 310 (Interstar), which held that the doctrine of penalties is limited to circumstances of breach of contract.
The primary judge agreed with ANZ and held that (except for the late payment fee) the fees were not charged in respect of a breach and therefore, in accordance with Interstar, the doctrine regarding relief against penalties did not apply.
The key issue for the High Court was not whether the fees were penalties but whether the doctrine regarding relief against penalties could apply, contrary to Interstar, in circumstances where the fee was not payable as a result of a breach of contract. If the doctrine could apply, the matter would go back to the Federal Court to determine upon further trial whether or not the fees actually were penalties.
The High Court rejected the Court of Appeal's decision in Interstar. It traced the development of the doctrine back to early times and concluded that it does not follow that the only terms in a contract which can be penalties are those that relate to breach.
Resolution of the proceedings
The High Court provided guidance as to the how the matter will be resolved by the Federal Court, pointing out there is a distinction between:
- An obligation to make a payment upon the failure or breach of some other term where the payment is out of all proportion or unrelated to any loss suffered (a penalty); and
- An obligation to make payment as the price of a right or benefit or for the exercise of a right or obtaining some additional right or benefit (not a penalty).
What does it all mean?
Considerations regarding the law of penalties usually concentrate upon clauses for pre-agreed liquidated damages (LDs) payable as a result of breach. The present case illustrates that fees and charges could be called into question if they relate to compensation payable upon the occurrence or non-occurrence of some event, irrespective of whether the event is a breach.
The key point relating to penalties is that they are obligations that, in essence, require a party to provide 'compensation' (usually, but not always, for a breach) where the required compensation is out of all proportion or unrelated to the actual loss suffered or that is likely to be suffered. This is in contrast with an obligation to pay the 'price' for a right or benefit (such as a service).
Therefore, to assist in avoiding provisions being struck down as penalties it is sensible to consider, at the contract drafting stage, whether it is possible to characterise a transaction as a payment for a right or benefit rather than as a payment of compensation for breach or failure of a term and, if so, which of these alternatives is the most appropriate. If the latter, then the usual considerations regarding LDs apply, namely, the payment must be a genuine pre-estimate of loss.
The present case provides an example of the former (namely, payment for a service rather than compensation). A credit card contract could prohibit customers from exceeding their credit limit and impose a fee if they do so. The fee would, in essence, be in the nature of compensation for breach and must be a genuine pre-estimate of the bank's likely loss (eg interest and administrative costs). Alternatively, as ANZ argued, the contract could be drafted in such a way that customers are not prohibited from exceeding their credit limit, rather, they can request the bank to process a payment that would cause the credit limit to be exceeded. If the bank allows the request, a fee is charged as the price for the service and the additional borrowing.
By analogy, the same could apply to arrangements for the supply of commodities such as oil, gas, water or electricity that allow customers to obtain supply up to a certain level of entitlement and if the customer exceeds that level, an additional (and perhaps higher) per unit price is payable for the excess.
- Penalties are obligations that, in essence, require a party to provide 'compensation' (usually, but not always, for a breach) where the required compensation is out of all proportion or unrelated to the loss that is or is likely to be suffered. It is a punishment to induce compliance.
- Penalties are unenforceable and therefore cannot be recovered.
- When drafting contracts, it is prudent to consider if it is possible to characterise the transaction (and draft the terms) as a payment for a right or benefit rather than as a payment of LDs for breach. Payment for a right or benefit under a contract should not ordinarily give rise to the risk of it being a penalty.
- Where a pre-agreed amount is to be paid in compensation, such as LDs for delay, then that amount must be a genuine pre-estimate of loss. If not, it is likely to be a penalty and therefore unenforceable.
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