In Interstar Wholesale Finance Pty Ltd v Integral Home Loans Pty Ltd, the NSW Court of Appeal invited the High Court to re-examine the law of penalties, forfeiture and freedom of contract. And, based on the transcript of the application for special leave to appeal, it appeared that the High Court was willing to do just that; however, the matter was settled before the High Court's decision was handed down.
So despite the Court of Appeal's frustration with the current law, and the High Court indicating that it was willing to revisit it, the status quo remained. That is until the recent High Court decision in Andrews v Australia and New Zealand Banking Group Limited, which may be the High Court's first step in changing the law in this area.
While the Andrews decision is of limited direct relevance, the move away from the law as stated in the Interstar decision, and any future High Court guidance, has implications for Commonwealth Agreements.
The Interstar decision
This case involved Interstar Wholesale Finance Pty Limited and Interstar Non-Conforming Finance Pty Limited (the Lender). Integral Home Loans Pty Limited and Integral Financial Pty Limited (Integral) found and introduced third party loan applications to the Lender, and, if those loan applications were successful, were responsible for servicing those loans.
To implement this arrangement, the Lender and Integral entered into two agreements on substantially the same terms. Under both agreements, Integral was paid an "originator's fee" for each loan that was settled.
The Lender believed that Integral had engaged in deceptive or fraudulent activity and exercised its right to terminate the agreements under a clause in the agreements. The Lender claimed that by exercising its right to terminate under this clause, instead of termination for breach of contract (which would have meant that Integral would still be entitled to the originator's fee), Integral was no longer entitled to receive the originator's fee. Integral argued that this clause was a penalty and unenforceable.
In overturning the decision of the trial judge, Allsop P (Giles and Ipp JJA agreeing) held:
- the originator's fee wasn't fully earned at the time of settlement of each loan, so there was no forfeiture of "fully earned" property to constitute a penalty
- the trial judge's finding that the doctrine of penalties was not limited to circumstances of breach of contract was not open on the basis of authority; however, the Court of Appeal invited the High Court to re-examine the issue, and
- even if the law of penalties applied, Integral's loss of the originator's fees was not extravagant or unconscionable compared to the damage that could be caused by deceptive or fraudulent activity.
While the Interstar decision did not change the law of penalties, and, in fact, one of the reasons for overturning the trial judge's decision was that the trial judge had attempted to do so, it:
- highlighted the potential effect of the law of penalties in contracts between parties
- acknowledged that the law of penalties is not limited to the payment of money, but can also apply to the forfeiture of rights or property, and
- expressly invited the High Court to re-examine the law of penalties, forfeiture and freedom of contract, despite relief against forfeiture not being pleaded in the case.
However, the Andrews decision has over turned one of the Court of Appeal's findings.
The Andrews decision
In the Andrews decision, the High Court held that amounts payable without a breach of contract (in this case certain bank fees) may still be penalties.
The High Court ruled that the distinction needs to be drawn between payments that are:
- in return for a service or other benefit, which are not a penalty, and
- security for the fulfilment of some condition, which may be a penalty if the payment exceeds the loss that could be suffered as a result of non-fulfilment of the condition.
What does this mean for agency agreements?
The expansion of the types of payments that may be penalties could potentially impact agency agreements. For example, it is common to have incentive and fee reductions based on performance against KPIs in long-term service agreements. Further, "standard Commonwealth Funding Agreements generally contain a number of provisions that are triggered on breach of contract including:
- repayment of funding provisions
- transfer of property provisions, and
- withholding, deduction or retention of payment provisions (where such payments may have been fully earned).
These could potentially fall foul of the law of penalties or be subject to claims for relief against forfeiture.
Until the Andrews decision, it was possible to "draft around" the law of penalties, for example:
- provisions could be drafted to be triggered on certain events rather than a breach of contract, and
- payment provisions could be structured on an "milestone incentive and indulgence" model rather than according to a "pay now and claw back" model.
Greater care will now have to be taken with the nature of the payments to ensure that they are not classified as a penalty. The Andrews decision may also signal the High Court's intention to review the current law of penalties and forfeiture. Any future developments in this area will need to be monitored to ensure agency agreements are consistent with any changes to the law.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.