Australia: Penalties: don't look back

Last Updated: 28 July 2015
Article by Ashley Cahif and Richard Morrison

Following the Full Federal Court's April 2015 decision in Paciocco v Australia and New Zealand Banking Corporation (Paciocco), there is now the potential for the High Court to give some much needed guidance on the application of the laws on penalties.

The initial uncertainty was caused by the High Court's previous decision in Andrews v Australian and New Zealand Banking Corporation. If the plaintiff appeals the Full Federal Court decision in Paciocco, which also involved a class action against the charging of a number of bank fees, the High Court may take the opportunity to clarify this area of law.

Paciocco – first instance

The Federal Court decision in Paciocco involved a representative action on whether certain bank fees were penalties.

To determine whether the fees were a penalty, the Court applied the principles in Andrewsand analysed the fees in terms of whether they were a:

  • collateral stipulation to secure the performance of a primary obligation, which is capable of being a penalty, or
  • payment in return for further services or accommodation, which is not a capable of being a penalty.
Importantly, the basis for overturning the decision was not due to the application of any of the Andrews principles, but rather because of the retrospective approach taken to determine whether the fees in question were penal in nature.

The Court categorised the late fee payment as a collateral stipulation to secure the performance of a primary obligation; therefore, it was capable of being a penalty.

The next question for the Court was whether the quantum of the payment was extravagant and unconscionable relative to the loss that may be incurred.

To answer this question the Court examined the fees that were charged and compared them against the actual cost associated with the events (as calculated by the Court). On the basis of this comparison, her Honour found the late payment fees to be penalties and the remainder of the fees in question were not.

Both parties appealed the decision.

Paciocco – the Full Federal Court

The Full Federal Court unanimously overturned the trial judge's decision that the late payment fees were penalties.

Importantly, the basis for overturning the decision was not due to the application of any of the Andrews principles, but rather because of the retrospective approach taken to determine whether the fees in question were penal in nature.

The Full Court held that the trial judge was mistaken in undertaking a calculation of the actual damage from the happening of the events (that is, calculating the actual damages at the time of the breach) rather than undertaking an enquiry into the greatest loss that might have flowed from a breach as at the time of entering the contract.

Additionally, the Full Court held that a number of the costs that the trial judge had excluded from the calculation of the actual damage should have been included, with the result that even if the analysis the trial judge undertook was correct, the actual damage suffered would mean that there was no penalty as the difference was not enough to be extravagant, exorbitant or oppressive.

What this means for agencies

While High Court guidance in the area of penalties would be most welcome, the two findings of the Full Federal Court may mean that there is little chance that this case will be the vehicle to provide it.

For example, even if the plaintiffs can convince the High Court to hear the case on the basis of an error of law in the Full Court's reasoning, it is left with having to overcome the finding that, on the facts, the costs associated with the breach meant that the fees were not penal in nature.

However, there may be scope for an appeal based on the Full Court's reasoning to dismiss the plaintiff's appeal against the trial judge's decision on the other fees.

In dismissing the appeal, the Full Court discussed whether regard can be had to the parties' pre-contractual discussion.

Given the current uncertainty around whether evidence of surrounding circumstances is admissible to assist in the construction of a contract, whether or not the contractual

Lawyers should ensure that whenever they are drafting a clause that may meet the threshold test of possessing a character that has the potential to be a penalty, it reflects a genuine pre-estimate of damages.

language was ambiguous or susceptible of more than one meaning, it may be that the High Court is willing to hear a case involving whether external evidence of the parties' state of mind is also admissible.

Until then, based on the current state of the law, it seems that the only certainty is that a penalty requires the stipulation to be penal in nature.

Accordingly, lawyers should ensure that whenever they are drafting a clause that may meet the threshold test of possessing a character that has the potential to be a penalty, it reflects a genuine pre-estimate of damages.

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.

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Ashley Cahif
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