In 2012, this blog discussed the High Court's decision in Andrews v ANZ [2012] HCA 30 and how it changed our understanding of the penalties doctrine in contract law. In essence, the High Court held that fees can be unenforceable penalties even when they're not charged in relation to a breach of contract. More particularly, the High Court determined that fees charged by banks on certain events occurring — such as a late payment fee on a credit card — could be penalties and therefore unenforceable.

The question of which bank fees are penalties was sent back to the Federal Court, and in Paciocco v ANZ [2014] FCA 35, Gordon J determined that the late payment fees on a credit card were indeed penalties, because:

  • they were payments meant to secure a contractual obligation by the borrower, in this case, the obligation to pay on time; and
  • the amount of each late fee was 'extravagant and unconscionable' when compared with the loss suffered by the bank because of the late payment.

Earlier this month, however, the Full Federal Court in Paciocco v ANZ [2015] FCAFC 50 overturned this earlier decision, declaring that the bank's late fees were not penalties, and were therefore enforceable against its customers.

So what's a penalty now?

The Full Federal Court evaluated the previous decision, and agreed that the purpose of the late fees was to secure a customer's prompt payment of their credit card debts. However, it disagreed with the method for determining whether a fee is 'extravagant and unconscionable'.

In the lower court judgment, Gordon J had stated that measuring 'extravagance' is a post-facto evaluation of the loss actually suffered by the customer's late payment against the size of the fee charged.

On appeal, the Full Federal Court imposed a new 'ex ante' test: 'extravagance' is measured against the largest possible loss that could flow from a customer's non-payment, conceived when the contract began. Importantly, it was not necessary for the bank to prove that the potential damage occurred in order to justify the fee.  Evaluating the late payment fee this way, the Full Federal Court decided that the fee was reasonable considering the loss that the bank could potentially suffer from a customer's non-payment.

In considering the bank's calculation of potential harm, the Full Federal Court allowed a broad variety of costs to be included. Provisioning costs, additional regulatory capital costs and the bank's ongoing collection costs (which included an element for infrastructure) were all taken into account when measuring the 'extravagance' of ANZ's late fee. By doing so, the calculation of the potential loss suffered by ANZ due to late payment was greater than under Justice Gordon's formulation. The Full Federal Court concluded that the late fee charged by the bank was reasonable when measured against the bank's potential loss – with the result that the amount was held to be enforceable against the bank's customers.

What does this mean for technology contracts?

As previously discussed on this blog, technology contracts sometimes include obligations that require a party to pay a specific amount when certain contingent events occur. These include, for example:

  • the payment of 'liquidated damages' should the supplier fails to meet specific milestone dates;
  • the application of 'service credits' should the supplier fail to meet certain specified service levels; and
  • the payment of an 'early termination fee' to the supplier should the customer terminate the contract early for convenience.

All of these amounts may invoke the penalties doctrine – which means that, in order to be enforceable, each such amount would need to be a 'genuine pre-estimate' of the supplier's or customer's loss.

Under Justice Gordon's (narrower) formulation, a contingent amount would be unenforceable where it is extravagant in comparison with the loss suffered by the party affected by the triggering event. So, for example, in determining whether an early termination fee is a penalty, the quantum of the fee would need to be compared with the supplier's loss arising from the customer's decision to terminate the contract early — which, arguably, would be confined to the loss of profit foregone over what would have otherwise been the remainder of the contract term.

However, under the Full Federal Court's (broader) formulation of loss, in order to determine whether a contingent fee is enforceable, parties can consider the greatest possible loss that would flow from the early termination or other triggering event (conceived on a forward looking basis when the contract began), and calculate the fee by reference to this amount. A supplier could argue, therefore, that the quantum of the early termination amount should be calculated by reference to a broad range of direct and indirect costs, for example, the costs of redirecting resources and personnel to the engagement, the cost to the supplier of procuring underlying infrastructure required in order to undertake the engagement, and perhaps even the opportunity cost to the supplier of foregoing other engagements.

Although the decision of the Full Federal Court is widely expected to be appealed to the High Court, an appeal has not yet been lodged, and it may be some time before there is any certainty regarding contingent fees and charges.