The Supreme Court recently provided guidance on the determination of the reasonableness of fees charged by finance companies in consumer credit contracts.(1) However, in doing so, the court acknowledged that the reasonableness standard for fees in the Credit Contracts and Consumer Finance Act 2003 was inherently uncertain and difficult to apply, which it considered a valid criticism of the regime given that it left creditors exposed to criminal charges under broadly worded provisions.
The act prohibits unreasonable credit fees or default fees. The Commerce Commission is the regulatory body that enforces the act. It brought a test case under the regime against Sportzone Motorcycles Ltd and Motor Trade Finance Ltd (MTF).
Sportzone and MTF provided finance to consumers purchasing motorcycles from Sportzone. The commission alleged that the fees in Sportzone and MTF's consumer credit contracts were unreasonable. The fees challenged were:
- a fee for establishing the loan of NZ$200 by Sportzone and NZ$190 by MTF;
- a monthly account fee of NZ$5 by Sportzone and NZ$3 by MTF;
- a default fee of NZ$50 charged to debtors in arrears for 12 days (this was later increased to NZ$80); and
- a default fee of NZ$70 charged to debtors in arrears for 34 days (later increased to NZ$80).
The focus of the argument in the Supreme Court was on MTF's position, as Sportzone was, by then, in liquidation.
When the Credit Contracts and Consumer Finance Act was passed, MTF reviewed its fees and altered its fee structure to recover a greater proportion of its operating costs through fees rather than through the interest it charged. MTF divided its expenses into 'costs centres' containing a number of cost categories and line items. For each financial year, MTF undertook a separate allocation of each line item to one or more of the four different fee categories it was using – establishment fees, account maintenance fees, prepayment fees and default fees. The costs for each fee category were then divided by the estimated number of fees MTF expected to charge in the next 12-month period to get a fee per transaction.
MTF's view was that as its only business was the provision of credit, all of its costs were recoverable in its fees, even if not directly related to the activities involved in, for example, establishing the loan.
The Credit Contracts and Consumer Finance Act sets out its purpose in Section 3 as being:
"(a) to protect the interests of consumers in connection with credit contracts, consumer leases, and buy-back transactions of land; and
(b) to provide for the disclosure of adequate information to consumers under consumer credit contracts ...
(i) to enable consumers to distinguish between competing credit arrangements or competing lease arrangements; and ...
(c) to provide rules about interest charges, fees and payments in relation to consumer credit contracts."
Part 2 of the act governs consumer credit contracts. Section 41 contains the prohibition on unreasonable fees. Section 42 provides that, in determining whether an establishment fee is unreasonable, the court must have regard to whether the amount of the fee is equal or less than:
- the creditor's reasonable costs in connection with:
- the application for credit;
- processing the application; or
- documenting the advancing creditor; or
- the creditor's average reasonable costs for the appropriate class of consumer credit contract.
Section 43 relates to repayment fees and takes a different approach to the sections around it. It provides that a prepayment fee is unreasonable if, and only if, it exceeds a reasonable estimate of the creditor's loss arising from the repayment.
Section 44 sets out criteria for determining the reasonableness of other credit and default fees. It provides that the court must have regard, in relation to the matter giving rise to the fee, to whether the fee reasonably compensates the creditor for the cost incurred by the creditor or a reasonable estimate of any loss incurred by the creditor as a result of the debtor's acts or omissions and reasonable standards of commercial practice.
The High Court held that, in order to be taken into account in a fee, a cost must be sufficiently close and relevant to the establishment of the particular loan or to the administration of the loan or the consequences of the particular default.(2) It held that the determination of whether fees were reasonable under Sections 42 and 44 were transaction specific.
The Court of Appeal affirmed the High Court's approach.(3) It held that the requirement for costs to have a close connection with the loan reflected the statutory purpose of protecting vulnerable consumers and that there was little scope for a reasonable establishment fee to exceed the costs of the matters listed in Section 42.
Sportzone and MTF appealed to the Supreme Court.
The Supreme Court held that Sections 41 to 44 must be interpreted in light of their purpose and context. It held that the purposes of consumer protection and comparability were more important than flexibility. The court found that the act required a transaction-specific approach to fees so that not all operating or general overhead costs could be allocated to the fees. In order to be recoverable in fees, costs must be sufficiently close and relevant to the steps in the lending process to which the fee relates so as to be said to have been incurred in relation to that step. The court held that it was not helpful to substitute the statutory standard of 'reasonable' for accounting terms 'variable' or 'avoidable costs'.
The effect of this judgment is that creditors offering finance to consumers must consider each cost incurred and determine whether that cost is sufficiently connected to the activity for which it is charging the fee. Costs that do not satisfy the 'sufficiently close' test may not be recoverable as fees.
The Supreme Court had been considering the terms of the Credit Contracts and Consumer Finance Act before the amendment of relevant terms in 2014.(4)
Importantly, Section 3, which sets out the purposes of the act, has been amended to clarify that its primary purpose is to protect the interest of consumers in connection with credit contracts. Additional purposes have been added which support the primary consumer protection purpose. The purposes that were originally found in Subsections (b) to (g) of the section, have been moved to Subsection (3) of the amended provision, which provides that those matters are things provided for in the act in order to achieve its purposes.
Section 41 has been simplified, but still contains the same prohibition on unreasonable fees. Section 42 has not changed. Section 44 now deals only with other credit fees. Default fees are now in the new Section 44(A). In Section 44 the only matter specified for the courts in regard to determining whether a credit fee is unreasonable, is whether the fee reasonably compensates the creditor for any cost incurred by the creditor in relation to the matter giving rise to the fee. Reasonable commercial practice is no longer a matter to be considered in relation to whether the fee is unreasonable, but is instead to be considered in relation to whether the fee reasonably compensates the creditor. Similarly in Sections 44(A), the reasonable commercial practice is relegated to the determination of whether the creditor reasonably compensates the creditor rather than the issue of whether the fee is itself reasonable. The test is otherwise unamended.
Importantly, the definition of a 'credit fee' was amended in 2015 and now includes a list of fees or charges that are expressly included in the definition and those that are excluded – notably third-party fees have been expressly dealt with and are included in the definition of a credit fee if they relate to associated persons of the creditor, but are excluded if it is a non-associated third party.
The amendments have clarified the standards to be applied rather than substantially altering those standards. The separation of credit and default fees into separate sections has clarified which considerations are relevant to each. However, the amendments are unlikely to result in a court taking a different approach to the Supreme Court in Sportzone, but instead appear to support that approach. Credit and default fees will be reasonable if they are calculated so as to include compensation for costs only incurred by the creditor that are sufficiently close to the step in the transaction to which the fee relates.
The Supreme Court's decision has not come as a surprise to many in the industry. However, the case did illustrate how the broadly formed reasonableness standard and the provisions for determining the reasonableness of fees could lead to differing views on compliance. This is of particular concern, as creditors are exposed to criminal charges for breach of the provisions. The Supreme Court acknowledged that this was a valid criticism of the regime.
For further information on this topic please contact Ian Denton or Felicity Monteiro at Wilson Harle by telephone (+64 9 915 5700) or email (firstname.lastname@example.org or email@example.com). The Wilson Harle website can be accessed at www.wilsonharle.com.
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