Loss for plaintiffs
In a decision highly-anticipated by bank consumers and corporates alike, last month Australia’s High Court clarified the current state of Australia’s law of penalties.
In short, the High Court ruled that a contractual obligation to pay a specified sum of money upon breach of contract will be enforceable, as long as the amount payable is not ‘out of all proportion’ to the party’s interest in ensuring compliance with the relevant obligation. The relevant ‘interest’ for these purposes may include financial interests such as the cost associated with making accounting provisions and therefore may extend beyond the costs recoverable by way of damages in litigation.
In Paciocco v Australia and New Zealand Banking Group Limited, the High Court was asked to determine whether or not late payment fees payable upon failing to make a minimum payments under consumer credit card contracts, were truly penalties and therefore unenforceable at law. The appeals were pursued by Mr Paciocco for and on behalf of a group of similarly affected persons as part of a class action.
By a majority, the High Court determined that the late payment fees were not penalties, nor did the imposition of them contravene any of the applicable statutory provisions.
The appeals followed earlier decisions of the Full Federal Court of Australia and a single judge of the Federal Court.
Relevant underlying facts
Lead plaintiff Mr Paciocco held two credit card accounts with ANZ, the terms of each of which included:
- a requirement that he make the nominated minimum monthly payments; and
- an entitlement conferred upon ANZ to deduct fees and charges “for the provision and operation of the credit card account”.1
In accordance with these contractual terms, one of the fees charged to Mr Paciocco’s account was a monthly amount of $35 which was subsequently reduced to $20, being a ‘late payment fee’ for failing to pay the minimum monthly payment required under the contract.
The fact that the fees would be charged was made clear to, and understood by, Mr Paciocco. Similarly, Mr Paciocco was free to cancel the credit card contracts at any time. He chose not to do so. Instead he managed “those accounts at close to their limits and to bear the risk of being charged the late payment fee on those occasions when he failed to comply with the standard stipulation to make the minimum monthly payment by the due date.”2
The late payment fee was not calculated by ANZ as being the amount of loss it expected to suffer should Mr Paciocco fail to make the minimum payments under his contract. Rather, it was a fee charged generally to customers with similar accounts and did not vary having regard to the amount outstanding on the account.
Are fees a penalty?
ANZ argued that in determining the value of its late payment fee it was entitled to have regard to indirect costs associated with a failure of its customers to meet their contractual commitments. Relevantly, these indirect costs included:
- provisioning costs (costs attributable to the increased risk that a loan may be unrecoverable;
- regulatory capital costs (the costs of funding capital required to meet the relevant prudential standards); and
- operational costs (costs associated with taking steps to collect outstanding debts).
By majority the High Court agreed with ANZ.
In particular the Court accepted that each of these categories of cost, was one which was affected by a customer’s failure to meet his, her or its, contractual repayment commitments.
As part of ANZ’s financial interest which would be affected by a breach of contract, ANZ was therefore entitled to consider these costs in setting its standard late payment fee. Once regard was had to these costs, the value of the late payment fee it imposed upon Mr Paciocco was determined to be not ‘out of all proportion’ and was therefore enforceable.
Calculating in advance an amount payable upon breach of contract is a difficult exercise. However, the Court recognised in Paciocco that the “task is not one which calls for precision. The conclusion to be reached, after all, is whether the sum is ‘out of all proportion’ to the interests said to be damaged in the event of default.”3
Relevantly, contracting parties are not limited to considering only the direct costs attributable to a potential breach of contract. Instead, regard may be had to the effect of default on their broader interests. The fact that a sum payable upon default is disproportionate to the loss suffered as a result of that breach, is not determinative. Instead the defaulting party must establish that the amount payable is ‘out of all proportion’. In the absence of proof of that kind, the innocent party will be entitled to pursue recovery of the payment specified in the agreement.