The recent decision by the High Court in Paciocco v Australia and New Zealand Banking Group Limited  HCA 28 marked the end of a long representative action involving bank fees for late credit card bill payments. The decision provides much needed clarity to the formulation of the relevant test for the penalty doctrine in Australia since the High Court's decision in Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205. Whilst the practical implications of the decision remain to be seen, the key messages are that:
- Australian courts will take a cautious approach in invoking the penalty doctrine in a commercial deal struck between contracting parties. The doctrine will be invoked only if the relevant contract provision sought to be enforced is out of all proportion to the legitimate interests of the innocent party which it is the purpose of the provision to protect, and
- Although this means a greater level of certainty for contracting parties, care should still be exercised in drafting contracts to ensure that the penalty doctrine is not invoked unwittingly. In deciding whether to invoke the doctrine, the courts will have regard to the commercial context of the parties' deal. Accordingly, it is important to keep records of all matters considered in the parties' negotiation of relevant contract provisions including calculations of any agreed sum such as liquidated damages.
The case concerned the enforceability of late payment fee provisions in contracts between the appellant (Paciocco) and the respondent (ANZ) in relation to credit card accounts. Having been charged with 26 late fees, Paciocco alleged that, amongst other things, the late fees were unenforceable as penalties.
The Federal Court in the first instance held that the late fees were penalties as they were extravagant, having regard to the minimal loss actually suffered by ANZ. On appeal, the Full Federal Court held that the fees were not penalties as they were not extravagant, having regard to the greatest conceivable loss which could have flowed from the breach (instead of the actual loss suffered by ANZ). Paciocco subsequently appealed to the High Court seeking to overturn the Full Federal Court's decision that the late fees were not penalties.
The High Court considered expert evidence adduced by respective parties on the issue of ANZ's costs resulting from the late bill payments. Paciocco contended that whether the late fees were penalties ought to be assessed by reference to the amounts needed to restore ANZ to the position it would have been in had Paciocco paid the amounts owing on time. By contrast, ANZ contended that the issue required the consideration of potential losses to ANZ's financial position which comprised:
(a) operational costs, being the costs of ANZ's attempts to recover the outstanding payments;
(b) the costs of provisioning loss, due to the increased probability of default associated with the late payments adding to the overall level of ANZ's expenses; and
(c) the costs of regulatory capital, due to the need to hold a larger capital reserve given the increased probability of default adding to ANZ's funding costs
(collectively, the 'Conceptual Costs').
By 4:1 majority with Nettle J dissenting, the High Court dismissed the appeal and held that the Full Federal Court was correct to characterise the Conceptual Costs as affecting the legitimate interests of ANZ. The fact that the late fees were not genuine pre-estimates of damage and that the amounts charged were disproportionate to the actual loss suffered by ANZ did not render the late fees penalties.
The majority judges of the High Court each published separate judgments, although they reached the same conclusion on the issue of penalty (ie the late fees were not penalties).
Kiefel J, with whom French CJ agreed, held that the relevant test to apply for penalty is whether the provision is 'out of all proportion' to the interests of the party which it is the purpose of the provision to protect. These interests, which may be of a business or financial nature, are not confined to the actual losses suffered by the innocent party and may include the Conceptual Costs which, in the present case, were 'real as they had to be taken into account by ANZ'. As the late fees were not out of all proportion to the Conceptual Costs, they were not penalties.
Gageler J applied a different test for penalty. His Honour held that the relevant test is whether the late fees served the sole purpose of punishment or served ANZ's interests in ensuring that its credit card customers made timely monthly payments. His Honour held that the Conceptual Costs as reflected in the late fees represented ANZ's commercial interests in ensuring that its credit card customers as a cohort made minimum monthly payments by due dates. In light of these interests, the late fees could not be said to serve the sole purpose of punishment and, therefore, were not penalties.
Keane J endorsed the UK approach in Cavendish Square Holding BV v Makdessi; ParkingEye Limited v Beavis  UKSC 67 by formulating the relevant test as whether the late fees were 'exorbitant or unconscionable when regard is had to the innocent party's interest in the performance of the contract'. His Honour held that gross disproportion is needed to establish the punitive character of the late fees. The legitimate interests of ANZ in receiving monthly payments on time were multi-faceted, and had to be considered in the commercial context. ANZ's relevant interests included its need to provide financial accommodation to many customers on standard terms by fixing the risk and reward over multiple transactions and to pursue its business of lending to customers. His Honour held that the late fees were not grossly disproportionate to these interests and, therefore, did not constitute penalties.
Nettle J dissented as the only minority judge and held that the correct test to apply is whether the late fees were 'extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach'. His Honour held that the late fees were penalties as they were extravagant or otherwise out of all proportion to the greatest recoverable loss for the breach of the monthly payment obligation.
Difference between Australia and the UK
The decision in Paciocco confirms the clear divergence between Australia and the UK on the scope of the penalty doctrine since the High Court's decision in Andrews. In Australia, no breach of contract is required to engage the penalty doctrine whereas in the UK the doctrine is not engaged unless triggered by a breach. Although the scope of the doctrine was not in issue in Paciocco, French CJ provided the following comments in response to the UK Supreme Court's recent criticism of Andrews as a 'radical departure' from the existing law (find out more):
'A difference has emerged since the decision in Andrews between the Supreme Court of the United Kingdom and this Court in relation to the scope of the law relating to penalties. … The countries of the common law world have a shared heritage … . That shared heritage offers the undoubted advantage, but does not import the necessity, of development proceeding on similar lines' (at ).
Contracting parties adopting Australian law as the governing law should appreciate that the penalty doctrine applies to a much broader range of matters than under the UK law. Legal advice should be sought if uncertainty looms as to whether and how the penalty doctrine may affect relevant contract provisions.