The Commercial Court delivered its second judgment in the case brought by OFT to test the legal principles applicable to unarranged overdraft and returned payment item charges. This judgment considered whether certain historical terms providing for such charges, no longer used by the banks, were capable of being penalties under the common law. This follows the court's decision on 24 April that the common law on penalties does not apply to any of the charges currently imposed by the banks taking part in the test case. The parties agreed that, for a term to be a penalty:
- it had to be truly of contractual effect, not merely advisory;
- it had to impose an obligation or prohibition on the customer; and
- the charge had to be payable on a breach of it.
The court reiterated that, if a customer issues a payment instruction without available funds to cover it, on the face of it, he is seeking an overdraft facility and is not committing a breach of contract. In principle, the bank and the customer can expressly provide in the agreement that the customer will be in breach of contract if he allows his bank account to become overdrawn without prior arrangement. It may be unlikely the parties would do so, because, typically, an account will become overdrawn where the bank chooses to make a payment that it did not have to make.
The court also indicated that a charge payable upon a breach of contract can be a penalty even if the charge is payable only if certain other conditions are met. For example where the customer is given a "buffer" so there are no charges for overdrawing only by a small amount.
Against this background, the court decided that nearly all the historical terms providing for unarranged overdraft charges it reviewed were not subject to the rule against penalties. Sometimes, this was because the court interpreted the term as advisory, explaining how the account worked or as defining the limits of the customers' rights to have payment instructions to the bank honoured, rather than as creating a contractual prohibition. When considering a term in an old Woolwich agreement, the court suggested that, although when looked at alone it might appear to impose a contractual prohibition on the customer, when considered in the context of the other terms of the agreement it simply identified the circumstances in which the customer had a right to exceed his authorised overdraft limit, so was not capable of being a penalty.
The court found other charges felll outside the common law on penalties because, although a breach of a contractual obligation may have happened, the charge was not payable upon that breach of contract. In these cases the breach was simply part of the history that led to the charge.