In Andrews v ANZ Banking Group Ltd,1 the High Court has significantly widened what was generally understood to be the scope of the doctrine of penalties.

Summary

The law of penalties, in its standard application, is attracted where a contract provides that on breach, the contract-breaker will pay an agreed sum which exceeds what can be regarded as a genuine pre-estimate of the damage likely to be caused by the breach.2 A court will not enforce a penalty, leaving the innocent party to recover unliquidated damages.

In Andrews, the High Court held that an agreed sum payable under a contract could be a penalty even when it is not payable on breach of contract. Although the High Court’s decision was based on early English authorities, it involves a departure from more recent English decisions, which have held that an amount payable under a contract can only be a penalty when it is payable on breach. It also involves a departure from what had previously been understood to be the position in Australia.3

While it is clear that the doctrine of penalties may now be applied in a wider range cases, distinguishing between amounts that may or may not be penalties will be far from straightforward following the decision in Andrews.

First, it will now be necessary to determine, as a matter of substance not form, whether the amount is payable

  1. in return for a service or other benefit (in which case it cannot be a penalty), or
  2. as security for the fulfilment of some condition, even when the party liable to pay the amount did not promise that the condition would be fulfilled (in which case it may be a penalty).

While in many cases it will be clear into which category a payment falls, that will not always be the case. For instance, is a fee payable upon a bank account going into overdraft charged in return for the provision of financial accommodation, or is it imposed as security for the fulfilment of a condition that the customer not overdraw on the account? What is the significance of the quantum of the fee in deciding this question? And to what extent will the drafting of the contractual provisions be relevant?

Second, it is not entirely clear whether, for an amount to qualify as a penalty, the associated condition must be something within the control or responsibility of the party liable to make the payment, or whether any condition will suffice.

Third, even if it is concluded that an amount is payable as security for the fulfilment of a condition in the relevant sense, it will not be a penalty where the loss suffered as a result of non-fulfilment of the condition is not compensable by damages. No doubt the party seeking to enforce payment will contend that damages for non-fulfilment of the condition could never be accurately assessed and, therefore, the amount cannot be a penalty.

Given the importance of this case, we have summarised the reasoning in some detail below.

Background

The issue arose in the context of a class action brought by customers against ANZ in respect of so-called ‘exception fees’ charged to them. These fees included:

  • ‘honour fees’ (charged where a customer authorised a payment in circumstances where they had insufficient cleared funds in their account, and ANZ honoured the instruction),
  • ‘dishonour fees’ and ‘non-payment fees’ (charged where a customer authorised a payment in circumstances where they had insufficient cleared funds in their account, and ANZ refused to honour the instruction),
  • ‘overlimit fees’ (charged where a customer exceeded the credit limit on their credit card account),
  • ‘late payment fees’ (charged where monthly payments or other amounts due from a customer in respect of a credit card account were not paid within a specified time frame).

The customers claimed, among other things, that the fees were unenforceable penalties. They claimed that the fees could not be regarded as a genuine pre-estimate of the loss that ANZ would suffer as a result of the events that gave rise to the liability to pay the fees.

Similar actions have been brought against other major Australian banks, but until now have been stayed pending developments in the ANZ proceedings. (Freehills acts for Commonwealth Bank of Australia and Bankwest in those proceedings.)

At first instance, the question of whether the various exception fees were capable of being characterised as penalties was the subject of a preliminary determination, separate from the resolution of the other issues in dispute. Justice Gordon considered herself bound by the decision of the NSW Court of Appeal in Interstar to hold that an amount payable under a contract is only capable of being characterised as a penalty if it is payable on breach. Gordon J held that the credit card late payment fees were payable on breach and therefore capable of being penalties, subject to it being established that they could not be regarded as a genuine pre-estimate of the loss ANZ would suffer as a result of the late payment. However, her Honour held that the honour fees, dishonour fees, non-payment fees and credit card overlimit fees were not payable on a breach and, therefore, were not capable of being penalties.

The decision of the High Court

An appeal against the decision of Gordon J was removed to the High Court on the question whether the penalties doctrine was limited to amounts payable on breach of contract. The High Court unanimously allowed the appeal, rejecting the analysis in Interstar.

The court traced the history of the doctrine of penalties back to the law relating to bonds upon condition. Before the common law courts developed the action of ‘assumpsit’ to provide a remedy for breach of a simple contract (that is, a contract not under seal), the performance of an obligation was secured by the issue of a bond on condition. The usual form of bond was an instrument under seal such as a deed poll that required the ‘obligor’ to pay a sum of money to the ‘obligee’ unless a certain condition was fulfilled. Although the obligor did not promise to procure fulfilment of the condition, and in some cases the condition might not be in the control of the obligor, the purpose of the bond was usually to secure fulfilment of the condition by the obligor.

Courts of equity assumed jurisdiction to limit recovery where the obligee sought to enforce payment on a bond to the loss actually suffered by the obligee as a result of the non-fulfilment of the condition: an obligation to pay more than that amount was relieved against as a penalty. However, the court would only intervene where the non-fulfilment of the condition was compensable by a payment of money.

When the common law courts developed the action of assumpsit, permitting damages to be awarded for breach of a simple contract, the equitable jurisdiction could still be invoked to relieve against a penalty. By the seventeenth century, the common law courts themselves would limit damages in an action for breach of contract to the loss actually suffered, rather than requiring the defendant to commence an action in the courts of equity to relieve against a penalty. This development led Mason and Wilson JJ to observe that ‘the equitable jurisdiction to relieve against penalties withered on the vine’ because, except perhaps in very unusual circumstances, it offered no prospect of relief that was not available in a common law court.4

In Andrews, however, the High Court rejected the proposition that the development of a jurisdiction in common law courts to relieve against penalties supplanted the equitable jurisdiction. The court also held that, although the common law jurisdiction to relieve against penalties was developed in the context of actions for breach of contract, the equitable jurisdiction was not so limited. Just as a court of equity could relieve against a penalty in a bond on condition even though the obligor did not promise to bring about the fulfilment of the condition, so it might also relieve against a penalty in a simple contract even though the amount was not payable as a result of a breach of contract: that is, a failure to fulfil a contractual promise.

The limits of the doctrine of penalties

If an amount does not need to be payable on breach of contract in order to be a penalty, what are the limits on the doctrine? Is any amount payable under a contract capable of being characterised as a penalty so long as it does not represent a genuine pre-estimate of loss?

It is well established that a contract will be binding even though one party has made an improvident bargain by promising to pay more than market value in return for an asset or a service: that is, a court will not inquire into the inadequacy of consideration in assessing whether a contract has come into existence.5

The High Court in Andrews sought to reconcile this principle with a wider doctrine of penalties by drawing a distinction between:

  • an obligation to pay an amount in return for a right or benefit, which cannot be a penalty even if the amount payable exceeds the value of the right or benefit, and
  • an obligation that is in truth security for the fulfilment of some condition, which may be a penalty if it exceeds the loss that could be suffered as a result of non-fulfilment of the condition.

In considering on which side of this line a particular payment obligation falls, the court will have regard to substance over form. That is, an amount may be a penalty where it is payable on non-fulfilment of a condition, even though the party liable to pay does not promise to bring about fulfilment of that condition and therefore does not breach the contract when it is not fulfilled.

The High Court gave as an example the case of Metro-Goldwyn-Mayer Pty Ltd v Greenham.6 An exhibitor was licensed to screen a film once. The exhibitor was required to pay four times the original fee for each subsequent screening. The majority in the NSW Court of Appeal held that the fee for the subsequent screening could not be a penalty because it was in truth a hiring fee – that is, a fee paid in return for a benefit. Jacobs JA said:

‘There is no right in the exhibitor to use the film otherwise than on an authorized occasion. If he does so then he must be taken to have exercised an option so to do under the agreement, if the agreement so provides. The agreement provides that he may exercise such an option in one event only, namely, that he pay a hiring fee of four times the usual hiring fee.’

The decision, however, demonstrates the difficulty that will arise in practice in deciding whether or not an amount payable under a contract is capable of being a penalty. While Jacobs JA referred to the existence of an ‘option’, that option was not expressly provided for by the contract. Rather, the contract provided that the film could be screened once and then provided for payment of an amount equal to four times the hiring fee if it was screened more than once. This led the other member of the court to conclude that screening the film more than once was in fact a breach of contract and that amount payable on a second screening was not a hiring fee but a penalty – that is, an amount payable on non-fulfilment of the condition that the film be screened only once that exceeded the loss suffered by the owner of the film as a result of the re-screening.

The divergent opinions in the Metro-Goldwyn-Mayer case emphasise the lack of any bright line between payment of an agreed amount for a service on the one hand and security for the fulfilment of a condition on the other. For example, what is described as a ‘fee for service’ might be set at such a level that it is in reality designed to discourage the other party from drawing on that ‘service’. It seems unlikely that the payment of four times the usual hiring fee for an additional movie screening in Metro-Goldwyn-Mayer was contemplated as something that would typically be commercially sensible on the part of movie exhibitors. The fee could readily be seen as a deliberate discouragement of additional screenings, even accepting that it was also an agreed payment in return for a right or benefit.

While the focus is principally on the substance of the contract rather than form, it may well be that in close cases the precise wording of contractual provisions is an important factor. Indeed the High Court stated that resolution of this question was ultimately a matter of interpretation of the contract.

The High Court did not expressly state whether an amount is capable of being a penalty even where the associated condition is something beyond the control or responsibility of the liable party. Based on the court’s extensive consideration of the history of bonds upon condition, which could indeed include conditions beyond the control of the parties, it might be inferred that the doctrine of penalties can also apply to any condition. However, this is for the moment an area of uncertainty.

At several points in its judgment, the court also emphasised that the law of penalties did not apply where the loss suffered as a result of non-fulfilment of the condition could not be compensated by damages. One of the cases referred to in this context involved an amount payable under bond upon particular workers going on strike. This was held not to be a penalty on the basis that it was not possible to determine the quantum of loss that would be suffered by the employer as a result of not doing business for a period. There are arguably numerous modern commercial environments in which the loss suffered is equally difficult to quantify (for example, building contracts which contain liquidated damages clauses in respect of late completion). The court’s reasoning opens the possibility that plaintiffs in such situations might attempt to exclude the operation of the penalties doctrine on the basis that the actual loss suffered cannot be accurately assessed.

Finally, the High Court did not decide whether the particular exception fees in issue were or were not capable of being penalties. It will be left to the trial Judge to determine whether they are in truth:

  • amounts paid in return for some benefit, such as further financial accommodation (in the case of the honour and overlimit fees) or consideration of a request for further financial accommodation (in the case of the dishonour fees and non-payment fees), or
  • amounts payable as security for fulfilment of a condition (such as the account not going into overdraft or not exceeding the agreed credit limit).