Introduction

The recent High Court decision in Andrews v Australia and New Zealand Banking Group Ltd [2012] HCA 30 (which we have previously reported on) has generated much comment, and we wanted to unpack the issues this case raises in a bit more detail.

The rule against penalties continues to apply in situations that amount to a breach of contract.  In Andrews, the High Court decided that the rule could also apply in some situations that do not amount to a breach of contract, but not all situations.  The issue becomes where the line should be drawn between:

  • those non-breach situations that are susceptible to the application of the rule; and
  • those that are not.

Unfortunately at this stage there are no clear answers, but it's useful to explore the principles in any event.

Conflicting principles

Inherent in any consideration of the application of the rule against penalties is a tension between two fundamental principles of contract law:

  • First, courts do not inquire whether the consideration provided for under a contract is fair.  The old maxim is that “consideration need only be sufficient, but not adequate”.  The fact that you have paid too much, or were paid too little, under a contract is not, of itself, actionable.
  • In contrast, courts are prepared to consider the reasonableness of any consequence which contracting parties have agreed will flow from a particular event set out in a contract (whether or not this event amounts to a breach of contract).   This includes liquidated damages clauses.

Fees for services

In Andrews, the High Court made it clear that the rule against penalties would not apply to payment obligations that are properly characterised as fees for services.  In respect of fees for services, courts will not assess whether or not the particular fees being charged are fair or reasonable.

There are many types of situations which will clearly fall within the “fee for service” category.  For example, a promise by Joey to sell a car to Tim for $10,000, regardless of what the car is truly worth, will not engage the rule.  If Joey or Tim believes that they have entered into a bad deal, other legal principles will have to be relied upon (for example, mistake, misrepresentation, duress, etc.).

You may recall from our previous note the case of MGM v Greenham, under which a court held that an agreement under which an exhibitor could show a film once for a fee, but any subsequent showings would incur an increased fee (of 4 times the original fee), could not be challenged as falling foul of the rule against penalties as these fees constituted fees for services.

Conversely, there are many types of situations which will fall outside the “fee for service” category and be subject to the rule against penalties.  For example, a person may be entitled to terminate a contract before the end of the contract term, subject to the payment of an early termination fee.  The early termination fee will not likely constitute a “fee for service”, as the fee is paid to end the contract, not to receive any further service.

The grey area

Unlike the previous example, problems arise where the relevant event giving rise to the potential “penalty” does not result in the termination of the contract.

A real-life example recently reported in the press is Ryanair’s €60 charge for printing out a boarding pass at the check-in counter.  If a passenger prints out their own boarding pass at home, they avoid the €60 charge.

Is the €60 charge a “fee for service” – that is, is Ryanair providing a service of printing out boarding passes in respect of which it is charging a fee?  Or should the €60 be treated as being subject to the rule against penalties because Ryanair’s printing out of a boarding pass at the airport is not in substance a service – rather, it is a fee that is levied because the passenger has failed their own responsibility to print out their own boarding pass?  Good arguments may be made for both characterisations of the charge, and without further judicial guidance, it is difficult to come to a confident conclusion.

It must be remembered that the quantum of the fee should not colour the assessment of whether the fee is or is not subject to the rule against penalties.  The Ryanair example also highlights the difficulties that may be faced if businesses attempt to use their charging model to encourage or discourage certain behaviour in their customers.

Another example of this are software licences under which licensees purchase a set number of end-user licences.  Sometimes these software licences encourage licensees to ensure that they have sufficient licences by providing that:

  • licensees can order new end-user licences at any time, at the standard rate; or
  • if the licensor discovers that the licensee is under-licensed, then the licensee must purchase the additional end-user licences at a higher rate.

A licence fee would typically fall within the class of “fees for service”.  However, does the fact that a higher licence fee is levied under the second scenario affect its characterisation as a “fee for service”?  It is clear that a pricing structure such as this is designed to encourage licensees to self-report overuse of licences, however, is it imposing a penalty on licensees who fail to self-report?

The rule against penalties - a quick refresher

It should be remembered that if a payment obligation is subject to the rule against penalties, then you will need to assess whether the relevant payment amount is:

  • out of all proportion to the damage likely to be suffered as a result of the particular event; or
  • extravagant and unconscionable in comparison to the greatest loss that might conceivably be proved to have flowed from the particular event in that circumstance.

It is only if the relevant payment obligation fails one of these tests that it will be void for being a penalty.

Conclusion

Unfortunately, until Andrews is applied by the courts, it is difficult to provide any clear guidance on determining whether a particular payment or other obligation in this “grey area” falls within the scope of the rule against penalties.

From a practical perspective, when considering the nature of any payment obligation (or other consequence, such as surrendering a right), contracting parties should ask themselves:

  • What is the purpose of the parties in levying the particular payment obligation?
  • Is the amount of the payment being sought reasonable in the circumstances?

Where the purpose of the payment obligation is penal in nature (in the colloquial sense) or where the amount of the payment being sought is unreasonable, this ought to be a flag that the payment may be subject to the rule against penalties.