The recent High Court decision of ANZ v Andrews  HCA 30 (Andrews) handed down on 6 September 2012, expanded the circumstances in which a contractual requirement to pay a fee may be held to be void on the basis that it constitutes a penalty. The expanded range of clauses to which the penalty doctrine may apply could have significant consequences for Australian Government agencies entering into service contracts or other contractual arrangements requiring the payment of amounts on the occurrence of stipulated events which may not constitute breach of contract. Agencies should be aware of the new position when negotiating such clauses, lest they be void or unenforceable as penalties where the amount payable is out of all proportion to the actual loss (if any) suffered by the payee as a result of the event.
The pre-Andrews position
Prior to the Andrews decision, the penalty doctrine operated to void clauses in contracts that required a party to pay an amount (or to forfeit property) that would be out of all proportion to the greatest conceivable loss that might be suffered by the other party if the relevant breach occurred. On the other hand, if the stipulated amount reflected a genuine pre-estimate of the damage that would likely be suffered, made at the time the parties entered into the contract, the relevant clause would not be void as a penalty.
Importantly, despite some dissenting or overruled judgments to the contrary, it was generally held throughout the common law world that the penalty doctrine could apply only when an amount became payable by a party as a result of a breach of contract, and therefore not to clauses which merely required a party to pay an amount upon the occurrence of a certain stipulated event arising from the contractual relationship.
The proceeding was commenced in the Federal Court as a class action brought on behalf of some 38,000 customers of the ANZ Bank. The applicants sought a declaration from the Court that various honour, dishonour, non-payment, late payment and overlimit fees charged by ANZ (Exception Fees) were void or unenforceable as penalties. The applicants’ obligations to pay such fees arose from their individual contractual arrangements with the bank, which were on the same or similar terms.
ANZ conceded that the Exception Fees did not reflect a genuine pre-estimate of any loss it would suffer in the relevant circumstances, but disputed that the Exception Fees could attract the penalty doctrine because they were only payable upon the happening of certain stipulated events, rather than upon breach of contract. Given that this issue ran to the heart of the dispute, it was heard as a separate, preliminary question.
At first instance, Justice Gordon rejected the applicants’ argument that the Exception Fees (with the exception of late payment fees) were capable of being construed as penalties. In arriving at this finding, her Honour relied primarily upon reasoning in the NSW Court of Appeal’s decision in Interstar Wholesale Finance Pty Ltd v Integral Home Loans Pty Ltd  NSWCA 310 as authority for the proposition that the penalty doctrine can only apply to payments required to be made upon a breach of contract.
The applicants appealed to the Full Federal Court; however the question was referred to the High Court for determination.
The High Court’s decision
The Court unanimously held that it was not correct that the application of the penalty doctrine was limited to situations of breach of contract; rather it might also apply where a payment or a forfeiture of property is triggered by non-performance of some condition – even if there was no (express) contractual promise that the condition would be performed. The Court accepted the view that, in substance (if not in form), the situations were equivalent.
Of potential significance to the future disposition of the proceeding is the critical distinction noted by the Court between an obligation to pay an amount which, in substance and on its proper construction, is in the nature of a payment for some other new or additional benefit, on the one hand, and a payment which is intended to secure the performance of some other obligation, on the other hand. In accordance with the Court’s decision, the latter is clearly capable of being a penalty, however expressed. But the Court left open for determination whether or not the Exception Fees are in fact obligations of the former kind.
By removing the historical requirement that the doctrine of penalties could only grant relief from an obligation to make a payment upon breach of contract, this decision expands the range of clauses which may be subject to the doctrine. When entering into contracts requiring payment to be made upon the occurrence of a mere stipulated event, Australian Government agencies should take care to ensure that such payments are structured to either:
- relate to the provision of some corresponding benefit or service provided by the payee, or
- be a genuine pre-estimate of damage or loss suffered by the agency as a consequence of the event.