In brief

  • Early termination fees will be assessable for unfairness because they will not be regarded as the main subject matter or the contract or part of the upfront price.
  • ASIC has provided guidance on how it will apply to the test of unfairness to early termination fees.
  • A term that complies with the provisions of the NCC may still be unfair.

Introduction

Following consultation in June,1 ASIC has now released its guidance paper on early termination fees for residential loans. The paper is called Regulatory Guide 220 – Early termination fees for residential loans: Unconscionable fees and unfair contract terms, November 2010 (RG 220).

RG 220 provides guidance on how ASIC will apply the law on unconscionable fees under the National Consumer Credit Protection Act 2009 (Cth) (National Credit Code) and the law on unfair terms in contracts under the new Australian Consumer Law to early termination fees in residential loans.

One of the key points emphasised by ASIC in RG 220 is in relation to section 12BI of the ASIC Act 2001 (Cth) (ASIC Act) which states that the unfair contract terms provisions do not apply to terms that define the ‘main subject matter’ of the contract or set the ‘upfront price’ payable under a contract. ASIC advises that it will administer the law on the basis that terms imposing early termination fees (including deferred establishment fees) generally do not fit within either of these categories and are therefore covered by the unfair contract terms provisions (see: RG 220.51–55). ASIC states that the subject matter of a residential loan primarily relates to lending money and repaying the money lent.

ASIC advises that determining whether a term of a contract is unfair will ultimately depend on the facts of each individual claim. However, ASIC considers that a contractual term providing for an early termination fee which is unconscionable under the National Credit Code is also likely to be unfair under the unfair contract terms provisions.

ASIC’s guidance on the elements of unfairness

Significant imbalance

Pursuant to the terms of the legislation, a term will be unfair if it:

  • would cause a significant imbalance in the parties’ rights and obligations arising under the contract
  • is not reasonably necessary to protect the legitimate interest of the party who would be advantaged by the term, and
  • would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied upon.

ASIC notes that:

  • assessing imbalance requires a factual assessment of the evidence to see if imbalance is created in the context of the contract as a whole, and
  • in the Australian market, most residential loan agreements give lenders an unfettered right, or a right subject to few restrictions, to vary the interest rate of the loan. This could be considered by a court when assessing unfairness.

ASIC is of the view that where the loan agreement gives the lender an unlimited unilateral right to vary an early termination fee or the circumstances in which the fee applies, the balance is not maintained. The reasoning is that there is no limit on the amount of the fee that can be charged and such a term does not allow the consumer to negotiate the fee under the contract.

Legitimate interests

ASIC provides an indication of what it does and does not consider to be a legitimate interest (see: RG 220.68–70).

ASIC considered that fees related to the lender’s reasonable costs arising directly from the early termination or break fees that reflect the amount needed to recover the lender’s loss from a fixed rate loan being terminated early are likely to be considered as reasonably necessary to protect the lender’s legitimate interests. In contrast, an early termination fee that has the effect of penalising the consumer for terminating the loan is not likely to be reasonably necessary to protect the lender’s legitimate interests. ASIC also considers that a term imposing such a fee is likely to be unfair.

Detriment

Examples provided by ASIC of ‘detriment’ resulting from contractual terms imposing early termination fees include:

  • taking longer to ‘break even’ when refinancing
  • having to enter into further debt to pay the early termination fee and exit the loan
  • being prevented from switching to a loan that is more suitable, and
  • having the terms changed unilaterally by the lender in a way that is unfavourable to the consumer.

ASIC indicates that the amount of detriment suffered is not of relevance.

Notes to lenders

ASIC advises lenders to explain early termination fees as transparently as possible including:

  • explaining in a meaningful and clear way when the fee will be charged
  • clearly stating the amount in dollars of the fee or, if that is not possible, the method of calculation
  • using prominent warnings to explain risks associated with early termination fees, particularly break fees, and
  • using meaningful worked examples of break fees, as long as the example can be provided in a way that is not misleading.

Interaction between the National Credit Code and the ASIC Act

Interestingly, ASIC notes that the difference between the test under the National Credit Code and that under the ASIC Act could have the effect that adequate disclosure under the National Credit Code will not constitute transparency or fairness under the ASIC Act. This is something that many people are unlikely to appreciate.