In Andrews v Australia and New Zealand Banking Group Ltd [2012] HCA 30, the Australian High Court decided that bank fees may potentially be penalties, notwithstanding the fact that the trigger for the imposition of most of the fees was not a breach of contract. I’ve already outlined the law against penalties in some detail in this earlier post. In short, parties are allowed to stipulate the amount payable for certain breaches of contract (known as ‘liquidated damages’), but if the amount payable is not a genuine pre-estimate of loss and is instead in terrorem of the other contracting party (i.e. designed to scare them into performance rather than compensate for loss) then the clause may be struck down by the law against penalties: see Ringrow Pty Ltd v BP Australia Pty Ltd [2005] HCA 71; (2005) 224 CLR 656, affirming Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79.
As I noted in the other post, Andrews is a class action case where certain customers of the ANZ Bank are suing it in relation to a variety of fees the bank had charged them. At first instance (in Andrews v Australian and New Zealand Banking Group [2011] FCA 1376) the plaintiffs were largely unsuccessful in their claim. Gordon J held that only late payment fees were capable of being characterised as a penalty, whereas honour fees, dishonour fees, overlimit fees and non-payment fees were held not to be penalties. She followed the New South Wales Court of Appeal in Interstar Wholesale Finance Pty Ltd v Integral Home Loans Pty Ltd [2008] NSWCA 310 and held that it was necessary for a breach of contract to trigger the necessity to make the payment, so that the law of penalties had no application to contractual payments that arose upon the occurrence of an event which did not constitute a breach of contract. The honour fees, dishonour fees, overlimit fees and non-payment fees were not incurred as a result of breach of contract, but were payable because ANZ had met a request for a loan or an advance from a customer. By contrast, credit card late payment fees were capable of being a penalty, as they were imposed when a customer failed to make a payment within the time stipulated (in other words, the contract had been breached).
As this extremely useful summary by King & Wood Mallesons notes, the effect of Interstar was that contracts drafted on a permissive basis would not contravene the law against penalties, despite the fact that a permissive clause effectively amounted to the same thing as a penalty:
For example, a fee payable on breach would be as follows:
(a) A leases a shop to B for $100 p/w, on the condition that the shop is not used on weekends.
(b) If (a) is breached, B agrees to pay A $500 for each breach.
If the fee of $500 is not a genuine pre-estimate of the damage suffered by A by B’s breach, it will be unenforceable as a penalty.
Yet, the same position could be validly achieved if the contractual terms were drafted permissively, for example:
(a) A leases a shop to B for $100 p/w for use Monday to Friday.
(b) B agrees to pay A $500 each time the property is used on the weekend
You can see from this that the substance of the two clauses is the same (B has to pay A a fee of $500 if the property is used on the weekend) but the form is different. The second clause would not be in breach of the Interstar version of the rule against penalties, even if the $500 is not a reasonable pre-estimate of the loss, because the obligation to pay $500 is not triggered by a breach of contract; instead, it arises because B has agreed with A that B will pay that sum on the occurrence of an event which is not stipulated to be a breach of contract (i.e. using the property on the weekend). However, the High Court did not accept that the second clause was different in substance from the first.
The High Court judgment in Andrews was a unanimous one from French CJ, Gummow, Crennan, Kiefel and Bell JJ. The judgment is learned and historical, with an emphasis on the historical background of the jurisdiction against penalties, which in fact has its origins in Roman times. (Do I sense the pen of Gummow J making use of its last splash of judicial ink?)
The important and central message from the High Court in Andrews is that it is substance of the clause which matters, not the form. The penalties doctrine is not prevented from operating because there is no express contractual promise to perform the condition, and indeed (as the example above illustrates) a promise that the condition will be satisfied may often be the same in substance as a penalty which arises on the failure of a condition. Moreover, it is made clear that the doctrine against penalties is equitable and that the rule against penalties arose in a context where express contractual promises to perform were not common; instead the usual means of drafting a contract was as a ‘bond upon a condition’, which looked a little more like the permissive contract example above (‘If I do not do X, I will owe you a debt of $Y’). Consequently equity is more than equal to dealing with the present situation. Equity has long had a jurisdiction to set aside unconscionable bargains, and indeed, in the past, was much less circumspect in the way it operated.
It should be noted that parties are still free to put a clause in their contract which allows for payment if further services are provided by one party (effectively, an option to obtain an additional service for a fee). Among other things, the High Court refers to Pomeroy’s A Treatise on Equity Jurisprudence, 5th ed (1941), vol 2, §437 (at [81] of the judgment). I went to Pomeroy and I saw that he says that parties to a contract may put a term in a contract where:
the contracting party so binds himself that he is entitled to perform either one of two alternative stipulations, at his option; and if he elects to perform one of these alternatives, he promises to pay a certain sum of money, but if he elects to perform the other alternative, then he binds himself to pay a larger sum of money…In such a case equity regards the stipulation for a larger payment, not as a penalty, but as liquidated damages agreed on by the parties. It will not relieve the contracting party from the payment of the larger sum…nor, on the other hand, will it deprive him of his election by compelling him to abstain from performing whichever alternative he may chose to adopt.
The High Court also adopts Metro-Goldwyn-Mayer Pty Ltd v Greenham [1966] 2 NSWR 717, a case which involved a contract for the hiring of films to exhibitors for public showing. The standard form contract conferred the right to one screening at a particular time, and if the exhibitor wished to make additional showings, he was obliged to pay a sum which was four times the original fee. A majority of the New South Wales Court of Appeal decided that this additional payment was not a penalty, but a legitimate option to obtain further screenings. The case was further complicated by the fact that the contract in question was a standard form contract prescribed by the Cinematograph Films Act 1935 – 1938 (NSW). I’ve now had a chance to look at that decision and it makes for interesting reading. Jacobs JA based his conclusion on the interpretation of the contractual terms, and argued that the date and place for screening was central to the contract, and accordingly, the clause as to the additional fee was not penal. He said at 723:
Upon such an approach it seems to me that cl. 56 is properly regarded as one providing for an additional hiring fee in the event of an additional showing of a film. It may well be intended by the agreement that such an additional showing should be strongly discouraged. For this reason a very large hiring fee compared with the original hiring fee is provided. However, that does not make the clause a penalty clause: cf. Bridge v Campbell Discount Co. Ltd., [1962] 1 All E.R. 385; [1962] A.C. 600.
Holmes JA, who was also in the majority, similarly found that the clause was not a penal clause. Unlike Jacobs JA, he considered whether the value of the fee (four times the original fee) might indicate a penal aspect, saying at 726:
The view that cl. 56(a) relates to damages or to penalty for breach of the agreement for hire in the end depends upon the circumstance that in the events described in the clause the exhibitor becomes liable to pay as hire four times the amount of hire otherwise payable, if I may be permitted to so describe it. It is the apparent enormity of the multiplication that gives colour to the argument that there is a penalty involved. Of course the hire need not be, as in this case, a fixed sum but may be a sum arrived at by a formula related to the gross receipts of the theatre in which the film is exhibited on the particular occasion. Four times the hire might then give a very large sum or it may not. This would all depend upon the method of hire chosen by the parties as the method to apply in respect of an ordinary exhibition of the film. …Four times the hire is a multiplier which would suggest that a penal sum and not liquidated damages is involved.
However, he then goes on to say that it could be likened to a lease to a farmer where a particular rate of rent was stipulated for one area of land with a covenant not to cultivate another area. The lease would say that if the farmer wished to cultivate that other area, he would have to pay a higher rate of rent. [Although Holmes JA does not reference it, this example must be derived from the scenario suggested by Lord St Leonards in French v Macale (1842) 2 Drury 269, 275-6 which the High Court cites in the instant case at [80]]. Holmes JA says that the clause in the screen contract is essentially analogous to this situation, as the additional use of a film beyond what was authorised might entitle the distributor to a much higher rent. He notes that further showings would result in greater profit for the exhibitor and will affect the rate of hire which the distributor can get from another exhibitor in the area, and that accordingly the clause is not a penalty.
Wallace P dissented. He decided that the clause was a penalty, partly because it operated as a sanction for breach of the negative covenant not to show the films at unauthorised times. Moreover, it did not represent a genuine pre-estimate of damages because the minds of the parties did not turn to the making of the contract – it was a statutory fixed term contract providing “an elaborate fixed menu of stipulations and conditions” (citing Lord Radcliffe, Bridge v Campbell Discount Co Ltd [1962] AC 600, 626).
Having diverted into a discussion of Metro-Goldwyn-Mayer, I now return to the main decision, but I hope you can see why I discussed it in such detail. The High Court’s endorsement of that case may make or break the plaintiffs’ case. The decision has now been remitted back to the Federal Court for determination according to the principles the High Court has outlined. I am wondering with the greatest of interest what the result will be. Will the banks be able to argue that the fees are simply options to gain further rights for greater sum? Or are they really penalties designed to force the other party to comply with their part of the bargain? In comments on an earlier post, Desipis argues as follows:
[T]he dishonor and non-payment fees would seem to be penalties. The over-limit fees however would be about the bank granting, and the account holder taking advantage of, additional rights (additional overdraft/credit) that would not exist without the same contractual terms containing the fees, and therefore not necessarily constitute a penalty. The honor fees would seem to be somewhere in between, although I would hope that withdrawing an account an additional few dollars beyond an already overdrawn amount would not constitute an ‘additional right’ within the context of this doctrine.
Even if a fee is a stipulation for an additional service, I think the law should still query whether the additional fee represents a fair value for the service or additional rights granted, or whether the substantive effect is that the additional fee is really in terrorem (i.e. designed to punish, because the fee does not fairly reflect the value of the service provided). Otherwise we are back at an Interstar position – you can avoid the rule against penalties by drafting your contract in such a way that it offers two alternative stipulations, even though it is still the same in substance as it was before. I think that at the least, Holmes JA’s judgment in Metro-Goldwyn-Mayer points to the possibility that some considerations of the fair value of the service in question are relevant. Surely the High Court’s emphasis on substance over form in the primary judgment indicates that they would not favour an effective return to the Interstar position? I guess we’ll have to watch to see how this battle unravels in court. My conclusion is that although the judgment appears to be an expansion of the previous law, it may be that its effect is less radical than it first appears because of the exception carved out for what Pomeroy calls ‘alternative stipulations’.
Presuming that the changes this judgment heralds are more substance than form, I wonder what other contracts will be affected by this decision? The kind that immediately popped into my mind after the decision was mobile phone contracts($); but some energy contracts may be affected too. Some businesses which thought that it was safe to impose carefully drafted ‘service fees’ and ‘late payment fees’ after Interstar may be in for a rude shock.
