Andrews v ANZ [2011] FCA 1376

Background

This case was the first important milestone of a class action brought against the banks by litigation funder IMF seeking to claw back various account fees on the grounds they are void as penalties.

A penalty is clause that punishes a breach of the contract with payment of a predetermined sum which is out of all proportion to the damages suffered by the innocent party.

ANZ has two arguments in its defence:

  1. the fees are not capable of being penalties as they are not designed to punish a breach, and
  2. they are not penalties because they are not out of all proportion to the actual damage suffered due to the breach.

The second argument will involve the bank showing how much it suffers as a result of customers breaching their contracts–and will be a expensive and time consuming exercise. Accordingly the court opted to decide the first argument as a preliminary question first. If ANZ was correct it would allow a huge saving of the court’s time and costs for both parties.

The fees that were in contention may be broken into two categories:

  1. where the action was prohibited.
  2. where the actions was allowed.

Where the action was prohibited

The fee in question was charged if the customer failed to make a payment on his credit card. He was prohibited by the clause from failing to make the minimum monthly payment. The court held this was capable of being a penalty. This was because there was a breach involved. The contract required the payment to be made, not making it was a breach, the fee was payable upon breach. Hence the court held it was capable of being a penalty (the question of whether it was out of all proportion to the damage suffered was left for another day).

Where the action was allowed

These fees involved overdrawings and attempted overdrawings. Under the contract the borrower could attempt to overdraw his account, and the bank could either accept the overdrawing by making the payment or decide not to by effusing to make the payment. Depending upon what the bank did it would either charge an honour fee or a dishonour fee.

The bank argued, and the court accepted, that the customer was not prohibited from attempting to overdraw his account. Far from being a breach, the contract actually envisaged the customer would attempt to overdraw the account, and the bank would consider that as a loan request–which it would charge for considering and refusing or approving. 

What does this mean for lenders?

The judge was emphatic and the authorities relied on were ancient, unbroken and unwavering–but perhaps never brought into such stark contrast. A lender can charge any fee at all and prevent it being a penalty simply by compliant construction. The question of whether the fee is extravagant, or out of all proportion to the damage suffered, is never even reached so long as the clause is drafted so as to regard the breach as merely a contingency rather than behaviour prohibited by the contract. 

For example, with the late payment fee that was found capable of being a penalty,  ANZ could have succeeded if it had drafted it as follows:

Whenever the account balance of your credit card is negative $2,000 then you will be charged a fee of $50 at the end of the month. This fee will be waived if you make a payment that brings the balance to less than negative $1,000 before the end of the month.

Note there is no requirement that the minimum payment be made. Instead a contingency is provided for with fees–this is perfectly allowable and the court will not scrutinise the harshness of the bargain.

The decision

Definition of penalty
Her Honour began by describing the law of penalties by quoting from the lead House of Lords authority, the passage was recently cited as binding authority by the Australian High Court:

  1. The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine covenanted pre-estimate of damage.
  2. The question whether a sum stipulated is penalty or liquidated damages is a question of construction to be decided upon the terms and inherent circumstances of each particular contract, judged of as at the time of the making of the contract, not as at the time of the breach.
  3. To assist this task of construction various tests have been suggested, which if applicable to the case under consideration may prove helpful, or even conclusive. Such are:
    a) It will be held to be penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach.
    b) It will be held to be a penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid. …
    c) There is a presumption (but no more) that it is penalty when “a single lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage”.

Liquidated damages clauses vs penalties
Her Honour then compared liquidated damages clauses to penalties:

The primary remedy for a breach of contract is an award of damages. The object of such an award of damages is to compensate for loss and damage occasioned by breach, not to punish the party in breach.

The, parties to a contract are entitled (and often do) stipulate in the contract an amount that will be payable by one to the other in the event of breach. Such clauses have been described as “agreed damages” clauses. These clauses are generally enforceable provided they fix a sum which is a genuine pre-estimate of loss or damage – sometimes described as “liquidated damages”. These clauses obviate the need to prove in court the amount of loss or damage suffered as a result of a breach. Courts have recognised that such clauses are mutually beneficial to the parties; providing certainty in respect of their rights and obligations without the need for costly litigation or, at the very least, minimising the cost of litigation.

A penalty, as its name suggests, is in the nature of a punishment for non-observance of a contractual stipulation; it consists of the imposition of an additional or different liability upon breach of the contractual stipulation …

There has to be something “extravagant and unconscionable” in the value of what is transferred compared to the price to be received or a “degree of disproportion” sufficient to point to oppressiveness. Put another way, the law of penalties requires the court to determine whether the payment for non-observance of the contract is payable in terrorem. That is, as a punishment to deter breach of the contractual obligation.

Requirement for breach
Her Honour then focussed on the crux of ANZ argument:

There is extensive and longstanding authority in Australia and the United Kingdom that the law of penalties has no application to a contractual provision requiring a payment on the happening of an event that does not constitute a breach of contract.

One question raised in these cases is whether the law of penalties has any application to contractual provisions that operate upon termination of the agreement, where the right to terminate the agreement is exercisable on the occurrence of a number of events, some of which constitute breaches of contract and some of which do not. The state of the authorities is that the law of penalties is applicable where the agreement is terminated for breach of contract. Conversely, the law of penalties has been held to have no application to contractual payments that arise upon termination of the agreement where the agreement is terminated on the occurrence of an event that does not constitute a breach of contract.

It would seem clear that a provision calling for the payment of money by one party on the occurrence of a specified event, rather than upon breach by that party, cannot be a penalty.

Interstar Wholesale Finance
The only significant deviation in the authorities from the breach rule was the case of Integral Home Loans Pty Ltd v Interstar Wholesale Finance Pty Ltd [2007] NSWSC 406 where Brereton J, at first instance, held that a non-breach provision in issue was a penalty. That decision was overturned on appeal by the New South Wales Court of Appeal in Interstar Wholesale Finance Pty Ltd v Integral Home Loans Pty Ltd [2008] NSWCA 310; The losing party to the appeal was granted special leave to appeal by the High Court but the parties settled before the High Court considered the matter. Her Honour was therefore obliged to consider the decision of Brereton in some detail.

Interstar engaged in lending on the security of mortgages. Integral was a mortgage originator. If a loan was made, Integral managed the loan. Under the origination deed, Interstar agreed to pay to Integral an upfront fee on settlement of a loan introduced by Integral and an ongoing trailer commission.

The origination deed required Integral “to act honestly in its dealing with all parties and not engage in misleading, deceptive or unethical conduct”. The deed entitled Interstar to terminate the agreement in various circumstances including the insolvency of Integral, a breach of the agreement by Integral or where Integral or its representative had engaged in any proven misleading or deceptive conduct in relation to a loan or where Interstar considered, in its reasonable opinion, that Integral or its representative had engaged in deceptive or fraudulent conduct in relation to a loan.

Interstar gave Integral notice that it was exercising its right of termination because it had formed the opinion that Integral had engaged in deceptive conduct in relation to loan application files. Integral contended that Interstar the clause was void as a penalty.

The trial judge (Brereton J) held the clause void as a penalty. His Honour concluded that a contractual provision entitling a party to terminate a contract on various events such as death or insolvency of the other party was susceptible to the law of penalties because they:

… serve to secure the interests of the [terminating] party in receiving performance of the main promise of the contract … Their effect is that the other party’s entitlement to continue to enjoy the benefit of the contract is conditional upon its not committing any event of default ….

What was new, and what was rejected by the Court of Appeal, was the view expressed by Brereton J that the law of penalties was not limited in its application to circumstances where a contract is terminated for breach but that its scope extended to circumstances where a contract is terminated pursuant to a right to do so upon occurrence of an event of default which the non-terminating party had, in substance, an obligation to avoid.

Her Honour was scathing:

With respect to Brereton J, I reject the contention that the law of penalties extends to circumstances where a contract is terminated pursuant to a right to do so upon occurrence of an event of default which the non-terminating party had, in substance, an obligation. It finds no support in history, in the decided cases in Australia, the United Kingdom, Canada, Hong Kong or New Zealand and, finally, and no less importantly, it is a phrase or concept devoid of certain meaning. Given the importance and rising significance of the freedom of contract since the late 19th century, it would be contrary to that trend to now expand the law of penalties in the manner proposed by Brereton J and, in particular, in a way which is at best uncertain and at worst ambiguous.

Her Honour then noted:

Courts have consistently rejected a jurisdiction in equity to interfere with contractual freedom on the generalised ground that the provision in question constitutes a hard bargain. Instead, courts have developed equitable and common law principles in particular circumstances to prevent contracts being used as a means of taking unfair advantage of persons in positions of vulnerability, particularly the principles relating to unconscionable conduct, undue influence and duress.

The terms that were not capable of being a penalty

Her Honour reasoned as follows:

A retail deposit customer does not breach his or her contract with ANZ when ANZ permits the customer to overdraw his or her account. The request is made by the customer. The bank decides whether to exercise its discretion and meet the request. If it does so, then the bank charges the fee – in this case, the Honour Fee – a fee that was not payable on breach of any term or condition of the contract between ANZ and the customer but on the bank meeting a request from a customer.

The terms that were capable of being a penalty

Her Honour reasoned as follows:

The late payment fee is properly to be characterised a fee imposed by ANZ on a customer when it fails to make a payment within the stipulated time, 28 days. Unlike the requests for a loan which are at the discretion of ANZ the failure to comply with the payment obligations within the stipulated time is not at the discretion of ANZ. That is, ANZ wants card customers to comply with the payment obligations within the stipulated time to provide it with some control over its credit exposure. The fee is imposed by ANZ on a customer for failing to comply with the payment obligation within the stipulated time.

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