27 Jul 2016

Late payment fees for credit cards not penalties, says High Court

Broad view taken will have ramifications beyond the financial services sector.

Late payment fees charged by ANZ on its credit cards are not unenforceable penalties, following the decision by the High Court earlier today in Paciocco v Australia and New Zealand Banking Group Limited [2016] HCA 28 in a resounding win for the Bank.

In arriving at its 4-1 majority decision on the issue, the High Court judges took a broad view of the factors that can be taken into account in determining whether there is a penalty. This is likely to limit the ambit of the doctrine of penalty generally. The issue is not just one that affects consumer financial services contracts, but all contracts, including standard form consumer contracts such as utility or telco contracts, and commercial contracts generally including project agreements, service and maintenance contracts construction contracts and contracts for the sale and purchase of assets.

The traditional view is that a penalty clause penalises a party for breaching the contract or for the failure of a primary stipulation by requiring it to pay a specified sum that is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach. If a clause is a penalty, it is void to the extent it exceeds the actual loss suffered by the party.

Crucially, the three judgments comprising the High Court majority have (although on slightly different bases) focused on the interest of the party seeking to uphold the clause and have taken a broad view of the losses that can be relevant. Each judgment expressly found that losses to be considered will not be limited to damages that could be recovered if the Bank sued the cardholder for breach of contract, so losses that would be considered too remote under the Hadley v Baxendale test can be included. The contract can therefore protect an interest that is different from, and greater than, the damages that could be recovered for the loss caused directly by the breach of contract.

In this case, three of the four judges in the majority expressly found that:

  • loss provision costs (being the provision in accounts made by the Bank each time a payment was late, reflecting an allowance for what the Bank may not recover and the impairment of the value of the Bank's financial assets); and
  • regulatory capital costs (being the costs attributable to having to hold extra regulatory capital as a consequence of a late payment); 

could be taken into account in determining whether the late fees were a penalty, even though such costs would not be recoverable as contractual damages. As these costs significantly exceeded the amount of the late fee, the Court found that the fee was not a penalty. 

The Court also rejected the argument that the provision for, and imposition of, late fees gave rise to statutory causes of action of unconscionability, unjust contracts and unfair contract terms.

Key takeouts from the Paciocco decision

For businesses such as financial institutions, utilities or telcos that use standard form contracts with provisions for fees, such as late fees, the Paciocco decision gives them a wide basis from which to justify fees that might be challenged as penalties.

For parties that impose the payment of fees, have regimes involving differential payments based upon compliance with performance indicators or have liquidated damages regimes for late delivery, the Paciocco decision's focus on the interests of the party seeking to uphold the clause offers greater scope for the justification of such clauses

The impact of the High Court's decision in Andrews was to expand the concept of penalties by dismissing the widely held perception that the penalties doctrine was limited to breaches of contract. The Paciocco decision is likely to have the reverse impact because it provides wider bases for clauses being found not to be penalties.

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Clayton Utz communications are intended to provide commentary and general information. They should not be relied upon as legal advice. Formal legal advice should be sought in particular transactions or on matters of interest arising from this communication. Persons listed may not be admitted in all States and Territories.