Wednesday’s decision by the Full Federal Court in the ANZ bank fees case (Paciocco v Australia and New Zealand Banking Group Limited  FCAFC 50) has restored freedom of contract to its rightful place as a fundamental principle underpinning our systems of law and commerce.
“Exceptions from freedom of contract,” said Justice Middleton at , “as the case law indicates, require good reason to attract judicial intervention in setting aside commercial bargains.” No longer, it seems, will plaintiffs be able, merely by showing that a fee was higher than a supplier’s costs in a particular case, or that a financial institution or other supplier had overwhelming bargaining power, have the supplier’s charges set aside as an unlawful penalty.
The Full Court has taken us back to basic principles in the task (not always an easy one) of ascertaining whether a fee or charge is an unlawful penalty. At its core is the notion that a charge will be a penalty only if it is “extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach”. There are several steps involved in the exercise, and it is important not to make the error of conflating them.
First, one has to determine whether the contractual provision in question is, on the one hand, the payment of an amount in the nature of damages for a breach, or on the other hand, simply provides for a price to be paid in consideration of the supply of an additional service. This has to be done using well established and well understood principles of objective contractual construction. A clause will be a damages clause only if it provides for a price to be paid:
- upon the occurrence of a breach, or
- as a form of security or disincentive to prevent the occurrence of a breach.
In this sense, the fees charged by the ANZ, such as late fees for the failure to repay a loan on time, were damages clauses. They were not, as the bank contended, merely charges for the provision of an additional period of credit.
Secondly, having characterised the contractual clause as a damages clause, it is necessary to determine whether the price paid is extravagant, exorbitant or unconscionable compared with the greatest loss that might be suffered by the supplier as a result of non-compliance with the contract. Critically, this is an ex-ante exercise, to be undertaken as at the time of entry into the contract. It is not to be performed by inquiring into what the supplier’s actual losses were in the case of a subsequent breach. The mere fact that for a particular customer who made a late repayment the bank suffered a loss of only a few cents but, under its damages clause, is able to charge a late fee of tens or hundreds of dollars is irrelevant, because that is an ex post calculation. It does not assist in the inquiry into whether the charge, viewed on an ex ante basis, was penal in character.
In answering the question whether, on this approach, a fee is extravagant, exorbitant or unconscionable:
- it does not matter whether the contract does or does not state that the fee is (or is intended to be) a genuine pre-estimate of the supplier’s losses,
- it does not matter whether the supplier, at the time of entering into the contract, did or did not actually think about or attempt to calculate the quantum of its likely losses upon the occurrence of a hypothetical future breach,
- the fact that a breach of a particular clause could give rise to a variety of consequences, some resulting in large and some in small losses, might make it difficult to conclude on an ex ante basis that a fee is extravagant, exorbitant or unconscionable – the relevant comparator is the maximum loss that could conceivably be proved in the case of a hypothetical future breach,
- it might be relevant, as part of the task of deciding whether a fee is extravagant, exorbitant or unconscionable, for suppliers (such as banks) with very large customer bases, to average out the their total likely losses across the number of customers likely to be in breach in order to calculate an average loss per breach,
- it is permissible to look at extrinsic material – this part of theexercise does not involve contractual construction and so the rule ofevidence against looking at extra-contractual material does not apply; it is instead a question of whether a contractually stipulated fee is extravagant. The court can admit, for example, evidence that the purpose of the fee was to enable the supplier to protect itself from future losses,
- it is relevant to have regard to the supplier’s superior bargaining power. However it is equally relevant to consider facts such as the number of customers (6 million in the case of ANZ), the fact that the terms were made available to customers before they decided whether to enter into the contract, the fact that customers could subsequently terminate the contract at will, and the fact that customers had the power (by their actions) to avoid circumstances in which the fees became payable,
- a wide range of costs can be included in calculating (ex ante) the likely loss flowing from a potential future breach, such as:
- accounting provisions taken up in the company’s financial books for the risk of breach,
- the additional costs of capital (including, in the case of banks, regulatory capital) resulting from the risk of breach.
The onus lies with the plaintiff to prove that the supplier’s fee is extravagant or unconscionable. Unless and until this is proved by the plaintiff, the freedom of banks or other suppliers to contract as they please will prevail, and the court will not intervene (subject, of course, to there being no other illegality, such as cartel conduct, anticompetitive misuse of market power, or unconscionable conduct).
Thirdly, if and only if the ex ante analysis shows that clause under which the fee is payable is a damages clause, and that its quantum was extravagant compared to the highest conceivable loss that might be suffered by the supplier, an ex post calculation is embarked upon to determine the amount by which the fee charged exceeded the loss caused by the customer’s breach. This is only done to calculate the damages to which the customer is entitled after it has been shown that the clause was an unlawful penalty clause, and not as part of the exercise of proving that matter.
The case is of considerable significance, not least to litigation funding firms that have invested millions of dollars in legal fees in this and similar class actions, and who now stand to make significant losses instead of the massive contingency fees they would otherwise have earned had the first instance judgment been upheld. A High Court appeal is doubtless on the cards.
In the meantime, corporations can breathe a small sigh of relief that a degree of commercial and legal good sense has prevailed. Contracting parties can once again negotiate damages clauses with greater certainty that they will do their job – which is to simplify, rather than complicate, the resolution of disputes arising out of a breach of contract. It is difficult to envisage a workable system of contracts in a world in which every customer is to be charged different fees depending upon the particular expected consequences of their own individual potential future breach.
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