Avoiding penalties: are your contracts enforceable?

Corporate eBulletin - 13 February 2014

Summary

On 5 February 2014, the Federal Court handed down its much anticipated decision in Paciocco v Australia and New Zealand Banking Group Limited. It found that the contractual terms which ANZ relied on when charging additional fees for late payments constituted penalty clauses and were therefore unenforceable.

This decision reinforces the earlier decision in Re Pioneer Energy Holdings Pty Ltd, which indicated that parties must take care to ensure that contractual clauses do not operate to impose a penalty on a party for non-performance under the contract. Such clauses are contrary to public policy and unenforceable.

In this eBulletin, we review both decisions and discuss their impact on your business.

 

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The Paciocco case

Lucio Robert Paciocco led a representative action against Australia and New Zealand Banking Group Limited (ANZ) alleging that certain contractual terms providing for payment of fees constituted penalties and were unenforceable. The fees in question were:

  • honour, dishonour and non-payment fees charged to consumer and business deposit accounts; and
  • late payment and over-limit fees charged to consumer credit card accounts.

ANZ claimed it was entitled to charge these fees under its consumer contracts.

Justice Gordon stated that the late payment fees constituted a penalty, but all other fees did not. Justice Gordon characterised the late payment fees as collateral or ancillary to the primary stipulation of making a payment by a particular date. She said that this collateral stipulation was in the nature of security for non-performance of the primary stipulation, and imposed an additional detriment which was extravagant, exorbitant and unconscionable.
In relation to the honour, dishonour, non-payment and over-limit fees, Justice Gordon concluded that these were made by ANZ for providing the service of allowing or disallowing a payment that had the effect of placing an account into overdraft. She said they were not collateral or ancillary to a primary stipulation, and that the liability to pay each arose from ANZ's response to an account holder failing to have sufficient funds in their account. In other words, ANZ was charging these fees for the service of allowing or disallowing the overdraft, not as a remedy or penalty for non-performance of a contractual obligation.

In her judgment, Justice Gordon also dismissed the argument that the honour, dishonour, non-payment and over-limit fees constituted unfair contractual terms or unconscionable conduct.

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The Pioneer case

Morgan Stanley Capital Group Inc (Morgan Stanley) and Blue Oil Energy Pty Ltd (Blue Oil) entered into a shareholders' agreement (Agreement) as part of a joint venture. The Agreement required the parties to respectively contribute amounts to the venture's funding. The relevant clause provided that in the event Blue Oil failed to make its contributions, Morgan Stanley could acquire all of Blue Oil's shares "for $1".

Chief Justice Bergin stated that the clause should be construed so that the shares could be acquired for $1 in total, rather than $1 per share. However, he also stated that this was a penalty clause and therefore unenforceable.

Chief Justice Bergin reasoned that while the clause could be deemed appropriate because it accounted for Morgan Stanley's risk of being left with a partially completed and worthless facility, it did not take into account the date of default. The later the default occurred in the process, the more likely the loss of shares would constitute a punishment or penalty, since more had been invested and the shares had a higher value. The result in the particular circumstances being litigated was that Blue Oil would lose its $12,944,487 investment for failing to pay an extra $1,247,500. In the opinion of Chief Justice Bergin, this was out of all proportion to the loss suffered by Morgan Stanley.

 

Implications for your business

When entering into a contract, parties should be careful of clauses that seek to recover a specific monetary amount from the other party or to compulsorily acquire property of the other party, where that other party has failed to fully perform its contractual obligations.

It is important to ensure that the relevant clause seeks to recover your business' loss arising from the non-performance, rather than impose a penalty on the defaulting party.

The clause can provide for recovery of a fixed amount to avoid the need to litigate over the calculation of the damage suffered; but it must be a genuine pre-estimate of loss. If the loss is likely to vary according to the circumstances (as was particularly the position in Pioneer) then the clause may need a formula which allows for the varying amount to be recovered.
If, however, there are circumstances where the amount proposed to be recovered under the contract is out of proportion to the likely loss flowing from the non-performance then the clause is likely to be unenforceable.

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Further information

All information on this site is of a general nature only and is not intended to be relied upon as, nor to be a substitute for, specific legal professional advice. No responsibility for the loss occasioned to any person acting on or refraining from action as a result of any material published can be accepted.