High Court expands operation of the doctrine of penalties

In Andrews v ANZ, the High Court found that certain bank fees charged to the bank's customers were not prevented from being characterised as penalties by reason of liability to pay those fees being triggered by events which were not a breach of contract. The decision potentially represents a significant enlargement of the court's jurisdiction to grant relief against penalties in commercial contracts.

Introduction

On 6 September 2012, the High Court of Australia handed down its decision in Andrews v ANZ, a decision which has potentially significant implications for the operation of the doctrine of penalties to commercial contracts.

The case arises from the ongoing class action litigation currently being pursued against major commercial banks by approximately 38,000 claimants in relation to the imposition of various bank fees on those customers. The fees concerned were various honour, dishonour and non-payment fees charged in respect of various retail deposit accounts and business deposit accounts, as well as certain 'over limit' and late payment fees charged in respect of consumer credit card accounts and commercial credit card accounts.

Integral to the customers' argument in the proceedings has been a claim that a number of those fees were void or unenforceable as "penalties" and therefore refundable to the customers.

The doctrine of penalties has developed as a means of granting a party relief against an obligation to make a payment by reason of that party's non-performance of another obligation under the contract, in circumstances where that sum was so out of proportion with the damage suffered by that non-performance that it could not be regarded as a genuine pre-estimate of liquidated damages (Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1914] UKHL 1; Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656). It is commonly resorted to by parties seeking to avoid an obligation to pay pre-agreed liquidated damages by reason of their breach of contract.

The decision at first instance

At first instance, Justice Gordon found that all of the fees in question (except the late payment fees) were not penalties, as the fees were not payable upon the occurrence of a breach of contract. Her Honour accepted the bank's argument that the fees were specified amounts payable on the occurrence of specific events which did not constitute breaches of the contracts between the bank and its customers, meaning that the doctrine of penalties had no application. In coming to this conclusion, Justice Gordon had followed the New South Wales Court of Appeal's decision in Interstar Wholesale Finance Pty Ltd v Integral Home Loans Pty Ltd (2008) 257 ALR 292 ("Interstar"). In Interstar, the New South Wales Court of Appeal had held that the primary judge in that case (Brereton J) had erred in:

1. denying that the doctrine of penalties had ceased to be one of equity and now is wholly a rule of law; and
2. concluding that the doctrine was not limited in its operation to non-performance of stipulations which constituted breaches of contract.

The approach of the High Court

In Andrews and ANZ, the High Court, in unanimously allowing the claimants' appeal against Justice Gordon's decision, rejected the New South Wales Court of Appeal's reasoning in Interstar. The Court stated in unequivocal terms that the doctrine of penalties can also extend to granting relief from a payment obligation triggered by the occurrence of a condition which does not amount to a breach of contract.

In coming to this conclusion, the High Court emphasised the historical development of the doctrine in the courts of equity as a jurisdiction to limit the recovery of damages in an action to enforce 'bonds', namely, a promise to pay 'a penal sum' of money made in order to secure strict performance of a specified principal condition. In this regard, the Court noted that the early equity courts had "not established any general proposition as to the contractual character of the condition of the bond", given the regard paid by equity to substance rather than form as reflected in a number of those cases resulting in the grant of relief in relation to 'penal bonds' for the non-performance of conditions which were not the subject of any contractual promise. This led the High Court to conclude that the term 'condition' as applied by equity is to be understood in a broader sense than merely connoting a material promise, the breach of which would amount to a repudiation of a contract. Instead, a 'condition' may be an occurrence or event which need not be some act or omission analogous to a contractual promise.

It followed that the equitable doctrine of penalties is not limited in its operation only to stipulations which are "contractual promises broken by the promisor". Accordingly, the facts that the honour, dishonour, non-payment and over limit fees were not charged by the bank upon breach of contract by its customers and that the customers had no obligation to avoid the occurrence of events upon which the fees were charged, did not render the fees incapable of being characterised as penalties.

Practical implications of the High Court's decision

The likely significance of the High Court's decision in Andrews v ANZ cannot be overstated. The following is a non-exhaustive list of the implications flowing from the decision:

• The decision represents a considerable enlargement of the equitable jurisdiction to supervise the operation of clauses in commercial contracts, particular those contracts which may have been drafted in accordance with Interstar so as to avoid the operation of the doctrine of penalties.
• One unresolved issue that arises is how far the ambit of the doctrine will extend beyond the banking sphere or the area of consumer protection law. It remains an open question as to whether the doctrine will be applied to liquidated damages clauses in construction law contracts and other contexts involving the use of "standard form" contracts.
• This, in turn, raises questions as to whether the doctrine of penalties may ultimately become an instrument which, contrary to the well-worn maxim that equity is a shield and not a sword, is utilised to rescue well-advised commercial parties from obligations which they were otherwise prepared to commit to at the time of contracting. This of course raises significant policy questions about upholding freedom of contract by ensuring that parties are kept to the commercial bargains they strike. It may well be that the courts will duly restrict the operation of the doctrine of penalties to contexts which are deemed appropriate for the intervention of equity, such as the consumer protection area and other cases involving power imbalances between contracting parties.
• However, there is a significant point in the High Court's reasoning which highlights the potential for parties to craft arguments to the effect that the penalties doctrine has no application. The Court identified a distinction between a requirement to pay fees as security for performance by the customer of other obligations to the ANZ, and a fee charged for an additional accommodation or service provided to the customer. The former would be capable of being regarded as a penalty, whereas the latter would not. This, in turn, creates scope for contracts, particularly in the banking and financial services context, to be drafted in terms that seek to avoid the operation of the doctrine of penalties by expressly providing that certain fees are charged in exchange for the performance of an additional service.