In 2010 a representative action was commenced against Australia and New Zealand Banking Group Limited (“ANZ”) by some of its customers in respect of various fees imposed on them. As part of those proceedings, it was alleged that that the fees payable by the customers to ANZ were void or unenforceable as penalties. At first instance, Justice Gordon held that the majority of those fees could not be penalties as the fees were not payable on breach of contract. The question was removed to the High Court for consideration.
A fee payable under contract will be a penalty where it is imposed to secure the performance of another obligation of the party required to pay, and the quantum of the fee is out of all proportion with the damage suffered by that non-performance.
Recent authority on penalties (e.g. Interstar Wholesale Finance Pty Ltd v Integral Home Loans Pty Ltd (2008) 257 ALR 292) had established that relief against penalties was only available for fees payable on breach of contract (“Recent Authority”).
Many commercial contracts have been drafted on the basis of this Recent Authority. Rather than such contractual fees being payable on breach of contract, such contractual fees are drafted permissively. For example, a fee payable on breach would be as follows:
(a) A leases a shop to B for $100 p/w, on the condition that the shop is not used on weekends.
(b) If (a) is breached, B agrees to pay A $500 for each breach.
If the fee of $500 is not a genuine pre-estimate of the damage suffered by A by B’s breach, it will be unenforceable as a penalty.
Yet, the same position could be validly achieved if the contractual terms were drafted permissively, for example:
(a) A leases a shop to B for $100 p/w for use Monday to Friday.
(b) B agrees to pay A $500 each time the property is used on the weekend.
Today the High Court unanimously ruled that Recent Authority is incorrect on the basis that relief against penalties is potentially available even if a fee is not payable on breach of contract. The High Court decided that the correct approach to determining whether a fee is a penalty is to ask whether the purpose of the fee is to secure performance of a primary obligation by the party subject to the fee or whether the fee is truly a fee for further services or accommodation. If it is a fee for further services or accommodation, it will not constitute a penalty even where the fee payable is significant. If the fee is payable to secure performance of the party subject to the fee, it will only be enforceable if it is a genuine pre-estimate of the damage suffered by reason of that party’s non-performance.
To emphasise the distinction between penalties and fees for services, the High Court outlined and approved of the decision in Metro-Goldwyn-Mayer v Greenham  2 NSWLR 717. That case involved a contract for the hiring of films to exhibitors for public showing. The contract gave exhibitors the right to one screening of the film only. The contract provided that a sum four times the original contract fee was payable for each additional screening. It was held that this fee was not a penalty, but merely a fee paid for the option to purchase the right to an additional screening.
It should be emphasised that although breach of contract is no longer a necessary ingredient for relief against penalties, where a fee is payable upon breach of contract, that will be a strong indication that its purpose is to secure performance of the obligation breached. Hence, unless such fees are a genuine pre-estimate of the damage suffered by such breach, they will be unenforceable.
As a result of today’s High Court decision, contractual fees drafted on the basis of the now overruled Recent Authority may be capable of constituting penalties and potentially unenforceable. Fees payable under a number of commercial contracts may now need to be considered, for example fees payable under contracts for services, transport, shipping and construction, franchise agreements and leases (to name but a few).
The purpose of such fees may need to be evaluated to determine whether they are payable to secure the performance of a primary obligation. In that regard it will be relevant whether, for instance, some further accommodation is provided for the fee (such as an additional right to screen a film).