When the High Court of Australia (HCA) handed down its judgment in Andrews v ANZ (2012) 247 CLR 205, it radically departed from the ancient rule of penalties established over 100 years ago in England.
Contractual terms, which are penal in nature, amount to “penalties” and are not enforceable in the Courts. What constitutes a “penalty” is where the ‘fortunes’ are divided!
The judgment of the House of Lords in Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79 is often cited as authoritatively stating the common law in England. The HCA considered, however, that the doctrine of penalties might be enlivened in equity in the absence of a breach of contract where a clause is in substance collateral or accessory to a primary obligation that imposes an additional detriment to secure compliance with that primary obligation.
The HCA considered that, independent of the common law rule, there subsisted an equitable jurisdiction to relieve against any collateral provision (being considered detrimental and in terrorem) which was conditional upon a failure to observe a primary provision, whether or not that failure was a breach of contract.
In other words, if an additional fee (eg a late payment fee) is charged in order to secure compliance with the primary obligation (eg payment of an outstanding credit card bill on time) it will be a penalty.
The application of the principle remains unsettled in Australia as can be seen in the judgment of the Full Court of the Federal Court of Australia in Paciocco v ANZ [2015] FCAFC 50 where the Full Court allowed ANZ’s appeal. Middleton J (who agreed with the reasons of Allsop CJ) put it succinctly when he observed that:
“400 The object and purpose of the penalty doctrine (controlling the use of extravagant or unconscionable terms) must always be kept in mind when determining the ultimate issue of whether a term is a penalty. Exceptions from freedom of contract, as the case law indicates, require good reason to attract judicial intervention in setting aside commercial bargains. This explains the high hurdle required in the case of a propounded penalty, such that it must be found to be “extravagant and unconscionable”.
401 One starting point in considering whether a penalty has been imposed is to identify the commercial interests that are sought to be protected by the bargain reached between the parties. This can be achieved through a consideration of the language used by the parties, the circumstances addressed by the bargain, and the objects that the bargain intended to secure. For instance, even though a sum designated to be paid is not at all referable to any genuine pre-estimate of loss, if the sum is referable to an additional benefit, or part of the bargain for another right, and is not out of all proportion to the attainment of that benefit or right, then no intervention of the Court is necessary or appropriate to disturb that commercial bargain.”
On 4 and 5 February 2016, the High Court of Australia heard the appeal in Paciocco v ANZ where the HCA has to determine whether late payment fees charged by the Bank on the non-payment of money by its customers are penalties.
A few months before the HCA appeal in Paciocco v ANZ, the UK's highest Court handed down its judgment in Cavendish Square Holding BV v Talal El Makdessi; Parking Eye Limited v Beavis [2015] UKSC 67 and reformulated the principles to the law of penalties in England thereby adopting a modern approach compared to the ‘haphazardly constructed edifice’ of the ancient past.
While the UK Supreme Court accepted that any decision of the HCA had strong persuasive force, the Court did not accept that English law should take the same path as in Australia which it considered as being inconsistent with established and unchallenged House of Lords authority. The UK Supreme Court said:
“[32] The true test is whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation. The innocent party can have no proper interest in simply punishing the defaulter. His interest is in performance or in some appropriate alternative to performance. In the case of a straightforward damages clause, that interest will rarely extend beyond compensation for the breach, and we therefore expect that Lord Dunedin's four tests would usually be perfectly adequate to determine its validity. But compensation is not necessarily the only legitimate interest that the innocent party may have in the performance of the defaulter's primary obligations. “
References were made to the Cavendish Square/Parking Eye case in the submissions in the HCA appeal in Paccioco v ANZ, but it seems unlikely that the HCA will unwind its radical departure from the previous understanding of the law of penalties as was commonly held in England. We await the HCA handing down its judgment to clarify and/or expand on the application of the rule of penalties applicable in Australia as stated in Andrews v ANZ, and anticipate that the HCA will sail further away from the current English position.