The big banks have been under fire the past few years, with the biggest class action in history for the $5 billion they have raked in for fees like break fees, late payment fees and over-limit fees. Here we’ll explain the crux of the argument against the banks – that certain bank fees are actually “penalties”, and therefore void – and the relevance of the argument for anyone in procurement that deals with contracts on a day to day basis.
What is the problem with a penalty clause?
If a clause in a contract is deemed to be a “penalty clause”, it will be unenforceable.
Quite often in a contract, parties may agree to use a liquidated damages clause (a clause that provides a pre-agreed measure of damages in the event of a breach) on the basis of the rationale that it provides certainty, and overcomes the difficulty of proving the loss by spelling out what the damages will be from the outset if there’s a breach. The only catch is, it must be a genuine pre-estimate of the damages.
However, a liquidated damages clause will be found to be a penalty clause (ie a clause that penalises a party for their breach of a contractual commitment, rather than providing a reasonable estimate of compensation) and therefore void, if it is unconscionably excessive in the circumstances, and an amount greater than would have been received if the contract had been performed.
It’s called a penalty clause because it penalises or punishes the party for breaching the contract, and requires payment of an amount that is extravagantly greater than the greatest loss that could be proved to have resulted from the breach. It’s a big stick that’s used to ensure compliance with the contract. And it’s not allowed.
The class action against the banks
The basis of the argument in the recent and ongoing class action against the major banks has been that bank fees in certain situations are penalties, and therefore void and refundable. In the words of Andrew Watson, a lawyer running the class action against various banks:
“We say the fees are excessive and extravagant – far beyond the actual cost of administration to the banks.”
So what are the implications for procurement?
The controversy over bank fees is an excellent reminder for anyone dealing in contracts to check that any clauses in your contracts setting out a pre-agreed measure of damages for a breach, aren’t out of proportion to the actual damages that are likely to be incurred. If they are, the offending clauses could potentially be considered void.
Look out for clauses like early termination fees, late delivery fees, and fees for being in arrears or going over a limit. All of these sorts of clauses should be reviewed in light of whether or not you can justify an argument that they are a genuine pre-estimate of the potential damages, or whether on the flip side an argument could be raised that they are excessive in comparison to the actual cost.
The bank fee litigation has also brought to light the possibility that a clause may be considered to be a “penalty” even if it is not triggered by a breach of the contract – broadening the ambit of the types of clauses that might fall foul of the penalty clause regime. The consequence of this is that clauses like service level abatements and break costs might also now be unenforceable.
Is this relevant to your contracts?
We provide a range of contract drafting, review and advice services to ensure that your contracts navigate these sorts of issues properly. If you have any concerns about your contracts, send us a quick email enquiry through to us at [email protected] or phone us on 02 8006 0830, and we will contact you to organise a time for a confidential discussion.
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