There was much media attention given recently to a decision of Australia’s High Court involving bank fees charged by the ANZ Bank, Andrews v Australian & New Zealand Banking Group Limited (‘the Bank case”). The main reason for the publicity was that the Court’s decision could affect just about everyone who has a bank account.

However there was another, largely unstated reason. This was that as a result of the Court’s decision, all kinds of contacts that businesspeople normally enter into could be affected. Individuals or companies which buys goods or services under a written contract, may now have a stronger argument against being obliged to pay compensation to the seller when something goes wrong.

In the Bank Case the High Court had to consider whether certain of ANZ’s fees were penal in nature and hence illegal. The lower court which first heard the case decided the fees were valid because the bank’s customers had to pay them even though they had not defaulted. The High Court said this wasn’t so – a contractual term could still be penal even if there was no default.

A “penalty” clause exists if a term in a contract says that a party (invariably the customer for the goods or services), does or fails to do a certain thing as a result of which it must pay a stipulated amount of money. To be a penalty, the amount must be disproportionate to what could objectively be regarded as a genuine estimate of the costs or damages incurred by the other party (the seller). In other words, if the clause looks like a punishment it is invalid.

So the key thing with a penalty clause is that it must be “over the top”: that is, the amount claimed from the defaulter materially exceeds the damage or loss suffered by the non-defaulter. On the other hand, an amount will not be a penalty if the innocent party grants to the defaulter a right or benefit in return, not necessarily in proportion but still a reasonable exchange for the payment being sought.

Two kinds of business contracts which may be affected by the Bank Case are equipment leases and stock or product supply contracts. With leases, areas of potential challenge are late payment and early termination fees, “break costs” and holding over (extension) clauses. In the case of supply contracts, there is usually, for example, a detriment imposed on a customer who is found to have re-sold or wholesaled products to other vendors, instead of retailing them in the normal course.

Note though that financiers and suppliers will have some “wriggle room” if they can show that the alleged penalty clause does not quantify or sufficiently specify the financial punishment. In the Bank Case the High Court said that if the clause is unclear about what detriment the defaulter suffers then it cannot be characterised as a penalty and hence remains valid. Also, the party not in breach is safe if it can point to a reasonable benefit flowing back to the breaching party, in return for accepting the deterrent provision.

In conclusion businesses may now need to take a fresh look at their terms of trade, and decide whether their legal risks have increased.