Coralling the penalties horse: Paciocco v Australia and New Zealand Banking Group Ltd

Paciocco v ANZ Case Page

It’s said that you can’t shut the stable door after the horse has bolted, but this presumes that there is only one door. If there is a gate on the field around the stable, then the horse can be successfully corralled by shutting the second door, even if the first door is left wide open. And in Paciocco v Australia and New Zealand Banking Group Ltd [2016] HCA 28, the High Court effectively shut a ‘second door’ to prevent the penalties doctrine from escaping. The ‘doors’ are the two questions a court must ask when establishing whether a clause is a penalty and thus void or unenforceable:

  1. Is this a clause to which penalties doctrine applies?
  2. On the facts, is this clause a penalty?

The first door had been left ajar in Andrews v Australia and New Zealand Banking Group Ltd [2012] HCA 30, potentially allowing the penalties doctrine to invalidate (at least partially) a wider range of clauses. This post will focus on the penalties doctrine rather than on the statutory claims of the appellants. It is suggested that after Paciocco there will only be a very small number of cases where plaintiffs can successfully challenge contractual clauses as void or unenforceable penalties. The Court’s findings regarding the question of whether a specific clause was a penalty indicate that the second door has been closed so that only the tiniest crack remains. This will be a relief for organisations such as banks and utility companies as they will have greater latitude to charge late payment fees. And it will provide particular relief for construction contractors, who were concerned that abatement provisions (often used in PPP or Public Private Partnerships) and time bar provisions would be penalties pursuant to Andrews.

The first door: What did the Court decide about the application of penalties doctrine? 

Prior to Andrews, it was thought that the doctrine of penalties had a fairly narrow operation because a clause could not be a penalty when a contractual payment was not triggered by a breach of contract: see Interstar Wholesale Finance Pty Ltd v Integral Home Loans Pty Ltd [2008] NSWCA 310. Consequently, if a clause was drafted permissively (“I agree to pay a fee of $50 if I overdraw my account”) it did not engage the rule against penalties because the payment was not triggered by a breach of contract. Parties could avoid the penalties rule with such drafting.

Andrews widened the opening of the first door considerably because it held that a breach of contract was not necessary to enliven the penalties doctrine. It held that the equitable doctrine of penalties had not ‘withered on the vine’ after the enactment of the Judicature Acts,  as had been suggested by Mason and Wilson JJ in AMEV-UDC Finance Ltd v Austin (1986) 162 CLR 170 at 201. Andrews said that the test for a penalty in equity was as follows at [10]:

In general terms, a stipulation prima facie imposes a penalty on a party (“the first party”) if, as a matter of substance, it is collateral (or accessory) to a primary stipulation in favour of a second party and this collateral stipulation, upon the failure of the primary stipulation, imposes upon the first party an additional detriment, the penalty, to the benefit of the second party.

Thus, the equitable penalties doctrine would apply if a clause was a ‘collateral stipulation’ to a primary stipulation and imposed ‘additional detriment’. However, contracting parties could use ‘alternative stipulations’ which provided ‘further accommodation’ without contravening the equitable penalties doctrine. These were clauses which allowed for a higher payment if further services or rights were provided by one party to the other (Andrews, [79]-[82]).

After Andrews, it was noted that it was difficult to distinguish between collateral and alternative stipulations. There was concern that clauses which had not previously been thought to be penalties would now contravene the law, as I discussed here.

Paciocco leaves the first door ajar – it affirms strongly that Andrews is still the applicable law in Australia. By comparison the UK Supreme Court recently rejected Andrews in  Cavendish Square Holding BV v El Makdessi [2015] UKSC 67. Lords Neuberger and Lord Sumption (with whom Lord Carnwath agreed) stated at [41] that Andrews was a ‘radical departure from the previous understanding of the law’. They were critical of the historical analysis in the decision and declined to follow it ([42] – [43]). Lord Mance at [130] and Lord Hodge at [240] also saw Andrews as an extension of the law of penalties, and chose not to follow it.

Only two of the judges in Paciocco provide a detailed response to Cavendish. French CJ’s short judgment states that he does not find it necessary to consider whether the UKSC’s reading of Andrews was correct, but that Australian law and English law differ on this point because the Australian common law is distinct from English law. Gageler J argues (at [118] – [127]) that the UKSC was incorrect to hold that Andrews departed from a previous understanding of the law.

Despite Gageler J’s arguments to the contrary, it is clear that Andrews represented a change from the previous understanding of the law. The consternation which greeted Andrews is proof enough (see a critical take on the case in JW Carter, W Courtney, A Stewart, GJ Tolhurst, ‘Contractual Penalties: Resurrecting the Equitable Jurisdiction’ (2013) 20 Journal of Contract Law 99). The Andrews decision was unexpected in part because the High Court had emphasised the importance of preserving freedom of contract in a slew of previous penalties cases (see eg, Ringrow Pty Ltd v BP Australia Pty Ltd [2005] HCA 71; (2005) 224 CLR 656 at [27], [31]-[32] (Full Court); AMEV-UDC (1986) 162 CLR 170 at 193 – 194 (Mason and Wilson JJ) and Esanda Finance Corporation Ltd v Plessnig (1989) 166 CLR 131 at 139 (Wilson and Toohey JJ)). As Carter et al note, the High Court in Andrews went in the other direction – without acknowledging the previous cases – and said at [5]:

But it may be observed that this pattern of remedial legislation [consumer legislation and the like] suggests the need for caution in dealing with the unwritten law as if laissez faire notions of an untrammelled “freedom of contract” provide a universal legal value.

Consequently, Andrews represented an outlier. Paciocco is far more in line with previous case law as a number of the judges emphasise the importance of ensuring that penalties law does not unduly encroach upon contractual freedom (Gageler J at [156], Keane J at [220] – [221], [250] – [251], Nettle J at [342]).

The High Court did not deal with the Andrews test in Paciocco because it dealt with the question of whether a clause was in fact a penalty (a ‘second door’ case). However, unfortunately, we are still faced with uncertainty about some aspects of Andrews, including guidance on how the test of whether a clause is a collateral or an alternative stipulation works in practice, and how the equitable and common law penalty doctrines sit together (Gageler J’s judgment indicates that they are distinct). In any case, Andrews has been rendered largely ineffective by the Court’s finding in Paciocco with regard to the test to be applied to ascertain if a particular clause was a penalty. I now turn to that question.

The second door: What did the court decide about the test to be applied to a particular clause to ascertain if it was a penalty?

The second question in penalties cases is whether on the facts a clause is a penalty. The test in Australia had been that stated by Lord Dunedin in Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79, as affirmed by the High Court in Ringrow [2005] HCA 71; (2005) 224 CLR 656.

Dunlop held that a penalty is a payment of money stipulated as in terrorem of the offending party (i.e. intended to frighten or intimidate), whereas the essence of a liquidated damages clause is a clause which constitutes a genuine agreed pre-estimate of damage. Famously, Lord Dunedin went on to suggest that a number of tests which “may prove helpful or even conclusive”:

(a) It will be held to be penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach…

(b) It will be held to be a penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid. This though one of the most ancient instances is truly a corollary to the last test. …

(c) There is a presumption (but no more) that it is penalty when “a single lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage”…

On the other hand:

(d) It is no obstacle to the sum stipulated being a genuine pre-estimate of damage, that the consequences of the breach are such as to make precise pre-estimation almost an impossibility. On the contrary, that is just the situation when it is probable that pre-estimated damage was the true bargain between the parties…

This test was approved by the High Court in Ringrow, which qualified category (a) by saying at [32] that if a sum is extravagant and unconscionable, it must be ‘out of all proportion’ to the potential loss.

Andrews also drew attention to the judgment of Lord Atkinson in Dunlop and summarised it as follows:

Lord Atkinson summarised the evidence directed to showing that even if the sum agreed appeared imprecise as a pre-estimate of damage, it protected the appellant’s interest in preventing undercutting, which would disorganise its trading system. Thus the critical issue, determined in favour of the appellant, was whether the sum agreed was commensurate with the interest protected by the bargain. [emphasis added]

Even without Cavendish, there was room for the High Court to consider the possibility of reconsidering the Dunlop test. It had flagged that possibility in Ringrow at [12] but declined to take the opportunity at that time.

But Cavendish suggests that the English courts have a new test to replace the ‘extravagant and unconscionable’ test from point (a) of Lord Dunedin’s test in Dunlop. Lord Neuberger and Lord Sumption’s joint judgment proposed the following test at [32] of Cavendish:

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. This was recognised in the early days of the penalty rule, when it was still the creature of equity, and is reflected in Lord Macclesfield’s observation in Peachyabout the application of the penalty rule to provisions which were “never intended by way of compensation”, for which equity would not relieve. It was reflected in the result in Dunlop. And it is recognised in the more recent decisions about commercial justification. And, as Lord Hodge shows, it is the principle underlying the Scottish authorities.

They went on to note that the rule against penalties interferes with freedom of contract which undermines certainty in the law, particularly in commercial contracting. They pointed to inequality of bargaining power as an important factor at [35], and said that ‘[i]n a negotiated contract between properly advised parties of comparable bargaining power, the strong initial presumption must be that the parties themselves are the best judges of what is legitimate in a provision dealing with the consequences of breach. They also cited Lord Woolf in Philips Hong Kong Ltd v Attorney General of Hong Kong (1993) 61 BLR 41 at 57 – 59 where he specifically said that a court could consider whether ‘one of the parties to the contract is able to dominate the other as to the choice of the terms of a contract’ as a factor in deciding whether a clause is a penalty.

In Paciocco, the majority also took the approach that the test should consider whether the sum was agreed was to punish, or whether it was to protect a legitimate interest of the contracting party (see Kiefel J at [51] – [56], with whom French CJ agrees on penalties, Gageler J at [166] and Keane J at [269] – [270]) although each of the judges framed the test in slightly different terms. Nettle J (dissenting) said that ordinarily the Dunlop test was appropriate for ascertaining whether a clause was a penalty and that considerations of legitimate interest only arose in more complex cases where the party had an interest beyond compensation for breach (at [318] – [322]).

As Kiefel J said in the special leave application hearing, principle is often ‘best understood by reference to its application to the facts’ (lines 587 – 600).The issue in this case was that ANZ had admitted that it did not calculate the late payment fees on its credit card according to what would have been recovered as damages. It conducted an ex post facto consideration of the costs which it incurred which included losses which would not have been available as damages for breach of contract. The majority held that ANZ had a legitimate interest in obtaining performance of the contract, and it did not matter that ANZ had not pre-estimated the costs before imposing them, nor did it matter that the costs were not costs that could be recovered for breach of contract. Kiefel J at [58] and Gageler J at [172] and [176] said that ANZ had a legitimate interest in receiving timely payment of credit. Keane J agreed at [274] – [277] that the bank had a legitimate interest in timely payment, but more than that, at [278], he said ANZ had an interest in lending profitably, and was entitled to charge fees which were greater than the contractual loss which was recoverable in order to profit. Nettle J (dissenting) said that this was the kind of contract where the bank had no other interest other than getting repayment of its losses recoverable in damages, and the Dunlop test applied – whether the agreed sum was ‘extravagant and unconscionable’ compared to the greatest loss that could conceivably be proved following a breach of the obligations (at [317]). Nettle J focused on the lateness of the payment rather than a failure to pay at all (at [338]).The fees were greater than any loss which could conceivably be proved, and thus they were illegitimate penalties.

In the event, the test proposed by the High Court in Paciocco looks very similar to the Cavendish test, and in practice, the outcomes of cases decided under the two jurisdictions are likely to be very similar. However, there is is one telling absence in the analysis of the High Court in Paciocco. To my mind, the only justification for interfering with freedom of contract via the doctrine of penalties is where there there are factors which suggest that the contracting was not actually free. One factor not considered by the High Court is disproportion in bargaining power between the parties. As Cavendish usefully points out, most commercial contracts involving well-matched and well-advised parties will not attract the doctrine of penalties. This cuts out a lot of the angst regarding the impact of the penalties doctrine on commercial contracts, but leaves an opening for the doctrine to operate where there is disproportion in bargaining power. In this case, as Nettle J’s dissenting judgment points out at [309] and [371], the bargain involved standard form contracts between large commerical parties and consumers much lower bargaining power. As I have argued elsewhere, while there may have been banks which offered lower fees on credit cards, the information was not readily available until 2009, and the transaction costs would be a disincentive for seeking a better bargain. Keane J said that Mr Paciocco ‘freely risked’ incurring a fee by not paying his credit card on time (at [267]), but can the bargain really be said to be free when he could not readily enter a contract with more advantageous terms with other banks? It is a pity that the majority did not explore this issue more thoroughly. As it stands now, I suggest that the second door has been slammed shut too thoroughly. Almost no clauses will be found to be penalties, as parties can almost always ex post facto justify the imposition of fees.

Conclusion – Whither the penalties doctrine?

Paciocco explicitly confirms the continued existence of the penalties doctrine in common law and equity, but one must query whether there is any point retaining it when it has such a narrow application once the law is applied to a particular clause, as in this case. To continue the metaphor, the shutting of the second door has effectively gelded the penalties horse in all but the most extreme cases. And it does not seem that consumers can gain much hope from statute either. Although this post has focused on the common law aspect of the decision, a majority of the High Court found that ANZ had not contravened any statutory provision against unconscionable or unfair terms. This is unsurprising, as what was at issue in this case was not unconscionability in terms of unfair pressure, vulnerability, lack of knowledge or the like. It was an allegation of substantive unfairness of the bargain itself, which seldom gives rise to relief. If Parliament wishes to provide relief for such bargains, it will have to legislate more explicitly.

AGLC3 Citation: Katy Barnett, ‘Coralling the Penalties Horse: Paciocco v Australia and New Zealand Banking Group Ltd‘ on Opinions on High (8 August 2016) <>.

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About Katy Barnett

Katy Barnett is a Professor at Melbourne Law School. She has published extensively in the areas of private law and remedies, and is a co-author of ‘Remedies in Australian Private Law’ with Dr Sirko Harder. In 2016 she received the Barbara Falk Award for excellence in teaching.

5 thoughts on “Coralling the penalties horse: Paciocco v Australia and New Zealand Banking Group Ltd

  1. Great article! Just one point of concern:

    “To continue the metaphor, the shutting of the second door has effectively gelded the penalties horse in all but the most extreme cases.”

    Shutting the door and gelding are two very different metaphors! Perhaps: “In shutting the second door, the High Court appears to have emblazoned the stables with an equine influenza quarantine notice, to ensure that anyone approaching the issue again will do so with extreme caution.”

    • Thanks Scott. I did wonder if I was taking things too far with gelding…! As one of the co-editors said – “It would have to be a very unlucky closing of the gate?”

      • Haha, indeed! The metaphorical RSPCA would not be happy with the High Court.

        Another thought: Keane J emphasised ANZ’s interest in raking a profit, but he was not alone. On my reading, Gaegler J makes a similar point (much briefer) at [172]:

        “Provisioning costs directly affected recorded profit, and the costs of regulatory capital were a real outgoing. The primary judge was undoubtedly correct in describing provisioning costs and regulatory capital costs as part of the costs of running a bank in Australia. But ANZ was not confined by a principle of law to adopting a pricing strategy for its credit card products which involved cross-subsidisation.”

        • Yes, I think you’re right. He’s more subtle about it than Keane J, but there’s a definite sense that making a profit is a legitimate interest.

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