The High Court last week struck a powerful blow for Goliath in determining that sky-high bank fees will remain legal. Judge Michelle Gordon, then in the Federal Court, had found that the late payment fees imposed by ANZ were an unenforceable penalty, largely because they didn’t relate directly to the loss suffered by the bank.
Gordon, who has since been appointed to the High Court, was overruled by the full court of the Federal Court, and last week by her colleagues on the High Court. But simply because some of the High Court (it was effectively a 4:2 decision) found in favour of the banks, that certainly doesn’t mean they got it right.
The specific case involved an ANZ customer, Lucio Paciocco, who had been charged 44 late payment fees by ANZ (of $35 and then $20) when he failed to make the minimum payments owing on his various credit cards. The ANZ conceded that this fee charged bore no resemblance to the specific actual loss and was not calculated on that basis.
Taking a step back -- the appeal largely revolved around a legal principle that, in simple terms, says if you enter into a contract which has specific fee provisions, those fees specified need to bear a resemblance to the loss suffered. For example, let’s say you enter into a contract with your personal trainer and in the contract there’s a clause that says “if you miss a session, you need to pay $50 for the session”. A clause like that would be considered liquidated damages and is perfectly legal (and makes sense, as it’s fair for the trainer to get paid what they otherwise would have, but for the breach).
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By contrast, if the contract said, “if you miss a session you have to pay $2000” that would probably be deemed an unenforceable penalty as the loss suffered by the personal trainer was a lot less than $2000 (old legal cases defined it as “extravagant, extortionate and unconscionable”).
The question here for the court was whether the $35 fee unilaterally charged by ANZ to every customer, regardless of the circumstances, when they fail to pay the minimum amount owing on their credit card was (legal) liquidated damages or a (not legal) penalty. This issue was largely a question of fact -- to resolve this, both the bank and original applicant provided accounting evidence as to the total cost incurred by ANZ when the minimum payment was not made.
A majority of the High Court (French, Kiefel, Gageler and Keane) found that while the direct cost of the late payment was probably around $3, the court could consider other factors in determining the cost to the bank. They agreed with ANZ that the actual loss suffered was not only operational costs, but also loss provisioning and increases in regulatory capital costs.
This is where the majority of the High Court got it completely wrong.
Let us consider each of the so called "costs" incurred by the ANZ when a customer failed to make a minimum payment.
First, operational costs. The ANZ’s expert claimed that the operational costs were not merely the direct costs of non-payment (which were between $0.50 and $5.00), but also all debt collection costs plus “an allowance for the recovery of a proportion of common costs and of fixed costs associated with overall collection activities”.
There is some merit in the shared cost argument. However, there is a bigger problem with attributing cost to collecting the debt. That is because, in many cases, collection costs do not really exist. This is because the amount owing could be repaid before the bank even has the opportunity to collect it, or the amount owed is too small to economically chase. Plus, the ANZ had a completely separate provision that allowed for recovery of these "collection costs" so by having a separate fee it was double dipping.
The High Court’s more bizarre reasoning (Geoffrey Nettle aside, whose analysis was far more detailed) was in attributing a cost to an increase in the provision for bad debts and an increase in regulatory capital.
The problem with the court’s reasoning for provisioning for bad debts is that banks make money when customers don’t pay their credit card fees. That is because banks charge extraordinarily high interest rates (usually upwards of 20%) on credit card balances. If every customer paid their credit card on time, banks wouldn’t offer them at all.
The specific fee here involved an additional cost to the customer where they don’t pay the “minimum repayment amount” as set by the bank. This minimum repayment amount is an arbitrary figure. It doesn’t mean that the customer is more or less likely to default on the amount owing. It’s essentially a number created by the banks for the sole purpose of allowing the banks to charge fees to their customers.
Remember -- banks charge interest on the entire balance outstanding. And a very high level of interest based on the fact that a credit card debt is unsecured, so there is, by implication, a higher default risk. Because interest is based on the balance outstanding and how long the debt has been owed, it is truly reflective of the bank’s cost.
Where the High Court erred was in not understanding the delineation between the legitimate charging of (high) interest rates, and the illegitimate charging of an extortionate fee. As Geoffrey Nettle found, simply because a debt is doubtful, doesn’t mean that the debt won’t be paid. In short, the court agreed that there is a cost to a bank based on the possibility that a debt won’t be repaid, even though that cost is purely an accounting entry and could be reversed the following month.
The court’s reasoning in finding that the increase in regulatory capital should be deemed a cost is even more flawed. Banking authorities base the level of capital required to be held by banks based on the riskiness of their assets. For example, under Basel III, home lending is considered less risky than, say, business -- and as such, requires less capital.
By choosing to undertake the riskier practice of unsecured lending, banks accept a higher risk of default (again, compensated by a higher level of interest). Aside from the court allowing banks to double dip again in fabricating their losses, estimates that this cost would only be a couple of dollars anyway so it should not have been considered in any event.
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The majority of the court did not appear to give any consideration to these matters, this gives the impression that it failed to properly understand them.
Given the commercial dubiousness of the High Court’s decision, one would have expected the business press would have been on hand to critically question the judgment. But rather than bother to read and understand the judgment, The Australian Financial Review instead claimed that the case involved “ambulance chaser attempts to portray those who choose not to pay their debts on time as victims and companies that simply seek to enforce private contracts as villains.”
But reality differs from the AFR’s utopic view of commerce. Bank penalty fees touch almost every Australian, and those most affected are those least in a position to pay the regressive charges. Many who incur bank fees don’t do so by choice, by rationally reallocating resources elsewhere (as suggested by the High Court), but rather, because they have no other choice.
Bank terms and conditions are not negotiated at arms' length between two equal parties -- rather, customers have no choice but to accept the banks' legal terms, which can be changed at a bank’s complete discretion without any input or appeal from the customer. Nor is there much point in a customer changing banks given the oligopolistic market that means every other bank charges equally high fees (this was conceded by the High Court).
The fees charged by banks represent a gross abuse of power by some of Australia’s biggest businesses. ANZ, which has been terribly managed in recent years, still delivered a profit margin of 34%. This is far higher than businesses operating in a truly competitive environment with talented executives who are subject to market forces and elasticity of customer demand. ANZ charges huge fees to customers not to maintain revenue streams but simply because it charges as much as it can to smaller, far less sophisticated and under-resourced customers.
It is not without irony that the Financial Review two days later pointed out that former ANZ CEO, Mike Smith, was paid $88 million over less than 10 years. That’s around the same amount that the ANZ makes each year in credit card fees from hapless customers.
*Adam Schwab is a company director, former lawyer and the author of Pigs at the Trough: Lessons from Australia’s Decade of Corporate Greed