Wednesday, July 4, 2007

The Law on Penalty Charges

This article by Tim Kevan and Anthony Johnson appeared on the Bar Council Blog dated 3/7/07

Much has been written about the David and Goliath type dispute between the banks and their customers over their charges in recent weeks. However, there has been little explanation of the main legal issues.

The charges at the heart of this dispute have generally been levied for issues such as late payments, bounced cheques and exceeding overdraft limits. Customers are raising a number of legal issues. The first is that such charges are unenforceable under the Unfair Contract Terms Act 1977. Section 4(1), they say, limits the extent to which a bank can claim an indemnity for breach of contract. In particular, any term allowing the bank to do so must be reasonable, something for the bank to prove and taking account of what the parties originally contemplated (section 11).

The next argument relies upon the Unfair Terms in Consumer Contract Regulations 1999. Penalty charge clauses are argued to be unenforceable under Regulation 5(1) due to being unfair, a concept which takes account of the balance of power between the parties. One example of an unfair term is given in Schedule 2 as one which has the effect of requiring disproportionately high compensation for breach of contract.

The other main argument based upon statutory provisions is that where the charges haven’t been clearly agreed beforehand, they should be reasonable under section 15(1) of the Supply of Goods and Services Act 1982. In addition customers also point to the common law and cases stemming from Dunlop Pneumatic Tyre Co v New Garage & Motor [1915] AC 79 which restrict the recoverable amount on a “penalty clause”. This has been defined as a sum that is “extravagant and unconscionable in relation to the greatest possible loss”. The amount, they say, must represent a genuine pre-estimate of loss.

In response to these arguments, the banks have said that the charges are a genuine estimate of the costs caused by the customer’s default. The difficulty in this respect is an evidential one as banks may be reluctant to give out sensitive information as to their whole costs structure. More attractive for them is to sidestep the penalty charge/breach of contract debate completely and argue simply that they are merely the usual charges for standard banking services. This in itself raises the distinction between penalty charges and standard fees, something that is likely to become crucial as the cases progress through the courts.

Whatever the end result, the battle lines have certainly been drawn and with the number of claims being issued almost bringing the online system to a halt it looks set to be a battle which will rumble on for a long time yet.

Tim Kevan is a barrister and Anthony Johnson a pupil barrister at 1 Temple Gardens

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