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Beware of Imposing Penalties

The Federal Court has recently found against the ANZ Bank on the ground that certain fees imposed on their customers operated as a penalty and were therefore void. Let’s focus on the late fee, which was $20 ($35 until 2009). The real cost to the ANZ of handling late payments was between 50c and $5.50. Therefore, the court found that the late fee was not a measure of probable loss. Rather, it was considered to be extravagant and a penalty at law.

The court asked:

  • whether the late fee was a genuine pre-estimate of damage; and
  • whether the fee was extravagant and unconscionable in amount compared to the greatest conceivable loss. The court said that, where the fee reflected the cost of likely losses that could be incurred, the fee would be acceptable. However, if the fee was not an accurate reflection of the cost involved, this tended to indicate that the sum was extravagant and that it was unconscionable to impose such a fee.

Further, the court said it was relevant to consider:

  • the degree of disproportion between the required sum and proposed loss: in the ANZ case, the late fee was at least four times the amount of the real cost;
  • the relationship between the contracting parties, in particular the lack of negotiation and inequality between the ANZ and its customers, where the ANZ unilaterally determined fees and varied terms.

The significance of this case for schools is that it underlines the risk of including in enrolment conditions provisions which could be construed as a penalty. The Federal Court judgment received much publicity and has already stimulated discussion among school business managers. One can be sure that parents will have also noticed. The judgment highlights that when a school imposes a late fee it is important that the fee reflects the estimated cost to the school of the school fees being paid late and is not an amount that could be considered extravagant or unconscionable.

The common provision requiring parents to give a term’s notice before withdrawing a child or pay a term’s fees in lieu is also at risk. Is this provision enforceable? The law says “No” if it is a penalty but “Yes” if it is for “liquidated damages.” A penalty is a requirement to pay an amount of money to frighten the potential offending party into compliance. In other words, a penalty involves the school threatening the parents: “Give notice or pay up!” Liquidated damages, on the other hand, are a genuine pre-estimate of the loss to the school of the parents’ failure to give notice. To determine whether the provision in the enrolment contract is a penalty or liquidated damages, one must look at the circumstances at the time the contract is entered into, not at the time of the parents’ failure to give notice which may, of course, be years later. Looking at the contract, one must determine whether it was the objective intention of the parties that the provision was to be a coercive penalty, or whether the intention was that it be a genuine pre-estimate of the value of the damage. The subjective intention of the parties is irrelevant. The name, if any, given to the payment in the enrolment contract is not determinative. In other words, to simply say that the term’s fees in lieu of notice are a genuine pre-estimate of damage will not save the provision if a term’s fees were not, at the time the contract was made, a genuine pre-estimate of damage.

Having said that, it is no obstacle to the amount 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. Indeed, that is just the situation when one needs to estimate the amount of the future damage. Of some comfort is that the courts have said that latitude must be given to genuine pre-estimates of damage, and that the sum must be “out of all proportion,” or “extravagant, exorbitant or unconscionable” before being declared a penalty.

if you have a question about possible penalty provisions in your school's enrolment contract.

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Ever had to sue for school fees?

In the past year, there has been an 11% increase in the enrolment of overseas students in Australian schools. There can be particular problems recovering unpaid school fees when the student's parents are overseas. A recent case provides some useful lessons.

Kim was accepted into year 10 at a NSW high school. His 1997 fees were paid by his parents, who were overseas, through a third party which had arranged the enrolment. Kim's guardian, Mr Park, was not involved in the enrolment process or the payment of the fees. Kim simply lived with Mr Park and even this stopped in early 1997. However, in February 1997, Mr Park did sign an "Acceptance of Offer" form which included a statement that "School fees are to be paid one year in advance".

The 1998 and 1999 fees were not paid. The School obtained a default judgment against Mr Park for some $18,000. Mr Park then made three payments in the belief that he would be reimbursed by the student's parents. Finally, the School began bankruptcy proceedings against Mr Park. However, the Federal Court dismissed the School's petition and held that Mr Park was not indebted to the School for the fees. The Court said that the "Acceptance of Offer" form did not amount to an undertaking to pay the fees as Mr Park had not been a party to the arrangements with the School for Kim's enrolment and the School had not previously obtained Mr Park's acceptance of financial responsibility for Kim. In fact, Mr Park understood that Kim's parents would pay the fees. Rather than an acceptance to pay school fees, the "Acceptance of Offer" form was one touching upon the day-to-day relations between the School, the child and the person with whom Kim was living; namely, Mr Park. Thus, a person in Mr Park's position could not be liable to pay the fees.

The School had pursued the wrong person. It should have commenced proceedings against the parents. As a practical matter, recovery from people overseas is difficult. It is therefore important that a school secure its position by either getting fees paid in advance or by having a binding agreement from some local person of substance to pay the fees.

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