When are lenders’ fees unreasonable? Guidance from the Court of Appeal

By Sophie East & Jane Standage*

In an eagerly anticipated judgment the Court of Appeal has laid down the test for determining when fees charged to borrowers are unreasonable.

The judgment in Commerce Commission v Sportzone¹ is a win for the Commerce Commission and for those who argue that the relevant statute, the Credit Contracts and Consumer Finance Act 2003 (the CCCFA), should be interpreted as strictly as possible in order to achieve its objective of consumer protection.

The Court of Appeal held that in charging fees to borrowers under consumer credit contracts (where the borrower is a natural person and the loan is for personal, domestic or household purposes), lenders can only seek to recover costs which are closely connected to the activity for which the fee is charged.

In practice this means that cost recovery via fees will largely be limited to variable costs (costs that change in proportion to a volume of activity) and direct costs (costs that are easily identified as relating to a cost object within an organisation). By contrast, many fixed and indirect costs (e.g. general business overheads) which are not closely related to a particular loan transaction cannot be recovered through fees.

High Court decision

The case concerned the fees charged by a vehicle finance company, Motor Trade Finance (MTF). MTF was the unlucky lender selected by the Commerce Commission to run a test case as to what constitutes an “unreasonable” fee prohibited by the CCCFA.

In answering this question, the High Court focussed on the provisions in the CCCFA which state that in order to be reasonable, the lenders’ costs which form part of the fees must be costs incurred “in connection with” the particular lending activity.²

The High Court interpreted the words “in connection with” to require that the costs recoverable through fees must be sufficiently close and relevant to the particular activity for which the fee is charged, i.e., the establishment, administration, maintenance or default of the particular loan. This has been referred to as the “close relevance test”.

In a second judgment (the Quantification Judgment), the High Court then applied the close relevance test to the particular fees charged by MTF.³ In doing so, the High Court examined line-by-line the various costs incurred by MTF and identified a specific percentage of the cost that could be recovered through fees.

The categories of recoverable costs included a percentage of the following costs (provided the costs were closely connected to the particular activity for which the fee was charged):

staff salaries (including temporary staff) and payments under staff performance schemes;

premises costs (which included costs of storage, office rental, rates, energy costs, insurance, security and cleaning, maintenance, and depreciation of fixtures and fittings);

telecommunication costs;

charges imposed by the Land Transport Safety Authority for vehicle checks; and

IT hardware and software depreciation.

Court of Appeal

MTF appealed to the Court of Appeal. The Court of Appeal upheld the close relevance test and applied a three stage analysis to assessing the reasonableness of establishment fees (i.e., the fee a lender charges for setting up a line of credit). The analysis is:

First, any costs charged to borrowers must be closely relevant to the following four activities: application for credit, processing and considering that application, documenting the application and advancing the credit (the four establishment activities).

Second, the lender must consider whether the amount of the fee is “equal to or less than” its reasonable costs in connection with those four establishment activities.

Third, the Court held that any additional considerations for including costs in fees ought to be “compelling” and consistent with the statutory purpose (the restriction of fees).

For credit and default fees, the question is whether the fee reasonably compensates the lender for any cost incurred in providing the fee-related service or any loss incurred in relation to the debtor’s actions. Reasonable standards of commercial practice may also be considered.

The Court of Appeal also affirmed the Quantification Judgment.

Outcomes

Presumably many lenders had hoped that the Court of Appeal would take a broader approach to cost recovery via fees, i.e., that costs are recoverable via fees as long as those costs have a beneficial relationship with the lending activity. However, the outcome of the Sportzone case and the way the close relevance test has been applied, means that in assessing whether fees are unreasonable, courts will be required to undertake a detailed line-by-line assessment of a lender’s costs.

It remains to be seen whether this will result in a better outcome for consumers, particularly given that there are no restrictions around lenders incorporating any costs which cannot be allocated to fees into the lender’s interest rate.

Putting aside whether or not individual lenders change their approach to fees, lenders would be well-advised to (where possible) at least assess their fee levels in light of the decision in Sportzone. That is, to identify the costs associated with their business of providing credit, assess which of these costs may be said to be closely connected to the activities for which fees are charged (e.g., loan establishment, account maintenance and customer default), compare their fee levels in light of that analysis, and to take advice if they are at all uncertain as to how those fees levels compare.

1 [2015] NZCA 78.
2 [2013] NZHC 2531.
3 [2014] NZHC 2486.

----------------------

*Sophie East is a partner at Bell Gully and Jane Standage a senior associate at Bell Gully. This article first appeared on Bell Gully's website here.