New Zealand Law Society - Court of appeal decision on reasonableness of credit fees

Court of appeal decision on reasonableness of credit fees

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The Court of Appeal gave its judgment in the case of Sportzone Motorcycles v Commerce Commission1 on 30 March.

The case concerned whether certain credit and default fees charged by Sportzone and Motor Trade Finance (MTF) were unreasonable in breach of s 41 of the Credit Contracts and Consumer Finance Act 2003 (CCCFA). That in turn required consideration of s 42 which sets out the test for when establishment fees will be considered unreasonable and s 44 which sets out the test for other credit fees and for default fees.

The Court of Appeal upheld a test for reasonableness of credit fees under the Credit Contracts and Consumer Finance Act 2003 (CCCFA) that requires the costs a creditor seeks to recover in respect of a particular activity to be “sufficiently close and relevant” to that activity (at [51]).

The Court of Appeal judgment will provide some certainty to creditors looking to calculate or reassess credit fees under consumer credit transactions.

The Court of Appeal judgment endorses the approach of Justice Toogood in the High Court. Justice Toogood had given two judgments which provide specific guidance as to the approach to the calculation of credit fees.

In his first judgment (referred to as the liability judgment) Justice Toogood held that credit fees charged by Sportzone and MTF were unreasonable2. In his second judgment (referred to as the quantum judgment) Justice Toogood gave more detailed guidance as to what costs could properly be recovered by Sportzone and MTF in their credit fees3.

In the liability judgment, Justice Toogood stated that the real issue in the case was the extent to which a borrower may recover by a credit or default fee, general overheads which are not directly or closely related to the particular activity concerned (such as the activity of setting up and processing an application for credit) (at [4]).

MTF’s essential argument was that the legislation allowed it to recover essentially all its costs by way of fees (with it then making profits from the margin between the cost of acquiring funds and the interest rate charged to the borrower) (liability judgment at [30]). MTF called as an expert Professor David Lont whose evidence supported a wide approach to cost recovery based on a test of whether costs had a “beneficial relationship” to the activity or matter.

The Court of Appeal agreed with Justice Toogood that such a test was inappropriate.

The Court of Appeal noted how the explanatory note for the Bill that eventually became the CCCFA observed that the tests under ss 42 and 44 were designed to ensure creditors matched fees to the specific costs of the matters giving rise to the fee.

The Court of Appeal considered that it was the clear intention of the legislature to define reasonableness of costs by identifying specific activities and costs, and requiring a link to them (at [61]).

The Court of Appeal stated that the statutory obligations in both ss 42 and 44 to have regard to costs of specific activities of the creditor did not sit comfortably with the argument of MTF that the statutory language permits the inclusion of all reasonable costs of offering a finance facility. The Court commented that if the CCCFA permitted the recovery through credit fees of a portion of all costs of the finance business, it would dilute the regulation of fees to such an extent that it offered virtually no regulation at all (at [68]).

In relation to the reasonableness of establishment fees under s 42, the Court of Appeal set out a three-stage analysis.

First, any fees charged under the section must be connected to and have close relevance to costs incurred by the creditor in the four establishment fee activities listed in s 42 (costs in connection with the application for credit, processing and considering the application for credit, documenting the consumer credit contract and advancing the credit).

Second, the Court should inquire as to whether the amount of the fee in question is equal to or less than the creditor’s reasonable costs in connection with those four activities. There is no need for comparison of fees within the market, or any benchmarking exercise.

Thirdly, there is limited scope under s 41 of the CCCFA to introduce additional grounds for inquiring whether the credit contract provides for an unreasonable credit fee. Such additional factors ought to be compelling and clearly relevant to and consistent with the statutory purpose.

In relation to the reasonableness of other credit fees and default fees under s 44, the Court of Appeal said that it considered the inquiry will proceed in a broadly similar way to s 42.

The Court of Appeal did say that under s 44 the fee must be assessed in relation to whether it reasonably compensates the creditor for any cost incurred by the creditor in providing the fee-related service, or any loss incurred by the creditor in relation to the debtor’s actions. Section 44 requires the fee being charged to relate to the service generating the cost it recovers. The Court of Appeal said this would require a “careful application” of the close connection test without setting out further guidance as to what that meant.

The Court said that the same considerations for s 41 apply for s 44 as for s 42. By this I assume that the Court meant that it considered that there was limited scope under s 41 to introduce additional grounds for inquiring whether the credit contract provides for an unreasonable credit fee.

A further issue in the case was whether the Court should make an order under s 94 of the CCCFA directing MTF to refund borrowers the amounts by which the MTF credit fees exceeded what would have been reasonable credit fees.

MTF argued that the Commission had not shown any of the borrowers had suffered loss, saying that if MTF had charged lower fees, MTF would in turn have increased the interest rate on the loans.

The Court of Appeal rejected this argument. It considered a borrower has plainly suffered loss if he or she has paid an unreasonable fee. The loss is simply the amount by which the fee exceeds what the creditor is lawfully entitled to charge. The Court said the argument as to what might have happened with regards to MTF increasing interest rates was speculative, and there was no evidence that borrowers would have entered into loan transactions with MTF at a higher interest rate.

The Court of Appeal also upheld Justice Toogood’s quantum judgment but without traversing the approach taken in that judgment.

The Court of Appeal judgment is important in reinforcing the general approach to reasonableness of credit fees and for its endorsement of the approach taken by Justice Toogood. Creditors seeking specific guidance as to how they should calculate credit fees should look to the liability and quantum judgments of Justice Toogood.

For example, the liability judgment of Justice Toogood gives some general guidance as to the approach to allocation of staff costs towards credit fees.

So for an establishment fee:

  • the creditor should assess the time taken by the responsible employees to consider, process and document each loan;
  • this can be done on an average basis;
  • the creditor should assess the total cost of the relevant employee’s remuneration; and
  • the creditor should then allocate the total cost of remuneration to the employee’s various functions (so that the appropriate amount is allocated to the time taken to establish the loan) (at [86]).

The liability judgment also sets out specific guidance on some other matters. For example, in relation to default fees, the judge said that the test of close relevance will not be satisfied in respect of any part of a default fee imposed for the purpose of deterring defaults (at [95]).

Justice Toogood’s quantum judgment will be an important reference guide to creditors as it indicates the Court’s likely approach to recoverability within credit fees of a number of cost headings.

The quantum judgment confirms some important points of principle relating to what costs can be included within credit fees or default fees. For example, the judge said that:

  • Costs associated with the acquisition of finance are a company overhead referable to the general business of lending money. They are not sufficiently related to the establishment of loans and will have to be recovered through the interest rate (at [68] and [94]);
  • The cost of bad debts cannot be recovered through default fees. Default fees are directed at loss from particular debtors’ actions. The cost of bad debts is a general overhead and is only recoverable through the interest rate (at [115]).

Justice Toogood did a cost-by-cost analysis of what costs could be relied on to comprise part of an establishment fee or an account maintenance fee or a default fee.

This was a very detailed exercise. It involved going through the costs of each department of MTF to assess what proportion of costs could fairly be allocated to the particular activity that the credit fee related to.

Justice Toogood first ruled out certain costs across the board.

The judge held that training costs support the activity rather than are incurred in carrying out the activity. Accordingly credit fees could not include the cost of training (at [44]).

The judge also held that staff travel costs would not normally be closely related to any particular credit contract (at [45]). In relation to directors fees and travel the judge held that director’ fees and travel were not closely related to the making of any particular loan.

The judge did accept, however, that in a smaller business directors might have a more direct role in approval of particular transactions (at [47]).

Justice Toogood also held that accounting, audit and legal fees would not normally be recoverable as part of a credit fee unless they were closely relevant to particular transactions (at [48] to [50]).

Justice Toogood then went through an analysis for each fee on a department by department basis, assessing what costs could be relied on to support the calculation of a credit fee. In most cases there were three different calculations for each of three years.

For example, for establishment fees the judge looked first at the finance cost centre department of MTF and assessed what proportion of salaries of staff of that department should be allocated to activities relating to the establishment of loans, what proportion of premises costs should be allocated and what proportion of phone costs. The judge then went on to do similar exercises with all other MTF departments.

The quantum judgment demonstrates the microscopic scrutiny under which a creditor’s calculation of credit fees will be placed. It will be important for creditors to be familiar with the principles in the judgments of Justice Toogood and ensure that their calculation of credit fees can be justified under those principles.

The Sportzone case concerned credit fees and default fees charged in the 2006, 2007 and 2008 financial years. Since then s 44 of the CCCFA has been amended but in a way that is not likely to affect the analysis of the Courts in the Sportzone case.

A new s 44B has been inserted to the CCCFA providing that evidence of a creditor’s compliance with provisions of the Responsible Lending Code is to be treated as evidence that a credit fee or default fee is not unreasonable. The Responsible Lending Code was issued in March 2015. Section 10 of the Code (pages 39 to 42) provides guidance on the setting of credit fees and default fees but is to be reviewed having regard to the outcome of the Sportzone case.

In conclusion, the Court of Appeal decision is helpful in confirming the test that credit fees may only recover costs that are sufficiently close and relevant to the relevant activity, and in endorsing the approach of Justice Toogood in the High Court.

Creditors should ensure that credit and default fees are calculated having regard to the specific guidance of Justice Toogood and the guidance on credit fees in the Responsible Lending Code (which is subject to revision).

John Land is a competition law specialist and commercial litigator at Bankside Chambers in Auckland. Formerly a partner of Kensington Swan for 20 years, he can be contacted on 09 379 1513 or at

  • Sportzone Motorcycles Ltd (in liquidation) and Motor Trade Finances Ltd v Commerce Commission [2015] NZCA 78
  • Commerce Commission v Sportzone Motorcycles Ltd [2013] NZHC 2531.
  • Commerce Commission v Sportzone Motorcycles Ltd (No 2) [2014] NZHC 2486
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