A unanimous Supreme Court ruled on 12 May that finance companies are not able to charge as fees the costs of their business that are not referable to certain identified transaction-specific steps.

Following its review of the fees provisions of the Credit Contracts and Consumer Finance Act 2003 (CCCFA), the Supreme Court held in Sportzone Motorcycles Limited (in liquidation) and Motor Trade Finances Ltd v Commerce Commission [2016] NZSC 53 at [74] that the CCCFA “can be seen as starting from the premise that charges will be levied as interest, with the exception of fees that are subject to the reasonableness limitation”.

Consumer protection primary purpose

Like the lower courts before it, the Supreme Court was first tasked with determining the relevant purposes of the CCCFA.

It was common ground before the Supreme Court that the protection of consumers was “an important purpose” of the CCCFA. Now, with the passing of the Credit Contracts and Consumer Finance Amendment Act 2014, there can be no confusion as to its position in the purposes’ hierarchy. Section 3(1) clearly states that the “primary purpose” of the CCCFA is “the protection of consumers in connection with credit contracts, consumer leases, and buy-back transactions of land”.

At trial, Motor Trade Finances Ltd (MTF) had argued that the promotion of pricing flexibility was another of the CCCFA’s purposes.

In Commerce Commission v Sportzone Motorcycles Limited (in liquidation) [2013] NZHC 2531 (Liability Judgment), Justice Toogood had acknowledged the validity of MTF’s argument (at [59]).

However, the Supreme Court did not agree. While it acknowledged that the promotion of efficiency and the facilitation of pricing flexibility had been factors that drove the reform, the Supreme Court found it “notable” that neither of these factors had been mentioned in s 3 of the CCCFA (at [61]).

“We do not discount efficiency and pricing flexibility as a factor to be taken into account, but we think it is clear from the express words of s 3 that Parliament saw the need to protect consumers and to allow for comparability between competing credit offerings as more important purposes.” This has been borne out by the recently amended purposes in s 3 (such amendments coming into effect on 6 June 2015), which again omitted any reference to pricing flexibility.

What is reasonableness?

In its consideration of the fee provisions, the Supreme Court pointed out that the concept of reasonableness was central to the scheme of these provisions (at [39]). This was obvious, it noted, by the “repeated resort in the provisions to reasonableness as a standard”, which also suggested that the assessment was an objective one, and that it was intended “to place a real constraint on what creditors are entitled to charge by way of fees”.

In the Liability Judgment, Justice Toogood had held at [65] that the overriding consideration in determining whether costs were “in connection with” and “relevant to” was that of “reasonableness” (as set out in s 41 of the CCCFA, which now simply states: “A consumer credit contract must not provide for a credit fee or a default fee that is unreasonable”).

Reasonableness was to be judged, said his Honour, “from the view of an informed objective bystander considering whether it is reasonable for the particular borrower to meet the costs which the lender seeks to recover by the fees charged. Justice Toogood said that determining reasonableness would not be assisted by a test “which, in effect, permits a creditor to justify any fee on the basis that it is simply recovering an actual business cost incurred by the creditor, other than the cost of the funds advanced, no matter how remote the cost may be from the transaction in which the fee is charged”.

The appropriate test to adopt, held Justice Toogood at [66], was that set out by the High Court in Yurjevich v Commissioner of Inland Revenue (1991) 13 NZTC 8,185:

“To be reasonable, the cost the creditor seeks to recover must be sufficiently close and relevant to the establishment of the particular loan, to the administration and maintenance of the particular loan, or to the actual consequences of the particular default, such that it can reasonably be said that the cost was incurred in connection with or in relation to the relevant matter.”

A transaction-specific approach

Justice Toogood’s transaction-specific approach was upheld by the Court of Appeal in Sportzone Motorcycles (in liq) v Commerce Commission [2015] 3 NZLR 191, and ultimately by the Supreme Court.

Section 42 of the CCCFA provides that in determining when an establishment fee is unreasonable, the court must have regard to:

“(a) whether the amount of the fee is equal to or less than the creditor’s reasonable costs in connection with the application for credit, processing and considering that application, documenting the consumer credit contract, and advancing the credit; or

(b) whether the amount of the fee is equal to or less than the creditor’s average reasonable costs of the matters referred to in paragraph (a) for the appropriate class of consumer credit contract.”

With respect to s 42(a), the Supreme Court agreed with the Court of Appeal’s conclusion that the use of the definite articles “the” and “that” indicated a statutory emphasis on specific transactions (at [68]). The Court of Appeal had found that the specific wording of s 42 supported its conclusion (at [59]):

“The statutory definition of establishment fees refers to fees or charges that relate to the costs of four particular aspects of the credit contract transaction. The relevant costs to be recovered are those relating to the four activities listed in that definition. This definition expressly excludes any fee or charge for an “optional service”. In excluding those services, then, it is apparent the definition focuses on costs involved in all steps by which the creditor first provides credit to a debtor. This is significant in identifying what aspects of the credit transaction the legislature was seeking to capture in this section – namely controlling only those costs closely related to that part of the financial service.”

In its analysis of s 44, which related to other credit fees and default fees, the Court of Appeal found that its statutory emphasis was also on actual, specific costs, and the specific quantum of estimated loss (at [60]).

“[T]he use of the definite article before ‘matter’, ‘creditor’ and ‘debtor’ introduces a specific focus on the creditor’s reasonable costs and the creditor’s reasonable estimate of any potential loss, relating to credit and default fees,” the Court of Appeal said.

The Supreme Court agreed, stating at [68] that the reference to the loss incurred by the creditor as a result of the debtor’s acts or omissions could not sensibly be seen as referring to acts and omissions of debtors generally or even debtors of a particular class. Rather, the Supreme Court said, it focuses on the individual debtor on whom the fee was levied.

Average reasonable costs

In its assessment of the average reasonable costs set out in s 42(b), the Supreme Court did not accept that averaging gave any indication of the appropriate costs measure.

“All it envisages is that whatever cost measure is used, an average can be calculated by dividing the figure by the number of transactions,” it said at [72].

“Given the context in which s 42(b) appears (as an alternative to the single transaction approach in s 42(a)), we see the cost measure as that which represents the total amount of anticipated transaction-specific costs for the anticipated number of transactions.”

The Supreme Court’s approach to setting fees

Having preferred the transaction-specific approach, the Supreme Court helpfully set out the approach which should be taken when setting fees on this basis (at [73]).

“[T]he approach should have to identify what steps were undertaken in relation to particular aspects of the provision of credit under a consumer credit contract and calculate the costs of taking those steps. Where averaging is permitted, this should be done for a representative sample of transactions so that the average cost per transaction can be assessed.”

The costs incurred in the carrying on of the finance company’s business that were not referable to the identified steps could be recovered in the interest charged to debtors, the Supreme Court said. They could not be recovered as fees. The Supreme Court found that this accorded with the overall scheme of the CCCFA, “which provides for no limit on the interest rate that can be charged but limits fees to those that are reasonable in nature and extent” (at [74]).

It’s not just about costs

It was argued before the Supreme Court that cost should not be the only relevant consideration in determining whether a fee was “reasonable”. While the Supreme Court agreed, it also cautioned against courts concluding that factors other than costs could outweigh cost in the determination of the reasonableness of the fee (at [92]).

The Supreme Court also cautioned against reliance on a similarity with competitors’ fees as an indication that the fees must be reasonable.

“Given the focus on costs in ss 42 and 44, the proposition that similarity with competitors indicates reasonableness cannot be accepted at face value, because it does not take into account the relationship between the costs of competitors and the fees they charge,” said the Supreme Court at [93]. “Nor can it be assumed that competitors’ practices are, themselves, reasonable commercial practice.”

Allegations of absurdities rejected

Before the Supreme Court, MTF had argued that the lower courts’ approaches had led to “absurd outcomes and must therefore be wrong”. The Supreme Court did not agree. In response to that argument, the Supreme Court findings included the following:

• “The cost of capital is a general cost of the business structure. It is not in any way related to specific transactions … We agree with the High Court Judge that it is appropriate to require MTF to recover the cost of capital in its interest rate” (at [101]).
• “We also agree with [Justice] Toogood … that there is no compelling reason why temporary defaulters should pay costs attributable to other debtors who default permanently. Temporary defaulters, who can be charged fees covering the cost of their own defaults, have no greater responsibility to pay for the costs involved with permanent defaulters than any other debtors” (at [105]).
• “We agree with [Justice] Toogood … that treasury costs constitute a general cost of the business of lending rather than particular costs associated with individual transactions” (at [107]).

Conclusion

Three successive courts have now concluded that “reasonableness” is the statutory standard governing the setting of fees in consumer credit contracts.

However, as the Supreme Court has acknowledged, it is a standard that “is imprecise and difficult to apply to particular situations”, especially where creditors do not have precise information on their costs, and may not know the number of transactions they will enter into during the period that the fee level is to be applied (at [116]).

In applying the reasonableness standard, the Supreme Court said, lines will need to be drawn, and reasonable minds may differ on where those lines should be drawn.

The Supreme Court also accepted that the calculation of fees on the transaction-specific approach will be difficult for creditors and hard for the Disputes Tribunal and courts to apply. But that criticism, said the Supreme Court, is really directed at the statutory regime itself, and not a particular approach to its application. Having found no error in the Court of Appeal’s analysis, the Supreme Court dismissed the appeal.

Darise Bennington is a senior solicitor at Duncan Cotterill.