Early termination fees for residential loans: Unconscionable fees and unfair contract terms

Overview

Last month, the Australian Securities and Investments Commission (ASIC) released Regulatory Guide 220 – Early termination fees for residential loans: Unconscionable fees and unfair contract terms (RG 220).  The guide sets out general guidance on when an early termination fee on a residential loan may be unconscionable or unfair and the factors ASIC will consider in determining whether to take action. 

An 'early termination fee' refers to any fee payable due to the early repayment of a loan that is in addition to the standard discharge fees and charges that are payable regardless of whether a loan is terminated early.  These types of fees may include deferred establishment fees and break fees (also known as break costs) typically associated with fixed interest rate facilities.

The laws administered by ASIC that are relevant to early termination fees for residential loans are:

• the National Credit Code (Code) set out in Schedule 1 of the National Consumer Credit Protection Act 2009; and
  
  
• the Australian Securities and Investments Commission Act 2001 (ASIC Act) and in particular, the unfair contract terms provisions in Subdivision BA of Division 2 of Part 2.

When an early termination fee may be unconscionable

Under the Code (section 78(4)), a fee payable upon early termination of a loan is unconscionable if it exceeds a reasonable estimate of the lender’s loss arising from the early termination, including the lender’s average reasonable administrative costs in respect of such a termination.

Section B of RG 220 sets out ASIC’s guidance on matters it will take into consideration when assessing whether an early termination fee is unconscionable.  Such matters include ASIC’s view that a deferred establishment fee is a type of early termination fee that section 78(4) of the Code will apply to, together with some examples of what ASIC considers is a loss which is caused by and arises from the early termination of a loan.

Types of loss which ASIC considers are less likely to be losses arising from early termination and therefore should not be recovered through fees payable on early termination include:

• loss of profits that would have been received if the loan proceeded to the expected term or if the loan had lasted beyond the time at which the customer terminated the loan;
  
  
• marketing costs and other costs associated with obtaining new customers; and
  
  
• costs associated with developing new products and product features.

A court can annul or reduce an early termination fee if it is unconscionable and may make ancillary or consequential orders (section 78(1)). 

When an early termination fee may be unfair

Under the ASIC Act (section 12BG) a term of a consumer contract is unfair if:

• it would cause a significant imbalance in the parties’ rights and obligations arising under the contract;
  
  
• it is not reasonably necessary in order to protect the legitimate interests of the party who would be advantaged by the term; and
  
  
• it would cause detriment (whether financial or otherwise) to a party if it were to be applied or relied on.

Each of these elements need to be satisfied for a court to find a term providing for an early termination fee to be unfair.  Examples of some of the kinds of terms that may be unfair are also set out in section 12BH of the ASIC Act.  Determining whether a contractual term is unfair will depend on the facts of each case.  ASIC indicates that its guidance on these factors in RG 220 is to illustrate when ASIC is more likely to take action, rather than being a definitive statement of the law.

ASIC considers that if an early termination fee is found to be unconscionable under the Code, it is also likely to be an unfair term under the ASIC Act.

In determining whether a term is unfair, a court may take into account such matters as it thinks relevant, but must take into account the extent to which the term is transparent and the contract as a whole (section 12BG(2)).  A term is ‘transparent’ if the term is expressed in reasonably plain language, is legible, presented clearly and readily available to any party affected by the term (section 12BG(3)).

A term will be void under the ASIC Act if a court determines that it is unfair (section 12BF(1)).  Other remedies may also be available.  For example, the court may order the refund of monies or return of property to consumers that were not a party to the actual proceedings (section 12GNC(d)).

Requirements under the Code and ASIC Act

Importantly, ASIC notes that lenders need to consider the relevant requirements and provisions under both the Code and the ASIC Act applying to early termination fees because, for example, a contractual term that is adequately disclosed under the Code may not necessarily satisfy the relevant transparency or fairness tests under the unfair contract terms provisions of the ASIC Act.

Explanation of early repayment fees by lenders

ASIC advises lenders to be transparent in explaining early termination fees so that consumers will understand what they need to pay if they terminate a loan early, such as by:

• explaining in a meaningful and clear way when the fee will be charged;
  
  
• clearly stating the amount of the fee in dollars, or if that is not possible, the method of calculation;
  
  
• using prominent warnings to explain risks associated with early termination fees, particularly break fees; and
  
  
• using meaningful worked examples of break fees, as long as they can be provided in a way that is not misleading.

Lavan Legal comment

RG 220 is aimed at helping lenders understand the types of loss and what costs ASIC considers may be recovered by lenders through early termination fees.  The guide is high-level and principles based and whether an early termination fee will be unconscionable or unfair will depend on the individual circumstances.  

We recommend lenders make themselves aware of ASIC’s views and intended approach with respect to the application of the laws applying to early termination fees, and in particular:

• ensure they have appropriate record keeping processes in place as ASIC expects lenders to keep detailed records of how they calculate fees payable on termination.
  
  
• review the early termination fee terms in their documentation to ensure those terms would not be unconscionable under the Code or unfair under the ASIC Act.
  
  
• analyse the method of calculating early repayment fees to ensure they reflect the types of charges and loss that may be recoverable by lenders through early repayment fees.
  
  
• ensure appropriate measures and systems are in place with respect to the ‘transparent’ explanation of early repayment fees.

For further information please contact Special Counsel, Kylie O'Keeffe on (08) 9288 6852 / kylie.okeeffe@lavanlegal.com.au.

Christmas update

We hope that you have enjoyed the legal updates from our team throughout 2010 and that you have found these to be both informative and practical.

We will be taking a short break from Finance News over Christmas and will return in February 2011 with more useful articles for you and your business.

If there are any specific areas which you would like us to consider in future editions of these publications, please do not hesitate to contact our coordinator, Anna Zander at anna.zander@lavanlegal.com.au, and we will do our best to cover those areas in 2011.

We wish you and your families a safe and happy Christmas season.

The Banking and Finance Team