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Judgement highlights

Posted on 08 April, 2015
Judgement highlights

The court of appeal’s latest judgement sheds light on the prosecution’s case against Motor Trade Financed Limited (MTF) and Sportzone Motorcycles. They lost their appeal in the long-running credit fees case brought by the Commerce Commission with the court publishing its judgement on March 31 – as reported exclusively and first by Autofile Online. The court’s ruling upheld earlier high-court judgements that backed the commission’s approach to assessing whether credit fees charged by lenders are reasonable as required by the Credit Contracts and Consumer Finance Act (CCCFA). The commission has alleged MTF and Sportzone charged unreasonable establishment and other fees on 39 finance contracts from 2005-08. This article takes a look at some of the issues in the court of appeal’s judgement. The decisions have far-ranging implications for the wider finance and automotive industries because the precedents will form part of revisions to the government’s lending code.

MTF AND SPORTZONE’S CASE

MTF and Sportzone – the appellants – challenged the findings and conclusions in the high-court’s liability and quantum judgments. Their appeal mainly focused on interpretation of statutory provisions. The court of appeal approached this with an eye to policy apparent in the CCCFA and its purpose as “an important consumer protection measure”. The appellants rejected what they called the high court’s “fine-grained costs-based approach” to determining if a fee was unreasonable under section 41 of the CCCFA. They argued the high court wrongly accepted the Commerce Commission’s approach, which was inconsistent with the text and purpose of sections 41, 42 and 44, and the scheme and purpose of the CCCFA in broad terms. They contended the approach accepted was unworkable in practice, produced results of little or no practical use to debtors, discouraged innovation and efficiency, and was unfair to creditors. The appellants’ key proposition was section 41 required the court to assess the reasonableness of fees in a common-sense manner and informed, but not determined by, a consideration of actual costs. Fees need not match costs dollar for dollar, and they said the court wasn’t required to carry out detailed cost accounting. It was argued costs to be considered in assessing whether fees charged were reasonable included all costs connected with the matter in question. The nature of the cost – and connection between the cost and matter giving rise to the fee – might be relevant to assessing “reasonableness”. But the high-court judgements’ interpretation of reasonableness used section 41 in a manner for which there was no statutory basis. The appellants contended this was an attempt to redefine the word by “thrusting on it a spurious degree of precision”. Their proposition was if a fee did no more than recover reasonable costs associated with an activity relevant to its basis, that fee cannot be unreasonable. It was submitted the court must consider whether an establishment fee was “equal to or less than the creditor’s reasonable costs in connection with the application for credit”. It was argued the converse was not a mandatory consideration – a fee might be reasonable even though it wasn’t equal to or was more than the costs incurred. Thus, direct cost recovery was a “safe harbour”, a potential guide to setting reasonable fees, but not a statutory necessity. The appellants submitted that when assessing whether a fee was reasonable, the court must also account for other mandatory factors, such as reasonable standards of commercial practice, and other matters that shed light on “reasonableness”. The premise of the appellants’ case was anything logically capable of informing or illuminating the reasonableness of the fee should be included.

ARGUMENTS PUT BY COMMISSION

Counsel for the commission characterised this proposed interpretation as requiring a vague link between the cost and fee charged with the key focus on identifying only “outlier” fees – those that are clearly unreasonable. On that basis, any fee a creditor might charge, benchmarked against other lenders, could be reasonable. The commission submitted this approach had the effect of converting the test for unreasonableness in section 41 to one prohibiting only fees that “no reasonable lender could adopt”. This interpretation would mean sections 41-44 of the CCCFA would have little, if any, independent role in the statutory scheme.

ISSUES SUBJECT OF APPEAL

At the heart of this appeal was the nature and extent of matching required by the CCCFA between fees charged and costs to the creditor of performing the related activity. Breaking down this issue, the parties were in broad agreement the following were issues to be determined:
  • What is the test for assessing whether a fee is unreasonable under section 41?
  • Were fees charged by Sportzone/MTF unreasonable under this section?
  • If any of the fees were unreasonable, was relief available under section 94 to recover the portions of the fees held to be unreasonable or was relief available only under section 41?
  • If relief was available under section 94(1)(b), was it established any borrower had suffered loss recoverable?
  • Does section 45 assist the appellants in terms of who was responsible for that portion of the fee passed on?
  • If relief was available, and if loss had been suffered by any borrower, what was the quantum of that loss?

BUSINESS PRACTICES EXAMINED

Sportzone entered into 39 specific loan transactions for customers to buy motorcycles. Each customer borrowed from Sportzone and granted to it a security interest in the purchase. Sportzone borrowed funds from MTF to advance the loans to its customers, and its interests in the loan were then assigned to MTF, which in turn sold them to MTFS. Repayments were made directly to MTFS, which used them to make its payments due on debt securities it had issued and meet the costs of its programme. Any surplus was paid to MTF. Its only business was that of making and managing loans of this kind. The terms of each Sportzone loan provided for the customer to pay certain fees. These included fees at issue on appeal, an establishment fee and an account maintenance fee charged by Sportzone, establishment and maintenance fees charged by MTF, and pre-possession and repossession fees charged by MTF. The MTF fees were charged to Sportzone, which passed them onto borrowers. An establishment fee of $190 and $200 was charged by MTF and Sportzone respectively, and a monthly maintenance fee of $3 and $5 respectively was applied to each account. Generally pre-possession fees of between $50 and $80, and repossession fees of between $70 and $80, were charged. These loans were entered into between May 26, 2005, and July 16, 2008. They comprised 39 of about 100,000 consumer credit contracts entered into by MTF’s dealer shareholders in the years after the CCCFA came into force in April 2005. It seemed MTF reviewed and changed its loan pricing in the light of the CCCFA’s introduction. MTF then altered its structure to recover a greater proportion of operating costs through fees. MTF claimed its fees still didn’t cover all operating costs and any increase was matched by reducing MTF’s lending interest rate margin. Dealers passed on an even greater reduction in interest rate margin to their customers. MTF said its increased fee income didn’t lead to increased profits. It contended the amount of each of its fees was in line with amounts charged by competing lenders.

INTERVENTION BY COMMISSION

In response to a complaint in August 2006, the commission started investigating Sportzone, and identified evidence that raised concerns regarding its and MTF’s approach to CCCFA compliance. The case’s central focus was the cost analysis carried out by the appellants to show the connection between costs, and establishment, credit and default fees charged. Sportzone’s allocations were “relatively simple” and MTF’s allocations were “highly complex”. It was submitted this complexity was largely the result of MTF’s decision to recover virtually all of its costs through one or more of its fees. Sportzone and MTF had adopted a practice of drawing “increasingly tenuous connections between overhead and other indirect fixed costs and using those to justify its fees”. MTF used a full cost-absorption model in which the only cost excluded from recovery through fees was the cost of funds, its securitisation programme and the cost of capital. It divided its expenses into a number of separate “cost centres”, such as finance, treasury, credit, managing director and sales management. The budget for each contained categories and line items. For each financial year, MTF undertook a separate allocation of each line item to one or more of the four different fee categories it was using, namely establishment, maintenance, pre-payment and default fees. The costs for each were divided by the estimated number of fees MTF expected to charge in the next 12-month period. They were then compared to existing or proposed fees. It seemed from evidence before the high court that MTF’s board treated the introduction of the CCCFA as presenting “profit opportunities” including the chance to “boost fee income”. The commission contended the evidence showed there was some discomfort, even within MTF, at this aggressive approach to recovering costs through fees. One of MTF’s senior executives commented any attempt to claw back provisions and bad debts through fees “would be wrong”. Nevertheless, MTF sought to recover, and was still seeking to recover before the court of appeal, such items through fees.

COURT OF APPEAL’S DECISION

The court considered the commission’s approach was correct. The purpose of the fee provisions in sub-part six of the CCCFA was to restrict costs that can be recovered as fees. The aim was to identify and proscribe “unreasonable fees”. The principles set out in sections 42 and 44 required the costs a creditor sought to recover in respect of a fee to be “sufficiently close and relevant” to that activity. The court accepted the commission’s approach. The connection in the provisions between the fee and costs incurred in generating it supported this approach. Fees must recover costs only generated “in connection with” or “in relation to” the activity to which fees were said to relate. The court considered the application of each relevant provision at issue called for a three-stage analysis. Section 42 of the CCCFA required: (a)  Fees charged must comply with the definition in section five – fees must be connected to and have close relevance to costs incurred by the creditor in the listed activities falling within the ambit of “establishment fee” activities. (b)  The court had to inquire whether the amount of the fee was “equal to or less than” the creditor’s reasonable costs in connection with those four activities. There was no requirement to compare fees within the market or any “benchmarking”. (c)  Section 41(1) provided for a limited scope to introduce extra grounds for inquiring whether the contract provided for an unreasonable credit fee. Given the prescribed nature of the inquiry, any such additional factors should be compelling, and relevant to and consistent with the statutory purpose. Nonetheless, this statutory structure again emphasised actual costs were the decisive criterion. Accordingly, the court of appeal agreed with the judge there must be a close connection between the fee charged and costs incurred in generating that portion of the credit service.

IS RELIEF AVAILABLE UNDER SECTION 94?

When the high court considered the question of quantum, the commission sought orders for the repayment of amounts by MTF to reflect the unreasonable portion of the fees under the 39 contracts. Judge Toogood reserved leave to apply for formal orders under section 94(1)(b) directing the payment of refunds to the borrowers named in the proceeding. Sportzone and MTF challenged the commission’s right to seek such orders on the basis the court had no jurisdiction to make them and the commission had failed to prove loss. The quantum judgement addressed particular costs relied on by MTF to justify fees it charged. This judgement contained a detailed analysis of cost items claimed by MTF. Judge Toogood made detailed findings as to the correct allocation of costs. Before turning to the extent to which fees were unreasonable, he addressed cost items relied on by MTF he considered were not connected with or related to fees charged. These included training costs (which could not be closely relevant to a particular transaction), travel costs (which MTF never tried to explain with reference to a particular transaction), directors’ fees and travel costs (which were also not clearly linked to any specific loans), and professional and accounting, legal and audit fees. Judge Toogood assessed each cost centre to which MTF allocated fees. This was broken down further to line items. He went through each to determine whether they should be permitted:
  • 10 per cent of all staff salaries and performance schemes were attributable to activities covered by establishment fees.
  • 10 per cent of bank activity fees were allocated as costs recoverable by establishment fees.
  • 10 per cent of banking, direct credit and debit facilities were allocated as costs recoverable by establishment fees.
  • All treasury cost centre costs were disallowed outside of bank charges noted above.
  • Hardware and software depreciation was allowed as recoverable indirect costs allocated across multiple different fees on the basis of generally accepted accounting practice.
  • The judge disallowed any recovery for the cost of capital because it wasn’t an actual cost incurred to establish any loan.

SUMMING UP COURT’S JUDGEMENT

The court of appeal was satisfied the judge’s approach was correct and sound – and capable of precise and clear application. The quantum judgement explained the different treatment of costs. The judge and commission accepted it had been proved the cost of this depreciation was sufficiently connected to specific activities so as to be recoverable through fees relating to them. This was contrasted with his finding in respect of the cost of capital – the link to any fee-generating activity was simply too tenuous. That was a rational basis on which to differentiate between these costs. The appeal court was satisfied the judge made no error applying the principles to the case’s facts. Orders as to quantum apparent from the quantum judgment were upheld and this ground of appeal also failed. A copy of the court of appeal’s ruling can be found on the Commerce Commission’s website. Click here to access the 45-page PDF. This article expands on a story published in the April 9 issue of Autofile. To subscribe to the magazine in print, click here.