Bell Gully says court ruling means lenders ought to assess which of their costs are closely connected to the activities they charge fees for

By Sophie East and Jane Standage*

The Supreme Court has laid down the final test for determining whether fees charged to borrowers are unreasonable.

In Commerce Commission v Sportzone,¹ the Commerce Commission successfully argued that the relevant statute, the Credit Contracts and Consumer Finance Act 2003 (CCCFA), should be interpreted strictly to protect consumers. The practical outcome is that under consumer credit contracts,² lenders are only permitted to recover their costs in the fees they charge customers where those costs are closely connected to the activity for which the fee is charged; for example, where costs are closely connected to the establishment of a loan or closely connected to an instance of customer default. 

This means that cost recovery via fees will largely be limited to variable costs (costs that change in proportion to 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 and Court of Appeal decisions 

The case concerned the credit 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 focused on the provisions in the CCCFA which state that in order to be reasonable, the lender's costs which form part of the fees must be costs incurred "in connection with" the particular lending activity.³ 

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". The High Court also undertook a detailed line by line assessment of MTF's costs to ascertain whether each cost was closely connected to the activity for which the fee was charged.⁴ The Court of Appeal upheld the decision of the High Court.⁵ 

Supreme Court position 

The Supreme Court held that the main purpose of the CCCFA was to ensure consumer protection and comparability of credit arrangements. This purpose drove the Court's interpretation of the "reasonableness" provisions of the CCCFA, not MTF's perspective, which was that the Act is designed to allow lenders the flexibility to allocate costs between fees and the interest rate. The Supreme Court held that when applying the Act's purpose of consumer protection, it was clear that the fee provisions were designed to constrain lenders so that they can only seek to recover costs which are closely connected to the activity for which the fee is charged.

Although the Supreme Court acknowledged that lenders may take into account other non-cost considerations (for example, fee levels in the market), it is unlikely that those factors could outweigh a determination that a cost was not closely connected to a fee. The fact that MTF's fees were in line with competitors did not materially assist the Court in assessing reasonableness as it could not be assumed that the competitors' practices were reasonable. 

The Supreme Court noted that if costs were not closely connected to fee-related activities, lenders could recover those costs via the interest they charge. MTF had argued that limiting the fees and requiring lenders to recover costs via the interest rate would result in consumers being worse off in net terms. However, the Supreme Court rejected this and said price competition would place downward pressure on interest rates.

After confirming the close relevance test, the Court considered some cost items in detail including cost of capital and bad debts. The Court found that cost of capital (the cost of funds used to finance a business) was too remote from any particular transaction to justify recovery through fees, but rather was a general business overhead which ought to be recovered in the interest rate. In relation to default fees, MTF argued that it was preferable for the cost of bad debts to be recovered through a default fee (charged to those temporarily in default) rather than via the interest rate charged to all debtors (including those who are not in default). The Court rejected this and said the cost of bad debts is more appropriately recovered through the interest rate charged to all borrowers. 

Outcomes

The way the close relevance test has played out at a practical level in the Sportzone case has required the lower courts to delve into a detailed line by line assessment of MTF's costs and consider evidence about the connection between its costs and the activities for which it charges fees. This has now been confirmed as the correct approach under the CCCFA. Interestingly, the Supreme Court also recognised that the reasonableness standard set by the CCCFA is imprecise, difficult to apply, and that often a creditor will need to set its fees in circumstances where it may not have precise information on its costs.

One of the points of emphasis for the Supreme Court was that costs which do not meet the close relevance test may otherwise be recoverable in the interest rate. The rationale is that this will create better comparability of credit offerings as consumers can focus primarily on the interest rate. It remains to be seen if consumers will be better off as a result of this approach. 

Now that the test has been finally determined, lenders are well-advised to assess which of their costs are closely connected to the activities for which they charge fees (e.g. loan establishment, account maintenance and customer default), to compare their current fee levels in light of that cost analysis, and to take advice if there is any uncertainty as to how those fee levels compare. ​ 

1 [2016] NZSC 53.
2 Where the borrower is a natural person and the loan is for personal, domestic or household purposes.
3 [2013] NZHC 2531.
4 [2014] NZHC 2486.
5 [2015] NZCA 78.

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

*Sophie East is a partner at Bell Gully and Jane Standage a senior associate. This article first appeared here, and is used with permission.