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Early Repayment Fees, unconscionability & unfair contract terms – Australian regulator releases guidance for mortgage lenders

Early Repayment Fees (also known as prepayment penalties in the US or early termination fees or exit fees in Australia) will be assessable for unfairness in Australia, meaning that even a term that complies with consumer credit law may still be judged as unfair.

ASIC sets out expectations of lender practices on mortgage early termination fees, 10-234MR, 10 November 2010
REP 216 Response to submissions on CP 135 Mortgage exit fees: Unconscionable fees and unfair contract terms
Download the report | Read the media release | Read CP 135 | Read the regulation impact statement

10-234MR ASIC sets out expectations of lender practices on mortgage early termination fees

Wednesday 10 November 2010

ASIC today released guidance for mortgage lenders that sets out how provisions in the National Credit Code and unfair contract terms law apply to mortgage early termination fees (exit fees).
This follows consultation leading up to and after the 1 July 2010 start date for the new legislation.
Regulatory Guide 220 Early termination fees for residential loans: unconscionable fees and unfair contract terms (RG 220) spells out ASIC’s guidance on points including:

what costs and types of loss can be included in exit fees
types of loss that should not be recovered through exit fees
the limited circumstances in which a lender may vary exit fees during the life of a mortgage.

A summary of key points in RG 220 is attached to this media release.

ASIC Chairman Tony D’Aloisio said the guidance would ensure that lenders are clear on ASIC’s expectations of their conduct. ‘The law limits these fees to the recovery of a lender’s loss caused by the early termination. Lenders cannot use exit fees to discourage a borrower from switching their loan or to punish them for doing so.’ Mr D’Aloisio said he anticipated that – in light of the guidance published today – lenders would review their practices and their fees to ensure they comply with the law. Mr D’Aloisio said that ASIC’s initial focus will be on the highest fees in the market as they create the biggest barriers to switching. ‘We will challenge lenders who charge high fees to justify how their fee reflects actual losses caused by early termination. Where an exit fee cannot be justified by the lender, ASIC will take compliance or enforcement action.’ Mr D’Aloisio also said that fees must be limited to the losses that occur at the time that the early termination takes place. ‘Generally, the longer the consumer has had the loan, the smaller the exit fee should be.’ In addition, the law prevents double-dipping: ‘Lenders that charge establishment fees must ensure that they don’t charge consumers for the same costs a second time through an early termination fee.’ ‘ASIC is also aware that lenders may recover some losses from third-parties (e.g. a broker) when an early termination occurs. Any early termination fee must be reduced where this is the case.’ Mr D’Aloisio said that consumers who have concerns about exit fees can take a dispute to the lender’s external dispute resolution (EDR) scheme, and have their specific case heard and resolved by an independent party. Consumers can also complain to ASIC on 1300 300 630 or online at www.asic.gov.au/complain.

Importantly, the law and - ASIC’s guidance on it - does not prevent lenders, including smaller lenders, from using flexible pricing, including by offering discounted establishment fees or honeymoon-rate loans.

Background

The applicable laws – under which an exit fee can be challenged in court – are:

the National Credit Code which is part of the National Consumer Credit Protection Act 2009
the Australian Securities and Investments Commission Act 2001 (ASIC Act).

The National Credit Code applies to home mortgages that were already in existence on 1 July 2010, or which have been established since then. The Code allows courts to review certain lender’s charges – referred to the courts by ASIC or a consumer – on the grounds they are unconscionable.

Under the Code, a court can annul or reduce an exit or pre-payment fee if the court determines it exceeds a reasonable estimate of the lender’s loss arising from early termination or pre-payment (i.e. the fees are found to be unconscionable under the National Consumer Credit Protection Act).

Under the unfair contract terms provisions of the ASIC Act, terms in a contract are unfair if:

they would cause a significant imbalance in the parties’ rights and obligations arising under the contract,
they are not reasonably necessary to protect the legitimate interests of the party who would be advantaged by them, and
they would cause detriment (financial or otherwise) if they were to be relied on.

In order to be ‘unfair’ under the unfair contract terms provisions, terms in a contract must meet all three tests. A court can declare terms void if the court finds the terms are unfair. The court may also make orders directed at redressing the loss suffered by consumers as a result of the unfair terms.

Under the National Consumer Credit Protection Act, lenders must be a member of an ASIC- approved EDR scheme. The two approved schemes are the Financial Ombudsman Service and the Credit Ombudsman Service Limited.

Today’s guidance follows consultation – which included representatives of consumer interests and lenders – that began in June 2010 with a consultation paper (Consultation Paper 135 Mortgage early exit fees: unconscionable fees and unfair contract terms (CP 135)).

For further information:
ASIC Media Unit
Telephone: 1300 208 215
Email: media.unit@asic.gov.au

Download:

Summary

Key issue	Summary of ASIC guidance
What is an early exit fee?	Any fee payable on early termination of a residential loan, generally including deferred establishment fees.
Types of costs and losses which may be able to be included in an exit fee	break fees when a fixed rate loan is terminated administrative costs (e.g for processing the early termination and calculating the payout figure) third party costs that arise because of the early termination costs that have not been recovered because a loan with a honeymoon or introductory interest rate is terminated early unrecovered establishment costs arising from a lender’s inability to recover establishment costs during the shortened period the loan was on foot.
Types of costs and losses which may not be included in an exit fee	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 costs associated with developing new products.
The limited circumstances in which a lender may vary an exit fees	Lenders will generally not be allowed to increase early exit fees on variable rate loans after the loan has commenced, particularly if the early exit fee comprises unrecovered establishment costs.
How lenders can explain their early exit fees transparently	explaining in a meaningful and clear way when the fee will be charged clearly stating the amount in dollars of the fee or, if that is not possible, the method of calculation using prominent warnings to explain risks associated with early termination fees, particularly break fees using meaningful worked examples of break fees, as long as they can be provided in a way that is not misleading.
Break fees on fixed rate mortgages	The break fee must reflect the cost incurred by the lender because the loan was terminated early.

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Article from Freehills (Tony Joyner, Alison Williams and Rupert Baker), November 17 2010
http://www.lexology.com/library/detail.aspx?g=fa9ec9ee-f88c-4878-aba0-4164c60ae2cd

Applying the unfair terms provisions of the ASIC Act: ASIC guidance on early termination fees for residential loans

Freehills, Tony Joyner, Alison Williams and Rupert Baker,November 17 2010

In brief

Early termination fees will be assessable for unfairness because they will not be regarded as the main subject matter or the contract or part of the upfront price.
ASIC has provided guidance on how it will apply to the test of unfairness to early termination fees.
A term that complies with the provisions of the NCC may still be unfair.

Introduction

Following consultation in June,1 ASIC has now released its guidance paper on early termination fees for residential loans. The paper is called Regulatory Guide 220 – Early termination fees for residential loans: Unconscionable fees and unfair contract terms, November 2010 (RG 220).

RG 220 provides guidance on how ASIC will apply the law on unconscionable fees under the National Consumer Credit Protection Act 2009 (Cth) (National Credit Code) and the law on unfair terms in contracts under the new Australian Consumer Law to early termination fees in residential loans.

One of the key points emphasised by ASIC in RG 220 is in relation to section 12BI of the ASIC Act 2001 (Cth) (ASIC Act) which states that the unfair contract terms provisions do not apply to terms that define the ‘main subject matter’ of the contract or set the ‘upfront price’ payable under a contract. ASIC advises that it will administer the law on the basis that terms imposing early termination fees (including deferred establishment fees) generally do not fit within either of these categories and are therefore covered by the unfair contract terms provisions (see: RG 220.51–55). ASIC states that the subject matter of a residential loan primarily relates to lending money and repaying the money lent.

ASIC advises that determining whether a term of a contract is unfair will ultimately depend on the facts of each individual claim. However, ASIC considers that a contractual term providing for an early termination fee which is unconscionable under the National Credit Code is also likely to be unfair under the unfair contract terms provisions.

ASIC’s guidance on the elements of unfairness

Significant imbalance

Pursuant to the terms of the legislation, a term will be unfair if it:

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

ASIC notes that:

assessing imbalance requires a factual assessment of the evidence to see if imbalance is created in the context of the contract as a whole, and
in the Australian market, most residential loan agreements give lenders an unfettered right, or a right subject to few restrictions, to vary the interest rate of the loan. This could be considered by a court when assessing unfairness.

ASIC is of the view that where the loan agreement gives the lender an unlimited unilateral right to vary an early termination fee or the circumstances in which the fee applies, the balance is not maintained. The reasoning is that there is no limit on the amount of the fee that can be charged and such a term does not allow the consumer to negotiate the fee under the contract.

Legitimate interests

ASIC provides an indication of what it does and does not consider to be a legitimate interest (see: RG 220.68–70).

ASIC considered that fees related to the lender’s reasonable costs arising directly from the early termination or break fees that reflect the amount needed to recover the lender’s loss from a fixed rate loan being terminated early are likely to be considered as reasonably necessary to protect the lender’s legitimate interests. In contrast, an early termination fee that has the effect of penalising the consumer for terminating the loan is not likely to be reasonably necessary to protect the lender’s legitimate interests. ASIC also considers that a term imposing such a fee is likely to be unfair.

Detriment

Examples provided by ASIC of ‘detriment’ resulting from contractual terms imposing early termination fees include:

taking longer to ‘break even’ when refinancing
having to enter into further debt to pay the early termination fee and exit the loan
being prevented from switching to a loan that is more suitable, and
having the terms changed unilaterally by the lender in a way that is unfavourable to the consumer.

ASIC indicates that the amount of detriment suffered is not of relevance.

Notes to lenders

ASIC advises lenders to explain early termination fees as transparently as possible including:

explaining in a meaningful and clear way when the fee will be charged
clearly stating the amount in dollars of the fee 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 the example can be provided in a way that is not misleading.

Interaction between the National Credit Code and the ASIC Act

Interestingly, ASIC notes that the difference between the test under the National Credit Code and that under the ASIC Act could have the effect that adequate disclosure under the National Credit Code will not constitute transparency or fairness under the ASIC Act. This is something that many people are unlikely to appreciate.

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