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Liquidated damages and unenforceable penalties
These charges are not charges for providing services under the contract; they are charges imposed because the customer has breached the terms of the contract. Under contract law, when either party to a contract breaks a term of the contract, the other party is entitled to recover damages for this breach.
They could sue the other party in the courts to recover the damages. As this would not be very sensible for every minor breach of a contract, the law allows parties to a contract to agree in advance what damages would be payable if either party breaks a term of the contract. If the sum payable appears to the courts to be a genuine pre-estimate of the damages that are likely to be incurred, the courts will accept that this sum is what is called liquidated damages and the offending party will be obliged to pay this sum.
However, if the sum specified in the contract is not a genuine pre-estimate of the loss that will be incurred but is excessive and is inserted in terrorem (from Latin, as a warning or deterrent, basically to frighten the other party) the courts call this a “penalty” and will not enforce it.
Therefore, in the case of financial institutions and their customers, the charges made by them because the customer has broken their overdraft limit or not made a payment on time should not exceed the damages that the bank has suffered because of the customer’s breach of contract. If the sum payable is excessive, it will become a penalty and will be unenforceable by the courts.
The damages that the bank suffers if the customer’s overdraft limit has been exceeded are:
a) the customer now owes the bank more than he or she previously did, and, obviously the bank is entitled to recover this amount, but they will do so in due course anyway plus interest (unless the customer defaults all together)
plus:
b) the costs incurred in notifying the customer of the incident. However - does it really cost a bank £20 to send a computer generated, automated letter to the customer to notify them that the account has breached the overdraft limit?
The damages that the bank suffers if they have to return a cheque or direct debit are merely the cost of sending the cheque back to the other bank or notifying them that the direct debit cannot be paid, plus the cost of notifying the offending customer. Does it really cost £30-35 to do these things when these processes are virtually all automated and computer-generated, generally without any human intervention?
It would seem to be very difficult for any bank to justify their charges as being liquidated damages and, as far as we know, there have been no cases where a bank has been prepared to go to court to defend their charges.
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The case of Laura Sanders
Laura Saunders v. Yorkshire Bank (2005)
Can Bob fix it? For Laura, he can
Laura is a young woman who had a current account with Yorkshire Bank. She had a job and she had an agreed overdraft limit of £500.
In January 2004, Laura lost her job and was then trying to manage on Job Seeker’s Allowance of just £44 per week. Yorkshire Bank promptly notified her that they were going to reduce her overdraft limit by £50 per month until it reached zero, i.e. over the next 10 months.
Over the next 10 months, Laura desperately tried to repay the money that she owed, but she could not quite repay it fast enough. Each month, as the overdraft limit was reduced, Laura was left with a debit balance just over the new limit. The bank promptly charged her £8 per day for each day that she was over the limit plus a further charge of £20 each month that this happened. When Laura wrote a cheque that took her over the limit or a direct debit was applied to her account that would have taken her over the limit, the bank did not pay the cheque or direct debit and charged Laura £33.
In total, from January to November 2004, Yorkshire Bank charged Laura £806 in penalty charges on an account that had at no time been more than £500 overdrawn.
In November 2004, Laura finally managed to pay off the balance and closed her account. She then made a claim in the Small Claims Court (County Court) for recovery of the charges of £806 plus interest on these charges and court fee of £80. The bank at first submitted an acknowledgement of claim within 14 days which gave them another 14 days to file a defence to the claim. They did not file a defence, and on 13 January 2005, judgment was entered against Yorkshire Bank for the full amount plus further interest from the day of the claim.
New! Read the Press Release done by Andrew George M.P. about Laura vs. Yorkshire Bank.
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Some other examples ...
Mark Isles v. Alliance & Leicester (2004)
Mark did a law degree a few years ago and remembered the penalty/liquidated damages clauses section in the textbook on contract law.
In summer 2004 he had a contretemps with Alliance & Leicester when they charged him £25 twice for going £105.41 over his agreed overdraft limit for 2 days.
A quick look in Anson's Law of Contract, [ANSON, W.R. Anson's Law of Contract. Oxford: OUP, 2002] and sure enough, even after all these years, it still makes reference to the distinction between liquidated damages and penalty clauses.
Had Alliance & Leicester taken any positive action apart from sending Mark a couple of computer-generated letters, he could see that his going overdrawn might have cost them some money - they also charged him interest for going overdrawn, which he did not dispute.
But as it was, Mark could not avoid the belief that the above mentioned charges were a fine, intended to punish him for going overdrawn and generate profit for Alliance & Leicester, rather than compensate them for their actual loss.
Needless to say, A & L refused to budge when Mark complained (even when he quoted the above) and so, on the above basis, he launched an online money claim against them for the charges plus £50 for his time and trouble.
They paid up in full.
Yorkshire Bank is dragging its feet...
By 31 January, the bank had still not paid the amount due. Laura, represented by a tenacious friend, who wants to be known only as Bob, then considered issuing a warrant of execution (i.e. sending in the bailiffs).
Before doing so, a phone call was made to the bank advising them that the warrant was about to be issued. This produced a flurry of phone calls first from the bank itself and then from their solicitors (3 calls in 25 minutes) trying to negotiate a deal involving a confidentiality clause.
Their offers were refused and finally the solicitors agreed to pay the full amount plus the bailiff’s fee which had by then been incurred.
So, at 9 a.m. on 1 February, a cheque for the full amount including costs (£972.22 in total) was received by Laura.
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