In a settlement reached with the Commerce Commission, Foundation Custodians, a non-bank financier, has admitted breaching the Credit Contracts and Consumer Finance Act (CCCF Act) and the Fair Trading Act in relation to fees charged on early loan repayments. The company will provide refunds of $200,000 to affected customers.

Loan documents issued by Foundation Custodians stated that in the event of a fixed-rate loan being paid back before its full term, the formula used to calculate any break fee would be the 'safe harbour' formula which is set out in the CCCF Regulations. However, between August 2008 and September 2009, when a customer wanted to repay a loan early, Foundation Custodians used a different formula when calculating the fee to be charged, which was based on changes in wholesale interest rates. This resulted in higher break fees being quoted and passed on to customers. The company did not notify customers that it was using a different formula.

Under the CCCF Act, lenders must set out in the contract how they are going to calculate any break fee in the event that the customer elects to repay their loan early. By using a formula that was different to the one set out in the contract, Foundation Custodians admitted that it breached the CCCF Act. Foundation Custodians also admitted that using the different formula was liable to mislead its customers about the cost of break fees and breach the Fair Trading Act.

"Consumers are entitled to presume that the terms and conditions that are in the credit contract will be followed by their credit provider. As the formulae that mortgage providers use to calculate break fees is complicated, it is difficult for the average consumer to work out whether they have been charged the correct fee. It is important that businesses providing consumer credit ensure that their conduct is consistent with the contract and complies with the relevant legislation," said Graham Gill, Commerce Commission Fair Trading Manager, Auckland.

"Foundation Custodian's customers believed and were led to believe that the safe harbour formula would be applied and they were misled when Foundation Custodians applied a different formula without notification of the change. The misrepresentation had detrimental consequences both for customers repaying and those seeking quotes to repay," said Mr Gill.

The Commission accepts that at the time Foundation Custodians started applying the incorrect formula, it believed that fee it charged would be reasonable and would not produce a higher charge than the safe harbour formula.   Foundation Custodians has cooperated with the Commission's investigation and has agreed to recalculate the break fee that should have been charged to their customers who prepaid their loans between 1 August 2008 and 8 September 2009. Total refunds of about $200,000 will be provided to the 35 affected customers.

During the investigation, Foundation Custodians informed its existing customers that there had been a change in the way that the break fees would be calculated to comply with the CCCF Act.

Background

Foundation Custodians Limited is a New Zealand based non-bank mortgage provider. It began lending in July 2006. In December 2008, Foundation Custodians stopped fixed rate lending and in February 2009 suspended all new lending.

A break fee, or prepayment fee, is a fee charged by a creditor to recover its loss when a customer repays their loan early. Under the CCCF Act creditors are entitled to recover their loss when a customer makes an early prepayment or breaks the term of a fixed interest loan, as long as the creditors use what the CCCF Act describes as an appropriate procedure to calculate a reasonable estimate of loss.

Section 54 of the Credit Contracts and Consumer Finance Act 2003 states:

(1) A creditor must calculate a reasonable estimate of its loss arising from a full prepayment using -

(a)       a procedure prescribed for the purposes of this section by regulations; or

(b)     an appropriate procedure set out in the consumer credit contract for calculating that loss.

(2) If a creditor uses a procedure prescribed for the purposes of this section by regulations, the amount calculated is to be treated in any court and in any proceedings under this Act as a reasonable estimate of the creditor's loss.

The safe harbour formula. The procedure set out in the CCCF Regulations is colloquially known as the safe harbour formula.   It is based on the movement in retail rates.   If a creditor follows the safe harbour formula, then the creditor will be assumed to have assessed a reasonable estimate of loss in accordance with section 54(2) above.

Disclosure under the CCCF Act. The CCCF Act requires creditors to provide particular disclosure to all debtors entering into consumer credit contracts.   Information required to be disclosed includes the method of calculating the fee charged by a creditor to compensate it when a consumer credit contract is repaid early.

Section 13(g) of the Fair Trading Act states:

No person shall, in trade, in connection with the supply or possible supply of goods or services or with the promotion by any means of the supply or use of goods or services, ….make a false or misleading representation with respect to the price of any goods or services.

Only the Courts can decide if the CCCF and Fair Trading Acts have been breached and set appropriate penalties.