The law relating to penalty charges

When a customer opens a bank account, he or she enters into a contract with the bank. That contract is governed by the laws of contract. These laws are derived from statutes enacted by Parliament; and by cases which have been determined in the courts over the years and have established precedents which are followed by judges in subsequent cases.

When a bank makes charges to a customer for services provided, these form part of the terms of the contract, and, within reason, provided the customer has agreed to them, these charges can be at any level and the customer is legally obliged to pay these charges.

When a bank customer exceeds their overdraft limit, they are breaking a term of their contract with the bank, i.e. that they should not do anything that causes their account to break the overdraft limit. This may be explicitly stated in the original agreement that the customer signed when opening the account, or it may be implicit in the way that the account is supposed to be operated.

If the bank says that there is an “agreed overdraft limit” it is implicit that anything above this amount is “not agreed” and, therefore, the customer is breaking the contract by causing the limit to be breached. This breach may have been deliberate, where the customer knew that he or she would break the limit, or it may have been accidental, where the customer did not realise that their action would break the limit.

When the customer does this, the bank will either allow the transaction to go through and the customer’s negative balance will exceed the limit, or the bank will return the cheque or direct debit and refuse to honour it. In either case, the bank will generally impose a charge on the offending customer’s account.

These charges are typically large, e.g. £40-60 for exceeding the limit, then, possibly, a further charge of £3-10 per day that the account remains over the overdraft limit or a fee of £45-65 for returning an unpaid cheque or direct debit.