Civil penalties – compliance at a cost

By Simon Haines, senior solicitor, Russell McVeagh

Why are there so many regulatory regimes that can now be enforced by civil penalties? Why are the penalties becoming increasingly severe? What are the social costs of this?
 
It seems that lawmakers are looking for ways to make businesses comply with regulatory regimes that avoid the cost of prosecution resources and the process of criminal sanctions. Civil penalties appear to be the vehicle that promises to deliver in this regard. (See commentary on “Civil Regime Versus Criminal Regime” in the Telecommunications Amendment Bill as reported from the Finance and Expenditure Committee.)

An Australian study describes a civil penalty in the following way:

“Civil penalty provisions have been described as a hybrid between the criminal and the civil law. They are clearly founded on the notion of preventing public harm. The offence itself may be similar to a criminal offence (for example, breaches of a company director’s duties) and the purpose of imposing a sanction may include an element of punishment of the offender; however, the procedure by which the offender is sanctioned is based on civil court processes.”
(Australian Law Reform Commission, “Securing Compliance – Civil and Administrative Penalties in Federal Regulation” Media Briefing, 23 May 2002).

Given that the civil penalty is a hybrid creature, the introduction of a civil penalty regime may require a number of trade offs. Civil penalty regimes can come at the cost of a number of protections built into the criminal justice system:
• There is often a reduction in process requirements that must be met before a penalty can be imposed upon an individual;
• Civil investigation regimes can abrogate fundamental rights, such as the right against self-incrimination; and
• Civil penalty provisions are often of a strict liability nature.

Therefore, whenever a civil penalties regime is proposed, it must not go too far in terms of surrendering useful legal protections to achieve the compliance objective of the regime.

Challenging a civil penalty regime
On at least two recent occasions, the Legislation Advisory Committee (LAC), a body made up of senior members of the legal profession, has made submissions against civil penalty regimes that have subsequently become law in New Zealand. One occasion was in 2006 when the Telecommunications Act 2001 was amended to introduce a civil infringement regime for telecommunications businesses. Another occasion was in relation to the civil penalty regime under the Unsolicited Electronic Messages Act 2007. In both instances, the fundamental concern was the same; the proposed penalties were set so high that the LAC considered that the process protections of the criminal law should apply. The introduction of these two regimes, despite the position of the LAC, suggests that the penalties now being provided under civil penalty regimes may be increasing to a point where the prosecution expediency versus legal protection balance is being shifted too far in favour of compliance. (It should be acknowledged that the civil infringement regime under the Telecommunications Act was ameliorated following further advice from the LAC before it was enacted. ‘Reasonable excuse’ defences apply to some obligations, and other provisions now have a mens rea element that must be proved. However, it remains a civil penalty regime.)

The practical costs of a civil penalty regime
In addition to the rights and protections that are surrendered when a civil penalties regime is introduced, more practical costs also need to be counted. Fundamentally, businesses are forced to spend time and money meeting their compliance obligations. This then raises the price of the goods or services for consumers. This cost of regulation has been acknowledged by the Quality Regulation Review led by the Ministry of Economic Development, which has the purpose of removing unnecessary compliance burdens on businesses. However, the more subtle point about civil penalties (that was not considered in the Review) is that the magnitude of penalty that a regime imposes can govern the overall cost to society of the regime.

Threat of moderate penalties will create incentives for a regulated business to take certain reasonable steps to comply. Threat of high penalties, on the other hand, will create incentives for a regulated business to build more extensive compliance systems to make certain that it will not fail to comply. Therefore, the higher the maximum penalty, the greater the burden that a regime imposes in terms of costs passed on to the consumer. 

The question this raises is whether some of the penalties that are currently being introduced into the legal system are being set too high, thus requiring businesses to take excessive compliance steps which may, on balance, be harmful to the economy.

For example, the manufacture and supply of homeopathic and herbal remedies is currently unregulated in New Zealand. The Therapeutic Products and Medicines Bill 2006 (now suspended) would have imposed a compliance regime under which civil penalties of up to $5.5 million could be enforced for breaches of an administrative nature. The threat of such severe penalties is likely to create incentives for businesses either to implement elaborate measures to ensure that they do not breach or to exit the market altogether. This is likely to drive up prices and/or result in less choice for consumers as businesses exit. In this way, the civil penalty regime may operate to the detriment of the competitive process. The question is, why raise compliance requirements to such a level when the products themselves are acknowledged to be of a low risk nature? (Page 83 of the Regulatory Impact Statement to the Bill under the subheading “Complementary medicines” states, “Most complementary medicines contain ingredients with a very low inherent risk.”)

A matter of design
As well as the magnitude of penalty, it is equally important to consider the design of the regime. For example, if breaches are triggered too easily, the perception is created that businesses will inevitably breach the regime, no matter what they do, and the cost will be in some form of diminishment in service or increase in cost to consumers.

The electricity lines sector is an example in which this is an acknowledged problem (see “Potential Issues With the Current Regime” in Review of Regulatory Control Provisions Under the Commerce Act 1986: Discussion Document, Ministry of Economic Development, April 2007). In essence, electricity lines businesses currently are required to operate within certain revenue and quality thresholds under Part 4A of the Commerce Act 1986. (They are only able to earn a particular revenue in any given year and have a maximum number of faults, and maximum duration of faults, in any given year.) If a lines business crosses these thresholds by any amount, for any reason, the Commerce Commission may consider whether or not to declare control of that business.

Control is arguably not a penalty as such but a form of economic correction to a business. However, from the perspective of the regulated, it is an outcome that potentially has severe financial consequences, and thus has the same practical deterrent effect as a penalty.

One fundamental problem with the regime is that the thresholds were designed in such a way as to cause lines businesses to frequently breach for reasons beyond their control. Since 2003, there have been over 100 breaches of the thresholds, with the consequence that most, if not all, lines businesses have technically been considered, or are due to be considered, for control by the Commerce Commission. This (along with other factors) has proven to be an untenable situation for the sector, and as a result, there has been insufficient investment. Arguably, the losers in this have been the public. They rely on electricity distribution networks that, as a result of investment, are not necessarily as robust as they ought to be, and they may have to pay substantially increased prices when the necessary investment does eventually occur.

The Commerce Amendment Bill (Bill), which is primarily motivated by a desire to restore confidence to invest, is currently before Parliament for the redesign of the regulatory settings for the sector. Unfortunately, the Bill does not entirely fix the problem described because it retains the current thresholds that can be triggered for reasons beyond the control of the lines business for at least two years after its enactment, and civil penalties can apply whenever there is a breach, however caused. Therefore, at the very least, there is a case for some form of defence to be written into the penalty provisions to ameliorate this problem.

Often when there is a perceived problem with the way in which a regime is being enforced, the regulator is held to blame. However, the regulator is merely administering a regime that it has been given under statute. It is at the design stage that greater consideration of the consequences of a regime should occur. The legal profession, with its interest in protecting the rights and freedoms of individuals, is best placed to monitor emergent enforcement regimes and to ensure that the price of achieving compliance is not set too high.

NZLawyer, 16 May 2008