Banks launch final battle to avoid £1bn charges payout

Two-year fight against compensation to end with House of Lords ruling

High street banks took their two-year legal battle over bank charges to the House of Lords yesterday in an attempt to avoid paying out £1bn in refunds to current-account holders.

The three-day test case will establish whether fees of up to £35 for unauthorised overdrafts fall within unfairness legislation, as the Office of Fair Trading (OFT) argues.

The High Court and the Court of Appeal have ruled that overdraft charges are subject to the 1999 Unfair Terms in Contracts regulations, but the banks have refused to accept the judgments, winning the right to appeal to the House of Lords.

If this week's hearing goes against the banks, the office is likely to declare the charges unfair in law and demand that they be lowered or scrapped.

Unless the seven financial institutions can find another way of thwarting the OFT – which could involve a legal challenge against any declaration that the charges are unfair – the banks will be forced to pay back £1bn in claims on hold and settle cases with 65,000 litigants pursuing them through the courts. They would also have to reduce the £2.6bn charges they make from overdraft fees each year.

Six banks – Abbey, Barclays, Clydesdale, Lloyds and HBOS, HSBC, and RBS – and the Nationwide Building Society are contesting the case which the OFT launched in April 2007. In a controversial "waiver", the Financial Services Authority agreed financial institutions could put all claims against them (except for "hardship cases") on hold while the case went through the courts. Prior to the waiver, banks had paid out £559m in refunds to customers.

The Independent has fought a campaign against overdraft fees, which are estimated to cost current-account providers no more than £2.50 each.

Opening the banks' case yesterday, Jonathan Sumption QC, for Barclays, told five law lords that the charges involved a cross-subsidy from wealthy to indebted customers but denied the banks were acting as "Robin Hood in reverse". An OFT victory might render all past overdraft payments unenforcable, he said. "The issues are of considerable importance to consumers and the future of retail banking."

Four senior judges have rejected the banks' arguments in the past 14 months. High Court judge Justice Andrew Smith ruled against them last April. In February, three appeal court judges backed that ruling and refused the right to appeal to the Lords. In April, the Lords agreed to hear the matter. Last night, the consumer group Which? said that banking customers had still not had justice. "It's disappointing that nearly two years since this saga began, little has changed for the millions of consumers being hit with these charges," said its chief executive, Peter Vicary-Smith. "If you're struggling with basic living costs such as rent and utility bills then you may be eligible to get your claim fast-tracked under the terms of the waiver."

The personal finance campaigner Martin Lewis said: "The banks have used lawyers as a calculated weapon deliberately to delay claims.

"The High Court and the Court of Appeal have both ruled against the banks and the Court of Appeal did not want the banks to be able to appeal to the House of Lords. The law is very clear that bank charges are governed by unfairness regulations and the banks have never really argued they are fair in law if the regulations apply – yet the regulator has put on hold consumers' ability to reclaim charges."

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