The moral of the story is never to be in arrears in your loan repayments.

You should clearly understand the default interest rate which may be a significant uplift on the interest that you are now paying on your loan.

Many property investors may also be shot to learn that their loan may be considered one that is used for commercial purposes?

Therefore in a recent commercial loan that was provided by Arab Bank to a property developer, penalty interest rate clauses were held to be fair!

EXECUTIVE SUMMARY

Arab Bank provided a loan to a property developer and included in the documents a 2% default interest rate and the question was whether this 2% default interest rate was a penalty? The borrower repaid the whole of the loan but had to repay a significant extra amount

The court came to the conclusion that this default interest rate (which was added to the existing interest rate) was not a penalty because it was not seen to be punishing the borrower, it was not extravagant or unconscionable and it was not out of all proportion compared to the maximum conceivable loss that the lender could incur.

Incentive vs Penalty

The court agreed the law recognises a distinction between a clause which provides an incentive for prompt payment and a clause where the applicable rate of interest is increased upon failing to make a prompt payment.

The court further recognised that provisions which operate prospectively when the increased interest rate applied only to outstanding payable amounts post the event of default is seen not as a punishment for default, if they constitute a genuine pre-estimate of compensation to the bank for late payment.

Ultimately the court considered the imposition of the penalty rate for a minor

Arab Bank provided a loan to a property developer and included in the documents a 2% default interest rate and the question was whether this 2% default interest rate was a penalty? The borrower repaid the whole of the loan but had to repay a significant extra amount

The court came to the conclusion that this default interest rate (which was added to the existing interest rate) was not a penalty because it was not seen to be punishing the borrower, it was not extravagant or unconscionable and it was not out of all proportion compared to the maximum conceivable loss that the lender could incur.

Incentive vs Penalty

The court agreed the law recognises a distinction between a clause which provides an incentive for prompt payment and a clause where the applicable rate of interest is increased upon failing to make a prompt payment.

The court further recognised that provisions which operate prospectively when the increased interest rate applied only to outstanding payable amounts post the event of default is seen not as a punishment for default, if they constitute a genuine pre-estimate of compensation to the bank for late payment.

Ultimately the court considered the imposition of the penalty rate for a minor default was not a genuine pre-estimate of the loss which would be incurred by the Bank and awarded Sayde $352,302.00, plus costs.

Loan facilities and securities which apply a higher rate of interest, discounted upon the client making prompt payment will not generally be considered a penalty.

WHY SHOULD I READ THIS

What This Means For You!

On 17 June 2011 the defendant offered an extension of the 2006 facility in the sum of $7,050,000.00. This was referred to as the “fixed interest facility”. The interest rate was fixed at 8.54% per annum, with a default rate of 10.54%.

A distinction was made in the lower courts between minor and major defaults and if such an interest rate was applied to minor defaults it could be that this may be seen as a penalty and therefore unenforceable.

The characterization of a clause as penal needs to be assessed by reference to the evidence.

Naturally there is a distinction between commercial lending contracts and those lending contracts which are provided to non-commercial borrowers (such as residential home loans).

It is important to note that in certain circumstances then the unfair contract terms legislation may apply as well.

If you are going to assert that a clause as penal in nature then you have the onus of proof in establishing the claim.

In this particular case it is useful to look at the expert evidence and the distinction between the relevant experts as to whether a clause is reasonable unconscionable and therefore may be seen as penal.

THE MEATY PART

The 24 payments referred to were made between 20 April 2009 and 21 June 2013. Of the total sum, $50,244.44 represented default interest that was charged by the defendant in respect of repayments not paid by the due date, but which repayments were paid within three working days of the due date. Those payments represent the plaintiff’s alternative claim.

The issue in the plaintiff’s primary case therefore, is whether the charges paid by the defendant for late payment, which it referred to as “penalty interest”, charged at the default rate of interest under the facilities, on the whole amount of the debt outstanding, were penal in nature and therefore repayable to the plaintiff. Determination of that issue involves a consideration of the relevant contractual arrangements between the parties, consideration of the evidence, and in particular, the expert evidence relied on by both parties, and the application of well settled legal principles.

(See table- insert)

The court found that the payments charged, by way of penalty interest by the defendant, on the plaintiff’s account, and paid by the plaintiff on the relevant dates set out above, constituted a penalty and therefore are repayable to the plaintiff and a verdict and judgment for the plaintiff in the amount claimed of $352,302.00.

WHO ELSE IS THIS IMPORTANT FOR

Implications For Lenders And Borrowers!

• Provisions that aim to recover legitimate business costs that are not out of all proportion to the interest that it is intended to protect will not be a penalty.

• The courts will take a commercial approach in assessing similar default interest clauses. The costs that may be considered include both direct and indirect costs. These include, but are not limited to:

1. capital adequacy costs;

2. regulatory costs (compliance with Australian Prudential Standards, Basel II);

3. recovery costs;

4. provisioning costs;

5. reserve costs; and

6. head office and labour costs.

TAKEAWAY POINTS AND FOLLOW-UP

The Court adopted the commercial approach taken in the recent High Court decision in Paciocco v Australia and New Zealand Banking Group Ltd [2016] HCA 28 which affirmed ANZ’s right to charge late payment fees in relation to credit card transactions. In upholding the default interest clause by reference to evidence as to the bank’s costs arising on default, the latest decision has provided greater certainty concerning default interest charges.

Goldman lawyers are skilled and analysing these requirements under the family Law act, trusts, litigation and complex property and securities law.

Speak to a Goldman & Co senior lawyer if you are either a lender or borrower and are concerned about being overcharged or penalized or seek to review the terms of your loan agreement(s).

TECHNICAL CASE REFERENCE

Arab Bank Australia v Sayde Developments Pty Ltd [2016] NSWCA 328

The New South Wales Court of Appeal

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