A property investor buying into Sydney’s prestigious Point Piper has successfully challenged the propriety of a lender’s charges by proving some of are illegal as a loan default penalty.
Australian Property Enterprise acquired the luxury unit in November 2018 with a $1,725,000 loan repayable in 12 months.
The security granted to lender N & M Investments was not only a mortgage over the subject property but one over “all other real property owned” by the borrower and each of three guarantors. It thus extended to two other units in Point Piper and two units in Wolli Creek.
The loan provided for interest at 14.5% per annum or at a lower rate of 10.5% if all terms of the loan were strictly observed.
Interest payments were duly made for the first three months of the loan but that due in February 2019 was missed, triggering a default which had not since been remedied.
The lender – in reliance on a “conclusive evidence” certificate as to arrears – filed proceedings in June 2020 seeking judgment for $555,000 against the borrower and guarantors.
That sum included $29k as a “Further Establishment Fee” and $75/day by way of a “Default Loan Management Fee” mandated by the loan terms as payable in the event of any default.
By the time the matter came before Justice Rowan Darke in the NSW Supreme Court in November 2021, the borrower conceded its default but contested the propriety of both default fees, the latter of which had by then accumulated to over $100,000.
The lender sought to justify the additional establishment fee on the basis that the default had prevented it from “recycling its investors funds into a new facility with a new borrower” and also increased the risk of reputational damage.
The Default Loan Management fee was also justified – it claimed – on the basis of the additional effort required to manage a loan in default.
The borrower argued on the other hand that both charges were a loan default penalty and that it was unconscionable of the plaintiff to collect them.
It was revealed through the course of evidence that the lender had contracted a loan manager – Pacific 8 Pty Ltd – for whose services the lender allocated the establishment fee and 1.5% of the 10.5% per annum interest on the outstanding loan.
And when the default interest rate kicked in, the loan manager received half of the additional 4% interest.
It was an officer of Pacific 8 – Adam Tilley – who gave all the evidence on behalf of the lender. That company and not the lender held the requisite Australian Financial Services Licence but was not a party to the court proceedings that were brought in the lender’s name only.
Justice Darke explained that amounts that become payable only upon the event default engage the doctrine of penalties but can only be characterised as “penal” if they are for a sum that is extravagant and unconscionable or “out of all proportion to the interests of the party which it is the purpose of the provision to protect”.
The evidence made it clear that although the additional fees were – in both cases – for the loan manager’s benefit, no genuine interest had been identified on its part to justify their imposition.
The stated rationale could not be said to represent a “genuine pre-estimate of the loss” that would likely be sustained by the lender upon the borrower’s default.
In his honour’s view the additional payments were “extravagant and unconscionable and out of all proportion to the interest of N & M that it seeks to protect”.
The provisions were intended to operate in terrorem “to deter default by threat of punishment”.
His Honour ordered that the arrears be re-calculated without regard to the two charges that he had judged to have been a loan default penalty.
By arriving at that conclusion, it was not necessary for the court to consider whether the charging of those fees would otherwise amount to unconscionable conduct on the part of the lender.
N & M Investments/Properties Pty Ltd v Australian Property Enterprise Pty Ltd  NSWSC 1370 Darke J, 12 October 2022 Read case