In a decision that will be intently studied by the finance industry and borrowers alike, the supreme court today refused to decree that the differential between base and default interest rates are a de facto illegal “penalty” but conceded that the “well-established” rule that protects such practice “may have unsatisfactory origins” and that “the time may have arrived for it to be replaced”.
In the same ruling, the mezzanine lender to a 2009 Noosa hinterland property purchase, was found to be in breach of s 12CC of the ASIC Act and s 51AC of the Trade Practices Act because “capitalisation of interest at such a high rate imperilled any prospect that the borrowers had of being able to pay out the loan balance” and was “irreconcilable with what is right and reasonable”.
PSAL Limited – part of an “established segment of the commercial finance industry which provides customers with an alternative to traditional finance” – provided last minute two month $1.2 million finance to nurse-investor Wendy Kellas-Sharpe, as the worst of the GFC was thought to be fading, in December 2009.
The loan was on the time honoured terms of a “standard” interest rate of 7.5% per month and a “concessional” rate if payments were made promptly – and if the borrower was not otherwise in default – of 4% per month.
Noting that the rule allowing interest rate spreads “has been recognised for more than 300 years, and has been restated in recent times by Australian courts …. and recognised by judges of the High Court” his honour decided “I do not consider that it is open to me to not follow it”.
Its commercial effect did not therefore attract the doctrine concerning the avoidance of illegal penalties in contracts.
The borrower also demanded the loan rates to be varied, claiming they were unconscionable – because of the high interest rate and the capitalisation of interest – pursuant to the ASIC Act and the TPA.
This she claimed arose from the “superior bargaining position” of the lender who had used “unfair tactics” and had “unconscionably exploited [her] necessitous circumstances …to extort from her exorbitant interest rates”.
To appreciate what follows in the contest, readers must hear more of our story.
As settlement for the Lake Cooroibah property bore down, Wendy engaged a further finance broker in a series of intermediaries to find “the cheapest interest rate possible”. Her ultimate broker Scott Wiley, executed her request in part only, warning that PSAL’s “rates won‘t be kind”.
Wendy’s intention was to refinance with a long term funder she hoped, in vain, to find during the period of the short term loan.
Evidence was that PSAL itself obtained funds – at a time when “smaller banks had withdrawn from some market segments and other non-bank lenders had tightened their credit policies – by borrowing money from investors at 30% per annum and that at the time short term rates ranged from 1.5% to 12% per month.
Given this background, the court felt comfortable in ruling that the rate of 7.5% per month was not unconscionable.
A victory for PSAL so far, but the sting was still to come in the tail.
Capitalisation at such rates “for a period of months and years” – and which yielded interest of $460,000 in just 5 months – was indeed unfair and denied the borrower “any real prospect that they had of being able to refinance the mortgage debt”.
As stated by his honour: “It would not have been unjust for that higher or default rate to be charged for a period of a few months during which time the borrowers were given a reasonable opportunity to refinance. However, continuing to charge that rate of interest, capitalised monthly, for the long period during which interest was charged at the default rate was unconscionable…. By mid-2010 the loan had ceased to be a short term loan and the capitalisation of interest at such a high rate imperiled any prospect that the borrowers had of being able to pay out the loan balance.”
Noting the broad discretion under the remedy provisions of the ASIC Act and the TPA, his honour substituted a new “default” rate of 5% in lieu of the 7.5% that had been documented and allowed capitalisation at that lower rate.
The instruction in this case is derived from the latter points on how capitalised high rates can be unfair over longer terms.
As to the penalty rate issue, it will take immense borrower desperation – and money – to battle through the appellate level to the High Court, the only forum able to reformulate judicial thinking on this pervasive issue.