The Supreme Court of NSW has decided if an interest rate of 70.72% per annum made a short-term loan secured by residential mortgage unjust.
This is an analysis of Commercial N Pty Limited v Huang & Ors [2024] NSWSC 23, a decision of the Supreme Court of New South Wales (31 January 2024).
The decision is of particular interest to practitioners acting for lenders and borrowers because his Honour Justice Henry (the Court) gave detailed consideration to the defences often relied upon by borrowers to defend loan recovery claims, namely penalty, misleading representations, unconscionable conduct and unjust contracts, in the course of a lengthy judgment of 377 paragraphs.
Facts
The proceedings were brought by Commercial N (the lender) against Ms Huang and her daughter Ms Chien (the borrowers), for possession and sale of their residence in Burwood Road, Burwood, a suburb in Sydney. The residence was sold before the hearing, and so the dispute was narrowed to the interest payable.
In September 2019, the borrowers needed to urgently refinance an expired short-term loan with Detex. Their mortgage broker, MaxFunding, sourced an indicative letter of offer from the lender for a loan of $588,000, based on the borrower’s estimate of value for the residence of $3,000,000.
On 2 October 2019, the borrowers signed Loan Documentation (principally a mortgage) for a loan of $588,000. Tthe loan amount was subject to variation according to the lender’s valuation. The loan was short-term, for a period of 26 weeks. Interest was payable monthly either at the rate of 0.35% per week (Lower Interest Rate) or at the rate of 1.36% per week (Higher Interest Rate). The Higher Interest Rate was to apply unless payments were made on the due date.
On 14 October 2019, a Deed of Variation was signed to reduce the loan amount to $430,000, in line with a 75% LVR (Loan to Value Ratio) of the lender’s market valuation of $2,600,000.
As a result, the loan amount was only enough to repay the short-term loan from Detex of $364,700 (i.e. the loan to be refinanced), and debts consisting of mortgage arrears to the National Australia Bank (the first mortgagee) of $35,300, lenders fees of $28,000 and water rates arrears of $2,000. There were no surplus funds available for the borrowers.
The interest, payable monthly in arrears, was $6,325.13 (at the Lower Interest Rate) and $25,327 (at the Higher Interest Rate) per month. The borrowers were in default almost from the start, making only one payment of interest.
The lender initially registered a caveat over the title to the Burwood residence to secure the loan, and registered a second mortgage later.
The claims and issues for determination
The lender claimed that the borrowers were indebted in the sum of $3,611,074.84 (as at 7 November 2022), comprising the principal sum of $430,000 together with interest of $3,187,486.90, calculated at the rate of 70.72% per annum, the interest compounding monthly.
The borrowers claimed that:
- the Higher Interest Rate was a penalty;
- MaxFunding, the mortgage broker which had arranged the mortgage for the borrowers had made misleading or deceptive representations on behalf of the lender;
- the lender had acted unconscionably;
- the Mortgage and Deed of Variation were unjust contracts.
They sought an order that the interest provisions be set aside.
Was the Higher Interest Rate a penalty?
The Memorandum of Mortgage contained these clauses:
“5.3 The Interest to be paid by the Debtor shall at all times be the Higher Interest Amount unless the Lender notifies the Debtor that the Lower Interest Amount is payable by the Debtor for any Interest Period.
5.4 The Lender may notify the Debtor that a Lower Interest Amount is to be paid for any Interest Period and upon the Lender giving that notice the interest to be paid for that Interest Period shall be that Lower Interest Amount.” [184]
The Court quoted Lord Dunedin: “The essence of a penalty is a payment of money stipulated as in terrorem of the offending party” (Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd [1915] AC 79 (at 86)).
The Court raised two primary issues for determination:
- Was it a collateral stipulation? “… the liability to pay interest at the Higher Interest Rate compounding monthly … does not impose an additional or different contractual liability that arises upon the non-observance of the primary contractual obligation to pay the Higher Interest Amount, but rather is payable because the reduced rate has not been paid punctually.” [217]
- Was the stipulation penal? “While finely balanced, I do not consider it open to infer from the Higher Interest Rate itself that it is out of all proportion, extravagant or unconscionably disproportionate or was purely punitive in character, noting the short-term nature of the loan, that Commercial N was likely a lender of last resort for the Defendants and the interest rates that applied in the authorities to which I refer below.” [224] Note: the interest rates ‘in the authorities’ were 144% per annum.
The Court found that the Higher Interest Amount was not a penalty.
Did the mortgage broker make misleading or deceptive representations?
The representations claimed to be made by MaxFunding were that:
(1) that the amount advanced would be $588,000 (in accordance with the indicative letter of offer) which would leave an amount of $210,000 available to the borrowers; and
(2) that the Deed of Variation was misrepresented as being in relation to the outstanding water rates, not a reduction in the loan amount.
These misleading or deceptive representations were alleged to have been made under s 18 of the Australian Consumer Law and/or s 12DA of the Australian Securities and Investments Commission Act 2001 (Cth) (the ASIC Act).
The claim failed because the borrowers could not establish that MaxFunding was an employee and/or agent and/or representative of the lender.
Did the lender engage in unconscionable conduct and was the contract unjust?
This claim was of unconscionable conduct, and that the interest rate and the variation of the loan were unconscionable or unjust.
The alleged breach was of ss 20 and 21 of the Australian Consumer Law (ACL) and ss 12CA and 12CB of the ASIC Act.
A parallel claim of an unjust contract was made under the Contracts Review Act 1980 (NSW).
The orders sought by the borrowers were that the loan documents were void ab initio and of no effect and/or not enforceable against them or either of them.
The borrowers failed to prove the ‘special disadvantage’ requirement under the ASIC Act.
The Court found that the borrowers limited command of English was offset by their operating a business, by not requesting an interpreter, by obtaining independent legal advice before signing, and “other than the fact the loan was for a short-term and the interest rates were very high, the terms and conditions were not in themselves unusual or unfair”. [292]
In distinguishing these facts from the High Court of Australia decision in Stubbings v Jams 2 Pty Ltd [2022] HCA 6, the Court said:
“I do not consider that this is a case where the certificates of [legal] advice were “window dressing”: cf Stubbings at [49]. They may have used boilerplate wording but it could not be said that Commercial N took advantage of Ms Chien or acted unfairly by seeking to have T&C Excellent [their trading entity] interposed as a borrower to prevent or impede the transaction coming under the National Credit Code in light of the fact that T&C Excellent was the borrower of the Detex Loan. Ms Chien had also turned her attention to servicing the loan through business income, with an exit strategy of property refinance or sale early on.” [300]
The Court found that the Higher Interest Rate was not unconscionable, for the same reasons that it was not penal.
But the Court found that: “capitalisation and monthly compounding of the Higher Interest Rate of 70.72% … is inherently oppressive and unconscionable”. [304] “enforcement of the Higher Interest Rate with capitalisation could never be said to be reasonably necessary for the protection of Commercial N’s legitimate interests.” The capitalisation resulted in “an effective annual rate … of about 417% per annum”. [305]
The Court concluded:
“Commercial N’s conduct in entering into the Agreement and Deed of Variation on those terms is irreconcilable with what is right and reasonable and involves a level of sharp practice and unfairness that is unconscionable within the meaning of s 21 of the ACL and s 12CB of the ASIC Act.” [306]
The Court declared that the capitalisation was void and ordered its removal. As a result, on a simple interest approach, the interest payable (to 16 August 2022) was $882,417.62 compared with $2,789.342.52 on a capitalised approach.
In terms of the Contracts Review Act, the Court said:
“I am not satisfied that the Defendants, as co-borrowers of the principal amount of $430,000, did not appreciate or understand that interest was payable at the Higher Interest Rate in the event of default, and that a failure to make interest payments and the principal sum at the end of the term led to a risk they would lose the Burwood Property. Commercial N was also entitled to rely on the receipt of legal advice by the Defendants” [324]
Asset lending and the public interest
A public interest test applies to asset lending. Court said:
“there is also a public interest in treating contracts for asset lending, where the security provided is the sole residence of the borrower, as unjust where borrowers have demonstrated an inability to reasonably protect their own interests: Perpetual Trustee Co Ltd v Khoshaba [2006] NSWCA 41 at [128] (Basten JA)”. [327]
[This is how Basten JA described asset lending: “[to] lend money without regard to the ability of the borrower to repay by instalments under the contract, in the knowledge that adequate security is available in the event of default”.]
[in this case] “While I do not consider that the Defendants were unable to protect their interests in entering into the Agreement and the Deed of Variation in all respects, the substantive burden placed on the Defendants from the application of the Higher Interest Rate on a capitalised basis satisfies me that it would be contrary to the public interest for Commercial N to be able to enforce against the Defendants the interest provisions in the Memorandum that provide for the Higher Interest Rate, other than when applied on a simple interest basis.” [328]
Costs orders
The Court ordered that the borrowers pay 50% of the lender’s costs of the proceedings on an ordinary basis.
Comments
A loan with an interest rate of 70.72% per annum is not ‘inherently oppressive and unconscionable’. But the interest must be calculated as simple interest.
In this case the lender overreached by charging compounding interest (i.e. ‘interest on interest’), which was unconscionable and unjust.
Asset lending against the sole residence of a borrower is contrary to the public interest and is unjust, unless as in this case, the borrowers were capable of protecting their interests. In this case, the capability was a co-borrower (T&C Excellent) which they operated as a business, and which they said was able to pay the interest instalments.
While the borrowers had independent legal advice (which was found to be satisfactory), in this case the borrowers were not required by the lender to obtain independent financial advice (which might have addressed their ability to make the repayments and ‘exit strategy’).