The question of when bank default charges become unreasonable penalties, which is a central issue in the ongoing bank fees class action, was canvassed in a recent case before the District Court of News South Wales involving Arab Bank and a property developer.The court ruled in Sayde Developments Pty Ltd v Arab Bank Australia Ltd that default interest charged on the total outstanding principal when payments were overdue was an excessive penalty and was refundable.Tony Bassil owned a concreting business, a ten pin bowling alley and investment properties - all located in the outer-Sydney suburb of Liverpool. Cash flow from these businesses was used for development activities.His company Sayde Developments bought a parcel of land in Liverpool in 2006 and funded the acquisition with a A$6.8 million loan from Arab Bank. The facility was renewed in 2008 and again in 2010 and 2011.According to the court, Bassil went through periods of financial difficulty, especially during the financial crisis, and while he made all his interest payments to Arab Bank, he was sometimes late. When payments were late the bank charged penalty interest.By the time the loan was repaid in 2013, Sayde had made 24 penalty interest payments worth $248,938.The issue before the court was whether the penalty interest was "penal in nature" and therefore repayable.The legal principle is that a sum charged upon default is a penalty if it is "extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be provided to have followed from the breach."The loan contract stipulated that if repayments were not made on time interest would be calculated at a default rate until the amount was paid. The default rate was a margin of 200 basis points over the current variable rate.Sayde presented expert evidence, which said the default interest was not a genuine pre-estimation of what the bank suffered as a result of the loan being in arrears.The expert evidence said cost estimations were already built into the risk grading system used by the bank, which was reflected in the interest rate. The rate Sayde paid included a margin reflecting a given risk grade based on probability of default and potential default recovery costs.Arab Bank's expert disagreed with this analysis, saying that part of the risk rating factored the possibility of default but not costs associated with arrears or defaults.Arab Bank argued in its defence that Sayde's default rate "must be so disproportionate as to amount to oppressiveness before a stipulation will be regarded as a penalty."The court ruled that Sayde's late payments did not constitute a major default. It said that because the default interest was charged on the whole outstanding principal it was extravagant and unconscionable in the amount charged, when compared with the loss the bank could conceivably have suffered from each breach.Law firm K&L Gates said in a note to clients that lenders should review how their default interest provisions operate and ensure that the amount charged as default interest can be justified as a genuine