A court has found that a short-term commercial loan with a compounding interest rate of more than 70 per cent a year was unconscionable - “utterly crushing” for the borrower and far in excess of what was necessary to protect the lender’s “legitimate interests”.
In 2019 Commercial N Pty Ltd loaned A$430,000 to T&C Excellent Pty Ltd, an information technology consultancy in Burwood, Sydney. Stephanie Wei-Jen Chien was the sole director of T&C Excellent. Her mother Hsing-Yi Huang was a joint borrower.
The loan was secured by a mortgage over a residential property and was for a term of 26 weeks. The terms included a lower interest rate of 0.35 per cent a week and a higher rate of 1.36 per cent a week.
The higher rate would apply if the borrowers failed to pay interest on the due date and would compound monthly until the outstanding interest was paid in full.
At the time the loan was made the Burwood property was valued at $2.6 million, with money owing on an NAB mortgage.
The money was used to discharge another loan and pay mortgage arrears and outstanding water rates. The borrowers defaulted on their interest payments and failed to repay the principal.
Commercial N took the matter to the Supreme Court of New South Wales, seeking possession of the property and a monetary judgement.
By the time the matter got to court in 2022, Commercial N claimed that the debt had grown to more than $3 million.
Chien and Huang argued that the higher interest rate, an annual rate of 70.72 per cent, was excessive and amounted to a penalty. They also claimed Commercial N’s conduct was unconscionable. They sought an order that the loan agreement be set aside.
They brought a cross-claim against the solicitor who advised them about the loan agreement, alleging breaches of his retainer and duty of care. They claimed they were not given a proper understanding of the loan agreement when they signed it and also that they were not properly informed about a deed of variation to the loan (which reduced the amount advanced).
While describing the higher rate as “seemingly extravagant”, Justice Patricia Henry said: “I am not persuaded that interest at the higher interest rate compounding monthly is a penalty, based on the recognised distinction between provisions in agreements, such as a mortgage or a guarantee, which incentivise prompt payment and clauses which increase the rate of interest upon failure to make prompt payment, where the latter may be held to be a penalty clause and the former are not.
Henry cited an earlier ruling, which said that “there is a conventional view that a properly drafted mortgage containing higher and lower rates does not attract the law of penalties at all”.
“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.”
Chien and Huang claimed that Commercial N’s behaviour was unconscionable because it loaned the money even though it would have known that the borrowers would default, especially after the deed of variation lowered the loan amount, leaving them with no surplus funds.
The court ruled that Commercial N’s conduct was not unconscionable, except for one matter – the compounding of the interest.
“The capitalisation and monthly compounding on the higher rate of 70.72 per cent per annum, which the defendants could expect to pay on default, on a loan of $430,000 for six months is inherently oppressive and unconscionable,” Henry said.
Compounding at the higher rate out to August 2022, the balance of the loan reached $3.2 million. On a simple interest basis, the outstanding loan would have grown to $1.3 million.
“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 higher interest rate with capitalisation, in the year to October 2022, was in the order of an effective annual interest rate of about 417 per cent,” Henry said.
The court voided those parts of the mortgage agreement that provided for interest at the higher rate to be compounded and capitalised.
This did not render the entire agreement unjust and the court ruled that Commercial N was entitled to get its $430,000 back plus simple interest at the higher rate.
The court rejected the counter-claim against the borrowers’ lawyer.