unfair loan claims: practically useless?

The unfair loan as a voidable transaction, found in s 588FD of the Corporations Act 2001 (the Act), is “quite different,”[1] as it is the only cause of action without a defined period to which the transaction that is said to be unfair must be related-back to (ie in the form of the relation-back period).[2] Therefore, practically speaking, a Liquidator can look back to any time from the formation of the Company[3] until her or his eventual appointment as External Administrator (ie the relation-back day).

Although, the ability to relate-back to any time could be powerful to Liquidators, our research (at the date of this article) did not reveal any successfully run actions arising under s 588FD of the Act.[4] This is interesting considering the unfair loan provisions have been around since 1992, following the passage of the Corporate Law Reform Bill 1992 (Cth).

The purpose of this article is to explain the complexities underpinning the provision and will conclude with some tips on what Practitioners should look for.

What is required?

In order for a transaction to fall under s 588FD(1) of the Act, a Liquidator would need to prove that the interest on, or the charges in relation to, the loan is extortionate.

In determining whether the interest on, or the charges in relation to, the loan is extortionate, various indicia are set out in s 588FD(2) of the Act:

(c) “the risk to which the lender was exposed;

(d) the value of any security in respect of the loan;

(e) the term of the loan;

(f) the schedule for payments of interest and charges and for repayments of principal;

(g) the amount of the loan; and

(h) any other relevant matter.”

A Liquidator making a claim to a court under s 588FF of the Act, for an unfair loan need not determine whether the Company was insolvent at the time of entering into the loan, but whether the defendant creditor in question may still rely upon the ‘good faith defence’ under s 588FG(1) of the Act.[5] We suspect, however, that the utility of this defence would be limited, because to ‘extort’ (as that word is defined within this article) would quite possibly fall foul of the requirement to actually receive the benefit from the unfair loan in ‘good faith’.[6]

Emanuel Management:[7] the leading case

The leading case on this issue is Emanuel Management Pty Ltd & Ors v Foster’s Brewing Group Ltd & Ors [2003] QSC 205. In this case, Emanuel Management having borrowed funds from the Foster’s Brewing Group defaulted, leaving a $180 million debt outstanding.

The Liquidator claimed the loan given by Foster’s Brewing Group was an unfair loan, because:

  1. In September 1988, Foster’s Brewing Group extended the loan repayment date in consideration for a $2 million increase to the existing profit share fee of $2 million (first issue); and
  2. The interest rate payable on the loan was 18.25% pa, if paid promptly, but otherwise ranged from 19.5% pa to 21.5% pa (second issue).

On the first issue, despite the fact that the Court held that the loan was incapable of being an unfair loan, because it predated the enactment of Pt 5.7B of the Act, Chesterman J (in obiter) observed that the profit share fee was not extortionate because of the substantial risk undertaken by the Foster’s Brewing Group and that without the extension, the debt would have become immediately due and payable by Emanuel Management. Evidence was also submitted that the directors of Emanuel Management were repeatedly unsuccessful in obtaining refinancing from a number of other lending institutions.[8]

On the second issue, Chesterman J held that the interest rate was not of itself extortionate. In dealing with the wording of s 588FD of the Act, Chesterman J said:

“[Extortionate] means it must be exorbitant, or grossly excessive, or characterised by extortion … it is not enough … that the interest rate charged is higher than the market rate. There must be something in the fixing of the rate which brings to mind the concepts implicit in the word [extortionate].”[9]

Chesterman J also rejected the proposition that a failure to reduce interest rates to reflect the market trend could trigger an unfair loan claim.[10]

Summary of other decisions[11]

Case Interest rate or charge Reasoning/key points

Takemura v National Australia Bank Ltd [2003] NSWSC 339

Three loans:

1. $250,000 loan, at greater than 72% pa interest rate

2. $270,000, at greater than 60% pa interest rate

3. $100,000, at an interest rate that was to be mutually determined

All loans were secured by mortgages over real property.

Young CJ concluded that the rates of interest although high, should not preclude the plaintiff from specific performance as an equitable mortgagee.

Interestingly, Young CJ hints at s 588FD of the Act being a derivation of the third class of situations in which equity would step in, based on the works of Waldock[12] and Cousins.[13] Although we do not have access to this level of legal research, interested and able parties are encouraged to look into this area (please let us know what you find).[14]

Reading Trust Ltd v Spero [1930] 1 KB 492

A business man dealing in jewellery, with poor cash flow and very little capital entered into a financing arrangement with a moneylender at interest rates of 80-96%

Rowlatt J held:

- No evidence of pressure

- No evidence of unconscionability

- Rather, the businessman was: “a man of great intelligence … carrying on a high class business, simply finding that his business is so speculative that he cannot get finance from the banks, but so profitable in his skilful hands that he can make profits which can pay 60 or 80% interest.”[15]

Re Octaviar (No 8) [2009] QSC 202

Two transactions in question:

1. An extension of time to repay $150m, granted on the basis of an extension fee of $1.5m and additional interest charges of circa $4.5m

2. Additional $50m loan, but $7m retained by the lender as a participation fee

McMurdo J doubted that the first transaction was a particularly strong case,[16] but acknowledged that for both transactions a Liquidator would want to carry out further investigations if appointed.[17]

Guardian Mortgages v Miller [2004] NSWSC 1236

Mortgage given with an interest rate of 174% pa, reducible to 144% pa if paid promptly

Wood CJ held that there was no unconscionable pressure, but rather it was merely a commercial dealing

Accom Finance Pty Ltd v Mars Pty Ltd [2007] NSWSC 726

Loan given with an interest rate of 120% pa, reducible to 60% pa if paid promptly

Windeyer J in deciding that the loan was not unconscionable said:

… bad bargains are not necessarily unconscionable bargains or illustrative of unconscionable conduct. … the higher rates really have everything to do with what the lender thinks can be got away with … However, unless there is pure asset lending, the fact that the rates appear exorbitant does not in itself make them unconscionable.”[18] 

Re Essendon Apartment Developments Pty Ltd (In Liquidation) (No 2) [2013] VSC 210

Second mortgage given for a loan with an interest rate of 60% pa (or 72% pa if not paid on time), however, the loan was for only 3 months

- Interest rate was 5% per month

- It was a second mortgage secured against undeveloped land

- Loan never repaid in full

Arab Bank Australia Ltd v Sayde Developments Pty Ltd [2016] NSWCA 328

(case handed down on 28 November 2016)

Default interest rate charged at 2% above the headline rate, if interest charges not paid on time

This case considered and applied the penalty doctrines following the decisions of Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205 and Paciocco v Australia and New Zealand Banking Group Ltd [2016] HCA 28. McDougall J (with the leading judgement) considered whether the 2% default rate was

extravagant and unconscionable in “comparison with the greatest loss that could conceivably be proved to have followed from the breach.” In His Honours’ opinion, the answer to this was no

 

Practically useless?

Clearly, since its inception more than 23 years ago, s 588FD of the Act has had little practical utility for Liquidators to date. Arguably, with the narrow approach that has been adopted, Courts have played a big part in the limited jurisprudence that is available.[19]

Nonetheless, the following are some key things to look at/for before commencing an unfair claim under s 588FD of the Act:[20]

  1. The percentage of the interest rate is not the most important determiner, even if the interest rate is above market rates (on a per annum or monthly basis);
  2. Evidence of the correspondence or dealings between the lender and borrower. You would be looking for evidence of the lender yielding undue influence, unconscionability or extortion (including unlawful threats and bullying tactics) to gain some sort of advantage in the transaction;
  3. Evidence of the borrower attempting to source funding from other sources. If no such attempts can be evidenced, you would query why not?;
  4. Evidence of the lender undertaking due diligence or a strategic review of the borrower;
  5. How is the interest secured? In Accom Finance[21] (although not directly dealing with s 588FD of the Act), Windeyer J makes an interesting statement when His Honour said: "However, unless there is pure asset lending, the fact that the rates appear exorbitant does not in itself make then unconscionable."[22] If a loan was fully secured, and rates appear to be materially above market rates, could such a transaction fall within s 588FD of the Act; and
  6. We query whether expert evidence concerning the risk profile of the borrower, could assist when coupled with the above indicators (at least in part)? 

Takeaway

It will be interesting to see how (and if) Courts continue to evolve and refine the unfair loan regime under s 588FD of the Act. At this stage, we have a long way to go before Practitioners will have certainty around what needs to be established to bring such a claim.

If you or your clients have any questions concerning this article or anything relating to voidable transactions, expert solvency reports or insolvent trading, please feel free to contact one of the SV Voidable expert advisors.

 

Article written by Matthew Hudson, Manager, Queensland

 

[1] Explanatory Memorandum, Corporate Law Reform Bill 1992 (Cth), 1048.

[2] See s 588FE(6) of the Act.

[3] But only from on or after the commencement of the Corporate Law Reform Act 1992 (Cth) (ie on or after 23 June 1993).

[4]

[5] But not s 588FG(2).

[6] Section 588FG(1)(b)(i) of the Act.

[7] Emanuel Management Pty Ltd v Foster’s Brewing Group Ltd [2003] QSC 205.

[8] Ibid, 484.

[9] Ibid, 620-621.

[10] Ibid, 493.

[11] Please be aware that these decisions do not necessarily all deal directly with s 588FD of the Act.

[12] Sir Claud Humphrey Meredith Waldock, Waldock on Mortgages (Stevens & Sons, 2nd ed, 1950), 192.

[13] Edward F Cousins et al, Cousins on the Law of Mortgages (Sweet & Maxwell, 1st ed, 1989), 311.

[14] Takemura v National Australia Bank Ltd [2003] NSWSC 339, 22.

[15] Reading Trust Ltd v Spero [1930] 1 KB 492, 515.

[16] Re Octaviar (No 8) [2009] QSC 202, 143.

[17] Ibid, 143-144.

[18] Farrid Assaf et al, Voidable Transaction in Company Insolvency (LexisNexis Butterworths, 2015) 6.22 citing Accom Finance Pty Ltd v Mars Pty Ltd [2007] NSWSC 726, 54.

[19] Ibid. We highly recommend Farrid Assaf’s book to interested readers of the law underpinning all types of voidable transactions.

[20] Please note that this is not provided as legal advice, but merely for general information purposes. 

[21] Accom Finance Pty Ltd v Mars Pty Ltd [2007] NSWSC 726.

[22] Farrid Assaf et al, Voidable Transaction in Company Insolvency (LexisNexis Butterworths, 2015) 6.22 citing Accom Finance Pty Ltd v Mars Pty Ltd [2007] NSWSC 726, 54.

 

 

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