B. & G. Properties Pty Limited v Fayad

1. Clauses 2, 3 and 4 of the Deed of Agreement were in the following terms: 2. NR Developers shall be liable to pay B & G fees and charges at the rate of twenty-five (25%) per centum of the advance per annum or part thereof to be paid in two instalments as stipulated and in the manner set forth in the Second Schedule hereto. 3. That whilst all or any of the monies comprising the advance are outstanding to B & G NR Developers will pay fees and charges thereon in the manner set forth in the Second Schedule hereto. 4. Default fees and charges applies to any payment pursuant to this agreement that NR Developers has not made by the due date for that payment and applies from that due date until that payment is made. The Default fee and charges also applies to any and all sums owing at the time of any other default by NR Developers and applies from the date of that default. The Default fees and charges will be at the rate of thirty (30%) per centum of the advance per annum or part thereof.
2. The references to the Second Schedule in cls 2 and 3 were obvious mistakes. They should have been a reference to the Third Schedule. That schedule was in the following terms: Fees & Charges, Calculations and Payments Fes [sic] & Charges rate: Twenty-five (25%) per centum per annum In two (2) instalments as follows:- Frequency and timing: (a) The sum of $250,000.00 on or before the [sic] 1 May 2015; and (b) The sum of $250,000.00 on or before 1 August 2015.

1. The guarantees given by Mr Fayad were set out in cls 18 and 19 of the Deed of Agreement, which were in the following terms: 18. The Guarantor guarantees to B & G the payment of any monies payable by NR Developers pursuant to this Agreement and the due and faithful performance NR Developers of each and every covenant on its part contained herein and the Guarantor agrees to pay to B & G upon demand all money payable pursuant to this Agreement in respect of which NR Developers shall have made default and the Guarantor hereby indemnifies and agrees to keep B & G indemnified against any loss or expense whatsoever and howsoever arising in connection with any default by NR Developers in so performing the covenants on its part to be performed pursuant to this Agreement and will upon demand being made by B & G make good immediately any such default or defaults by NR Developers and the Guarantor hereby covenants that he will do all things necessary or convenient and use his best endeavours to ensure that NR Developers performs all the covenants on its part to be performed pursuant to this Agreement. 19. The guarantee provided for in clause shall be a continuing guarantee and shall not be revocable by the Guarantor and shall not be limited by any time or times mentioned in this Agreement but shall continue to have full force and effect so long as any monies are due by NR Developers pursuant to this Agreement and the guarantee and indemnity provided for in clause shall continue to have full force and effect notwithstanding the termination of this Agreement or any other event whatsoever.
2. Clause 36 of the Deed of Agreement relevantly provides: NR Developers will be deemed to be in default of this Agreement if: (a) there is a default of any term or condition of this Agreement (and in this regard the following clauses are deemed to be essential terms clause 2, 3, 4, 5, 6, 7, 9, 10, 14, 15, 18, 19 and 21); (b) NR Developers fail to pay any money due under this Agreement by the loan repayment date; (c) … …
3. Clause 38 was in the following terms: If NR Developers are in default B & G may: (a) demand repayment of any money due under this Agreement; and/or (b) exercise any rights, powers or privileges conferred by any law, this Agreement or any mortgage or security provided under this Agreement.
4. The loan of $4,000,000 was advanced on the day the Deed of Agreement was signed. It was not repaid on the due date. Instead, the parties executed an undated Deed of Variation (the First Variation Deed). The First Variation Deed corrected the reference in cl 2 to the Second Schedule in the Deed of Agreement. It also amended the First Schedule so that the final repayment date was 15 November 2018. It amended the Third Schedule to provide the following: Fees & Charges, Calculations and Payments Fees & Charges rate: Twenty-five (25%) per centum per annum in the total amount of $3,750,000.00 for the period from 16 February 2015 to the Final Repayment Date. Payment of fees and charges: B & G acknowledges receipt of the amount of $2,350,000.00 on account of the above fees and charges. On the Final Repayment Date, NR Developers must pay the amount of $1,400,000.00 in payment of the outstanding fees and charges.

1. The Deed of Agreement was amended again by a Deed of Further Variation dated 14 November 2018. That deed amended the First Schedule to provide for a final repayment date of 15 December 2018. It also amended the Third Schedule so that it read as follows: Fees & Charges, Calculations and Payments Fees & Charges rate: Twenty-five (25%) per centum per annum in the total amount of 3,833,333.00 for the period from 16 February 2015 to the Final Repayment Date. Payment of fees and charges: B & G acknowledges receipt of the amount of $2,350,000.00 on account of the above fees and charges. On the Final Repayment Date, NR Developers must pay the amount of $1,483,333.00 in payment of the outstanding fees and charges.

1. NRD did not pay the outstanding amounts owing under the Deed of Agreement (as amended) by 15 December 2018.
2. On 18 December 2018, BGP's solicitors sent an email to Norton Rose Fulbright who were acting for NRD at the time, asking "when your client will be in a position to effect settlement". They did not receive a substantive response. On 19 February 2019, they sent a formal demand to NRD by email to Norton Rose Fulbright, which was relevantly in the following terms: Deed of Agreement for Loan between B & G Properties Pty Limited, NR Developers Pty Ltd and Sam Fayad The above Agreement (as varied) required the loan amount of $4,000,000.00 plus interest of $1,483,333.00 to be paid on the Final Repayment Date, being 15 December 2018. The borrowers and the guarantor are in default under this Agreement. As at 15 February 2019, the total amount payable is $5,757,499.65, being the outstanding amount $5,483,333.00 plus default interest of $274,166.65, calculated at 30% per annum on the outstanding amount for 2 months of delay in accordance with clause 4 of the Deed of Agreement. Our client requires the borrower and guarantor to urgently rectify the default no later than Friday, 22 February 2019.
3. A number of additional demands were made for payment and for payment of default interest. Ultimately, on or about 12 March 2021 BGP served a creditor's statutory demand on NRD. Subsequently, NRD was placed into external administration.
4. BGP commenced these proceedings on 13 April 2021 to recover the amount said to be owing to it under the guarantee given by Mr Fayad.
5. Originally, Mr Fayad raised four principal defences to BGP's claim. First, he contended that BGP had provided no consideration for the guarantee he gave. Second, he submitted that the clause of the Deed of Agreement providing for the payment of default interest of 30 percent (cl 4) was an unenforceable penalty. Third, he submitted that, on its correct construction, cl 4 of the Deed of Agreement only required him to pay default interest on the outstanding principal. Lastly, he submitted that BGP had failed to mitigate its loss.
6. Mr Fayad rightly abandoned the first contention at the start of the hearing and the last contention at its conclusion. Consequently, the only two remaining issues are the correct construction of cl 4 of the Deed of Agreement and whether, on its correct construction, the clause imposes a penalty. If it does, there is a question of what interest, if any, BGP is entitled to recover. The parties agreed that it was appropriate for the Court to deliver judgment on those issues in the expectation that they would be able to agree on the precise calculation of the amount owing once the outstanding questions had been resolved.

The correct construction of cl 4

1. The principles relating to the construction of commercial contracts are not relevantly in dispute. Most recently they were summarised in these terms by Bathurst CJ in Central Coast Council v Norcross Pictorial Calendars Pty Ltd [2021] NSWCA 75 at [55]: The principles governing the construction of commercial contracts such as the present were not in dispute. The contract is to be construed by what a reasonable business person would understand it to mean. That requires consideration of the language used by the parties, the surrounding circumstances known to them, and the commercial purpose or objects to be secured by the contract: Electricity Generation Corporation v Woodside Energy Ltd (2014) 251 CLR 640; [2014] HCA 7 at [35]; see also Mount Bruce Mining Pty Ltd v Wright Prospecting Pty Ltd (2015) 256 CLR 104; [2015] HCA 37 at [46]-[52]; Victoria v Tatts Group Ltd [2016] HCA 5; (2016) 90 ALJR 392 at [51]; Simic v New South Wales Land and Housing Corporation (2016) 260 CLR 85; [2016] HCA 47 at [18] and [78].
2. Two other subsidiary principles should also be borne in mind in this case. First, consistently with the principle that the contract is to be construed by reference to what a reasonable business person would understand it to mean, a court will construe a contract to avoid an absurdity: Watson v Phipps (1985) 60 ALJR 1 at 3 per Lord Brightman. Second, a court will generally seek to give all of the words of a contract some operation. As Lockhart and Hill JJ explained in Chapmans Ltd v Australian Stock Exchange Ltd (1996) 67 FCR 402 at 411: It is an elementary proposition that a contract will be read as a whole giving weight to all clauses of it, where possible, in an endeavour to give effect to the intention of the parties as reflected in the language which they have used. A court will strain against interpreting a contract so that a particular clause in it is nugatory or ineffective, particularly if a meaning can be given to it consonant with other provisions in a contract.
3. BGP contends that the effect of cl 4 is that, upon default, it requires NRD, and therefore Mr Fayad, to pay interest on (1) any amount outstanding at the date of default and (2) any further amount that becomes payable (such as interest) after that date (3) at the rate of 30 percent per annum compounded annually. Proposition (1) is said to come from the first sentence of the clause. Proposition (2) is said to come from the second. Proposition (3) is said to follow from a combination of the second and third sentences. The second sentence provides for the payment of interest on interest. The third sentence provides for the payment of interest at 30 percent and for interest to be paid annually. This interpretation requires reading the phrase "the advance" in the third sentence to mean any amount payable under the first two sentences, contrary to the meaning given to that expression in the recital.
4. Mr Fayad, on the other hand, contends that cl 4 only provides for interest at 30 percent on the principal then outstanding. That is said to follow from the definition of "the advance" and the statement in the third sentence that default fees and charges "will be at the rate of thirty (30%) per centum of the advance …".
5. Clause 4 of the Deed of Agreement is poorly drafted. Any interpretation involves doing some violence to the language used. However, in my opinion, the interpretation advanced by Mr Fayad must be rejected. That interpretation involves interpreting "the advance" to mean the amount of principal outstanding, whereas in the recital it is defined to mean the $4,000,000. Mr Fayad's interpretation involves interpreting the words "will be at the rate of thirty (30%) per centum of the advance per annum …" as meaning the default fees and charges will only be payable on the amount of the advance outstanding at the rate of 30 percent per annum, whereas read literally the sentence seems to suggest that the default fees and charges will be $1,200,000 (30 percent of $4,000,000) for each year or part thereof that NRD is in default. Neither party contended for that literal interpretation. Moreover, Mr Fayad's interpretation appears to ignore the first two sentences of the clause, which specifically state that default fees and charges "applies" to any payment not made by the due date, which may include the payment of interest.
6. On the other hand, I do not accept BGP's contention that interest is to be compounded annually. In my opinion, on its correct interpretation cl 4 simply provides for the payment of interest at the rate of 30 percent per annum on amounts not paid by the due date, whether those amounts are principal or interest. Interest continues to run at the rate of 30 percent until payment is made.
7. In interpreting cl 4, it is important to start with the terms of the original Deed of Agreement, since cl 4 was drafted in that context.
8. Under the terms of the original Deed of Agreement, NRD was to make three payments: (1) it was to repay principal of $4,000,000 six months after the date of the agreement; (2) it was to pay the sum of $250,000 in "fees and charges" on or before 1 May 2015; (3) it was to pay the sum of $250,000 in "fees and charges" on or before 1 August 2015. The first sentence of cl 4 states that if any of those payments were not made by the due date then NRD had to pay default fees and charges from the due date to the date of payment. The second sentence of cl 4 states that if there is another default - most obviously, a default in making one of the other three payments due under the agreement - then default fees and charges are payable on that payment from the date it was due to the date of payment. The third sentence of cl 4 states that the default rate is 30 percent. As I have said, it uses the poorly expressed phrase "of the advance" to describe what the 30 percent is payable on. But in the context "of the advance" must mean "on the amount outstanding". Any other interpretation makes no sense. Understood in this way, cl 4 contemplates that what is in effect default interest may be payable on the two interest payments due under the agreement. However, there is nothing in cl 4 that provides for the further compounding of interest. The words "per annum" simply fix the interest rate. It is 30 percent per annum, not, for example, 30 percent per month. The words "or part thereof" have been added to make it clear that interest should be calculated (at the rate of 30 percent per annum) on parts of a year in which an amount due under the agreement is unpaid.
9. There is nothing in the two variation deeds that affect the position. They simply alter the dates by which certain amounts are due and, therefore, the time from when default interest runs and the amount on which it runs. In particular, the result of the Deed of Further Variation is that default fees and charges (of 30 percent per annum) are payable on the outstanding principal from 15 December 2018. They are also payable on outstanding fees and charges of $1,483,333.00 from that date. However, there is no compounding of those amounts. Under the agreement, interest continues to run on those two amounts at the rate of 30 percent per annum until they are paid. Plainly, if there is partial payment, interest continues to run on the balance at that rate until it is paid.

Is clause 4 a penalty?

1. A contractual stipulation the essence of which is to punish the other party for a breach of contract will be unenforceable as a penalty: see Paciocco v Australia & New Zealand Banking Group Ltd (2016) 258 CLR 525 (Paciocco); Arab Bank Australia Ltd v Sayde Developments Pty Ltd (2016) 93 NSWLR 231 (Arab Bank). The impugned stipulation must solely (Paciocco at para [166] per Gageler J) or predominantly (ibid at para [221] per Keane J) be punitive in nature. The question whether a contractual stipulation is penal in nature directs attention to whether the sum stipulated is extravagant and unconscionable (see Dunlop Pneumatic Tyre Company Ltd v New Garage and Motor Company Ltd [1915] AC 79 at 87 per Lord Dunedin; Paciocco at para [29] per Kiefel J; Arab Bank at para [74] per McDougall J (citations omitted)). The party who impugns a contractual stipulation as a penalty bears the evidentiary and persuasive onus of proving that that stipulation meets the relevant requirements: see Paciocco at para [167] per Gageler J; Arab Bank at para [75] per McDougall J). Whether a contractual stipulation for the payment of a sum of money on breach of contract is so extravagant and unconscionable as to amount to a penalty is to be judged by reference to the circumstances that existed at the time the contract was made: see Paciocco at para [62] per Kiefel J, para [169] per Gageler J; Arab Bank at para [74] per McDougall J. See also Australia Capital Financial Management Pty Ltd v Linfield Developments Pty Ltd; Guan v Linfield Developments Pty Ltd [2017] NSWCA 99 at [329]-[330] per Ward JA).
2. The penalty doctrine operates as an exception to freedom of contract: see Arab Bank at [105] per McDougall J). Accordingly, when applying the doctrine, "courts will not lightly invalidate a contractual provision for an agreed payment on the ground that it has the character of a punishment" (Paciocco at para [220] per Keane J).
3. Clause 4 is said to be penal in nature because it provides in effect for the compounding of interest and provides for what is in effect an increase in the interest rate.
4. Neither of those propositions can be accepted. There is nothing penal in nature in compound interest. The requirement to pay interest on interest compensates a creditor for the fact that the creditor is out of pocket for the interest and consequently is unable to invest that interest in other profit-making investments.
5. The question whether a default interest rate of 30 percent is penal in nature must be judged in the context of the agreement. The interest rate under the agreement was 25 percent. To the extent that it is relevant, that interest rate was negotiated between experienced property developers and, no doubt, reflects both the risks and rewards associated with the project and the convenience that a loan on informal terms provided to NRD. In any event, the real question is whether an increase of five percent on default is penal - that is, whether it is out of all proportion to the loss that BGP might be expected to have suffered at the time the contract was entered into if NRD defaulted on its obligations. In my opinion, it plainly is not. As McDougall J (with whom Gleeson JA agreed) explained in Arab Bank at [106]-[107], an important purpose of "penalty" interest is to compensate the lender for the increase in risk that it will not be repaid following a default by the borrower. Here, the increase represents an increase of 20 percent on the rate originally payable under the contract. No reason is advanced for why an increase of that magnitude is out of all proportion to the additional risk that BGP assumed following a default by NRD. As BGP pointed out in its submissions, the increase is in substance no different from an increase from five percent to six percent. An increase of that magnitude is not obviously penal and, as I have said, Mr Fayad does not advance any reason for why it is.
6. In his written submissions, Mr Fayad refers to the reasons Mr Barakat gave in his affidavit for asking for default interest of 30 percent, which focus on the fact that Mr Barakat intended the loan to be short-term and believed that he would be able to obtain better rates of return from other investments. Mr Fayad submits that this evidence is undermined by the fact that BGP did agree to extend the terms of the loan on two occasions without increasing the interest rate. In my opinion, Mr Barakat's evidence is of limited assistance and the submission must be rejected. Mr Barakat's subjective reasons for seeking default interest are irrelevant. The question must be judged objectively, and the issue is whether the increase in interest rate is out of all proportion to the loss that BGP might suffer if NRD defaulted. For the reasons I have given, it is not.

Costs and orders

1. The solicitors for the plaintiff have sought an opportunity to make written submissions on the question of costs. Since no submissions were made on costs at the time of the hearing, I will not deal with costs until I have received those submissions.
2. The orders of the Court are: 1. Within 14 days of the date of this judgment the parties bring in short minutes of order to give effect to these reasons for judgment. 2. If the parties cannot agree on short minutes of order, or on the question of costs, then within a further seven days each party provide to my Associate the short minutes of orders for which that party contends and submissions not exceeding three pages in support of those short minutes of order; 3. The form of the orders to be made be determined on the papers unless the Court requests a further oral hearing.

Amendments 15 November 2021 - Change B&G Properties Pty Ltd to "B. & G. Properties Pty Ltd" on pages 1, 2 & 3 DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 15 November 2021