N & M Investments/Properties Pty Ltd v Australian Property Enterprise Pty Ltd

Summary of salient evidence

The plaintiff adduced evidence from Mr Adam Tilley. In his affidavit of 6 May 2022, Mr Tilley describes himself as the mortgage manager for the plaintiff. However, it would be more accurate to state that the functions of mortgage management in respect of the loan are carried out by Pacific 8 Pty Ltd and/or Pacific 8 Management Pty Ltd, companies of which Mr Tilley is a director and in which he indirectly holds a shareholding interest.
In respect of the Further Establishment fee, Mr Tilley deposed that it is "intended to cover the loss to the plaintiff of the plaintiff's inability to re-lend the funds the subject of this facility to a new borrower, which new borrower would be obliged to pay its own establishment fee". Mr Tilley further deposed: In particular, the further management fee [sic] is levied because any default in repayment by the borrower prevents the plaintiff from 'recycling' its investors' funds into a new facility with a new borrower. The plaintiff's business revolves around the recycling of funds from one loan to the next. Shorter-term loans are deliberately written by the plaintiff to achieve this purpose. A borrower can request an extension to its loan, however a condition of such approval is always the payment of an additional management fee, as the funds the subject of that loan cannot then be on-lent to another borrower. Additionally, it can be the case that when borrowers go into default on their loans that the plaintiff is actually required to make payments of fees, operating costs and other incidental expenses from its own balance sheet as those payments cannot abide the repayments by the borrower. The terms of the plaintiff's licence also require it to keep a certain minimum amount of funds on deposit. If the borrower remains in default, those amounts paid by the plaintiff from its own balance sheet are either not repaid for a very considerable period of time or sometimes not repaid at all. It is often the case in defaulting loans that there is an increasing risk of reputational damage to the plaintiff amongst its investors. In the case of defaulting loans, where the plaintiff is required to divert any funds it receives to make interest payments to its investors to ameliorate the reputational damage, the plaintiff normally ends up being considerably out of pocket.
In respect of the Default Loan Management fee of $75 per day, Mr Tilley deposed that the fee is "intended to cover the additional costs and expenses incurred by the plaintiff in having to deal with a facility in default, particularly with regard to the need for the plaintiff to have its staff following up and dealing with the defaulting borrower…". Mr Tilley further deposed: The default management fee is calculated at the rate of $75 per day for each day the facility is in default. As I have mentioned above, this fee is designed to cover the additional costs and more particularly the additional time incurred by the plaintiff in dealing with a defaulting borrower. In this particular instance, after default occurred, the plaintiff was required to deal, regularly and repeatedly, with a small army of third-party service providers and other persons, which meant that the plaintiff and its staff were spending considerably more time each day in the administration of the loan once it was in default than whilst it was not in default. In my experience over 7 of [sic] years in managing the plaintiff's loans, I have seen the following additional attendances required when dealing with defaults. I will also give specific examples of the kinds of additional work that went into this particular loan once it was in default…
In cross-examination, Mr Tilley agreed that he entirety of the Establishment Fee that was paid at the commencement of the loan went to a Pacific 8 company to cover the costs of setting up the loan, and that none of the fee went to the lender (N & M).
Mr Tilley further agreed that the emails that set out the terms of the arrangements between the Pacific 8 companies and N & M provided for the Lower Rate of Interest of 10.5% per annum to include the 1.5% management fee paid to Pacific 8 Management Pty Ltd, so that the return to the lender would be 9% per annum Mr Tilley then agreed that the emails provided that the additional 4% per annum under the "Default Interest Rate" of 14.5% per annum would be split 50:50 between N & M and Pacific 8 Pty Ltd, so that the return to the lender would become 11% per annum.
Mr Tilley agreed that the references in his affidavit to staff were references to staff of the Pacific 8 companies. He agreed that the relevant Australian Financial Services Licence was held by Pacific 8 Pty Ltd, and that he believed N & M did not have a credit licence. He accepted that the references in his affidavit to loss of reputation were references to Pacific 8. Mr Tilley further accepted that the reference to making payments "from its own balance sheet" were references to Pacific 8.

Are the impugned fees unenforceable as penalties?

A statement of the general principle to be applied was made by the High Court in Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205; [2012] HCA 30 at [10] as follows: In general terms, a stipulation prima facie imposes a penalty on a party (the first party) if, as a matter of substance, it is collateral (or accessory) to a primary stipulation in favour of a second party and this collateral stipulation, upon the failure of the primary stipulation, imposes upon the first party an additional detriment, the penalty, to the benefit of the second party. In that sense, the collateral or accessory stipulation is described as being in the nature of a security for and in terrorem of the satisfaction of the primary stipulation. If compensation can be made to the second party for the prejudice suffered by failure of the primary stipulation, the collateral stipulation and the penalty are enforced only to the extent of that compensation. The first party is relieved to that degree from liability to satisfy the collateral stipulation.
Here, the defendants/cross-claimants contend that the stipulations for the payment of the Further Establishment fee and the Default Loan Management fee following an Event of Default are, as a matter of substance, collateral to the primary stipulations in the Mortgage the defendants/cross-claimants are bound to perform.
I agree that the provisions for the payment of those fees can be regarded as collateral to the primary obligations of the defendants/cross-claimants under the Mortgage. The fee provisions, which operate only upon an Event of Default, provide a clear negative incentive to the defendants/cross-claimants to discharge their primary obligations. In those circumstances, it can be said that the doctrine of penalties is "engaged" (see Australia Capital Financial Management Pty Ltd v Linfield Developments Pty Ltd (2017) 18 BPR 36,683; [2017] NSWCA 99 at [361]). However, it does not necessarily follow that the these collateral stipulations should be characterised as penal and thus held to be unenforceable.
In Paciocco v Australia and New Zealand Banking Group Ltd (2016) 258 CLR 525; [2016] HCA 28, Kiefel J (with whom French CJ agreed) stated at [29], in relation to stipulations that operate to require the payment of a sum of money, that the sum must be "extravagant and unconscionable" or "out of all proportion to the interests of the party which it is the purpose of the provision to protect" before it can be characterised as a penalty. At [34], Kiefel J stated that, in this context, words such as "extravagant" and "unconscionable" all describe "the plainly excessive nature of the stipulation in comparison with the interest sought to be protected by that stipulation".
In the same case, Gageler J stated at [158]: To ask whether a stipulation serves merely to secure the enjoyment of a collateral object is to ask whether the conclusion objectively to be drawn from the totality of the circumstances is that the only purpose of the stipulation was to punish: to impose a detriment on a contracting party in the event that a principal contractual stipulation is not observed, in order to deter non-observance of that principal stipulation. To ask that question in the context of a stipulation for the payment of money on breach of contract accords with the statement of Lord Dunedin in Dunlop that "[t]he essence of a penalty is a payment of money stipulated as in terrorem of the offending party." His Honour continued (at [164]): And as the facts in Clydebank and Dunlop again both sufficiently illustrate, the fact that the amount of a payment stipulated to be made on breach of contract is set at a level which provides a negative incentive - even a very strong negative incentive - to perform the contract is not enough to justify the conclusion that the stipulation served only to punish. The prospect of paying compensatory damages to be assessed by a court in the event of breach itself provides a negative incentive to perform a contract. The relevant indicator of punishment lies in the negative incentive to perform being so far out of proportion with the positive interest in performance that the negative incentive amounts to deterrence by threat of punishment.
Also in Paciocco v Australia and New Zealand Banking Group Ltd (supra), Keane J stated (at [270]): In Andrews, this Court summarised the "critical issue" as being "whether the sum agreed was commensurate with the interest protected by the bargain". This Court's discussion in Andrews of the decision in Dunlop focused upon the reasons of Lord Atkinson, who accepted that an agreed payment upon breach should not be unenforceable where, though it "appeared imprecise as a pre-estimate of damage, it protected the [seller's] interest in preventing undercutting, which would disorganise its trading system". Accordingly, the question to be addressed in order to distinguish a penalty from a provision protective of a legitimate interest is: "whether the sum or remedy stipulated as a consequence of a breach of contract is exorbitant or unconscionable, when regard is had to the innocent party's interest in the performance of the contract."
It is clear that attention must be given to the interest or interests sought to be protected or advanced by the impugned collateral stipulation. This factor was critical to the decision in the seminal case of Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79, and in particular to the speech of Lord Atkinson at 91-3 (see also Andrews v Australia and New Zealand Banking Group Ltd (supra) at [75]).
Accordingly, whilst the question has been said to be one of construction, it is not a question that will necessarily be answered by recourse to the language of the contract alone. It is to be considered in light of the inherent circumstances of the contract, which includes the position of the party whose interests are sought to be protected by the impugned stipulation (see Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd (supra) at 86-7 per Lord Dunedin; Paciocco v Australia and New Zealand Banking Group Ltd (supra) at [30] and [146]). The Court may thus receive evidence of the purposes sought to be achieved by the parties to the contract (see Paciocco v Australia and New Zealand Banking Group Ltd (2015) 236 FCR 199; [2015] FCAFC 50 at [225] per Allsop CJ). However, it is clear that the question whether a provision should be characterised as penal is to be determined by reference to the time when the contract was made (see Webster v Bosanquet [1912] AC 394 at 398 per Lord Mersey for the Board; Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd (supra) at 86-7; Paciocco v Australia and New Zealand Banking Group Ltd (supra) at [62] per Kiefel J).
Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd (supra) is also significant because of the four "tests" propounded by Lord Dunedin (at 87-88). The tests are as follows: 4 To assist this task of construction various tests have been suggested, which if applicable to the case under consideration may prove helpful, or even conclusive. Such are: (a) It will be held to be penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach … (b) It will be held to be a penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which ought to have been paid … (c) There is a presumption (but no more) that it is penalty when "a single lump sum is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage" … On the other hand: (d) It is no obstacle to the sum stipulated being a genuine pre-estimate of damage, that the consequences of the breach are such as to make precise pre-estimation almost an impossibility. On the contrary, that is just the situation when it is probable that pre-estimated damage was the true bargain between the parties …
In Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656; [2005] HCA 71 at [12], the High Court stated: Neither side in the appeal contested the foregoing statement by Lord Dunedin of the principles governing the identification, proof and consequences of penalties in contractual stipulations. The formulation has endured for ninety years. It has been applied countless times in this and other courts. In these circumstances, the present appeal afforded no occasion for a general reconsideration of Lord Dunedin's tests to determine whether any particular feature of Australian conditions, any change in the nature of penalties or any element in the contemporary market-place suggest the need for a new formulation. It is therefore proper to proceed on the basis that Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd continues to express the law applicable in this country, leaving any more substantial reconsideration than that advanced, to a future case where reconsideration or reformulation is in issue.
More recently, statements have been made by the High Court that emphasise that the "tests" propounded by Lord Dunedin were intended as guidance only, or as indicia (see Paciocco v Australia and New Zealand Banking Group Ltd (supra) at [32], [149] and [268]).
In the present case, the defendants/cross-claimants submitted that the third of Lord Dunedin's tests was applicable as the definition of Event of Default encompassed a wide variety of contractual breaches, from trivial to serious.
The defendants/cross-claimants also took issue with the rationale for the impugned fees advanced in Mr Tilley's evidence. It was submitted that he conflated the interests of the Pacific 8 companies on the one hand with the interests of N & M on the other. It was put that the adverse consequences of default he referred to, including additional costs and expenses and reputational damage, were consequences that would be suffered by the Pacific 8 companies, not by N & M as the lender. In relation to the Further Establishment fee (which is defined as the same amount as the Establishment Fee), it was submitted that such a loss would not have been expected to be incurred by N & M upon the happening of an Event of Default, even if the default is a failure to repay the loan at the end of the term. It was pointed out that in that situation the Higher Rate of Interest would be charged on the loan, with half of the additional interest to be to the benefit of N & M and the other half to be to the benefit of Pacific 8 Pty Ltd (who would be managing the loan in default). It was also stated that under the terms of the Mortgage, N & M was entitled to be reimbursed costs and expenses (including legal fees) incurred in connection with the exercise of rights arising from any Event of Default (see the definitions of Secured Money and Costs and Expenses in cl 1.1 of the Memorandum). It was submitted that, in those circumstances, it would not have been expected that N & M would have incurred additional loan management costs of $75 per day as provided for by the Default Loan Management fee. The point was also made that there was no basis for such a fee if, as stated in Schedule B, the Further Establishment fee was itself a pre-estimate of the loss sustained by the lender due to default.
The plaintiff submitted that Mr Tilley's evidence demonstrated that if the loan was not repaid as required by the terms of the Mortgage, the lender lost the opportunity to "recycle" the money lent by lending it again. It was further submitted that the defendants/cross-claimants agreed to the terms concerning fees with open eyes after obtaining legal advice. The plaintiff submitted that in the circumstances, including the difficulty in estimating the amount of loss with respect to a future Event of Default, the provisions imposing the impugned fees should be regarded as valid liquidated damages clauses containing genuine pre-estimates of loss. It was also submitted that, even if the costs to be incurred on default were those of Pacific 8 rather than N & M, Pacific 8 was acting "at the behest of the lender".
For the reasons which follow, it is my opinion that both the Further Establishment fee and the Default Loan Management fee should be characterised as being penal in nature, and that the provisions imposing those fees are thus unenforceable.
Dealing first with the Further Establishment fee, the fee is said to be a pre-estimate of the loss sustained by the Lender (N & M) due to the Debtor's default. The amount of the fee is stated to be the same amount as the Establishment Fee ($28,642). That suggests that the losses in contemplation are similar to the costs that are incurred when a new loan is being established. The explanation advanced by Mr Tilley is that the fee is intended to cover a loss to the plaintiff arising from an inability to re-lend the funds to a new borrower who would be obliged to pay its own Establishment Fee. However, the references in Mr Tilley's affidavit to "the plaintiff" in this regard (in paragraphs 7(h) and 19) seem inapt. Reading his affidavit as a whole (including his description of the plaintiff's business in providing credit to "clients" using funds raised from "investors"), and in the light of the answers he gave in cross-examination, the loss arising from an inability to re-lend or recycle funds that he refers to is a loss that would be incurred by a Pacific 8 company, not N & M.
Moreover, insofar as Mr Tilley referred to costs and expenses required to be made from "its own balance sheet", it is apparent that he was referring to a Pacific 8 company. The same can be said in relation to the references to licence requirements and reputational damage. It is not to the point that the Pacific 8 companies might be acting "at the behest of the lender". Whatever that expression means, it has not been established that the costs and expenses referred to would be borne by N & M.
In my opinion, the evidence of Mr Tilley fails to identify any interests of N & M (as opposed to the Pacific 8 companies) that are sought to be protected by the Further Establishment fee beyond its interest in the performance by the Debtors of their obligations under the Mortgage. Further, it seems to me that the rationale for the fee, as explained by Mr Tilley, is inadequate to establish that the amount of the fee is a genuine pre-estimate of a loss that would likely be sustained by N & M upon the Debtor's default.
It may be accepted that if the loan was not repaid as required by the terms of the Mortgage, N & M could be expected to lose the opportunity to promptly "recycle" the money lent by lending it again. However, as submitted by the defendants/cross-claimants, it was not shown how an amount of $28,642 could be regarded as a genuine pre-estimate of the loss that would likely be incurred by N & M in that situation, where interest would be charged at the Higher Rate, and N & M would be entitled to be reimbursed costs and expenses incurred in connection with the default.
In addition, the Further Establishment fee becomes payable on demand following any Event of Default. The definition of Event of Default, parts of which are set out above, is broad and covers a wide variety of events. Some of those events would not be expected to give rise to anything more than minor damage. Examples, which could be multiplied, include: the making of a payment of interest 1 or 2 days late; the satisfaction of a judgment within 8 days (not 7 as required); and the payment of an insurance premium a few days late. The third of the "tests" enunciated by Lord Dunedin in Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd (supra) seems to me to apply. A single lump sum is payable on the occurrence of one or more of several events, some of which may occasion serious, and others but trifling, damage. Accepting that those tests merely provide guidance or identify indicia, it may nonetheless be said that a presumption arises that the single sum is penal. As I have said, the evidence of Mr Tilley fails to identify any interests of N & M that are sought to be protected by the Further Establishment fee beyond its interest in the performance by the Debtors of their obligations, and his evidence fails to establish that the sum is a genuine pre-estimate of a loss that would likely be sustained by N & M. The contractual statement that the amount is a pre-estimate of loss is, of course, not conclusive (see Clydebank Engineering & Shipbuilding Co Ltd v Castaneda [1905] AC 6 at 9 per Earl of Halsbury LC; O'Dea v Allstates Leasing System (WA) Pty Ltd (1983) 152 CLR 359 at 400 per Deane J). I appreciate that the making of such an estimate would be very difficult, having regard to the range of defaults covered by the provision. However, the present case is not one where the parties have agreed upon a fair sum to become payable upon a particular breach, or even a particular type of breach, where it would be difficult to prove and assess the actual loss (cf Robophone Facilities Ltd v Blank [1966] 1 WLR 1428 at 1447 per Diplock LJ).
In circumstances where the Further Establishment fee of $28,642 becomes payable upon demand following numerous Events of Default likely to occasion but trifling loss to N & M, I consider that the stipulation for that fee should be characterised as penal in nature. In providing for that sum to become payable in those circumstances, the stipulation can be regarded as extravagant and unconscionable, and out of all proportion to the interest of N & M that it seeks to protect. In substance, the stipulation imposes a penalty upon default that is so far out of proportion with the interest of N & M in performance that it can be seen as intended to operate in terrorem of the satisfaction of the primary stipulations, to deter default by threat of punishment.
I turn now to the Default Loan Management fee (of $75 per day). Again, the fee becomes payable on demand once an Event of Default occurs, and the third of the "tests" enunciated by Lord Dunedin seems to me to apply. A single lump sum (albeit of only $75 per day) is payable on the occurrence of one or more of several events, some of which may occasion serious, and others but trifling, damage.
Mr Tilley gave evidence that the fee is intended to cover the additional costs and expenses incurred by the plaintiff in having to deal with a facility in default. However, it is again the case that the references in Mr Tilley's affidavit to "the plaintiff" in this regard (in paragraphs 7(g) and 22-24) are inapt. It is clear that Mr Tilley was there referring to costs and expenses incurred by a Pacific 8 company, not N & M. Once again, his evidence fails to identify any interests of N & M (as opposed to the Pacific 8 companies) that are sought to be protected by the Default Loan Management fee beyond its interest in the performance by the Debtors of their obligations under the Mortgage. Further, his evidence is inadequate to establish that the amount of the fee is a genuine pre-estimate of a loss that would likely be sustained by N & M upon the Debtor's default. That is particularly so in circumstances where N & M is otherwise entitled to be reimbursed costs and expenses incurred in connection with an Event of Default, and it is stated elsewhere in Schedule B that the Further Establishment fee is itself a pre-estimate of such loss.
For reasons similar to those set out above in relation to the Further Establishment fee, I consider that the stipulation for the Default Loan Management fee should be characterised as penal in nature. In circumstances where the fee becomes payable upon demand following numerous Events of Default likely to occasion but trifling loss to N & M, and where N & M is otherwise entitled to reimbursement of any costs or expenses incurred in connection with an Event of Default, I think that the stipulation can be regarded as extravagant and unconscionable, and out of all proportion to the interest of N & M that it seeks to protect. In substance, the stipulation imposes a penalty that is so far out of proportion with that interest that it can be seen as intended to operate in terrorem of the satisfaction of the primary stipulations, to deter default by threat of punishment.

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Judgment (7 paragraphs)

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Cases Cited (10)

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