Sayde Developments Pty Limited v Arab Bank Australia Limited

The contractual documents

1. By Letter of Offer dated 12 January 2006, the defendant offered facilities to the plaintiff for a commercial loan of $6,825,000.00. The terms and conditions included the following: "Purpose of facility: Originally granted to assist with the purchase of the commercial property at Liverpool, NSW. Now to extend the Facility to expire on 12/12/06. Interest rate The Bank's Prime Rate plus a margin of 0.05% (which currently provides a total rate of 9.00% per annum), reducible to the Prime Rate minus a margin 1.95% (which currently provides for a total rate of 7% per annum) on prompt payment. Please note that the interest rate is subject to variation. Interest payment date On the 20th day of each month. Term of the Facility To mature on the 12/12/2006. Monthly instalments Based on the current interest rate and the full Facility amount being drawn, monthly repayments are $41,885.00 covering interest only is payable on the interest payment date. This repayment amount will change in the event the interest rate varies."
2. It was common ground the offer contained other terms and conditions including the defendant's General Terms for Commercial Products as at March 2006. Those terms included terms for review of the Facility (Cll 5.1 - 5.5) and interest charges (Cll 11-13). They also contained, inter alia, what was to happen in the event of a default (Cll 24 and 25).
3. Clause 26 provided as follows: "26 Higher interest charges 26.1 If the Customer does not make a repayment due under Clause 7 on time, then, from and including the day that repayment is due until but excluding the day it is paid in full, the Bank calculates interest charges under Clause 11.1 at the default rate set out in the Letter of Offer. 26.2 The Customer's obligation to pay on time is not cancelled by this clause."
4. On 7 October 2008, the defendant offered a commercial loan Facility for the sum of $6,825,000.00. The Letter of Offer contained the following terms: "Interest rate The variable interest rate (which is currently a rate of 9.85% per annum). This rate is referred to as the "Prime Rate" in newspaper advertisements in English published by the Bank minus a margin of 1.70%. Repayment The Customer must pay:

• Interest Charges in terms of Cl 11 of the general terms for commercial products. As a guide, the monthly repayment will be approximately $56,021.88; and
• The final repayment of $6,881,021.88 First repayment date 20 October 2008 Default rate The default rate of interest at any time equals the interest rate at that time plus a margin of 2% per annum (which is currently a rate of 11.85% per annum)."

1. By Letter of Offer dated 2 March 2010, ABAL offered a commercial loan facility for $6,825,000.00. The letter specified a variable interest rate of 8.5% per annum and a default rate as follows: "The default rate of interest at any time equals the interest at that time plus a margin of 2% per annum (which is currently a rate of 10.5% per annum)."
2. By Letter of Offer dated 17 June 2011, the bank offered a commercial loan Facility in the sum of $7,050,000.00. Relevantly, the Letter of Offer referred to a fixed interest rate of 8.54% per annum for a fixed period of 90 days, with a monthly repayment of $50,172.50. The default rate was specified as follows: "The default rate of interest at any time equals the interest rate at that time plus a margin of 2% per annum (which is currently a rate of 10.54% per annum)."
3. That Letter of Offer included the defendant's General Terms for Commercial Products published in July 2010. Those terms also included provision for default events (Cll 24 and 25). Clause 26 provided as follows: "26 Higher interest charges 26.1 If the Customer does not make a repayment due under Cl 7 on time, then, from and including the day that repayment is due until but excluding the day it is paid in full, the Bank calculates interest charges under Cl 11.1 at the default rate set out in the Letter of Offer. 26.2 The Customer's obligation to pay on time is not cancelled by this clause."
4. Clause 40 of the terms and conditions adopted the 2004 Code of Banking Practice.
5. A further agreement was made on 2 December 2011 which extended the Facility, again on a fixed basis of three months, variable each three months.
6. Of the penalty interest charges made by the defendant, the charge made on 20 September 2009 was said to be referrable to the 2008 agreement. Those charges made on 20 August and 20 September 2010 were said to be referrable to the agreement made on 2 March 2010, and the charges made between 20 August 2011 and 23 June 2013 were said to be made pursuant to the agreements dated 17 June 2011 and 2 December 2011.
7. The plaintiff's alternative claim is based on a letter from the defendant to the plaintiff dated 5 December 2007. It read as follows: "Penalty RE: Penalty Interest accrued under loan account #700009722 Sayde Development Pty Limited Dear Tony, At your request, this letter is to confirm that all Penalty Interest charged to the above loan account was, and always will, continue to be a direct result of the minimum monthly interest payment not being made on the specified date or within three working days from the specified date. For ease of clarification and as a reminder, the required instalment date is the 20th of each month. Again, failure to meet the specified date will result with the accrual of Penalty Interest. Please do not hesitate to contact me direct on 02 9377 8940 for further elaboration if required. Tim Brown Relationship Manager, Sydney Branch, Arab Bank Australia Limited."
8. It is the plaintiff's case that that letter led to an express term being incorporated into the contract entered into by the parties on each subsequent occasion thereafter. The plaintiff contended it was part of the objective background circumstances by which the contractual arrangements between the parties are to be determined.

Evidence relied on by the plaintiff

1. The principal evidence relied upon by the plaintiff was an affidavit of Antonios Bassil, sworn 28 November 2014, which set out the background and facilities as outlined above. Mr Bassil was required for cross-examination to establish that in 2008 he had two cash flow businesses known as St George Concrete Pumping and High Rise Concrete Contractors. Both were substantial building operations from which he used the cash flow to engage in development activities, including the property at Liverpool.
2. It was established that Mr Bassil had been with ABAL since 1996 and had been a good and loyal customer. He agreed that during the GFC the bank did what it could to help him and his companies survive. ABAL did not sell up any of his properties.
3. Mr Bassil acknowledged cash flow problems experienced by the plaintiff during the period 2008 to 2013 and the fact that Liverpool Council obtained a judgment against him during that time in the amount of $240,000.00.
4. Mr Bassil agreed there were times when he could not make the interest payments under the commercial facility as a result of external factors beyond the plaintiff's control.
5. Mr Bassil gave the following evidence: "Q: You recognise that the price of Sayde staying alive and not having its properties sold up, for example, at the bottom of the market, was that you were required from time to time to pay penalty interest or default interest to the bank; correct? A: I never agreed to pay penalty interest. Q: You never agreed to pay it, but you recognise that was the price you had to pay to avoid being put in default? A: That's what they wanted. I didn't agree."
6. Mr Bassil agreed that prior to the GFC he had the Liverpool property on the market for $11,000,000.00. He disagreed that in 2009 he put the property on the market for $6,000,000.00. He agreed that he told the bank that he would lose on the transaction if he sold the property to clear his debt to the bank. He also agreed that the bank made it clear to him that it was not going to advance further monies for the construction costs of the project.
7. Mr Bassill agreed that during the period 2008 to 2013 he was in very regular contact with ABAL and was keeping them informed about what was going on with his business. He was asked: "Q: So far as you were aware, they were working with you to manage the position from their end to keep the loans alive; correct? A: I don't know if they were working with me, but they knew what happened. Yes. Q: But they were seeking to obtain information from you; correct? A: Yes. Q: And so far as you're aware, they were acting on that information; correct? A: Yes. Q: All of the meetings that you were having with the bank during the period 2008 to 2013, as you perceived it, the bank was doing what it could to keep your loans alive? A: They tried to help. I tried to work with them, yes."
8. There was no re-examination.
9. The plaintiff relied on an affidavit of Mr David Mullen sworn 28 November 2014, which calculated various interest calculations. It was uncontroversial and the deponent was not required for cross-examination.

The defendant's evidence

1. The defendant called Mr Rocco Reitano who swore an affidavit on 1 June 2015. He worked as the Manager, Recoveries, for the defendant.
2. The affidavit set out his duties in managing recovery processes for loans in default, which were largely uncontroversial. It also referred to the staff involved in managing default loans in the period 2008 to 2014 to quantify the resources of the defendant attributable to that process.
3. Mr Reitano was cross-examined about the defaults process employed by ABAL. He agreed that major defaults would be characterised as being a monetary default more than 90 days on any credit obligation to ABAL. He agreed that a major default was a breach of an essential term or condition where the bank has taken action to require the breach to be remedied by way of a Notice of Default. Mr Reitano also agreed that a major default was where a bank has made a determination that the borrower is unlikely to repay the loan in full without recourse by the bank to action, such as the realisation of security. This was known as "material adverse change".
4. Minor defaults were defaults in payment anywhere between one and 90 days. Other minor defaults could involve borrowers having outstanding land tax or unpaid rates.
5. As a Recoveries' Manager, Mr Reitano spent time dealing with both major defaults and minor defaults. He estimated that major defaults took up to 70% of his time, however, once defaults went over 30 days, relationship managers were required to do reports and recovery action could commence. Over the years, Mr Reitano spent 70 % of his time on the major defaults.
6. The defendant also relied on the affidavit of Mr Alan Bateson, sworn on 1 June 2015. Mr Bateson had been the Senior Manager, Recoveries, since 2012. As such, he dealt with defaulting loans of ABAL and deposed to the costs incurred by the bank in dealing with defaulting loans. Mr Bateson also deposed to the grading of loans whereby at the inception, each loan was allocated a risk grade commensurate with the risk involved in the transaction to the bank. The grades were from A to F. The loans were then graded G and H upon the happening of one or more of the following events: 1. Monetary default of more than 90 days on any material credit obligation to the bank; 2. Breach of an essential term or condition where the bank has taken action to require that breach to be remedied; 3. The bank considers the borrower unlikely to repay the loan in full without recourse by the bank to action such as realisation of security.
7. Mr Bateson also deposed to the quantum of loans in arrears and the total of grade G and H loans in default for the period 2008 to 2014.
8. With leave, Mr Bateson gave evidence that he spent 100% of his time on dealing with loans in default. Mr Reitano reported to him, however, prior to his appointment in August 2012, there was no one employed by ABAL in his position. He gave evidence that as a Senior Manager he spent 15 hours per week engaged in meeting with relationship managers and credit staff in relation to defaulting loans.
9. Mr Bateson was cross-examined on the characterisation of loans classified grade G and H. He spent 50% of his time dealing with major defaults and 50% on non-major defaults. Mr Bateson gave evidence that following up arrears of interest payments would involve the relationship manager sending a letter or making a phone call. A defaulting loan would stay with the relationship manager for a commercial loan for only 60 days.
10. Mr Bateson was cross-examined on the operating costs incurred by the bank in dealing with defaulting loans.
11. At [54] of his affidavit, Mr Bateson had deposed that: "when loans go into default, there is a greater risk that the bank will suffer a loss, so the bank can be required to increase the capital it holds."
12. He was cross-examined about his understanding of the general position which he obtained from discussions with "the finance people". Such a capital cost was not part of the bank's justification for the 2% penalty interest clause.
13. In re-examination, Mr Bateson stated that the requirement for a loan provision meant a detailed assessment of the bank's chances of recovery. He was asked about the expression "once past due", and said that his department will become involved once a borrower missed a payment and they appeared on the past due reports. He said: "So prior to that date, we don't necessarily get involved in them, unless catastrophic event happens that gets reported. But it's basically once they're in arrears, they're past due which is when they start attracting the default interest."
14. The past due reports were prepared by ABAL daily.

The expert evidence

1. The plaintiff relied on a report compiled by Mr V J Fairley dated 10 September 2015. There was no challenge to Mr Fairley's qualifications and he proffered the following opinion in his report: "The two per cent default interest charged by ABAL is not a genuine pre‑estimation of damage it suffered as a result of Sayde's loan being in default, especially from the inception of the loan up to the period towards the end of 2012. Estimations are already built into the risk grading and pricing system of ABAL which reflects in the interest rate price - i.e. a margin above or below a specified base rate for a given risk grade. This is based on probability of default, expected losses using profiling over various periods, and loan term, across the whole of the portfolio - not just the defaulting portfolio."
2. The defendant relied on an expert report of Mr B Auty dated 12 October 2015. There was no challenge to Mr Auty's qualifications, and his report responded to the report of Mr Fairley dated 10 September 2015. Mr Auty disagreed with Mr Fairley's conclusion that the two per cent default rate applied by ABAL for the periods that the payments were overdue was excessive on an individual account basis for Sayde and that banks should allocate the actual cost on a customer by customer basis.
3. Mr Fairley and Mr Auty met in conference on 23 November 2015 and provided a joint report dated 7 December 2015 (Ex B). That joint report set out the areas of agreement between the parties and their reasons for disagreement, in respect of a set of questions agreed between the parties.
4. Mr Fairley and Mr Auty gave concurrent evidence. In respect of question 1 in the joint report (Ex B), both experts agreed that a past due loan could be a default of $1.00 in a repayment. Both agreed that the amount of actual cost a bank can incur on default can vary significantly. Both agreed that banks can then send a letter or charge late payment fees, and that was standard procedure.
5. Mr Auty agreed that when ABAL assessed the rating of a customer at inception of the loan, it did so to give a particular interest rate on the loan. He also agreed that part of the rating has factored into it the possibility of default by the customer, but would not agree that a grading factored into the possibility of potential costs associated to the bank of the customer defaulting.
6. Mr Fairley gave evidence that potential default recovery costs were factored into ABAL's original interest calculation to reflect its risk allocation. These were costs that are normal for ABAL to incur in the course of trading. He referred to the requirements of the Australia Prudential Regulation Authority ("APRA") which regulated the ABAL's activities as follows: "Fairley: But basically they say it's a consequence of banking that you're going to have past dues. APRA requires that a bank take due regard and monitor accounts, and it requires that it has some form of system to monitor credit quality and so forth. All the banks in Australia have risk grading systems that reflect a range of different requirements around responsibility of default, expected loss at default, and so forth; therefore, at the time a contract is signed, the process to arrive at that point involves a credit assessment, a risk grading, and that will drive pricing. In essence, it's unremarkable that if you think you've got a higher risk, then you'll have a higher price. So in that context, all of those costs that are around the normal operation of a bank, the monitoring up to the point where a - specific costs occur, which it might be an acceleration, a serving of demand, a need to realise security, up until any of that point, the bank is incurring normal costs, and so it is built into the risk grading. So not every customer has got the same price because not every customer reflects the same risk to the bank or cost to the bank associated with their loan."
7. Mr Fairley gave evidence that it was when a major default occurred involving enforcement that additional costs arose which were specific to the particular customer. They would be for a loan 90 days past due.
8. In response to that evidence, Mr Auty said as follows: "Auty: I agree with the fact that costs are quite specific to an account, once formal default has - or once formal demand has been served and a legal process entered into, so Mr Fairley and I are on common ground there. It is the period before that - takes place - I guess the period where there is perhaps an expectation that a customer will be able to self-remedy a default, or there is the possibility that negotiations can take place and that the then existing default can be overcome. It is that kind of grey area, I suspect, that we have a difference of opinion on."
9. Mr Auty disagreed with Mr Fairley's evidence that up until the 90 day default occurs, the costs are not significant enough and are already built into the interest rate charged, by reference to the risk allocation to that client. When asked to explain why he did not agree, Mr Auty said: "Because in the - in the first instance, the costs being incurred are in relation to following up with the customer, trying to negotiate an outcome, looking to seek a solution and - and potential reporting to APRA. If you're of the view that the default is significant and you're likely to proceed to more formal - more formal default."
10. Mr Auty drew a distinction for commercial loans, and particularly commercial property loans, where a bank would immediately call for security review in the case of a default.
11. When asked for a further explanation, Mr Auty said: "Auty: Simply because the costs can be quite considerable. If you have a - a department of people looking after default in commercial loans, you've got their overhead, you've got their technology costs, you've got excess reporting that you're doing on those accounts, and you've actively tried to seek a solution with the customer. That involves time, effort and cost. … I will also add, you have to consider provisioning at that time, and I'm not talking about a $1 default here, but you actually have to consciously consider loan loss provisioning and also your costs of capital."
12. Mr Fairley did not agree with Mr Auty's analysis. Rather, he explained that every bank had a recoveries department and that it was a natural consequence of the business of banking that banks would have past dues and have to manage that on a portfolio basis. The bank built the costs of those things into the loans that they wrote. The bank can predict those costs and build it into the interest rate. It is therefore pre-estimated.
13. Both experts agreed that things factored into the risk grading carried out by ABAL were the probability of default, the loss given of default, the exposure at default and the effective maturity.
14. Both witnesses agreed that the interest rate charged on any loan was not just a function of the bank's own internal costing, but also a function of the relevant market in Australia.
15. Mr Fairley confirmed that part of his report in which he stated that the methodology or factors relied upon by both Mr Reitano and Mr Bateson in measuring the costs to the bank of defaulting loans, is in accordance with prudential standards and consists of three main elements or drivers. He accepted that there could be a change in capital adequacy costs after a loan becomes past due at some point, and also that provisioning and reserved costs could increase when a loan becomes past due. In respect of a loan 90 days past due, Mr Fairley said as follows: "Fairley: APRA says, and I, therefore, follow, that if a loan goes past due 90 days, an assessment about whether it is impaired or not needs to be made. There will - and then there's also other parts where there may be additional revisioning required. APRA also says that if a bank so determines, it may make that judgment ahead of the 90 days if it believes that it needs to do so in order to protect itself."
16. Mr Fairley agreed that after a loan is 90 days overdue, or it becomes on demand, or a notice of default is issued, accelerating, at that point, those extra costs are then recoverable from the customer within the 2% default interest.
17. It was put by counsel for the defendant to Mr Fairley that his view was black and white, and additional costs were not recoverable prior to the loan being 90 days overdue. Mr Fairley said: "Fairley: Not entirely. … However, the risk rating system, the capacity of the bank to look at a loan at any particular point in time is always there. I would agree with Mr Auty to say that there would be, in any portfolio or any bank, a loan that you might become concerned about that may be less than 90 days past due. What you would do is you would review that facility, and if it was determined that the risk had changed, you would re-price it based on the risk‑rating system to reflect the additional costs that you are incurring, and that could arise prior to 90 days past due. …"
18. Mr Fairley agreed that the 2% lift in interest rate to cover additional costs was not unreasonable once the loan accelerated.
19. Mr Fairley said that it would not be justified to charge 2% on the total balance of the loan prior to a major default, because the balance of the loan is not on demand. Before that time, it was the normal cost of business which was incorporated already in the interest rate being charged. Mr Fairley gave evidence that even for a customer who was making repayments on time, the bank incurred costs such as quarterly reviews and annual reviews.
20. Mr Fairley disagreed with the proposition that there was no basis in his report for his assertion that the additional costs that arise on a default are taken into account in ABAL's pricing framework. The basis of his disagreement was that the documents subpoenaed from ABAL included volumes of information, particularly around the risk rating system.
21. Mr Auty gave evidence confirming his opinion that the 2% default rate was appropriate immediately following a default, whereas Mr Fairley opined that the cost of managing the loan is actually contained in the interest rate set from the outset. When asked what the basis of his opinion was, that the 2% default rate was appropriate in those circumstances, Mr Auty said: "Auty: Well, I guess where I differ from Mr Fairley is that I think of this, this is a commercial loan and not a consumer loan, and in a consumer world where loans are generally homogenous, Mr Fairley's view would prevail. But where you have a commercial and where the amounts are large, that involves a lot of extra individual effort to try and - try and solve the problem, and it involves potentially, or significantly more cost. So in other words, there is time - there is effort, there is negotiation, those kinds - those kinds of issues. As well as regulatory - regulatory issues. In other words, the regulations say in APS 220, that Mr Fairley quoted, actually says that a bank should, as soon as it believes it has a default, take appropriate action, and appropriate action can be - can range from doing nothing, which you do with a lot of consumer loans, to, in the case of commercial loans, actually being quite active with the customer, delivering reports through to - through to your administration, that kind of thing."
22. When asked to comment on the evidence of Mr Auty, Mr Fairley said: "Fairley: I disagree that the distinction between consumer and commercial, in terms of when a default is a default and so forth, is there. Mr Auty has agreed with me that it is in the consumer area; I obviously agree with that. My view is that the same behaviours around providing an opportunity to actually rectify work with clients to do loans, not call past due defaults until a certain period of time and when they've made the assessments, that that practice is across the bank in - in all of the areas of its credit book, not just restricted to consumers. It even goes through to institutional as well as large corporate lending."
23. Mr Fairley agreed with Mr Auty that the $7,000,000.00 facility was a larger loan on the books of ABAL at the time. ABAL also had a lot of clients in property construction and were not per se a substantive consumer bank.
24. Mr Fairley gave evidence that the interest rates for lending commercial property and commercial property construction, start off considerably higher than consumer loans. Also, the commercial property sector was not a unique industry in Australia. Mr Auty agreed with those comments.
25. Mr Fairley agreed that if interest payments due of about $40,000.00 per month on a $7,000,000.00 loan were overdue for one day, or indeed, for 30 days, ABAL would not know whether that was something significant or something minor, causing the delay in payment. Both Mr Fairley and Mr Auty agreed that ABAL would need to take management action.
26. In respect of the actual interest rate of 9.85%, Mr Auty gave evidence that he understood 1.7% was deducted from that rate, and then the default rate increases that interest rate by 2% per annum. That was clearly incorrect. When this was brought to his attention by the court, he said that he could not tell that from the document. The parties agreed that his understanding of the interest rate was incorrect.
27. Mr Auty did agree that Mr Fairley was correct that the pricing system used by ABAL and other banks incorporated the probability of default assigned to the risk rated origination of the loan into the pricing, namely, that the pricing reflected expected loss on loans based on a risk rate profile at loan inception. According to Mr Auty, where he disagreed with Mr Fairley, was that in his view, any money event of default was not a minor event of default. He disagreed that the costs associated with such defaults were taken into account in setting the default interest rate at the inception of the loan. He did agree, however, that to a limited extent, costs of having employees, namely, staff who can deal with necessary reports and overhead costs, including administration cost and software costs, were factored into the interest rate.
28. Mr Auty agreed that, in his opinion, an important factor was that: "In the vast majority of cases, banks cannot readily increase the loan pricing; that is, the margin above the base interest rate as either the entire interest rate of margin or margin has been fixed for the period of the loan."
29. He also agreed that the primary purpose of the default interest mechanism was to provide the bank with an immediate increase in pricing for defaulting loans, to enable the bank to cover the cost of monitoring and reporting on these loans, and maintain its required risk adjusted return.
30. In respect of the stages of a default in payment or past due, Mr Auty gave the following evidence: "Auty: The general approach to a defaulting loan would be that any activity from the date of default up until any formal review on the conduct of the account, or the conduct of the borrower, had been taken by the organisation. The general approach is that the 2 per cent default rate takes care of a lot of activity that a bank would be caused with having to undertake, and then once a formal decision was made, then a rate could be increased, but it wouldn't just simply be, the risk grade wouldn't be changed and the loan loss provisioning put in place or anything like that, without some sort of formal process within an organisation."
31. When asked whether he had a different view, Mr Fairley said as follows: "Fairley: A: Yeah, Mr Auty's view is that when a loan goes in arrears four days, five day, one day, it is a default. And that is the language that he uses, and as a past due, it is ‑ there is a reporting regime to APRA around those, which is expected and known by the bank at all times. So I take the view, as I have mentioned before that, since sitting here in the chair, that default is a bit different to past due. Past due is an early warning indicator. It means that you take action to identify if you have an issue or not. And if you do think you have an issue, then you initiate further process but you may not, so that is why I take the view that a default rate of interest, outside of the one obligation to report to APRA, yeah, they have a responsibility to Court to report to APRA, but a bank also has ‑ it doesn't, just because they have to report something to APRA doesn't mean that suddenly it is a default in terms of the contract. It is something where you go and look at it so I take it back to my same view which is that it is a past due, and you might investigate, you might find that you have got a problem, so you might call a default. That might happen immediately or not, or you might look at it and go, it is a past due and I am concerned and I am going to reprice it. But I don't have the view that because something is suddenly one day overdue or two days overdue, that that is a default, and that means suddenly there is all of sudden these massively increased costs compared to the daily running of a bank, that is normally monitoring the accounts anyway. CASTLE: Q: I think the question I am seeking to address to you, Mr Fairley, is slightly different. What Mr Auty is saying at the bottom of 6.1.16 is that the 2% gives you an immediate repricing until you can do a formal review and reprice for the future. And your view is, there is no need for the immediate repricing, you just wait until you have your pricing review and then you reprice, is that how you put it? FAIRLEY: A: Well, here for instance there is not a mechanism around saying that it is ‑ that these things are linked to repayments so are we ‑ is the suggestion that you are repricing a loan for the period of time that it may be past due, or are you repricing the loan permanently because you have got some kind of change to the risk profile and you have decided that you have got a monitoring side. So yes, I am saying that if you have got a past due that is four days, and it becomes reportable and so forth, sure, you have got all of that but at that particular point, no, it is not a default rate of interest.

Defendant's submissions

1. Learned counsel for the defendant submitted that the determination of the issues in this case were within a narrow compass, both legally and factually, and depended substantially upon the expert testimony. The court would not accept Mr Fairley's opinion that the 2% penalty interest upon any default was an unreasonable charge. Both experts agreed that the 2% default interest, 90 days after default, was reasonable and the dispute between the experts was narrowed to the period from the first day following default to day 90. The defendant's expert, Mr Auty, said it was a reasonable charge for the bank to invoke the 2% default interest uplift during that period.
2. In a detailed, written outline of submissions, counsel set out the following areas of agreement between the experts following their concurrent evidence: 1. "Both experts agreed that the 2% default margin operates as a re-pricing of the loan to cover additional costs incurred by the Bank of the type identified in Mr Bateson's affidavit and, at least from the point from which it applies, Mr Fairley accepts that this charge is not unreasonable; 2. Both experts agree that the Bank must act to manage default loans in accordance with the APRA policy in APS 220, and that this policy applies from the day of payment default (when the loan became "past due"); 3. Both experts agree that $1 outstanding for 30 days would not cause major loss to the Bank, but that one cannot know, at the date the loan becomes "past due", whether this will lead to a "major" default or be a "minor" default (to use the plaintiff's dichotomy)."
3. There was no dispute between the parties as to the legal principles to be applied. The starting point is the statement by Lord Dunedin in Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd [1915] AC 79 at 87, where his Honour said that a sum charged upon default will be a 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."
4. Counsel for the defendant submitted that the greatest conceivable consequential loss must be so disproportionate as to amount to oppressiveness before a stipulation will be regarded as a penalty, relying on Ringrow Pty Ltd v BP Australia Pty Ltd (2005) 224 CLR 656. The assessment is forward looking, performed at the time of entry into the contract. It is not a mechanical exercise (referring to Paciocco v Australia and New Zealand Banking Group Ltd [2015] FCAFC 50 per Allsop CJ at [147]). The onus is on the plaintiff to establish the oppressiveness involved.
5. The defendant submitted that the default interest in issue here concerns a prospective charge from the date of default until the date of payment, not a retrospective charge covering the interest period itself.
6. Clause 26 of the respective facility terms, as set out above, provides that in the event of breach, on and from the new date, but excluding the payment date, interest is applied at the default rate which is the standard rate plus a margin of 2% per annum. Both rates apply to the outstanding account balance from time to time. The defendant submitted that the "sum stipulated for" in this case is therefore the additional 2% default interest margin which has the effect of re‑pricing the loan, so that the customer pays 2% more for the loan upon default until any arrears are cleared.
7. The defendant submitted that on the facility balance of $6,825,000.00, monthly interest due was in the order of $45,000.00. Any breach incurred additional default interest in the order of $374.00 per day, for every day the plaintiff was late in paying the monthly interest.
8. The defendant conceded that the greatest loss that could follow from breach, namely, failure to pay by the due date, is associated with a "major default". However, it was submitted that it does not follow that only minor costs are associated with a minor default in respect of commercial property loans. The evidence established that loans of this type are managed by the defendant on an individual basis and significant action might be precipitated to manage the loan. This particular loan would have been regarded by the defendant as one of the larger loans on its books at the time. The evidence established that default across the loan book generally, was high (in the order of 17-18%), and the associated costs would have been considerable. Costs incurred during the period of "minor default" included "department overheads, technology costs, excess reporting, the cost of seeking a solution with the customer, and of considering the possible requirement for a provision.
9. The losses incurred from a failure to pay by the due date, it was submitted, have three main components, recognised by the plaintiff's expert, Mr Fairley as capital adequacy costs, provisioning costs and the costs of staff time and overheads. Mr Fairley also accepted that those costs were in accordance with APRA requirements.
10. The defendant submitted that ABAL being kept out of its money for non‑payment of the monthly interest is not the loss for which the 2% is compensation as "following from the breach". Mr Bateson's estimate of the cost of managing default loans was on average, 6% of the value of loans in default. The evidence of Mr Reitano and Mr Bateson established the extensive involvement of bank officers in managing loans in default, particularly given the extensive nature of the reports written in relation to the plaintiff's defaults. The plaintiff did not lead any evidence to cast doubt on the magnitude of the assessment of Mr Bateson. Both experts agreed that banks must actively manage past due loans from the time of default.
11. Counsel for the defendant also submitted: "Mr Fairley's acknowledgement of the legitimacy of the 2% re-pricing in relation to 'major' defaults is sufficient for the bank's purposes, as the 'major' defaults are causative of the greatest loss that could follow from the breach. That is, the Bank can succeed, even if the court accepts Mr Fairley's evidence that the cost of default from day one, until a 'certain point', and between day 1 and day 90, are covered by the original loan pricing. Viewed at the time of entering into the loan agreement, the Bank must contemplate the fact that a payment default may be or may very quickly become a 'major default', as the experts have agreed. The Bank must therefore make an allowance for the costs associated with a 'major default' from day 1, even on Mr Fairley's approach, as the greatest loss that could follow from the breach, as the Bank has done in the loan agreements with the plaintiff."
12. The defendant submitted that the plaintiff had not borne out its onus to prove that the 2% default interest margin was extravagant, or "out of all proportion", so as to attract the penalty doctrine.
13. Counsel for the defendant submitted that the court should not accept Mr Fairley's opinion. There is no objective evidence that ABAL priced the cost of managing defaulting loans into the original interest rate. It was submitted that implicit in Mr Fairley's opinion was an assumption that ABAL charges ordinary compliant customers a charge for management of their loans, which is not referrable to them, but to risk associated with others. It was submitted that this was contrary to how other risk markets operate, for example, insurance companies dealing with "smokers or P-plate drivers". It was submitted that the better view was that of Mr Auty, namely, that the additional management costs incurred by ABAL after a payment default are recoverable from day one, and from customers whose behaviour causes those costs to be incurred by the bank.
14. In respect of the alternative claim made by the plaintiff, the letter dated 5 December 2007, upon which the plaintiff relies, was written during the currency of the 2006 facility. No claim is made by the plaintiff for recovery of any default interest under the facility then in force, i.e. pursuant to the Letter of Offer dated 12 January 2006. Secondly, the letter is not a "specific facility term for the purpose of the agreement", pursuant to the subsequent agreements. Thirdly, the standard terms specify only that the agreement comprises the Letter of Offer, specific facility terms and the General Terms, which should be read together.
15. Finally, the defendant submits that the alternative claim is confined to contract. It was submitted that the letter of 5 October 2007 could not be considered promisory, relying on JJ Savage & Sons Pty Ltd v Blakney (1970) 119 CLR 435. There was therefore no basis upon which the plaintiff could recover on its alternative claim.
16. In oral submissions, learned counsel for the defendant referred to bank documents relied on by the experts (for example Vol 3, Tab 57), which demonstrated the work carried out by the bank and the type of costs incurred.

Plaintiff's submissions

1. The plaintiff's written outline of closing submissions comprised 38 pages and 122 paragraphs. Learned senior counsel for the plaintiff submitted, and the court accepts, that the credibility of witnesses in the case was not in issue. Each witness was candid and truthful. It was also not in issue on the pleadings that the commercial loan facility in question was extended from time to time, secured by a myriad of security interests, and subject to guarantees from a number of related entities including natural persons. From 2008 onwards, the facilities were subject to the following identical provisions in the General Terms, namely, Cls 6.1, 7.1, 11, 12, 13 and 26, some of which are set out above.
2. In providing an overview of the legal principles applicable to the doctrine of penalty, the plaintiff set out the following: "(i) A collateral stipulation operates as a deterrent against breach, with the object of the stipulation to prevent the commission of a breach of the contract by coercing compliance: Fermiscan Pty Ltd v James (2009) 261 ALR 408 per Allsop P (Ipp JA and Hanley AJA agreeing): (ii) The collateral stipulation will not be a penalty if the detriment imposed goes no further than a genuine pre-estimate of damage: Andrews v Australia and New Zealand Banking Group Ltd (2012) 247 CLR 205. (iii) A collateral stipulation will be held to be a 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: Dunlop Pneumatic Tyre per Lord Dunedin. In Ringrow the court referred to a penalty as being characterised by 'a degree of disproportion sufficient to point to oppressiveness'. (iv) In Paciocco, the ANZ Banking Group Ltd (2015) 321 ALR 584, Allsop CJ said: 'The penal character of the provision is to derived from the extravagance of the relationship between the payment and the possible loss capable of compensation. If there is no such extravagance present, the provision (failure of which by breach or not) admits of compensation is to be taken to be a genuine pre-estimate of the damage, and not penal in character. This is so, even if the parties do not express the clause to be an agreed pre-estimate of damage and even if the parties did not negotiate or set the amount payable by reference to an estimate of damage.'"
3. The test of whether a collateral stipulation is a penalty is an objective one: O'Dea v Allstates Leasing System (WA) Pty Ltd (1983) 152 CLR 359 at 400. The assessment as to whether the stipulation is a penalty must be made having regard to all of the surrounding circumstances existing at the time of making the contract, as well as the terms of the contract itself, relying on Paciocco and other authorities. The legitimate commercial interests sought to be protected by the bargain reached between the parties may be taken into account. However, the determination depends on the substance of the transaction, not its form.
4. The plaintiff submitted that: "(i) A collateral stipulation will be held to be a penalty if the primary obligation consists only of paying a sum of money and the collateral stipulation requires a greater sum to be paid if the primary obligation is not discharged: Dunlop Pneumatic Tyre at [87]. … (ii) Further, there is a presumption (but no more) that a provision is a 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'."
5. The plaintiff submitted that there was an evidentiary shift in the onus of proof where the facts are peculiarly within the knowledge of one party. In that case, comparatively slight evidence may be sufficient to discharge the onus of proof lying on the party alleging a penalty: Bay Bon Investments Pty Ltd v Selvarajah [2008] NSWSC 1251 at [51] per White J.
6. The doctrine of penalty requires that provision to impose a detriment that is extravagant and unconscionable compared to the greatest conceivable loss.
7. Here, it is not part of the defendant's case, that, if Cl 26.1 is found to be penal, the defendant has in fact suffered a loss equivalent to the default interest charged to negative the plaintiff's claim. Such a case has not been pleaded, nor run at trial.
8. The plaintiff submitted that the law recognises a distinction between a clause providing an incentive for prompt payment and a clause where the applicable rate of interest is increased upon failing to make a prompt payment. The former has long been held not to be a penalty. Here, the provision imposing default interest (Cl 26.1 of the General Terms), is not framed as an incentive for prompt payment, and accordingly is a provision capable of being considered a penalty.
9. In David Securities Pty Ltd v Commonwealth Bank of Australia (1990) 23 FCR 1, the Full Federal Court said at [31], in respect of a provision that operated prospectively when the increased interest rate applied only to outstanding payable amounts post the event of default: "Such a provision does not have a retrospective operation so as to extend to the period before the default. In accordance with the line of authority which we have discussed, it is seen not as a punishment for default, but as a genuine pre-estimate of compensation to the bank with respect to funds it would otherwise have had available to it to reinvest."
10. In Bay Bon Investments Pty Ltd, supra, White J said at [48]: "In any event, a provision for the payment of interest at a higher rate after default which does not operate retrospectively is not a penalty provided it can be seen as a genuine pre-estimate of compensation for loss a lender would suffer by being kept out of its money. [citing David Securities at [30] - [31]]"
11. The plaintiff also relied on Beil v Pacific View (Qld) Pty Ltd [2006] 2 QdR 499, where Chesterman J said at [41]: "Clause 5 of the agreement will not therefore be a penalty merely because it stipulates for a higher rate of interest to be paid in the event of default. If, however, the increase is other than modest and cannot be explained by the greater risk to the lender in recovering his loan by reason of the default, or the cost of administering the loan in default, then the increase will not be justifiable. If, to adapt the language of Ringrow, the increase in interest would yield the lender a significant advantage over what his loss can genuinely be seen to be, the obligation to pay the increased interest will be a penalty."
12. Finally, the plaintiff relied on GE Mortgage Solutions Ltd v Whild [2013] VSC 503, where a provision in a loan agreement imposed ongoing late charges where a repayment was not made on time, calculated by charging 4% per annum interest on the total outstanding loan principal. The loan agreement did not contain any accelerated repayment provision that was engaged automatically upon a default occurring. Derham AsJ held the provision to be penal and concluded at [37]: "37 In this case, the effect of the stipulation in question is to raise the interest rate payable in respect of each instalment by 4%, as a clause applies the 4% loading to the whole of the amount outstanding, which includes the principal loan amount and any charges and outstanding instalments. That sum is payable only where all or part of the balance owing on your account is overdue. That encompasses the failure to pay a monthly repayment. It therefore seems to me to satisfy the test of a penalty."
13. So too here, it was submitted, where the default interest rate provision calculated default interest by reference to the entire amounts outstanding under the loan facility, when only the outstanding repayment sum (interest) was due and payable. This resulted in the defendant earning additional interest that was, in all of the circumstances, exorbitant and out of all proportion to the greatest conceivable loss arising from the plaintiff's failure to make a punctual repayment.
14. Senior counsel for the plaintiff submitted that on settled dicta, Cl 26.1 of the General Terms was presumed to be a penalty where 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: relying on Dunlop Pnuematic Tyre Co Ltd, supra, and Paciocco, supra. It was submitted that in the present case, default interest payable was calculated by reference to the entirety of the borrowings under the loan facility, irrespective of the amount presently due and payable. To illustrate the submission, it was submitted that if the plaintiff paid all but $1.00 of the standard monthly repayment, then it incurred additional interest of 2% per annum on all amounts owing under the facility, notwithstanding that the bank had only been kept out of $1.00. By imposing default interest by reference to the entire borrowings under the loan facility, rather than the amount due and payable, resulted in the defendant earning entirely extravagant rates of return on the amount actually due and payable. This was demonstrated by Mr Fairley's calculations in his report which showed that the defendant earned between 47.13% and 2,498% on the amounts actually overdue. There was no proportionality at work here, because the same amount was payable if the plaintiff failed to repay by the maturity date all interest and the principal borrowed under the facility.
15. The plaintiff submitted that there was six broad circumstances to be taken into consideration in determining the matter. The first was that the defendant was a bank, and an authorised deposit taking institution, and had substantial assets. Secondly, the defendant had a legitimate purpose in receiving punctual repayments. Thirdly, an inherent cost of the business of banking is late payments and defaults. Fourthly, there was the regulatory context in which the defendant operated. These were summarised in Mr Fairley's report by reference to the Australia Prudential Regulation Authority and its regulatory requirements. Fifthly, the defendant set interest rates having assessed the borrower's credit worthiness. At inception, every loan is automatically allocated a risk of grade in accordance with the bank's risk grade model. This risk assessment fed directly into the standard pricing of any loan facility and informed Mr Fairley's opinion "that the bank would not, in general terms, experience any additional costs above its price per risk of grade until the loan goes into material default, demand is served, and realisation commences, which it may or may not involve specific provisioning".
16. Mr Auty agreed with this proposition, but maintained that costs associated with default are unexpected costs. This was internally contradictory and Mr Fairley's opinion should be preferred.
17. Sixthly, the defendant did not call any evidence regarding the risk grading process or the determination of the interest rate under the plaintiff's facilities, or what costs of default this pricing incorporated. Any person who could have given such evidence was squarely within the defendant's camp, and in the absence of an explanation as to why they were not called to give evidence, the court would more readily draw inferences open on Mr Fairley's evidence, pursuant to Jones v Dunkel (1959) 101 CLR 298.
18. Also relevant was that the defendant had the ability under the facility to increase the interest rate and/or margin of the loan facility at any time without the plaintiff's consent. There is no evidence that it did so.
19. The plaintiff further submitted that the assessment of whether Cl 26 was penal, must take into consideration other provisions in the contract. This included the power of the defendant to change the interest rate or any applicable margin at any time. Also, Cl 5 of the General Terms, which permitted the defendant, upon annual review of the facilities, to vary the terms of the facility, and Cl 14 thereof, which provided power to the defendant to require the plaintiff to provide additional security if the loan facility exceeded a stipulated loan to security ratio.
20. The plaintiff acknowledged that it was conceivable that there may be some additional staff and monitoring costs occasioned by a failure to make punctual repayments. However, this was the only additional cost arising from a failure by the plaintiff to make a prompt payment. Secondly, those staff and monitoring costs are trivial by comparison to the amount of the default interest and, thirdly, whilst it was true that the defendant was kept out of its money by a failure by the plaintiff to make a prompt payment, the defendant was already compensated by the continually accruing standard interest. In any event, that was not a cost which the defendant was asserting was compensated by default interest.
21. The evidence in relation to the additional costs caused by defaulting generally demonstrated that for the relevant period, the defendant had one full time employee managing defaulting loans (Mr Reitano). Other persons involved in this process from time to time were relationship managers. In respect of minor defaults, Mr Reitano spent approximately 30% of his time managing those defaults. It was submitted that only 0.07% per dollar of defaulting loan per annum was attributable to full time employee ("FTE") and operating costs in managing minor defaults.
22. The plaintiff submitted that managing recoveries is an inherent cost of the banking business and, like regulatory costs, is reflected in the standard interest charged on the loan.
23. The plaintiff submitted that regulatory driven costs, namely, increasing provisioning requirements and capital adequacy requirements, were regulatory driven costs which were already built into the pricing system of ABAL and reflected in its interest rate price, relying on Mr Fairley. The evidence demonstrated that these were not costs which arose automatically from a failure to make a prompt repayment. Thus, the plaintiff was entitled to succeed on its application for restitution of the default interest paid by it between 2009 and 2013. Clause 26.1 amounted to a penalty. The plaintiff is entitled therefore to a refund of monies paid pursuant to that clause.
24. As to its alternate claim, the plaintiff focussed on the words "and always will" contained in the defendant's letter dated 5 December 2007, as set out above.
25. The plaintiff submitted that by its Letter of Offer dated 7 October 2008, the defendant rolled over the $6,825,000.00 commercial loan facility offered by the defendant's Letter of Offer dated 12 January 2006. The same facility was offered by Letter of Offer dated 17 June 2011.
26. The plaintiff submitted that the term set out in the defendant's letter dated 5 December 2007, was incorporated into the June 2011 facility, whether as a "Specific Facility Term", or otherwise. This was submitted to be the only natural reading of the expression that penalty interest "always will" be imposed if a repayment is not made within three working days of the due date.
27. In oral submissions, senior counsel for the plaintiff submitted that the court would not accept Mr Auty over Mr Fairley, when Mr Auty had not seen the actual Letter of Offer containing the alleged penalty clause, and was not asked to look at the ABAL's documents to make an assessment as to whether or not in fact the bank had already included default costs in its interest rate pricing. The defendant called no evidence as to that issue.
28. In responding to the defendant's submissions, senior counsel for the plaintiff, in oral submissions, submitted that in the case of default, the bank had a number of options, including the issue of a Notice of Default under Cl 25, the downgrading, and "the calling up of interest payments under variations, things like that". He went on to state: "The interest, the failure to pay money, breach, does not lead to these things. The greatest loss as a result of a consequence of that, is not from the breach. It is from other conduct of the bank in its discretion, which it may or may not elect to undertake. And that is, I suspect your Honour, where my friend and I are largely at odds."
29. Counsel went on to submit that the increase in interest rate, payable on the whole amount outstanding, will yield to the defendant a significant advantage over what its loss can genuinely be seen to be.
30. Senior counsel sought to support his reasoning that the payment pursuant to Cl 26.1 was a penalty by reference to calculations based on the plaintiff failing to repay $1.00 of the monthly interest payment. To calculate interest at the default interest rate on the whole of the commercial facility led to actual damage for ABAL of a fraction of a cent, whereas the bank already had the ability to send out letters to debtors for a $35.00 fee. The analogy, it was submitted, gave the flavour that the amounts charged by way of penalty interest were extravagant and out of proportion to the actual loss, which could have been reasonably estimated as being payable at the time the contract was entered into.
31. In respect of the alternative claim made by the plaintiff, relying on the letter dated 5 December 2007, senior counsel submitted that that document was incorporated into the further contractual relationship between the parties, based on an objective determination or assessment of the various competing documents. The document was between the same parties and related to the same account. It also referred to monthly repayments. The plaintiff relied upon it as an express term of the contractual arrangements between the parties, as pleaded by it.
32. In submissions in reply, counsel for the defendant submitted that the letter dated 5 December 2007 could not be an express terms of the contract. It was only in the case of ambiguity that one could look at the objective background circumstances to determine the express terms of the contract. That was not the case here. Counsel confirmed that it was the major default which brought the defendant within the rule in Dunlop Pnuematic, supra, and that meant the default interest rate could not be a penalty. The defendant was not running a case based on actual loss after the event.

Determination of whether clause 26.1 amounts to a penalty

1. The authorities referred to above make it clear that this is a matter to be determined objectively, and also prospectively, at the time the contract was entered into. The High Court held in Ringrow Pty Ltd, supra, at [12], that the principles set out by Lord Dunedin in Dunlop Pnuematic, supra, governed the identification, proof and consequences of penalties in contractual stipulations. Lord Dunedin said at 86 - 87: "2 The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine covenanted pre-estimate of damage … 3 The question whether a sum stipulated is penalty or liquidated damages is a question of construction to be decided upon the terms and inherent circumstances of each particular contract, judged of as at the time of the making of the contract, not as at the time of the breach … 4 To assist this task with construction various test 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 the sum greater than the sum which ought to have been paid. … (c) There is a presumption (but no more) that it is a 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'."
2. In Neale v Commonwealth Bank of Australia (t/as Bank of Western Australia Ltd) [2014] NSWSC 315, Hammerschlag J said at [244]: "244 It is well established that an increase in interest rates which operate only from the date of default in payment, will not be considered as a penalty, but rather as a liquidated satisfaction, fixed and agreed on by the parties as compensation for the lender being kept from his money: David Securities Pty Ltd v Commonwealth Bank of Australia (1990) 23 SCR 1 at [30] per Gummow J."
3. In David Securities, supra, it was held that where a loan agreement provides that upon default the interest rate is increased from the date of the default (that is, increase does not have a retrospective operation), the agreement does not thereby impose a penalty.
4. In David Securities, supra, the relevant clause (Cl 11.01) provided that monies owing under the loan agreement were to become: "Immediately due and payable to the bank upon the occurrence of any of a number of various events. Only some of those events were breaches by the borrower of its obligations to the bank. Clause 11.02 then made provision for payment of further interest if the borrower failed to pay any amount payable by it 'on the due date therefore'."
5. Clause 11.02 did not impose an obligation to pay interest on the overdue amount from a time before the due date, being the date on which there was a failure to pay. The "overdue amount" upon which interest was to be paid under Cl 11.02, was held to include, not only overdue monies in the nature of principal, but also interest. The default rate of interest was 1.5% above that which, before default, applied to the principal as a primary obligation. The court said: "Such a provision does not have a retrospective operation so as to extend to the period before default. In accordance with the line of authority which we have discussed, it is seen not as a punishment for default, but as a genuine pre‑estimate of compensation to the bank with respect to funds it would otherwise have had available to it to reinvest."
6. In GE Mortgage Solutions Ltd v Whild, supra, the Victorian Supreme Court held that a loan term imposing a late charge fee calculated on the balance owing on the loan account, at the end of the fourteenth day after payment became due, calculated by charging 4% per annum interest on the debit balance, namely, the total of the outstanding loan principal, and dividing it by 12 was a penalty. Derham ASJ at [36] referred to E.L.G. Tyler Fisher & Lightwood's Law of Mortgages, 2nd ed, 2005 at paragraph 3.18 where it is stated: "It is a well settled, if not an intelligible, rule that if the mortgagee wishes to stipulate for a higher rate of interest in default of punctual payment, he must reserve the higher rate as the interest payable under the mortgage and provide for its reduction in case of punctual payment. An agreement to pay a higher rate for non-payment at the appointed time, is considered to be a penalty against which equity may give relief. … [Citations omitted]."
7. In this case, both Mr Fairley, on behalf of the plaintiff, and Mr Auty, on behalf of the defendant, agreed that in the event of a major default, i.e. failure to make a payment due more than 90 days after the due date, the uplift in interest payable of 2% would not constitute a penalty. Where the experts differed in their opinions here, was in relation to what was referred to as "a minor breach", i.e. non-payment between 1 and 90 days. Mr Fairley reasoned that because the costs of managing the loan was built into the interest rate, determined by ABAL at the time of inception of the loan, having regard to its own risk assessment grading, it was not a pre-estimate of the cost to ABAL of the breach by the borrower, and therefore was a penalty. Mr Auty disagreed on the basis that the facility was a commercial facility of up to $7,000,000.00 on a total loan book of $55,000,000.00, and therefore constituted a significant part of the ABAL's loan book. It therefore required a close management in the event of default, during which, the bank incurred significant costs of which the uplift of 2% was a reasonable pre-estimate.
8. Whilst both Mr Fairley and Mr Auty were impressive witnesses, I prefer the evidence of Mr Fairley on this issue. Mr Fairley's evidence was more cogent, and in my view, focussed on the relevant test. I accept his evidence as to the role of the regulator, and the costs of compliance as set out in [55] above, in preference to that of Mr Auty referred to in [57] and [58] above. On the other hand, Mr Auty had not been fully qualified with the relevant documents, and in fact, had not seen the actual loan document. Further, Mr Auty misread the default interest clause (see [75] above), notwithstanding that the parties agreed on its construction to the contrary of his misunderstanding of it. The reasons given by Mr Auty for his opinion as set out in [70] above are speculative as to the costs incurred by the defendant in the case of a minor default of late payment of monthly interest. Further, he relies on the costs of compliance with the regulatory authority which the bank is, in any event, required to meet.
9. Mr Auty's reasoning set out in [79] above was also unpersuasive. It was a generalisation for him to state that the 2% default rate takes care of a lot of activity that a bank would be caused with having to undertake upon a minor default. Rather, I prefer the evidence of Mr Fairley as set out at [80], and accept that much of the costs caused by a late payment are incurred in the normal monitoring of the ABAL's accounts in any event. Finally, I accept the plaintiff's submission (at [112] above), that Mr Auty's opinion that the costs associated with default are unexpected costs as being internally contradictory with his agreement with the evidence given by Mr Fairley "that the bank would not, in General Terms, experience any additional costs above its price per risk of grade until the line goes into material fault, demand is served, and realisation commences". (see [111] above).
10. Further, the evidence established that the bank, before offering the facility, assessed the risk involved in making the loan and graded that risk according to its own assessment. That impacted directly on the interest rate offered on the facility. What was clear, was that whilst not a large bank, the defendant employed a recoveries manager and had other resources to manage loans without incurring significant additional costs, where only minor default occurred. As the experts agreed, significant other costs were incurred once a major default event occurred, which was not the case here.
11. The defendant called no evidence of the actual costs involved. The evidence of Mr Reitano to the effect that 30% of his time was, at the relevant time, attributed to dealing with or managing minor defaults, was necessarily imprecise and not directly attributable to the actual costs of managing the plaintiff's loan. It is clear from the evidence available to Mr Fairley, from the bank records, that there were protocols in place to manage such minor defaults by way of involvement of relationship managers and reporting within ABAL. However, there is no evidence that persuades me that the 2% default interest provision here was a genuine pre-estimate of the cost to the bank of a breach by the plaintiff of failure to pay the monthly amount due on the due date. I accept the evidence of Mr Fairley to the effect that this was the cost of doing business for the bank, as it was required to do by the regulatory authority, APRA, for example, by applying APS 220.
12. I do not accept the defendant's submission set out at [91] above, that Mr Fairley's acknowledgement of the legitimacy of the 2% repricing in relation to major defaults, is sufficient for the bank's purposes, as the major defaults are causative of the greatest loss that could follow from the breach. That was just not the case here, where there was no major breach that occurred during the course of the various facilities. Rather, the uplift in interest rate was applied upon a late payment of monthly interest payments. The greatest loss for such a breach was the loss of the use of that month's interest payment for the time that it remained unpaid. By charging an additional 2% on the whole of the loan outstanding, for that period of time, it compensated the defendant in an extravagant way which could not have conceivably been a pre‑estimate of the costs that it would incur as a result of that breach.
13. Applying the conventional test, the default interest imposed here by Cl 26.1, involving interest on the whole principal outstanding for the period during which default occurred, in respect of each late payment by the plaintiff during the term of each facility, satisfied the test of extravagance and unconscionability in the amount charged by the defendant in comparison with the greatest loss that could conceivably be proved to have followed from each breach, namely, late payment, but which did not constitute a major default, giving rise to other contractual consequences, namely, Notice of Default, acceleration of payment and the like.
14. It was not the subject of a submission by either party before me, however, I note that the interest rate provision in the 2006 facility, as set in [13] above, would not have been regarded as a penalty. In that case, the lower rate provided an incentive for prompt payment. However, the 2008, 2010 and 2011 facilities, pursuant to which the penalty interest charges were made (set out in [16], [17] and [18] above), when read with Cl 26 of the General Terms incorporated into each facility, should be properly characterised as penalty clauses.
15. I do not accept the plaintiff's evidence to the effect that he never agreed to the penalty interest clause. That evidence relied on ex post facto deduction by him. However, looking at the matter prospectively, as I must, at the time the facility was entered into, the imposition of the default interest rate on the whole amount of the principal outstanding was not a genuine pre-estimate of the cost to the defendant, emanating from the breach. It led to an extravagant return to ABAL by comparison to the greatest loss from that breach, and therefore constitutes a penalty.
16. Having regard to that finding, I do not have to determine the plaintiff's alternative claim. If I had have been required to do so, however, I would not have found that the letter dated 5 December 2007 constituted an express term of any subsequent agreement between the parties, and therefore I would have found the defendant not liable on the alternative basis.

Conclusion

1. Having regard to my findings and reasons set out above, I find that the payments charged, by way of penalty interest by the defendant, on the plaintiff's account, and paid by the plaintiff on the relevant dates set out above, constituted a penalty and therefore are repayable to the plaintiff. There will therefore be a verdict and judgment for the plaintiff in the amount claimed.
2. Interest will also be payable on the amount claimed, which I will direct the parties to calculate and agree to prior to entering final judgment in this matter.
3. In the absence of agreement between the parties, I determined by separate judgment dated 13 May 2016, questions of pre-judgment interest, costs (including costs of the defendant's Notice of Motion dated 3 February 2016), and the defendant's application for a stay of proceedings - see Sayde Developments Pty Limited v Arab Bank Australia Limited (No 2).

Orders

1. I make the following orders: 1. Verdict and judgment for the plaintiff against the defendant in the sum of $352,302.00. 2. The defendant to pay 90% of the plaintiff's costs of the proceedings. 3. The defendant to have a stay of proceedings for 28 days from 13 May 2016.

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