A case note on Bellas v Powers  NSW SC, where the NSW Supreme Court held that a clause that imposed a higher interest rate on a loan facility in the Event of Default was a penalty and therefore void and unenforceable. The decision aligns with the new legislative changes effective on 9 November 2023 to 'Unfair Contract Terms' and the crack down on facility agreements that contain provisions that are unconscionable.
The case of Bellas v Powers  NSW SC involved a dispute over the enforceability of a clause that imposed a higher interest rate on a loan facility in the event of default. The court held that the clause was a penalty as it was extravagant and unconscionable in comparison with the greatest loss that could be proved to have followed from the breach. The term was therefore deemed void and unenforceable.
The Plaintiffs, Artos Espresso Pty Ltd (Borrower) and Theo Bellas (Guarantor) entered into a facility agreement with Tommy Wayne Powers and Rosemary Ann Powers as the lender (Lender) dated 2 September 2021. They key terms of the facility were as follows:
- Facility: $3,000,000.
- Lower Rate: 1.75% per month.
- Higher Rate: 9.75% per month.
- Term: 2 months.
The Borrower defaulted under the facility agreement by failing to repay the $3,000,000 by the termination date on 1 September 2021. The Lender claimed that the amount owed by the Borrower was $7,803,142.59 which comprised of the Facility plus interest accumulating at the Higher Rate from 1 September 2021 to 19 July 2023, less a repayment on 22 March 2022 of $2,948,211.14 from the proceeds of sale of a property owned by Mr Bellas, on which there was a registered mortgage securing the loan.
The operation of the interest provisions meant that the Higher Interest would be applicable at all times, unless the interest was paid on time, in which the interest would then be discounted to the Lower Interest, as set out below:
5.1 Interest period
The Borrower shall pay to the Financier interest at the Standard Rate on the Termination Date provided that if no Event of Default has occurred or remains subsisting, then the Financier shall accept the payment of interest for the Term calculated at the Discounted Rate. Any difference between interest charged at the Standard Rate pursuant to clause 7.1 and the Interest Paid In Advance will be added to the Money Owing.
Due to the disproportionate amount of money owing to the Lender, the Borrower sought court orders that the Higher Rate should be deemed a penalty and therefore unenforceable. However, the Lender submitted that the Higher Rate should not be viewed as a penalty given both the Higher Rate and the Lower Rate were available alternatives under the facility agreement, with the Lower Rate being a discount for paying by the due date.
The Court drew to the test set out in Dunlop to determine whether the interest provisions would be deemed a penalty. In Paciocco, if the "stipulated sum is extravagant or out of all proportion to, or unconscionable in comparison with, the maximum amount of damage that might be anticipated to follow from the breach"1 then it can be said that the stipulation is a penalty and is intended to punish.
1Dunlop Pneumatic Tyre Co Ltd v New Garage and Motor Co Ltd  AC 79 at .
The court found that the terms of the facility agreement which imposed the Higher Rate were indeed a penalty due to the rate being disproportionate and not a genuine pre-estimate of the costs.
The amount of the debt owed by the Borrower to the Lender on the basis of the terms of the Facility Agreement which required the Borrower to the pay the Lender interest calculated at the Higher Rate were deemed void and unenforceable.
In reaching this decisions, Robb J noted:
- there was no evidence to suggest that the Higher Rate was
reasonable in the short-term loans market, however the Lower Rate
actually seem to align more so with the market rate for short term
loans secured by real property.
- the increase in interest between the Lower Rate and the Higher
Rate was exorbitant and the Higher Rate would increase the amount
recovered by the Lender far beyond their position had no event of
- clauses that stipulate a rate increase, withdraw a discount or stipulate a flat payment on the occurrence of an event of default may be viewed by the court as a penalty, particularly where these clauses apply to a wide variety of default events that can vary in the amount of loss that the Lender will incur.
Lenders should ensure that their facility agreements are drafted with caution. Any amount payable by the Borrower to the Lender, particularly in an event of default, should be a genuine pre-estimate of the loss and that any rates, fees or costs can be justified.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.