Two recent decisions of the Court of Appeal will be of interest to any financial institution, lender or receiver active in the Irish market (including anyone acquiring Irish loans in the secondary market) as they deal with determination of penalty clauses, standard saver of rights language in demand letters, receivers costs and typical general conditions in loan documentation covering surcharge or default interest, indemnities and recoverability of the costs of enforcement.
- The Irish Courts' approach to determining penalty clauses in contracts has now diverged from the recently re-stated and more liberal approach taken in the UK.
- For a default interest clause to be valid and enforceable, it must represent a genuine pre-estimate of the bank's likely loss upon default. Default interest clauses in the general conditions of loan documentation (not bespoke and not unique to the borrowers) will not be considered to be a genuine pre-estimate of a loss on default.
- The purchaser of the loan was estopped from charging default interest due to an implied representation by the original lender that default interest would not be charged.
- The purchaser of the loan was bound by the representations of the original lender. The presence of standard saver of rights language in the demand letters did not alter this position.
- Any contractual entitlement to costs of enforcement in proceedings is subject to the jurisdiction of the court and such costs may not be recovered except under an order of the Court and are a matter of discretion for the judge.
- Redemption figures cannot include contingent costs, though where costs have been incurred but no order has been made, an estimate of those costs can be included in the redemption figure.
The cases of John Flynn and Benray Limited v Breccia and Joseph Sheehan v Breccia & Others were closely related appeals of judgments of the High Court in 2016. The issues being appealed were the following:
- Is surcharge interest of 4% (payable under the general terms of a loan facility) an unlawful and unenforceable penalty clause?
- If not, was the lender estopped from applying surcharge interest between the date of default and the date that the basis for charging surcharge interest was first set out?
- In what circumstances can "enforcement costs" incurred in defending the proceedings be included in the redemption figure for the plaintiff's mortgage?
The facts of the cases are similar and are set out briefly: -
Sheehan entered into two facility agreements in 2006 and 2008 with Anglo Irish Bank, for the purpose of buying shares in Blackrock Hospital Limited. These facilities were due for repayment in December 2010 but were never demanded on by either Anglo Irish Bank or IBRC. In December 2014, Breccia purchased these facilities and the same month issued a demand.
Mr Flynn provided a guarantee in relation to 2006 and 2008 facilities provided by Anglo Irish Bank to Benray for the purpose of buying shares in Blackrock Hospital Limited. In 2009, the Benray Facilites vested in NAMA and in May 2014, Breccia purchased the Benray Facilities from NAMA along with the associated security. In August 2014, Breccia issued a demand.
In May 2015, Sheehan, Flynn and Benray requested redemption figures for their respective loans. Breccia responded with figures considerably in excess of those previously demanded. A breakdown showed that these figures included surcharge interest and the costs of enforcement.
1. Surcharge Interest - a penalty clause?
A penalty clause is a clause the dominant purpose of which is to deter a party from breaching a contract. This is in contrast to a liquidated damages clause - the objective of which is to compensate the party which suffered loss. Genuine liquidated damages clauses are valid and enforceable, while penalty clauses are unenforceable.
The relevant clause in these cases, contained within the general terms and conditions applicable to Anglo Irish Bank's lending arrangements, read as follows:
"Any monies due by the Borrower to the Bank and for the time being unpaid will bare surcharge interest at the rate of 4% over the Facility Interest Rate or at the Bank's discretion at a rate equivalent to the aggregate of 4% over the Facility Interest Rate on the due date calculated on a daily basis from the due date to the date of actual payment after as well as before demand is made, any judgment obtained hereunder or the insolvency of the Borrower".
The UK recently took a change of approach in relation to determining penalty clauses in the 2015 Supreme Court case of Cavendish, essentially providing that such clauses are only void where they are disproportionate and unconscionable. The Irish Court of Appeal in this instance however did not follow the UK Supreme Court's position and held that it was bound by the 1998 Supreme Court judgment of Pat O'Donnell & Co. v. Truck and Machinery Sales, which adopted the principles set out in Dunlop Pneumatic Tyre v New Garage  AC 79. The Dunlop principles are the following:
- the onus of establishing a clause is a penalty is on the party alleging it;
- whether it is penal must be assessed by reference to the time the agreement was entered into, rather than at the time of the breach;
- Courts are reluctant to interfere with terms of a contract between parties of equal bargaining power. An exception to this general rule is when a clause is determined to be a penalty.
Judge Finlay Geoghegan said that the Dunlop principles indicate a binary approach: the clause is either agreed liquidated damages payable in the event of a breach or not,and if not, it is a penalty. The question is whether the surcharge interest amount represents a genuine pre- estimate of the bank's likely loss upon default. The Court also held that where a loss is uncertain and difficult to estimate accurately, latitude is allowed to parties in considering the question as to whether a clause is a genuine pre-estimate of loss.
In deciding that the surcharge interest clause here was not a genuine attempt to agree upon liquidated damages or estimate the loss of the lender upon default, the following was taken into consideration:
- the clause formed part of the general conditions and so was not specific to the borrowings of the plaintiffs;
- it was not specified when surcharge interest would become payable by the borrowers;
- the bank did not have the right (as it did with facility interest) to debit surcharge interest automatically from the account of the borrower;
- the marked difference between the terms of the surcharge interest clause and the very specific provisions surrounding the payment of facility interest;
- there was expert evidence that the pre-estimate of probable loss in the event of default is a factor taken into account in the calculation of ordinary interest.
The fact that there was a separate indemnity clause in the general conditions which was expressly directed to the obligation to indemnify against losses which might be suffered by reason of any default, supported the above conclusion.
Practical Implications For Default Interest Clauses
By declining to follow recent UK precedent in the area, the recent decisions reaffirm that the traditional approach to assessment of enforcement of default interest clauses persists. Standard default interest provisions that apply to financial contracts will need to be reassessed in light of this. Such standard provisions will likely be unenforceable, particularly to the extent that they refer to a pre-determined percentage rate (as most do), as the functional effect is not to compensate the lender but to punish the defaulting borrower. This will impact upon:
- loan agreements or facility letters, particularly those that refer to a set of standard terms and conditions;
- ISDA agreements; and
To attempt to guard against this risk, documentation in future might:
- exclude, vary or modify the standard default interest clause in explicit language. Instead, bespoke provisions on payment of interest in the event of default could be included. These provisions should attempt to tie any payments in default to the loss of the lender arising from the default.
- include explicit statements/acknowledgements that the parties have negotiated and agreed the default interest provisions and consider them to be a genuine pre-estimate of loss and not a penalty.
- include clearer mechanisms for when default interest becomes payable, more closely reflecting the manner in which facility interest accrues, becomes payable and is paid/collected.
Given the conclusion that the surcharge interest was an unenforceable penalty clause, it was not necessary to consider whether the lender was estopped from charging surcharge interest. The Court found however, that even if Breccia had been entitled to charge surcharge interest, it would have been estopped from doing so.
Estoppel is a two limbed test:
- there must be an express or implied representation by the first party, intended to affect legal relations between the parties and for it to be acted on
- the other party must have acted to their detriment.
Here, there was no express representation that surcharge interest would not be charged. The Court however, inferred an implied representation from the general course of dealing between the parties for the following reasons:
- surcharge interest never appeared in bank statements provided;
- there was no verbal demand for surcharge interest;
- no reference was made to surcharge interest when IBRC first wrote to notify of the default;
- when Sheehan wrote to IBRC to inquire about redeeming his loan, IBRC responded that he could redeem it "at par". No reference was made to any surcharge interest.
It was held for these reasons that the silence of IBRC in relation to surcharge interest amounted to an implied representation that no surcharge interest would be charged.
The Court held that IBRC undoubtedly intended the above implied representation to be relied upon given that, in response to an inquiry from the borrower about redeeming his loan, IBRC responded that it could be redeemed at par. The same letter also stated "if you wish to pay off your loan in full please contact [X] … who will provide the amount outstanding by you", thereby providing a mechanism for the redemption.
The borrower placed reliance on the implied representation that no surcharge interest would be charged to his detriment by arranging a team of advisors in order to prepare a bid for the loans. Nothing in the sales documentation suggested that surcharge interest was included or that offers should take into account surcharge interest. Incidentally, the successful bidder (Breccia) also placed reliance on these representations and did not factor surcharge interest into their bid price.
Purchaser of loan also bound
Breccia, as purchasers of the loans, stood in the shoes of IBRC and was bound by the representations. They acquired the loan and security 'subject to the equities' and so were equally estopped from applying the surcharge interest up to the date of the assignment of the loans.
Saver of Rights language
Breccia's first demand letter did not refer to surcharge interest but they contended that they were not estopped from charging surcharge interest as their demand letter ended with the following saver of rights:
"This demand is without prejudice to and shall not be construed as a waiver of any other rights or remedies which we may have including, without limitation, the right to make further demands in respect of sums owing to us."
The Court found that:
- Breccia was aware that no surcharge interest had been charged by IBRC;
- if they intended to change the course of dealing of the previous four years, they should have expressly said as much;
- the saver of rights did not convey the intention to charge surcharge interest;
- surcharge interest was not included as part of the redemption figure until a later letter sent on behalf of Breccia and even then, no explanation was provided for the higher figure;
- Breccia could not advance one figure (for redemption of the loan) while reserving the right to later claim a higher figure without having first disclosed the basis of that higher claim;
- its failure to inform the borrower of its intention to charge surcharge interest amounted to a representation that it did not intend to charge surcharge interest.
Practical Implications For Borrower Communications & Demand Letters
Lenders will need to exercise caution in all communication with borrowers, especially in relation to statements of account and letters of demand. The following should be considered:
- include surcharge interest once it has arisen in all statements provided;
- include surcharge interest as part of any requested redemption figures;
- refer to surcharge interest expressly in demand letters;
- be aware that typical saver of rights language in a demand letter may not safeguard future rights to demand surcharge interest if not previously referenced. The saver of rights will need to convey the intention to later charge surcharge interest.
For anyone acquiring loans in the secondary market, it is important to be aware that a loan assignee will be bound by the actions of the assignor. Due diligence should include enquiries around the inclusion of references to surcharge interest in communications with the borrower to date so that it can be factored in to pricing and because it will inform any potential purchaser's post-transfer interaction with the borrower.
3. Enforcement and Costs
The legal costs connected with the defence of the proceedings were sought to be included in the redemption figure provided by Breccia, pursuant to a clause in the general conditions.
The trial judge had concluded that the defence of these proceedings formed part of "enforcement proceedings" as that term is used in the relevant clause.
- In relation to the recoverability of enforcement costs, the Court of Appeal held the following:
- Costs of proceedings may not be recovered except under an order of the Court;
- Costs of proceedings are a matter of discretion for the judge;
- when exercising discretion, the judge should consider the contractual right to recover;
- where a court had made an order directing the lender to pay the costs to the borrower, those costs could not be recovered contractually by the lender. To allow otherwise, would be to circumvent the jurisdiction of the Courts and may be contrary to public policy;
- where a lender is entitled to recover enforcement costs which are not litigation costs, there is no requirement for an order for costs by a court;
- Breccia was not entitled, as part of the redemption sum, to future or "contingent" costs which might be incurred;
- where costs have been incurred, but no order made, an estimate of costs incurred can be provided as part of the redemption figure;
- if taxation has not been finalised, the lender is entitled to include a reasonable estimate of costs.
In the Flynn case, Breccia had provided an indemnity to an appointed receiver for defending the proceedings brought. Breccia claimed to be entitled to include amounts paid to the receiver pursuant to the indemnity though the courts refused to make any order for costs. It was held that factually, such an entitlement did not come within the facility agreement. Breccia was not entitled to include the receiver's costs in the redemption figure as Breccia had not participated in the costs issues in the proceedings and the receiver never sought to have the plaintiff discharge the costs on a contractual basis.
Practical Implications For Enforcement Costs
Lenders must be cognisant of the jurisdiction of the Courts in relation to costs as summarised above. Contractual entitlements to enforcement costs in litigation proceedings will not trump the jurisdiction of the Court in this regard however, Counsel for any lender that has a contractual right to litigation costs in enforcement should bring that contractual provision to the attention of the Court and make a submission that by reason of the contractual entitlement that it should obtain an order for costs.
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.