THE ENFORCEABILITY OF INTEREST CLAUSES AND THE PENALTY RULE
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Are provisions for contractual interest and contractual default interest penalty clauses? In Alternative Advisors Investments Pte Ltd and another v Asidokona Mining Resources Pte Ltd and another [2022] SGHC 41 (“AAI v Asidokona”), the High Court held that the contractual interest clause concerned a primary obligation that was not regulated by the rule against penalties, while the rate under the contractual default interest clause had not been proven by the defendants to so “extravagant and unconscionable” as to constitute a penalty clause in law.
Facts. This case concerned a S$2m loan granted by the second plaintiff, Supreme Star Investments Ltd (“SSI”), in 2016, to the first defendant, Asidokona Mining Resources Pte Ltd (“Asidokona”), and personally guaranteed by the second defendant, Soh Sai Kiang (“Mr Soh”) (at [1] AAI v Asidokona). In 2018, SSI assigned the loan to the first plaintiff, Alternative Advisors Investments Pte Ltd (“AAI”), who claims the outstanding sum and interest due and owing from the defendants in this suit.
To deny liability for the claim, the defendants raised seven grounds (at [58] AAI v Asidokona).
This article will only focus on the last issue (at [58(g)] AAI v Asidokona), where the defendants claimed that the contractual interest clause and the contractual default interest clause under the loan agreement between Asidokona and SSI (the “Loan Agreement”) were unenforceable as they were penalty clauses in law.
The arguments. Under the Loan Agreement, the Parties had agreed that based on the outstanding principal amount of S$2m (at [128] AAI v Asidokona):
The contractual interest rate was 5% a month (amounting to S$100,000 a month). This is pursuant to “cl 6.1 read with Items 11, 12 and 13 of Schedule 1, [where] the “Interest” is “5% per month accruing on a daily basis from the commencement of the Initial Term” to be paid on the last day of each Interest Period (being one month) beginning from the Drawdown Date“ ([16(c)] AAI v Asidokona).
The contractual default interest rate was 6% a month (amounting to S$120,000 a month). This is pursuant to “… cl 7.1, [providing that] if the Borrower does not pay any amount it is obliged to when it is due, the Borrower shall pay interest on the unpaid amount outstanding “for the period beginning on its due date and ending on the date the Lender receives it, both before and after judgment”. Item 14 of Schedule 1 provides that such “Default Interest” is “6% per month accruing on a daily basis”“ ([16(d)] AAI v Asidokona).
As set out earlier, the defendants claimed that both clauses amounted to penalty clauses and were hence unenforceable. In particular, the parties were divided on the burden of proof and how to apply the case of E C Investment Holding Pte Ltd v Ridout Residence Pte Ltd and another (Orion Oil Ltd and another, interveners) [2011] 2 SLR 232 (“E C Investment”) (at [129] – [130] AAI v Asidokona).
This is because:
AAI submitted that it was for the defendants to show that the contractual default interest rate amounted to a penalty clause and was thus unenforceable.
But the defendants submitted that both interest rates were “clearly extortionate” and it was for AAI to prove that the interest claimed was a reasonable estimate of AAI’s loss.
In addition:
The defendants relied on E C Investment, where Loh J had found that a monthly interest rate of 6% “can be considered extortionate or usurious” (at [138]), to submit that the interest rates (of 5% and 6%) were penal in nature.
But AAI said that E C Investment is distinguishable, as the security provided in E C Investment and the security in this case were very different.
Legal principles. The High Court set out the legal principles applicable to the issue at [131] AAI v Asidokona. We set out the excerpt below for ease of reference:
“(a) the rule against contractual penalties (the “Penalty Rule”) applies only to secondary obligations (ie, obligations which arise upon a breach of contract) and not primary obligations: Leiman, Ricardo and another v Noble Resources Ltd and another [2020] 2 SLR 386 at [100];
(b) where parties stipulate in a contract the sum to be paid in the event of a breach, it is for the party being sued on the agreed sum to show that the term is a penalty: CLAAS Medical Centre Pte Ltd v Ng Boon Ching [2010] 2 SLR 386 at [63]; and
(c) the test for penalty clauses is whether 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 Co, Ltd v New Garage and Motor Co, Ltd [1915] AC 79 at 87, affirmed in Denka Advantech Pte Ltd and another v Seraya Energy Pte Ltd and another and other appeals [2021] 1 SLR 631 (“Denka”).”
Contractual interest rate. The High Court explained that the Court of Appeal’s holding in Denka was that the rule against penalties applies only to regulate secondary obligations (where there has been a breach of contract) and does not interfere with primary obligations between contracting parties (at [132] AAI v Asidokona).
Therefore, the High Court found that the rule against penalties could not be engaged on the contractual interest rate clause in question, as the clause concerned a primary obligation to repay the loan (at [133] AAI v Asidokona).
Burden of proof and evidence. The High Court also found that the defendants had not discharged their burden of proof as they had no evidence to show that the interest rates were “extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have followed from the breach” (at [134] AAI v Asidokona).
The High Court observed as follows (at [135] AAI v Asidokona):
“… I note that Mr Soh is an experienced banker and businessman. From the communications produced before me, when he entered into the Loan Agreement, Mr Soh was well aware of the applicable interest rates. Once again, I reiterate that Mr Soh has dropped his allegations that the bargaining process was imbalanced, he was pressured into accepting the high interest rates, and that the interest rate was meant to be 3% per month. Certainly, it is not for the court to question the commercial decision made by parties. It could be that, depending on the totality of the circumstances (such as the principal sum concerned, the urgency of the loan, and the type and nature of security for the loan, if any), such a default interest clause with such a default interest rate may amount to a penalty clause. …”
The High Court noted that Loh J had found on the facts of E C Investment that the interest on the loan at 6% per month “can be considered extortionate or usurious” (at [138]) as the loan of S$1.5m for 60 days was secured by real property worth S$29m (at [135] AAI v Asidokona).
However, in the present case, “… the short-term loan was secured only by Mr Soh’s personal guarantee, and Mr Soh’s shares in Asidokona which is a private company incorporated a year prior to the loan. The defendants have simply failed to adduce evidence to show that the interest rate of 6% per month (which is 1% above the applicable interest rate of 5% per month) is extravagant and unconscionable.” (at [135] AAI v Asidokona).
Significance. Hence, AAI v Asidokona does not make any new law: it is an important reminder that when it comes to arguments on penalties, parties must pay close attention to the particular obligation in question. It is vital to construe the clause in question carefully to examine if it is a primary obligation or a secondary obligation.
Additionally, when a party asserts that a particular provision is a “penalty”, the burden rests on that party to prove why the said provision in question amounts to a penalty. As emphasised by the High Court, the totality of the circumstances is relevant in determining whether the clause in question amounts to a penalty clause.
So, what may be found to be penal in one transaction may not be found to be penal in another transaction, depending on the nature of the transactions and the contracts in question. Relevant factors would include, e.g., whether there was any imbalance in the parties’ respective bargaining position, the sophistication of the parties, whether the parties were legally advised, and any other relevant features of the transaction in question (e.g., urgency of a loan, principal sum concerned, etc.).
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