CA says $28 million late payment fee not a penalty
A $28 million fee for late payment of a $37 million loan may sound steep, but on the facts of a recent Court of Appeal case (Wilaci Pty Ltd v Torchlight Fund) it was held to be proportionate to the lender’s legitimate interests and therefore enforceable.
The judgment provides a helpful guide to the current approach to the penalty doctrine (i.e. the principle that contracts should not allow parties to punish one another disproportionately), and sends a reassuring message to commercial lenders that the courts will be slow to intervene in loans between sophisticated parties.
The facts in Wilaci were as follows.
Torchlight, a private equity fund, required urgent short-term funding of A$37 million to settle the balance of the purchase price for certain debts it had acquired from the Bank of Scotland.
Torchlight was unable to arrange funding through commercial lenders, and agreed to borrow the sum from Wilaci, an Australian company. The term of the loan was 60 days. Wilaci was not a commercial lender, and sought to manage its risk by requiring various conditions, including payment by Torchlight of:
- interest of A$320,000 (reflecting Wilaci’s own cost of funds for the term);
- a lending fee of A$5 million (payable a further 60 days after the end of the term); and
- a weekly late payment fee of A$500,000 if Torchlight failed to repay the principal at the expiry of the term.
The date for repayment passed and Torchlight failed to repay the loan. After numerous requests to effect repayment (over nearly two years), Wilaci issued a demand for the late payment fee, which by then totalled over A$28 million.
Torchlight challenged the late payment fee as an unlawful penalty at common law. Torchlight issued the proceeding in New Zealand, although given the contract was governed by New South Wales law, the Courts have been bound by Australian law in reaching their conclusions (though also heavily influenced by the leading English cases on the subject).
The Court’s view
The High Court initially found that the late payment fee was an unenforceable penalty on the basis that: (i) its predominant purpose was deterrence; and (ii) the late payment fee so significantly exceeded the loss likely to be caused by the late payment of the loan that it was considered “extravagant”. Both of these are aspects of the test for a penalty as set out in the leading case of Dunlop Pneumatic Tyre Co Ltd v New Garage & Motor Co Ltd  AC 79 (HL).
The Court of Appeal took a different view and granted Wilaci’s appeal, holding that the late payment fee was not a penalty. In reaching this conclusion, Kós P (delivering the judgment of the Court) summarised the course of the penalty doctrine from the fluid principles set out in the 1905 decision Clydebank Engineering and Shipbuilding Co Ltd v Yzquierdo E Castaneda  AC 6 (HL), hardening into the oft-cited tests outlined by Lord Dunedin in Dunlop Pneumatic Tyre, before its recent return to a more flexible approach in the UK Supreme Court decision in Cavendish Square Holding BV v Makdessi  UKSC 67, and that of the High Court of Australia in Paciocco v Australia and New Zealand Banking Group Ltd  HCA 28.
The Court found that the late payment fee was not punitive because (applying the majority reasoning in Paciocco) it was not out of all proportion to Wilaci’s legitimate interest in ensuring repayment. The Court reached the same outcome applying the minority reasoning in Paciocco: the fee was not punitive because it was not predominantly intended to punish.
The Court stressed that the outcome was determined by the parties’ particular commercial context. Relevant factors included:
- the commercial experience of the parties, and the fact that Wilaci was not in the business of lending (so could legitimately demand more protection than a commercial lender);
- the substantial returns available to both parties in consequence of the transaction;
- the high degree of risk posed by the transaction, which was “unbankable except by lenders of last resort”; and
- the fact that the daily cost of credit arising from the late payment fee post-default was commensurate with (and in fact lower than) the daily cost of credit during the term of the loan. This “distinctive feature” was central to the Court’s finding that the fee was proportionate.
What does this mean?
It is important to note that the application of the penalty doctrine turns on the facts of each case. In other cases, where the bargaining strength between the parties is not as even, or the lender’s risks not so great, the Court may assess a fee’s proportionality with the lender’s interests more narrowly.
An appeal to the Supreme Court may follow. In the meantime, this judgment serves as a warning for any commercial borrowers who expect to avoid late payment fees by disputing their validity purely on the basis of scale. In the Court of Appeal’s view, “the scale of the debt it now faces is in large measure a consequence of the choices Torchlight made for itself”.
If you would like to discuss the implications of this case and what it means for your business, please contact the authors.