Red card for borrower claiming application fee as penalty

With the recent lending slowdown in the Australian banking sector, lead by the Banking Royal Commission, tougher lending standards and tighter serviceability requirements, demand for alternative non-bank lenders continues to increase.

It is common for a non-bank lender’s lending terms to include an up-front arrangement or origination fee in respect of the establishment of the loan.  In the recent case of Private Mortgages Australia Pty Limited ACN 600 628 813 as trustee for the PMA Trust v Stever [2019] NSWSC 462 (PMA v Stever) the NSW Supreme Court considered whether such a fee for a loan that did not proceed constituted a penalty.

The Court held that the fee was not a penalty as it was effectively a fee for service, payable in consideration of the lender taking steps to proceed with the establishment of the loan.

Facts

Private Mortgages Australia Pty Ltd as trustee for the PMA Trust (PMA) is a financier, offering loans to SMEs.  EMIC Holdings Pty Ltd I.I.O.R & A.T.F 165 Donaldson Range Road Unit Trust (EMIC) purchased a property and required finance to complete at settlement.  EMIC approached PMA for finance with the Defendants, Merril Stever and Bruce Maples agreeing to provide guarantees to support the loan.

PMA issued a letter of offer on 27 February 2015 (Letter of Offer) for a $550,000 loan which was signed by EMIC and the Defendants (as guarantors).  The Letter of Offer included an originator fee of $18,150 (being 3.3% of the loan amount) and an obligation to pay PMA’s legal fees in preparing the loan totalling $5,500 (Fees).  Regarding these Fees, the Letter of Offer stated:

The above fees shall be deducted from the loan advance in the event that the loan proceeds to settlement.  If the loan does not proceed, you will remain liable to Private Mortgages Australia for the fees in accordance with this Letter of Offer.

The Letter of Offer also included a statement from the borrower and guarantors agreeing to pay the Fees in consideration of PMA proceeding with the establishment of the loan.

After the Letter of Offer was executed, PMA started work on the loan and requested that the broker take certain steps to start satisfying the conditions precedent.  EMIC failed to settle on the property and, after enquiring about progression of the loan, PMA was told by the broker that the property settlement had not gone ahead.  PMA then issued an invoice for the Fees.

Issues

Amongst other things, the Court considered:

1. 1. whether the Fees were payable pursuant to the Letter of Offer in circumstances where the loan did not proceed; and
   2. if yes, whether the Fees constitute a penalty.

Enforceability of the Fees generally

The Defendants submitted that the Fees were only payable on settlement of the loan or, alternatively, when PMA confirmed that funds were available and it was otherwise ready, willing and able to proceed to settlement.

Henry J did not accept this argument, stating that the words in the Letter of Offer were unambiguous.  The obligation to pay the Fees was not tied to settlement or PMA being ready to provide the funds.  The Fees were payable as consideration for PMA taking preparatory steps to advance the funds, including obtaining valuations of the security property, seeking documents from the broker and performing credit checks.

Her Honour considered that the position may have been different if PMA had either been the cause of the loan not proceeding or elected, without cause, not to proceed without any reasonable basis, but this was not the case here.

Henry J took the view that the Fees became payable by the Defendants when they accepted the Letter of Offer, and consequently PMA was within its rights to pursue the Defendants for the Fees once it became clear that the Defendants did not wish to proceed with the loan.

Is the obligation to pay the Fees void as a penalty?

The Defendants claimed that the Fees were a penalty as they did not amount to any genuine pre-estimate of loss and were out of all proportion to the damage suffered by PMA.

Henry J rejected this submission.  Her Honour revisited well established principles on the doctrine of penalties, including in Legione v Hateley (1983) 152 CLR 406 where a penalty was described as follows:

A penalty, as its name suggests, is in the nature of a punishment for non-observance of a contractual stipulation; it consists of the imposition of an additional or different liability upon breach of the contractual stipulation.

Henry J held that the obligation to pay the Fees did not arise as a result of the Defendants’ failure to satisfy another obligation under the Letter of Offer.  Rather, the agreement to pay the Fees was a primary obligation.  It arose because the Defendants agreed to pay the Fees in consideration of the plaintiff taking steps to proceed with the establishment of the loan.  The fact that the loan did not complete does not transform the Fees into a penalty. Consequently it is irrelevant whether the Fees are a genuine pre-estimate of loss.

Her Honour commented that:

A contractual obligation to pay a fee in relation to a service which a party was ready, willing and able to perform but was not fully rendered due to the other party’s conduct is not enough to attract the penalty doctrine.

Accordingly, the Fees could be characterised as payment for a service, being the steps and activities involved in the establishment of the loan.

Implications

While this case is a positive result for lenders and their ability to enforce their up-front fees, it does highlight the importance of ensuring that any fees payable are drafted in a clear and unambiguous way.

If you have any concerns regarding your loan terms and would like them reviewed, please feel free to get in touch with us.

Authored by:

Elliot Raleigh, Partner, Melbourne

Yoni Baker, Lawyer, Melbourne

Clive Robért, Lawyer, Sydney