#6702 - Lordsvale Finance V. Bank Of Zambia - Commercial Remedies BCL

Lordsvale Finance v. Bank of Zambia

Facts

The claim arises in this way. On 24 April 1984 an international syndicate of banks entered into an oil import facility agreement with the defendant, a bank, under which a facility of U.S.$130m. was made available to the defendant. Amongst the participating banks were Sumitomo and B.C.C.I. On 19 July 1985 another international syndicate of banks, again including Sumitomo and B.C.C.I., entered into a further oil import facility agreement with the defendant in the sum of $100m.

In the course of 1986 the facility advances fell due for repayment, but the defendant defaulted. On 7 March 1995 solicitors acting on behalf of the plaintiffs made a demand on the defendant for payment of the amounts due under the two agreements.

The relevant clause stipulating an additional 1% margin:

“Default Interest and Indemnity. (A) In the event of default by the borrower in the payment on the due date therefor of any sum expressed to fall due under this agreement (or on demand in respect of any sum expressed to fall due under this paragraph (A)), the borrower shall pay interest on the participation of each bank in each such unpaid sum from (and including) the date of such default to (but excluding) the date on which such sum is paid in full (as well after as before judgment) at a rate per annum equal to the aggregate of (i) 1 per cent., (ii) the margin and (iii) the cost as determined by such bank of obtaining dollar deposits (from whatever source or sources it shall think fit) to fund its participation in the unpaid sum for such period or periods as the agent may from time to time determine.”

Defendant’s argument: The defendants contend that, inasmuch as the constituents of the default interest under article 10.03(A) include at (i) 1 per cent., a rate completely unexplained, in addition to the margin (defined in article 1 as 1 per cent.) and the cost of obtaining dollar deposits to fund the bank's participation, the 1 per cent. is a penalty. It is said to be in terrorem the borrower, its sole function being to ensure compliance with the agreements. This point is of considerable importance for English banking law because it is a well known fact that a default interest rate uplift is very widely used, particularly in syndicated loans, such as this.

Holding

It is clear that, if a loan agreement were to provide that upon the happening of a default in payment by the borrower the rate of interest were to be increased with retrospective effect, that which would be payable on default would be a sum in addition to the amount of principal and interest outstanding which would be calculated by reference to a period of time during which the borrower was entitled to the use of the principal and which might vary in length depending upon when the default in payment occurred in relation to the period of borrowing. Moreover, the amount of interest which would be payable would be unrelated to the extent of default. If therefore default in payment triggered a retrospective increase in the rate of interest, it would be impossible to say in advance how much extra interest would become payable and what arithmetical relationship it would have to the amount of time during which the principal was outstanding. Moreover, assuming that any increase in the rate of interest was to continue into the future, the period of time during which the default was continuing would be compensated by the continuing increased rate, but also by the accumulated increase in the interest derived from the period before default. Such a provision would therefore have all the indicia of a penalty.

Where, however, the loan agreement provides that the rate of interest will only increase prospectively from the time of default in payment, a rather different picture emerges. The additional amount payable is ex hypothesi directly proportional to the period of time during which the default in payment continues. Moreover, the borrower in default is not the same credit risk as the prospective borrower with whom the loan agreement was first negotiated. Merely for the pre-existing rate of interest to continue to accrue on the outstanding amount of the debt would not reflect the fact that the borrower no longer has a clean record. Given that money is more expensive for a less good credit risk than for a good credit risk, there would in principle seem to be no reason to deduce that a small rateable increase in interest charged prospectively upon default would have the dominant purpose of deterring default. That is not because there is in any real sense a genuine pre-estimate of loss, but because there is a good commercial reason for deducing that deterrence of breach is not the dominant contractual purpose of the term.

It is perfectly true that for upwards of a century the courts have been at pains to define penalties by means of distinguishing them for liquidated damages clauses. The question that has always had to be addressed is therefore whether the alleged penalty clause can pass muster as a genuine pre-estimate of loss. That is because the payment of liquidated damages is the most prevalent purpose for which an additional payment on breach might be required under a contract. However, the jurisdiction in relation to penalty clauses is concerned not primarily with the enforcement of...