Unfair loans are only unfair if the interest on the loan, or charges in relation to the loan, were extortionate when the loan was made, or has since become extortionate.
This determination is made considering the following:
- The risk to which the lender was exposed; and
- The value of any security in respect of the loan; and
- The term of the loan; and
- The schedule for payments of interest and charges and for repayments of principal; and
- The amount of the loan; and
- Any other relevant matter.
Section 588FD of the Corporations Act 2001 (CTH) (“the Corporations Act”) outlines the requirements on the unfair loans provision.
Although not used by liquidators much, in this article our insolvency lawyers explain unfair loans and voidable transactions in more detail.
If you have been contacted by a liquidator in relation unfair loans, you should contact an insolvency lawyer as soon as possible to attempt to defend the liquidator’s demand for money
OR CALL: 1300 545 133 FOR A FREE PHONE CONSULTATION
What are Voidable Transactions?
A voidable transaction in company insolvency is a transaction entered into by the company and a third-party which can be avoided and debt recovered by the liquidator of the company in liquidation.
Voidable transactions can include:
- 588FA – Unfair preferences;
- 588FB – Uncommercial transactions;
- 588FC – Insolvent transactions;
- 588FD – Unfair loans to a company; and
- 588FDA – Unreasonable director-related transactions.
If you fall into the category outlined above, then this transaction could be a voidable transaction.
Section 588FE(6) of the Corporations Act says:
The transaction is voidable if it is an unfair loan to the company made at any time on or before the day when the winding up began.
This means that there is no time limit as with other types of voidable transactions, simply at any time on or before the winding up began.
This article will focus on unfair loans.
What are unfair loans?
A loan is an unfair loan if the interest on the loan, or charges in relation to the loan, were extortionate when the loan was made, or has since become extortionate because of a variation to the loan.
In determining whether interest on a loan was or became extortionate or whether charges in relation to a loan were or became extortionate the liquidator must have regard to the following:
- The risk to which the lender was exposed; and
- The value of any security in respect of the loan; and
- The term of the loan; and
- The schedule for payments of interest and charges and for repayments of principal; and
- The amount of the loan; and
- Any other relevant matter.
588FD of the Corporations Act allows for two (2) parts – section 588FD(1) and section 588FD(2).
Section 588FD(1) of the Corporations Act says:
(1) A loan to a company is unfair if, and only if:
(a) the interest on the loan was extortionate when the loan was made, or has since become extortionate because of a variation; or
(b) the charges in relation to the loan were extortionate when the loan was made, or have since become extortionate because of a variation;
even if the interest is, or the charges are, no longer extortionate.
The first part of the section says that loans are only unfair loans if the interest on the loan, or charges in relation to the loan, were extortionate when the loan was made, or has since become extortionate.
In calculating whether the interest on the loan, or charges in relation to the loan, were, or have become extortionate, consideration must be given to section 588FD(2) of the Corporations Act which says:
(2) In determining:
(a) whether interest on a loan was or became extortionate at a particular time as mentioned in paragraph (1)(a); or
(b) whether charges in relation to a loan were or became extortionate at a particular time as mentioned in paragraph (1)(b);
regard is to be had to the following matters as at that time:
(c) the risk to which the lender was exposed; and
(d) the value of any security in respect of the loan; and
(e) the term of the loan; and
(f) the schedule for payments of interest and charges and for repayments of principal; and
(g) the amount of the loan; and
(h) any other relevant matter.
The explanatory memorandum contained in the Corporate Law Reform Bill 1992 (Cth) says:
373. ‘Unfair loan’ will be defined substantively in proposed section 588FD, to mean a loan in respect of which the interest rate or charges were extortionate at the time the loan was entered into. An unfair loan is liable to be set aside under proposed sections 588FE and 588FF.
The word extortionate sets a seemingly high bar, but what does extortionate mean?
What does Extortionate Mean?
The Oxford English Dictionary defines extortionate to mean:
(of a price) much too high; exorbitant.
The Oxford English Dictionary defines exorbitant to mean:
(of a price or amount charged) unreasonably high.
In John Irving as Liquidator of Mawson KLM Holdings P/L (In Liq) & Anor V Starmaker (NO 51) P/L [2005] SASC 309 a party referred to the word extortionate in pleadings as:
“grossly excessive”
Seemingly the bar is set very high for a loan to be unfair. Use of the word extortionate and the definitions contained above, and the considerations contained in section 588FD(2) of the Corporations Act makes it a very onerous task to persuade a Court that a loan was unfair pursuant to the Act.
Arguably, the legislature actually intended this to operate this way.
The explanatory memorandum contained in the Corporate Law Reform Bill 1992 (Cth) says:
1048. This provision is quite different from anything contained in the present law and is directed to the situation where the rights of unsecured creditors as a class are prejudiced by the company’s having entered into a loan agreement for which the consideration is excessive. The section is not directed to loans which in hindsight may be judged as bad bargains but at transactions which are grossly unfair, so that in normal circumstances no reasonable company is likely to have entered into such a contract unless there were some further rationale such as where the agreement is a sham agreement intended to operate in circumstances of insolvency to confer an undue benefit on the lender.
What is a Loan?
Again, there is no definition of “loan” in the Corporations Act.
The Oxford English Dictionary defines loan as:
A thing that is borrowed, especially a sum of money that is expected to be paid back with interest.
Butterworths Concise Australian Legal Dictionary defines a loan as:
An advance of money … the payment of an amount on behalf or at the request of a person where there is an obligation to repay the amount.
In Federal Commissioner of Taxation v Rawson Finances Pty Ltd [2012] FCA 753 Edmonds J said:
The essence of a loan of money from A to B is a corresponding contemporaneous obligation on the part of B to repay the money transferred from A to B … Absent that obligation, the transfer of the money from A to B is something else – a gift, a payment by direction, a payment or repayment of an anterior obligation – but it is not a loan.
In Commissioner of Taxation v Radilo Enterprises Pty Ltd [1997] FCA 22 the Court said:
In essence then a loan is a payment of money to or for someone on the condition that it will be repaid.
In Re Securitibank Ltd. (No. 2) [1978] 2 NZLR 136 Richardson J said:
The essence of a loan of money is the payment of a sum of money on condition that at some future time an equivalent amount will be repaid.
So, a loan is the advancement of money from one entity to another entity with the obligation that it be repaid at a later time.
This means that in a particular factual scenario it may be possible to argue that the liquidator’s claim for unfair loans might not actually be a loan. This will depend on the facts of each particular case.
If it is determined to be an unfair loan, the Courts can make a number of orders.
What Orders can the Court Make?
The Court can make orders relating to unfair loans such as an order directing a person to indemnify the company in respect of some or all of its liability to the assignee.
Section 588FF of the Corporations Act says:
Where, on the application of a company’s liquidator, a court is satisfied that a transaction of the company is voidable because of section 588FE, the court may make one or more of the following orders … (f) if the transaction is an unfair loan and such a debt, security or guarantee has been assigned–an order directing a person to indemnify the company in respect of some or all of its liability to the assignee;
There are also a number of other orders that the Court are able to make in relation to voidable transactions and unfair loans.
However, there are some defences to claims relating to unfair loans.
Defences to Unfair Loans Claims
Possible defences are outlined in the Corporations Act.
No Requirement for insolvency
There is no requirement for insolvency in unfair loans (just like unreasonable director-related transactions) for the insolvency defence or the defence of good faith are not available.
It was not a Loan
A person might be able to successfully argue that the alleged loan is not a loan in accordance with the definitions above. There are a number of factual scenarios where the company might incur a loan which is not typical, business restructuring, debt restructuring, etc. If the characteristic of the particular transaction is not a loan, then it may not be caught by this section.
It was not Extortionate
Probably the best defence to a liquidator claim for an unfair loan is that the interest and/or charges on the loan were not extortionate when the loan was made or have since become extortionate. As discussed above, the bar is set very high in relation to whether interest and/or charges are extortionate, and even seemingly very high interest rates may not be extortionate.
In practice there has rarely (or never) been a reported case where the Court has found for a liquidator in a claim for an unfair loan.
How have the Courts Decided?
In Re Essendon Apartment Developments Pty Ltd (in liquidation) (No 2) [2013] VSC 210 a caveator was attempting to argue that a second mortgage was an unfair loan because it bore an interest rate of 60% per annum or 72% per annum if in default. In determining this issue, Robson J said:
I am not satisfied that the loan was an unfair loan under s 588FD or that the liquidator was in error in deciding that it was not. On the evidence, the lender was exposed to relatively high risk. The mortgage was a second mortgage on an undeveloped development. There is no evidence of the value of the security. The loan was for three months. The loan was only for $120,000.
So, on balance, looking at all the circumstances, a loan which bore an interest rate of 60% to 72% per annum was not deemed “extortionate” or an unfair loan.
Non-588FD Unfair Loans Cases
As mentioned above, with a complete lack of and real judicial decisions in relation to 588FD Unfair Loans cases, other cases have decided whether interest rates and charges are reasonable.
In Takemura v National Australia Bank Ltd [2003] NSWSC 339 the Court considered whether 60% to 72% interest stopped the Mortgagee from obtaining an equitable remedy of specific performance. Young CJ said:
What must be shown is that there is unconscionable pressure on the mortgagor to enter into the arrangement. A mortgage given by a businessperson at a very high rate of interest, if that mortgage was freely and voluntarily given, will not be able to be attacked … it seems to me that short of unconscionability including what is sometimes comprehended in the defence of lack of clean hands, the mere fact that there is a high interest rate charged in trade and commerce between people of business does not of itself mean that equity would decline specific performance.
So again, an interest rate of between 60% and 72% did not mean that the lender had acted unconscionably in this matter.
In Ozzy Loans Pty Ltd v New Concept Pty Ltd & Zhong [2012] NSWSC 814 the Court was asked to consider if an interest rate of 72% to 120% per annum was unreasonable in the circumstances. In this case S G Campbell J said:
None of the four categories identified by his Honour [in Takemura] arises in this case on the findings I have made … It follows from what I have said that the plaintiff is entitled to judgment with interest at the mortgage interest rate …
So, even an interest rate of between 72% to 120% may not be excessive or extortionate.
In Re: Planet Securities Unit Trust v Dalrymple [1999] QSC 204 the Court was asked to consider if an interest rate of 180% (15% per month) was unreasonable. Again, after considering the authorities Hon. Mr Justice Shepherdson said:
I order that the Mortgage made between the plaintiff and the defendants and dated 18 November 1997 (Exhibit 12) be read and construed as if clause “Thirdly” thereof were deleted and the following substituted: “The Mortgagor will pay interest in advance on the principal sum or so much thereof as shall from time to time be outstanding at the rate of fifteen percent (15%) per calendar month such interest to be calculated from 10 November 1997.” … I give judgment for the plaintiff against the defendants in the sum of $292,936 … The sum of $292,936 is calculated on principal of $70,588 unpaid plus 21 instalments each of $10,588 for interest due and payable on the 9th of each month
What is Unreasonable?
Notwithstanding the above, the Courts will make an order that interest and charges are uncommercial in some instances, for example in Solomon-Innes v Carter-Lannstrom [2017] QSC 49 the applicants were seeking an order for (1) an injunction; (2) the applicants pay a commercial rate of interest on the balance outstanding. Ann Lyons J said:
The applicants allege they have been paying interest to the respondents at a rate which they say has, at times, been as high as “14,666% per annum” and that new loans were being taken out from the respondents for the purpose of repaying interest on existing loans, including penalties of $5,000 per day on the late payment of an interest instalment of $21,000.
Her Honour decided:
Having considered the material I am satisfied that the applicants have established that there is indeed a prima facie case and that the balance of convenience favours the grant of an injunction. I consider therefore that the injunction should be granted generally in the terms set out in paragraphs 1 and 2 of the Draft Order handed up by counsel at the hearing of this Application on 14 March 2017.
So, 14,666% interest on a loan may be too much. You think?
Section 588FD Unfair Loans
Hardly used by liquidators, the bar is seemingly set very high for a claim for unfair loans to be successful. However, if you receive a letter from a liquidator then it is very important that you contact a solicitor immediately.
If you have been contacted by a liquidator in relation unfair loans, you should contact an insolvency lawyer as soon as possible to attempt to defend the liquidator’s demand for money
OR CALL: 1300 545 133 FOR A FREE PHONE CONSULTATION
FAQ – Frequently Asked Questions
Navigating the complexities of company insolvency can be a daunting task. Among the intricate facets of this area are the notions of unfair loans and voidable transactions. Both of these concepts play significant roles in determining the fate of a company’s assets and liabilities when it faces insolvency.
As a means to demystify these topics and provide clarity, we have compiled a list of frequently asked questions, delving into the heart of unfair loans and voidable transactions.
What constitutes an unfair loan?
A loan is deemed unfair if the interest on the loan, or charges related to the loan, were extortionate when the loan was made, or have since become extortionate due to a variation.
How is the determination of an unfair loan made?
The decision is made by considering:
- The risk to which the lender was exposed
- The value of any security in respect of the loan
- The term of the loan
- The schedule for payments of interest, charges, and principal repayments
- The loan amount
- Any other relevant matters.
What does Section 588FD of the Corporations Act 2001 (CTH) entail?
This section outlines the requirements on the unfair loans provision.
What is a voidable transaction in company insolvency?
It’s a transaction between a company and a third party that can be avoided and reclaimed by the liquidator if the company goes into liquidation.
What transactions are considered voidable?
These can include unfair preferences, uncommercial transactions, insolvent transactions, unfair loans to a company, and unreasonable director-related transactions.
Is there a time limit on when an unfair loan becomes voidable?
No. If a transaction is an unfair loan to the company, it is voidable if made at any time on or before the day the company’s winding up began.
What determines if interest or charges on a loan are extortionate?
The liquidator considers factors such as lender risk, security value, loan term, payment schedules, loan amount, and other relevant matters.
What does “extortionate” mean?
The Oxford English Dictionary defines “extortionate” as a price that is much too high or exorbitant.
How is a “loan” defined?
A loan is an advance of money with an obligation for repayment. It can also be seen as the transfer of money from one entity to another with the expectation that it will be paid back later.
What actions can a court take regarding unfair loans?
The court can direct a person to indemnify the company regarding some or all of its liabilities to the assignee among other possible orders.
Are there defences against claims of unfair loans?
Yes. Defences can include arguing that there was no insolvency, that the transaction wasn’t actually a loan, or that the terms weren’t extortionate.
Have courts deemed high-interest rates as “extortionate”?
It varies. For example, in one case, an interest rate between 60% and 72% was not deemed “extortionate” or an unfair loan.
What is the significance of Section 588FF of the Corporations Act?
This section allows a court, upon application from a company’s liquidator, to make orders if it’s satisfied that a transaction of the company is voidable.
Can you defend against a claim of an unfair loan?
Yes, possible defences are outlined in the Corporations Act, including challenging the very definition of the “loan” or arguing the terms weren’t extortionate.
How frequently do courts find in favour of liquidators in unfair loan claims?
There have been rare or possibly no reported cases where courts have ruled in favour of a liquidator in a claim for an unfair loan.
