In the February 2017 issue, our article “Is a default interest rate a penalty?” examined the New South Wales Court of Appeal’s treatment of default interest rates in Arab Bank Australia Ltd v Sayde Developments Pty Ltd[1] (Sayde). In this article, we explore the Victorian Court of Appeal’s approach to penalties. In Melbourne Linh Son Buddhist Society Inc v Gippsreal Ltd[2] (Gippsreal), the court considered, among other things, whether an establishment fee constituted a penalty. Kyrou JA and Cameron AJA found that, in circumstances where that establishment fee was a component of a liquidated damages claim, it did. Maxwell P found that, on the available evidence, the court was not in a position to determine the matter. Their Honours’ conclusions are explored below.
Facts
Melbourne Linh Son Buddhist Society Inc (Society) is a community of Melbourne Buddhists of Vietnamese ethnicity led by Master Dao. Gippsreal Ltd (Gippsreal) is the responsible entity of a managed investment scheme engaged in what is sometimes described as “second tier” lending.
Over a period of about 9 months, the respondent, via a number of different brokers engaged by the Society, proposed a number of loans, each to be secured by different properties owned by the Society. The last of those was a proposal to lend the greater of $1,775,000 and 50% of the value of a property at Plumpton. A fairly recent valuation of that property indicated it was worth $3,507,345, but the Society expected its true value was about $4 million. Like all of the other proposals advanced, it provided for the payment of a 1.5% establishment fee to be deducted from the funds advanced.
A Deed of Offer was issued by Gippsreal. It provided for, among other things, the payment of liquidated damages as “a fair and reasonable pre-estimate of the damages which would be suffered by [Gippsreal]”.[3] The General Conditions applicable to the Deed of Offer relevantly provided that the Society’s liability to pay liquidated damages would arise if, after the offer was accepted, the Society did not proceed with the loan and Gippsreal exercised its rights to withdraw the offer.
A Schedule to the Deed of Offer provided for the quantum of the liquidated damages, which was the total of a number of constituent amounts. One of those was $31,625, described as being “on account of administrative and professional costs incurred by Gippsreal in investigating the loan prior to completion and procuring investors [sic] funds”.[4] This figure was itself made up of the establishment fee of $26,625 (being 1.5% of the proposed loan amount of $1,775,000) and a mortgage preparation fee of $5000.
When valued, the Plumpton property was found to be worth between $900,000 and $1.2 million. An amended Deed of Offer was sent to the Society, which was identical to the previous offer save that the amount of the loan was described as (in effect) the lesser of $500,000 and 50% of the value of the Plumpton property. Relevantly, the liquidated damages remained the same, including the establishment fee. Of course, the percentage of the loan that the establishment fee now represented was considerably greater than 1.5% of the loan amount, being close to 5% of the revised loan amount.
The Society’s solicitors wrote to Gippsreal’s solicitors, requesting that the establishment fee be reduced to $7500 so that it represented 1.5% of the proposed loan of $500,000. Gippsreal’s solicitors offered to reduce the fee to $20,000 as a “final offer” open for acceptance for slightly less than 24 hours. The Society’s solicitors did not respond at all, and after the expiry of the offer, Gippsreal sent a letter withdrawing the offer and claiming an amount including $72,671.88 for liquidated damages, a component of which was the $26,625 establishment fee.
Was the establishment fee component of the liquidated damages a penalty?
Analysis
Kyrou JA and Cameron AJA’s analysis commenced with the observation that the establishment fee served a dual purpose. First, it was an amount payable on deduction from the principal sum where the loan proceeded to settlement. That, of course, did not occur. Their Honours expressly declined to determine whether, considered in this context, the establishment fee was a penalty.
The second (and relevant) purpose the establishment fee served was as a component of liquidated damages payable under the contract as a consequence of the putative breach of the contract by the Society. Their Honours concluded that in this context, the establishment fee of $26,625 was a penalty because:
… it bears no relation to any possible damage to or interest of the respondent arising from the putative breach of the Deed of Offer by the applicant and it is not commensurate with any legitimate commercial interest of the respondent which is sought to be protected by that deed in the event of its breach.[5]
Regrettably, their Honours did not identify (at least explicitly) the commercial interests Gippsreal sought to protect by the establishment fee in its relevant context, or at all. This did not make it easy to understand the basis for their Honours’ conclusion that the necessary proportionality between those interests and the establishment fee was present. Their Honours’ reasons focused on the evidence given by Gippsreal’s managing director, Mr Rickard, as to his reasons for the retention of the higher establishment fee. Mr Rickard’s evidence in that regard was to the effect that, notwithstanding the reduction in the loan amount, the establishment fee was retained by reason of the increased administrative burden arising from the several aborted transactions which preceded the Deed of Offer. A further reason he gave was the risk inherent in the loan.
Their Honours ultimately found that the “irresistible inference” arising from Mr Rickard’s evidence (particularly in the absence of any evidence quantifying the administrative work undertaken) was that the quantum of the establishment fees was not reduced to 1.5% of the loan to punish the Society for the inconvenience its conduct caused Gippsreal.
By focusing on Mr Rickard’s evidence, Kyrou JA and Cameron AJA (it is respectfully submitted) missed an opportunity to conduct an objective analysis of the legitimate business interests that financial services providers seek to protect by the imposition of establishment fees. The more interesting enquiry their Honours may have undertaken in identifying those interests were the ways they differed from, or intersected with, other fees and charges (such as interest) by which financial services providers “price” transactions. In our opinion, Maxwell P’s observation that:
… with respect to Kyrou JA and Cameron AJA, [the] evidence given by Mr Rickard, about what he had in mind when he fixed the fee at $26,625, cannot assist the inquiry[,][6] was apt.
Expert evidence required?
Maxwell P considered that the state of the evidence was not such that a determination could be made as to whether the establishment fee was a penalty. His Honour referred to three important points which emerged from Paciocco v Australia and New Zealand Banking Group Ltd[7] regarding the nature of the inquiry as to whether a stipulated payment is a penalty. The first is an objective assessment of the legal character of provision, ascertained by examining its effect in the commercial context in which it operates. Second, that context must take into account the wider commercial interests of the party seeking to rely on it. Third, the implications of the term being found to be a penalty on that party’s interests may be unique to each particular case, thus requiring expert evidence to understand and evaluate those interests.
Maxwell P ultimately concluded that whether an establishment fee of 1.5%, or 5% as was the case in Gippsreal, was “wholly disproportionate” to the interest sought to be protected could only be determined on proper evidence, which in this case was not available at first instance or on appeal.
Conclusion
It is a pity that Gippsreal was not an appropriate vehicle to consider the issue of whether an establishment fee was a penalty in circumstances other than where it is a component of liquidated damages. It is difficult to see how parties’ agreement as to the price of a transaction could be viewed through the prism of the penalties doctrine. Addressing this aspect might have prompted a deeper analysis of whether the establishment fee component of the liquidated damages agreed to was permissible “loss of bargain” damages.
Matters of procedure arising from the decision are also noteworthy. In our article earlier this year examining Sayde, we highlighted the need in penalties cases (at least those involving financial services providers) for expert evidence so as to quantify the value of the full range of the bank’s interests protected by the provision sought to be impugned. While those observations were not borne out in the reasons of the majority in Gippsreal, Maxwell P’s treatment of that issue underscores the risk run by litigants who fail to lead expert evidence in penalties cases.
[1] Arab Bank Australia Ltd v Sayde Developments Pty Ltd [2016] NSWCA 328.
[2] Melbourne Linh Son Buddhist Society Inc v Gippsreal Ltd [2017] VSCA 161 ; BC201705000.
[3] Above n 2, at [34].
[4] Above n 2, at [35].
[5] Above n 2, at [195].
[6] Above n 2, at [8].
[7] Paciocco v Australia and New Zealand Banking Group Ltd (2016) 333 ALR 569 ; [2016] HCA 28 ; BC201606134.