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Bank Checked in Pursuit of Defaulting Property Borrower

January 9, 2013

No lapse of limited recourse

A loan was made by ACC Bank to Friends First and others in connection with the Crystal Property Development Fund to acquire lands in Co. Clare.  The Facility Letter contained limited recourse provisions limiting the liability of Friends First in respect of the loan to (a) the monies realised from any sale of the lands and (b) 46.6% of interest accruing on all amounts outstanding under the facility (the other borrowers being liable for the balance of the interest).  It further provided that the limited recourse provisions would lapse if a co-ownership agreement which had been entered into by Friends First and the other borrowers was amended materially without ACC’s consent.  An amendment agreement was entered into without the required consent. ACC claimed the amendments were material, deemed the limited recourse provisions as having lapsed and sought repayment by Friends First of all of the principal and interest.  

The High Court found that the amendments made to the co-ownership agreement were not material from the bank’s perspective as they didn’t affect the bank’s ability to enforce its security (which was referred to in the Facility Letter provisions that dealt with lapse of limited recourse) or affect the borrowers’ obligations to ACC. It held therefore that the limited recourse provisions had not lapsed and could be relied on by Friends First.  

No continuing interest on unpaid principal

The period in respect of which Friends First was liable for its 46.6% share of the loan interest was not clear from the Facility Letter.  ACC argued that interest continued to accrue for so long as the principal remained outstanding.  The High Court disagreed and decided that the Facility Letter contained an implied term which obliged ACC to sell the lands within a reasonable period after calling in the loan (under the general duty to mitigate loss) after which time the interest payment obligation would cease.  A reasonable period of time for sale was found, by reference to the business model for the initial investment, to be two years from ACC’s formal demand for repayment. Friends First would have no further liability in respect of loan interest accruing after that date, notwithstanding any principal remaining unpaid.

Bank surcharges were unenforceable

ACC’s general conditions entitled it to levy an additional 6% per annum surcharge on default sums. Friends First contended that due to its level this amounted to a penalty charge and was unenforceable. The High Court agreed, observing both that the surcharge would in effect double the interest rate, and that the surcharge significantly exceeded the actual additional cost of default to ACC.

Take-away points

  • A lender wishing to provide for the lapsing of limited recourse is advised to ensure the relevant provisions are very clearly drafted.
  • Where a borrower is to be liable for interest payments only, a lender should set out clearly the period of time during which interest will continue to be payable in circumstances where principal is not repaid by the borrower.
  • Lenders wishing to rely on borrower non-payment surcharges should be aware of the risk of their being unenforceable if they are disproportionate to the loss caused by the borrower’s default.

Contributed by Ciarán Tansey.

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