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Unfair relationships: The latest for lenders

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18/03/2019

January 2019 saw two key cases concerning ‘unfair relationships’ between lenders and borrowers. Banking & Finance Litigation specialist Christina Gill looks at Pontearso v Greenlands Trading [1] and Pilgrim Rock v Iwaniuk [2] and explains the latest key takeaways for lenders.

What is an ‘unfair relationship’?

Section 140A of the Consumer Credit Act 1974 (CCA) provides that a court may order the lender to reduce, discharge or repay a loan under a credit agreement should it determine that the relationship between the lender and the borrower is unfair to the borrower.

Unfairness may arise because of (a) the terms of the loan agreement; (b) the way in which the lender enforces its rights under the loan agreement; or (c) because of any other thing done or not done by or on behalf of the lender. When considering unfairness the court may take into account all matters it thinks relevant, plus the burden is on the lender to prove that the relationship is not unfair.

All of that means that the CCA affords significant scope for borrowers to challenge or reduce their liabilities pursuant to loan agreements, and the onus is on lenders to make sure that their terms and conduct are beyond reproach.

Why are these cases important?

The following recent cases provide up-to-date worked examples of the court’s approach to the question of unfairness. They should, therefore, help lenders to better formulate their products and policies to manage risk accordingly.

Key takeaways from these cases include:

  • Lenders should be alive to the risk of borrowers raising the ‘unfair relationship’ defence when things go wrong. In those circumstances, it is for the lender to rebut the accusation and to prove that the relationship was fair.
  • Lenders may be required to adduce evidence to illustrate industry standards. The Pontearso case demonstrates the judicial discretion to accept such evidence. Following this case, it is likely that a 3% per month default rate will be recognised as industry standard for short term loans.
  • In considering whether a relationship is unfair, the court should not be limited by the borrower’s perception and should instead make an objective assessment. That said, …
  • … The Iwaniuk case seems to allow greater scope for the scrutiny of the relationship between creditors and borrowers and all circumstances surrounding the loan agreement, thereby illustrating the breadth of the court’s power to have regard to any matter it thinks relevant. The case therefore highlights the importance of the factual context of a claim.
  • The Iwaniuk case also emphasises the importance of a lender’s conduct – in particular, silence as to ongoing default and accruing interest; and the failure to proactively and legitimately enforce rights in a timely fashion are likely to be given short shrift by the courts.
  • As well as having wide discretion to decide the question of unfairness – which, as these cases clearly demonstrate, can variably be exercised in favour of either party – the court has a wide discretion as to the orders it may make.
  • From a practical perspective, it is worth noting the appellate courts’ reluctance, in any case, to reverse a lower court’s findings without very good cause. Any party considering an appeal should be mindful to weigh its factual and legal case very carefully, so as to avoid the risk of throwing good money after bad.

Pontearso v Greenlands Trading

This case concerned a six month bridging loan with a default interest rate of 3%, secured by a residential property. The borrower’s exit strategy was to refinance a separate commercial property in order to repay the loan. However, unable to re-mortgage during the six month period, the borrower took a second bridging loan on similar terms, with the same exit strategy. Following further default, the lender sued for possession and a money judgement.  The claim was defended on the premise of an unfair relationship. At first instance, the judge accepted the lender’s evidence, deemed the relationship fair, and made the orders sought.

The borrower appealed to the High Court, contending that judge was wrong: (1) to accept 3% as an industry standard rate and fair; (2) to rely on an earlier case [3], which the borrower alleged provided an unrelated test for unfairness; and (3) finding that the borrower had a workable exit strategy for taking out the second loan.

The High Court held on appeal that: (1) permitting the evidence on default interest rates, even thought it was not expert evidence, was a case management decision which was open to the judge. The finding that 3% was standard and fair was therefore an evaluative judgement with which it was not possible to interfere.  (2) The judge should have followed the test in Plevin [4], however there was nothing to suggest that he had placed particular reliance on Chubb, and even if he had, Plevin acknowledges that there is a wide breadth of relevant considerations for unfair relationship determinations.  Furthermore, some of the factors considered in the two cases overlap.  The judge’s approach was therefore permissible. (3)  The judge had a close view of the facts and there was insufficient reason to go back on the judge’s conclusion that the borrower had a possible exit strategy.

The High Court also stated, in passing, that the question of whether a relationship was unfair was not limited by the borrower’s perception – unfairness is to be determined by the court’s objective assessment.

The borrower’s appeal was therefore dismissed.

Pilgrim Rock v Iwaniuk

In this case the relationship between a lender and the borrower had been deemed unfair at first instance on the following grounds: (a) aspects of the terms of the agreement – that is, escalating interest at the end of the fixed term of the loan and interest rate provisions that were more onerous than terms obtainable on the open market; and (b) the way in which the lender had sought to enforce its rights – that is, compounding interest quarterly and doing nothing to notify the borrower of the debt or to enforce the loan, thereby allowing default interest to accrue for several years.  The lender appealed.

There are three key findings within the High Court’s appeal judgement that should be of interest to lenders:

  1. Terms. The critical terms scrutinised in the loan agreement were the interest rate and methodology of calculating the interest. The initial interest rate of 6% provided reasonable protection for the creditor in the context of interest rates at the time, however the compounding of interest was found to be a significant feature of unfairness. The loan was taken out over a four year period, in support of a property development project. Upon expiry of this period a higher rate of 9% interest would be triggered. Should the project overrun at all, the borrower would be significantly penalised. This was considered by the court to be unfair as the term of the agreement was an artificially fixed short term. In the particular case, the escalated interest rate was also unfair (as to which, see below).
  2. Conduct. The four-year silence between the creditor and debtor was said to demonstrate unfairness as the lender had not done anything to enforce its rights for all that time, whilst interest was accruing at an escalating rate. It was held that no reasonable creditor would allow such substantial indebtedness to accrue where the creditor would recover the underlying asset. There had therefore been a failure to reasonably enforce the lender’s rights.
  3. Relevant matters. The case is also interesting for its application of the court’s power under section 140A (2) of the CCA to have regard to all matters it thinks relevant in determining whether or not a relationship is unfair. Here, the judge had taken into account the involvement of another individual, Mr Semka, who was both a long-standing friend of the borrower and also the ultimate source of funds behind the lender (albeit the lender was a separate corporate and legal entity). The High Court held that the judge, in considering Mr Semka’s involvement, took account of the origins of the loan agreement and the understanding reached between Mr Semka and the borrower, to establish the true nature of the creditor-debtor relationship. That was entirely reasonable under section 140A (2), albeit not of itself determinative of fairness.

The appeal was therefore dismissed and the loan agreement stood as varied in favour of the borrower by an extension to the term; a reduction in the default interest rate; and compounding allowed on an annual, rather than a quarterly, basis.

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[1] [2019] EWHC 278 (Ch)
[2] [2019] EWHC 203 (Ch)
[3] Chubb v Dean [2013] EWHC 1282 (Ch)
[4] See our earlier briefing on the Plevin case

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