Supreme Court Dismisses Claim on Uncertain Interest Obligations

The court dismissed a claim regarding uncertain interest obligations in loan agreements, finding that the agreements were not void for uncertainty as they included a standard of reasonableness for determining the interest rate and payment times. Judgment by Pembroke J, Supreme Court of New South Wales, [2019] NSWSC 242.

Supreme Court New South Wales

Medium Neutral Citation: [COMPANY] v [NAME] [2019] NSWSC 242 Hearing dates: 8 March 2019 Date of orders: 15 March 2019 Decision date: 15 March 2019 Jurisdiction: Equity Before: Pembroke J Decision: Summons dismissed Catchwords: CONTRACT – construction – uncertainty – matter left for determination of one party – interest rate – times and periods – requirement of reasonableness – no uncertainty Legislation Cited: Income Tax Assessment Act 1936 (Cth) Cases Cited: [NAME] v [COMPANY] (unreported, FCA, 29 April 1994) [COMPANY] v [NAME] [1996] FCA 1665; (1996) 2 ACCR 479 Godecke v Kirwan (1973) 129 CLR 629 [NAME] (1981-82) 149 CLR 571 [COMPANY] v [COMPANY] [2006] NSWSC 1027 [COMPANY] v [COMPANY] [2005] NSWSC 1345 Shield Lifestone Holdings Pty Limited v LSKF Holdings Pty Limited [2018] NSWSC 335 Trad Financial Services Pty Ltd v Trad [2013] NSWSC 1691 Victorian Producers Co-Operative Co Ltd v Edwards & Ors (1993) 62 SASR 415 Category: Principal judgment Parties: [COMPANY] – first plaintiff [COMPANY] – second plaintiff [NAME] – second defendant [COMPANY] – third defendant [COMPANY] – fourth defendant [NAME] – sixth defendant [COMPANY] – seventh defendant [COMPANY] – eighth defendant [COMPANY] – ninth defendant Jolistare Pty Limited – tenth defendant Representation: Counsel: [redacted] [NAME] SC with [NAME] – for the second, third, fourth, sixth, seventh, eighth, ninth and tenth defendants

Solicitors: [redacted] [NAME] - for the second, third, fourth, sixth, seventh, eighth, ninth and tenth defendants File Number(s): 2017/338356

Judgment

Introduction 1. This proceeding arises from a contest between interests associated with [NAME] on the one hand and [NAME] on the other. It concerns the distribution of approximately $36 million from [NAME] in which each set of interests is a beneficiary. The contest relates to the validity of interest obligations under back-to-back loan agreements between a number of related party companies of which [NAME] and [NAME] were directors at the relevant times.

2. The back-to-back loan agreements have been ongoing for many years. Since at least 1998, the parties have utilised the 'benchmark interest rate' under Pt III, Div 7A of the Income Tax Assessment Act 1936 (Cth) (ITAA). I was informed that this rate did not change frequently; was independently determined and easily identifiable; and was considered to be a reasonable figure for unsecured debt finance. The adoption of this rate is evident in calculations of interest going back to the 1990s. One document in evidence records 'Interest at Div 7A rate on compounded balance' and 'Div 7A rate applied from 1998'. [NAME] is a director of the plaintiff trust companies. [NAME] was, but is no longer, a director. [NAME] now perceives that it would be advantageous to his interests if the accrued interest were not paid, and that the parties receive their distributions from the trust without any deduction for such interest.

3. The prior adoption and use of the Division 7A 'benchmark interest rate' appears to have been designed to avoid the risk that the loan arrangements would be deemed to be dividends under s109D(1) of the ITAA. That section provides: A private company is taken to pay a dividend to an entity at the end of one of the private company's years of income (the current year) if: (a) the private company makes a loan to the entity during the current year; and (b) the loan is not fully repaid before the lodgement day for the current year; and (c) Subdivision D does not prevent the private company from being taken to pay a dividend because of the loan at the end of the current year; and (d) either: (i) the entity is a shareholder in the private company, or an associate of such a shareholder, when the loan is made; or (ii) a reasonable person would conclude (having regard to all the circumstances) that the loan is made because the entity has been such a shareholder or associate at some time.

1. Subdivision D of the ITAA excludes certain transactions from the deeming provisions. Section 109N provides that a loan will not fall within the deeming provision under s109D if, among other things, the interest rate payable on the loan is at least the 'benchmark interest rate'. That rate is defined in s109N(2) as follows: The benchmark interest rate for the year of income is the Indicator Lending Rates-Bank variable housing loans interest rate last published by the Reserve Bank of Australia before the start of the year of income. However, the benchmark interest rate is the rate worked out under the regulations, if they provide for working it out.

1. A number of agreements were tendered – some dated 1 July 2011 (referred to as the Main Loan Agreements) and others dated 10 February 2006 (referred to as the Related Loans). All of the loans are unsecured and repayable on written demand or no later than ten years from the drawdown date. Not all loan agreements were in evidence.

Separate Issue for Determination 1. The threshold issue is whether two clauses in common form contained in the loan agreements are void for uncertainty. The first clause is in the following form: [NAME] will pay interest to [NAME] on [NAME]'s outstanding loan account in the books of [NAME] at the rate specified in and in accordance with any agreement, written or oral, between [NAME] and [NAME]. Interest will not accrue from day to day but will be determined from time to time by agreement as aforesaid. In the absence of agreement between the parties interest will become due and payable by [NAME] to [NAME] at such times, for such periods and at such rate or rates as shall be determined by [NAME] from time to time. (emphasis added)

1. The second clause is in a different form but the effect is similar. The interest obligation is contained in a clause that provides: [NAME] shall pay interest at the Interest Rate on the outstanding principal until it becomes due and owing.

1. The definition of Interest Rates provides: 'Interest Rate' means interest at such rate percentage per annum as shall be agreed in writing between the [NAME] and [NAME] from time to time. In the absence of agreement between the [NAME] and [NAME] interest will be payable at such times, for such periods and at such rates as shall be determined by the [NAME] from time to time. (emphasis added)

General Principle - Uncertainty 1. I set out in Shield Lifestone Holdings Pty Limited v LSKF Holdings Pty Limited [2018] NSWSC 335 at [17] and [18] the broad general legal principle in relation to uncertainty as follows: 17 The general principle is that a contractual obligation expressed in language 'so obscure and so incapable of any definite or precise meaning that the court is unable to` attribute to the parties any particular contractual intention' is void for uncertainty. Scammell & Nephew Ltd v Ouston [1941] AC 251 at 268; [NAME] (1981-2) 149 CLR 571 at 587. However, an important qualification is that, where possible, courts are 'astute to adopt a construction which will preserve the validity of the contract': [NAME] J at 589. As Barwick CJ said in Upper Hunter County District Council v Australian Chilling & Freezing Co Ltd (1967-8) 118 CLR 429 at 437: In the search for that intention, no narrow or pedantic approach is warranted, particularly in the case of commercial arrangements. Thus will uncertainty of meaning, as distinct from absence of meaning or of intention, be resolved. 18 More recently, in Mount Bruce Mining Pty Ltd v Wright Prospecting Pty Ltd [2015] HCA 37 at [51], the High Court reaffirmed that, unless a contrary intention is indicated in the contract, a court should approach the task of giving a commercial contract an interpretation based on the assumption that the parties intended to produce a commercial result. Further, a commercial contract should be construed so as to avoid it 'making commercial nonsense or working commercial inconvenience'; see also Electricity Generation Corporation v Woodside Energy Ltd [2014] HCA 7; (2014) 251 CLR 640 at 657 [35], citing [NAME] v [NAME] of New South Wales [2004] HCA 56; (2004) 218 CLR 530 at 559 [82]; [2004] HCA 56.

1. The precise issue in this case is whether the relevant interest obligations are void for uncertainty and 'incapable of any definite or precise meaning' because 'some matter is left to be determined by one of the contracting parties': Godecke v Kirwan (1973) 129 CLR 629 at 642 (Walsh J). I am quite satisfied that, as a matter of principle, the fact that 'some matter' is left to be determined by one of the parties to a contract is not necessarily fatal to the validity of a commercial contract. That must be so logically where the determination of the 'matter' by the party to whom the power of determination is given, is expressly or by necessary implication subject to a standard of reasonableness or to some other objective criterion, parameter or guideline. In that sense, the determination by the party is justiciable. As Mason J said in [NAME] (1981-82) 149 CLR 571 at 589: …the courts are quite capable of deciding whether [a party] is acting honestly and reasonably.

1. The reasoning in Victorian Producers Co-Operative Co Ltd v Edwards & Ors (1993) 62 SASR 415 at [10]; [COMPANY] v [NAME] [1996] FCA 1665; (1996) 2 ACCR 479 at 532; [COMPANY] v [COMPANY] [2006] NSWSC 1027 at [18]; [COMPANY] v [COMPANY] [2005] NSWSC 1345 at [32] and Trad Financial Services Pty Ltd v Trad [2013] NSWSC 1691 at [83] supports the general principle that I have explained. To the extent that [NAME] v [COMPANY] (unreported, FCA, 29 April 1994) suggests otherwise, I do not agree. Among other things, the explanation given by Sundberg J in [NAME] v [NAME] at 532 as to why [NAME] should not be followed, is persuasive.

2. In this particular case, the 'matter' left for determination by one party is not only the applicable interest rate. In the absence of agreement, the interest is payable 'at such times, for such periods and at such rates' as [NAME] may determine from time to time (emphasis added). In this context, I do not think that the obligation of [NAME] to determine 'times' and 'periods' in relation to the payment of interest renders the interest obligation void. In commercial contracts such as these related party loan agreements, involving multiple back-to-back unsecured loans repayable on demand, the application of a standard of reasonableness is not difficult to infer or imply. I am satisfied that there could be no realistic difficulty in arriving at a reasonable resolution of either the applicable interest rate, or the times at which interest should be payable, or for what periods it should be paid. And if the parties cannot agree, the court is capable of doing so.

3. I reiterate that this issue of construction arises in the context of [NAME] with a long history of operation. The loans are back-to-back, unsecured and repayable on demand. They are not arms-length transactions. There are obvious practical and reasonable constraints on the selection of the applicable times at which, and the periods for which, interest should be charged. I accept the submission of counsel for the participating defendants, which warrants repeating: The point is this: That in a [COMPANY] situation, it is obvious that what you are going to do is to sit down with your accountant and work out what your profits are for the year and work out how much you can take out of those profits to pay interest and the like. It is not like a bank. You don't have to work out whether it is monthly or what it is. You just sit down and do the balance when you do the profit and loss and that is a sensible, reasonable, normal way to do it. And reasonableness would have no difficulty having a role to play in that context. In the real world, a clause like this can work just as the interest rate aspect of it can work for, as I put to your Honour, the timing can also work.

Conclusion 1. For those reasons, the plaintiffs are not entitled to the declarations that they seek. I therefore dismiss the summons with costs. DISCLAIMER - Every effort has been made to comply with suppression orders or statutory provisions prohibiting publication that may apply to this judgment or decision. The onus remains on any person using material in the judgment or decision to ensure that the intended use of that material does not breach any such order or provision. Further enquiries may be directed to the Registry of the Court or Tribunal in which it was generated. Decision last updated: 15 March 2019