28/04/2014

A borrower who’d fallen on hard times negotiates with the lender to repay only a discounted part of the original loan.  The repayment is by instalments.  The borrower misses the final instalment and ends up with a court judgment for the full amount of the original loan plus interest and legal costs.

In the 1990’s there were a number of orchard based investments promoted as being able to claim a tax deduction where the monies were borrowed to make the investment.  Unfortunately the ATO took a different view on the deductibility of the investment and a number of investors lost their investment, could not claim the deduction and were left to repay the loan more than 10 years after the investment failed.

The lender sells the debt to a debt collection company for a small fraction of the face value of the debt.

One particular investor reaches an agreement with the debt collection company to repay only $300,000 of the amount owing of $1.3 million.  So far so good – a $1 million reduction.  Even better, the $300,000 is payable by instalments.

The story then takes a turn for the worse. The investor defaults on the final $10,000 instalment payment and as a result of the default in the final payment the court orders the investor to pay the full $1.3 million less the amounts already paid.  That is, approximately $1 million extra now has to be repaid to the lender because of the failure to pay $10,000 on time.

The Court stated:

“It must be recognised that [the investor’s obligations] were based upon an agreement, made freely and voluntarily, between the parties. Whilst the Court retains a discretion to give an extension of time for compliance in such cases... the existence of a binding contract which is not itself able to be varied or set aside is a significant factor.”

The investor argued that this was an ‘exceptional case’:

• he had laboured under a mistaken belief that he had paid all amounts due under the Deed, and it was only for that reason that he was in breach of the obligation to make the final payment;
• the debt collection company was aware, or should have been aware, of the investor’s mistake, but did not bring this to his attention;
• the debt collection company waited six months to chase up the final payment and then did so during the summer holiday period, when the investor was in fact away;
• the investor reasonably requested information from the debt collection company so he could reconcile its information with his own information which his accountant was gathering, but this request was ignored by the debt collection company;
• the investor paid the outstanding amount immediately upon satisfying himself that there was indeed a final payment of $10,000 outstanding; and
• the debt collection company suffered no real prejudice as a result of the late payment.

On the other hand the debt collection company submitted:

• there was nothing exceptional about this case;
• it was a foreseeable and inevitable consequence of the agreement which required payment on due dates;
• the absence of a time of the essence provision was not relevant in circumstances where the Deed provided a regime for payments and notice;
• it was irrelevant whether the debt collection company knew or ought to have known that the investor was under a mistake as to the amount owing; and
• the total debt was not a penalty and therefore the Deed was enforceable.

The Court stated:

“… the failure to comply with the notice, and the consequences which flow from that, must be treated as [the investor’s] own fault. I am not prepared to hold that [the debt collection company] contributed in any material way to that failure. Some sympathy may be held for [the investor] in the situation he is in, but... such sympathy is not sufficient reason to deprive [the debt collection company] of its contractual rights arising from [the investor’s] failure.

For these reasons, the case seems to me to be one where a creditor agrees, on certain conditions, to accept part payment of a debt in full discharge, but stipulates that if the conditions are not met, the full amount of the debt… is payable. It is well established that the doctrine of penalties does not apply in such a situation.”

The key message from the above case is DO NOT AGREE to compromise a debt on the basis that if you fail to make an instalment payment the whole debt becomes due and owing BUT IF YOU DO then you MUST ensure you comply with the conditions down to the letter.

If you have any questions in relation to the settlement of debts or Court proceedings please call us on (02) 8296 6222.