Lachlan v HP Mercantile Pty Ltd [2014] NSWSC 356, and its appellate case Lachlan v HP Mercantile Pty Ltd [2015] NSWCA 130; 89 NSWLR 198, provide a useful reminder as to the importance of careful drafting, especially when it comes to default clauses in contracts or deeds.

Facts
On 24 June 2011, Dr Lachlan (the borrower) and HPM (the lender) entered into a Deed for payment by Dr Lachlan of $300,000 in twenty six instalments. This agreement was captured within consent orders submitted to the Court and made on 28 June 2011.

Dr Lachlan defaulted on the final instalment payment of $10,000 due on 15 July 2013.

On 17 January 2014, HPC sought judgment in its favour against Dr Lachlan in the sum of $1,656,366.52 in accordance with orders of the Court which provided that upon default by Dr Lachlan on his obligations under the Deed, HPC be granted leave to enter judgment for the amount of $1,570,292.12 less any payments made by the Dr Lachlan under the Deed.

Issues
Dr Lachlan sought for an extension of time to pay the final instalment of the settlement amount and argued that the clause in the Deed which provides for HPC to enter judgment for the judgment debt was unenforceable as a penalty.

HPM submitted that there was no penalty in this case because it was an example of a situation where a present debt was owed to a creditor who agreed to accept part payment of the debt in full discharge provided certain conditions were met, but stipulated that if the conditions were not met, the full amount of the debt would be payable. In cases of that kind, it has been held that there is no penalty. HPM raised the fact that Dr Lachlan confirmed the existence of the indebtedness of the judgment debt (through the recitals in the Deed), as evidence of this point.

Dr Lachlan argued that the only debt was the debt of $300,000 due under the Deed and the Judgment Debt was not a present debt that was due and payable. Rather, the obligation to pay the Judgement Debt following default under the deed should be seen as operating in terrorem to induce performance of the primary obligation to pay the Settlement Amount under the Deed.

The Court did not accept Dr Lachlan’s submissions and ultimately held that (at [62] and [64]) (our emphasis):

“It is important to consider the substance of the matter. HPM was pursuing Dr Lachlan for the amount outstanding on the loans, which was an amount at least as great as the Judgement Debt. As part of a compromise, Dr Lachlan confirmed the existence of that indebtedness, and at the same time secured the opportunity to obtain a discharge by paying a lesser sum (the Net Settlement Amount). In my opinion, implicit in this agreement is an acknowledgement on Dr Lachlan’s part that he is indebted to HPM for the amount of the Judgement Debt…

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 (implicitly acknowledged by the debtor to be the Judgement Debt) is payable. It is well established that the doctrine of penalties does not apply in such a situation.”

Dr Lachlan appealed this decision, however the decision in this case was upheld in the Court of Appeal in Lachlan v HP Mercantile Pty Ltd [2015] NSWCA 130; 89 NSWLR 198.

Take away lesson
At the time of entering into the Deed, the proceedings were still on-going, and the Court had not yet made any determination as to liability by any of the parties.

Even so, the Court found that the (implicit) acknowledgement from Mr Lachlan that the debt was owing as part of a settlement (in the deed and the consent orders submitted to the Court) was sufficient to preclude the clause from being a penalty.

This case serves as a useful reminder to borrowers and lenders to carefully consider whether, even implicitly, there is an acknowledgement from the borrower that the balance of the underlying debt is due and payable.

Emerson Lewis Lawyers has extensive experience in drafting clauses of this nature, and also has successfully enforced such clauses in NSW District and Supreme Courts. Call us today on (02) 9300 9406 should you wish to speak to a member of our team and find out more.