Is it a penalty or not? Analysis of Kellas-Sharpe & Ors v PSAL Limited  QCA 371
A common question that arises in disputes between borrowers and lenders is whether clauses which require borrowers to pay a higher interest rate upon default would be deemed to be unenforceable as a penalty.
Although handed down over a decade ago, Kellas-Sharpe & Ors v PSAL Limited  QCA 371 is a useful reminder of an established principle that, where there is a contractual provision with a standard higher interest rate but a lower interest rate that would apply for punctual payment, the clause relating to the higher interest rate would not be deemed to be a penalty.
Wendy Kellas-Sharpe (First Appellant) was an experienced investor and would work with companies to borrow and lend money and make investments with the borrowed money. She was the sole director of Goldiway Pty Ltd (Second Appellant).
PSAL Limited (Respondent) was an unlisted public company, in the business of providing short-term finance to business and investment client borrowers.
The Appellants and Respondent entered into a loan agreement whereby the Appellants would borrow a sum from the Respondent to fund the purchase of the rural land. The interest rate under the loan agreement was a standard rate of 7.5% per month, however, while the Appellants were ‘not in default’ under the Facility, then a concessional rate of 4% applied. The Appellants failed to repay any of the principal sum by the repayment date and the Respondent commenced proceedings to recover the amount owing and exercise their power of sale.
The Appellants argued that the provisions defining the interest rate under the loan agreement constituted a penalty and were therefore void. The trial judge declined to find that the interest rate provision was a penalty and instead applied the rule that a provision with a higher interest rate and a lower interest rate for punctual payment, is not a penalty.
The Appellants appealed the decision on two grounds:
(a) the trial judge erred in finding that the interest rate provision was not subject to the equitable jurisdiction to relieve against penalties; and
(b) the trial judge erred in failing to hold the provision was a penalty and therefore void.
Gotterson JA (Margaret McMurdo P and Fryberg J agreeing) noted that the trial judge was justified in stating that the rule is ‘well-established’ in Australian law. Gotterson JA referred to a number of cases where the rule had been acknowledged. More specifically, Gotterson JA referred to Isaacs J in Brett v Barr Smith (1919) 26 CLR 87 where his Honour stated that the rule is ‘firmly established’. Gotterson JA noted that while the correctness of the rule has never been affirmed after the High Court’s examination of it, it has still been acknowledged more than once by members of the High Court and other intermediate courts. Further, Gotterson JA acknowledged that the rule may contradict equity’s preference for substance over form. However, Gotterson JA noted that despite the criticism of the rule, he was not convinced the rule was plainly wrong and stated he was bound by previous authority to apply the rule. Therefore, the ground (a) of appeal failed.
In relation to the ground (b), Gotterson JA noted that the failure of ground (a) precludes the success of ground (b). However, his Honour noted that even if ground (a) had succeeded it would be difficult for the Appellants to succeed on the ground (b) where it does not challenge the finding that the interest rate provision is not a penalty. Therefore, the Court dismissed the appeal.
Despite contradicting equity’s preference for substance over form, this case affirms that the interest rate structure rule still applies, and loan agreements can stipulate a lower interest rate for punctual payments without constituting a penalty. Additionally, this case demonstrates lower courts’ reluctance to abolish a principle that is generally supported by the High Court and other immediate courts despite there being criticisms of the rule.