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THE HIGH COURT
[2025] IEHC 219
[Record No. 2021 558 S]
BETWEEN
GOVERNOR AND COMPANY OF THE BANK OF IRELAND
PLAINTIFF
AND
DECLAN O'BOYLE AS ADMINISTRATOR IN THE ESTATE OF JAMES BOYLE DECEASED
DEFENDANT
JUDGMENT of Ms. Justice Marguerite Bolger delivered on the 2nd day of April 2025
1. The plaintiff bank seeks to determine the legality and enforceability of a surcharge interest rate of 9% per annum that it applied to the defendant's loan upon his failure to adhere to his repayment obligations. For the reasons set out below I find in favour of the defendant.
2. In this judgment, I will examine:
a) How this rate of surcharge interest was developed by the bank;
b) What the motivation was for setting this rate;
c) The work that was done by the bank in managing the defendant's default;
d) The cost, both estimated and actual, of that work to the bank;
e) How that cost relates to the surcharge interest that was charged;
I will consider the law on surcharge interest and the legal test for determining the enforceability of the surcharge interest charged to this defendant. I will then assess the legality and enforceability of the surcharge interest in this case in the light of the relevant law.
Background
3. The defendant borrower is now deceased, and the action is defended on behalf of his estate. I will refer to the late Mr. Boyle as "the defendant". The defendant was a farmer who decided to develop his land to build houses. In 2004 he entered into a loan agreement with the plaintiff bank. That loan was not repaid, and the loan facility was continued in 2010 and restructured in 2015, but the defendant continued to default in repaying his debt. Surcharge interest was applied in 2015, which is not the subject of these proceedings. The bank's surcharge interest rate of 9% was struck many years ago and was the subject of correspondence between the bank and the Central Bank and later the Irish Financial Regulatory Authority, the detail of which is discussed at para. 41 below.
4. Throughout 2015 and 2017 there was ongoing contact between the bank, the defendant, members of his family and other representatives on his behalf. A lot of work was done by the bank to deal with the defendant's default at this time, including conducting a number of credit reviews. Each credit review takes one to two days to complete, and a subsequent credit review requires the relationship manager to review all the information and establish what needs to be changed to reflect the up-to-date situation. The bank's rules require a credit review to be done at least every six months where a borrower is in default.
5. On 25 November 2017, the bank offered the defendant a new facility in the amount of 1,203,245 (hereinafter referred to as "the 2017 facility") which reflected the balance due and owing on the 2015 facility comprising of the principal, interest and surcharge interest. This loan facility was secured by six of the defendant's properties and was to be repaid in full by 15 May 2018 or earlier. The relevant terms of the 2017 facility are as follows:
"8. Interest Surcharges
8A. Interest Surcharges Rates and amounts on which Interest Surcharges will be charged
An additional interest charge at rates of:
a. 1% per month or part of a month (i.e. 12% per annum) for overdrafts; and/or
b. 0.75% per month or part of a month (i.e. 9% per annum), subject to a minimum of 2.54 per month, for all other loans the subject of this Offer Letter
will be paid by the Borrower on the following amounts;
(i) any amount not paid by the Borrower to the Bank by its due date.
(ii) any amount not repaid on the Bank's demand where such demand is made in the case of an Overdraft facility or other facility repayable on demand;
(iii) any outstandings which become repayable by the Borrower to the Bank following the occurrence of an Event of Default pursuant to Clause 12 of these Terms and Conditions; and
...
8C. Surcharge Interest - Additional
The Borrower shall discharge interest due to the Bank at the rate relevant to the amounts owing by the Borrower to the Bank in addition to any amount of additional interest as provided for in this Clause 8.
8D. When and How Surcharge Interest is Payable
The additional interest charge provided for in this Clause 8 shall be payable by the Borrower to the Bank at the same time and in the same manner as the relevant interest charge, currently quarterly. Such additional interest shall be charged to the Borrower's account or accounts with the Bank.
8E. Liquidated Damages
Any such additional interest charge as is provided for in this Clause 8 is intended to constitute liquidated damages to the Bank including compensation for its increased administrative and related general costs occasioned by:
(i) the Borrower's default in payment of any amount when due including when such amount becomes due on the Bank's demand; and or
(ii) the Borrower causing any unauthorised Overdraft or any unauthorised excess over an authorised Overdraft limit to occur; and or
(iii) the Borrower otherwise defaulting in respect of the Borrower's obligations to the Bank.
...
9. Legal & Other Charges
1.1 The Borrower shall pay to the Bank on demand, on the basis of a full indemnity, all Costs (such Costs to be charged in accordance with applicable law at the Bank's rates prevailing from time to time) incurred by the Bank in connection with:
(a) the negotiation, preparation and completion of this Offer Letter and the Security Documents;
(b) the inspection, valuation (including, without limitation, any valuation), maintenance and monitoring of any security and/or title to any property forming part of the security of this Offer Letter;
(c) the preservation and enforcement of any of the Bank's rights under this Offer Letter and the Security Documents;
(d) the consideration of, or giving of any consent to, any charging, letting, leasing or other dealing with any property forming part of the security for this Offer Letter (whether or not such consent is given);
(e) any registration, filing, amendment, release, consent, variation of or waiver in connection with this Offer Letter, the Security Documents and any related documents; and
(f) the supervision, provision of information or monitoring by the Bank of any account.
The Borrower hereby authorises the Bank to debit any accounts with the Bank or with any other Bank or financial institution in the name of the Borrower with any and all of the foregoing Costs and amounts, as they arise from time to time.
Any survey or valuation fees will be the responsibility of the Borrower."
6. The 2017 facility was not repaid by the due date of 15 May 2018. On 20 August 2018 the bank commenced charging surcharge interest on the entire facility that was outstanding, in accordance with clause 8 of the loan agreement. On 18 May 2020 the bank stopped charging surcharge interest, having concluded it was unlikely the defendant would repay any of his debt. In August 2021 the bank suspended its previous practice of applying surcharge interest on all its accounts in default due to uncertainty over the legal position of that interest. An internal review was then done to compare gross surcharge interest income with related collection costs for the period 2015 to 2021, which concluded that the bank's collection costs were greater than the income it received from surcharge interest. The bank's methodology excluded some surcharge interest returned to customers who had got their repayments back on track and surcharge interest that was not recovered from a defaulting customer, from its calculation of net income. The calculations applied in the review were independently verified by PwC but not the methodology. The defendant did not challenge the accuracy of the calculations but asserted a flaw in the bank's methodology in excluding some of the surcharge interest charged and/or paid from its calculations of net income.
7. The bank moved to debt recovery proceedings against the defendant on 23 May 2022 and judgment was granted in the amount of 1,154,639.94. The surcharge interest of 204,501.23that had accrued between August 2018 and May 2020 was not included in that judgment and that aspect of the bank's claim against the defendant was adjourned to plenary hearing.
Submissions of the parties
8. In its written submissions (at para. 7) the bank sets out the following as a summary of its objective in charging surcharge interest:
"...to address the significant collection costs that defaulting borrowers cause, to make provision for impairment losses which arise when a borrower is not going to repay and to address the increased capital requirements that it must comply with when borrowers are categorised as non-performing."
9. The bank submits that its rate of 9% surcharge interest was a genuine pre-estimate of the probable loss occasioned by reason of the defendant's breach in failing to repay their loan on time and, therefore, accords with the Dunlop Pneumatic Tyre Co v. New Garage and Motor Co Ltd [1915] AC 79 principles as applied in this jurisdiction. They maintain it was, or must have been, within the reasonable contemplation of the parties on 25 November 2017 that the defendant's failure to repay the sum due of approximately 1.2 million would have caused a loss to the bank, but that there was a genuine uncertainty at that time as to the level of such loss and that the Court must, therefore, determine whether the sum charged was "extravagant or unconscionable". The bank urged the Court to revisit the treatment of surcharge interest in Irish law and to prefer what it calls the recalibrated approach of the UK Supreme Court in Cavendish Square Holding BV v. El Makdessi [2015] UKSC 67.
10. The defendant disputes that managing his default could ever have cost the bank the sum of 204,501.23 that is claimed, that the 9% interest rate lacks any true connection to the cost of dealing with him or other defaulting customers and was a generic charge set in 1993 without any analysis of the actual cost of managing a defaulting customer or any link to the amount of the loan, the security available and the customer's credit rating. The defendant maintains that the bank could have tracked the work done on managing his default and crafted a charge reflecting the actual cost, rather than the blunt instrument, 'one size fixed all' approach that the defendant claims was unlawfully adopted here. The defendant contends for a continuation of the principles outlined in Dunlop and Pat O'Donnell & Company Ltd v. Truck and Machinery Sales Ltd [1998] 4 IR 191 and submits that this Court has no jurisdiction to prefer the approach of the UK Supreme Court in Cavendish. Points made that are not relevant to the bank's claim
11. At the outset I wish to clarify certain points that are not relevant to the issues to be determined. Clauses 9 and 11 of the 2017 agreement make separate provision for the recovery of costs from a customer. The bank never sought to invoke those clauses against this defendant. Whether or not the bank could have, is not for this Court and has not been pleaded. There is no evidence that the surcharge interest charged to the defendant pursuant to clause 8 of the 2017 agreement included any claim the bank might have had under clauses 9 or 11. The bank's entitlement to seek a full indemnity from its customer pursuant to clause 11, which was not invoked by the bank against this defendant, is not relevant to this claim pursuant to clause 8.
12. The defendant also argued that the cost of defaulting customers, calculated at c.6 million, was not a significant cost when set against the bank's overall income and cost figure. Whether a cost is significant or not, or whether a particular sum of money might or might not affect the bank's solvency is not relevant to this claim. Either the surcharge interest charged was legally enforceable or it was not. Its individual impact, whether positive, negative or neutral, on the bank's overall financial position and viability does not render the sum sought any more or less enforceable.
13. Those points could be subject to the extent to which the law might require the bank to establish a commercial justification for its rate of surcharge interest, an argument which I do not consider to be relevant for the reasons I address further below at para. 75.
14. The bank asserted that a breach of a customer's loan agreement entitled them to charge surcharge interest on the balance of capital and interest once the full amount became due (as occurred with this defendant when he defaulted in his contractual commitments to repay the entire 2017 facility by 15 May 2018). The defendant questioned whether the Central Bank had ever authorised the bank to charge surcharge interest on the entire balance of capital and income. The defendant has not established a lack of authority on the part of the bank to impose surcharge interest in the manner provided for in the terms of the loan agreement. As the defendant breached his loan agreement when he failed to repay the entire amount due on 15 May 2018, the bank was entitled to charge surcharge interest on the entire amount due. That is, of course, subject to that surcharge interest and the rate thereof in itself being lawful, an issue which is addressed in this judgment.
Expert evidence
15. The Court heard evidence from an expert witness on both sides, and both sides challenged the expertise of the other's expert witnesses. I set out below the relevant evidence given and the conclusions and findings I have drawn therefrom.
Mr. Hanif Virji for the plaintiff
16. Mr. Virji's academic background is in the study of physics. Following a short period of postgraduate teaching, he commenced working in trading derivatives and trading equity options from 1988 to 2000. Thereafter, he spent two years as Chief Financial Officer of a technology company, and 17 years in his own financial markets' disputes advisory, litigation funding and corporate finance advisory firm. Since 2018 he has worked with another financial markets' disputes advisory firm. He acknowledged his lack of experience in the Irish banking market but maintained that the issues on which he offered an opinion did not require such knowledge, and that the expert opinions he proffered were based on his experience working in the financial industry in various jurisdictions.
17. Mr. Virji (as did the defendant's expert Mr. Allen) said that a lender could not know at the outset of a loan whether the borrower will default and, if they did so default, how much additional work might be required to manage that default. Both he and the defendant's expert Mr. Allen, agreed that the best the bank could do was to estimate the cost of administering defaulting borrowers in setting its surcharge interest rate.
18. Mr. Virji opined that the purpose of surcharge interest was for the bank to recoup the cost of administering defaulting borrowers arising from collection costs, greater capital requirement and the resulting loss of opportunity and general administration costs. He disputed Mr. Allen's opinion that surcharge interest was to deter or penalise customers (Day 4, p. 28) but he accepted that "discourage" was one of the rationales for the surcharge interest rate of 1% for which the bank sought permission from the Central Bank in 1993 (Day 4, p. 79). He agreed that surcharge interest may deter customers from defaulting on their loan (Day 4, p. 28 and again at p. 79). He observed from the bank's letter of 9 September 1993 to the Central Bank referring to the bank's view of surcharge interest as necessary to, inter alia, discourage breach of agreed limits, that "clearly the Bank believes there's a deterrent effect" (Day 4, p. 107).
19. He said that the only purpose of surcharge interest is to offset additional costs and not to penalise a customer, because surcharge interest is estimated based on past experience (Day 4, p. 80). He accepted that he was speaking generally and that he had no evidence of any exercise of that sort being carried out in this case (Day 4, p. 81). He went on to say:
"...the best that a bank can do is to try and ascertain what would be the average cost to it and then determine the surcharge interest in that way" (Day 4, pp. 81 to 82).
20. He said the bank's experience might show surcharge interest having been undercharged, which would require the bank to increase it if they wanted to break even and if it was lower, the bank should decrease it (Day 4, p. 82). He accepted that the bank had charged the same rate of surcharge interest since 1993 despite changes in the economy during that time, but maintained that:
"...you look back over a period of time, work out what you think it might be in the future period of time, and try and hit the zero on average... which I think is broadly what the evidence has shown" (Day 4, p. 83).
21. He went on to discuss the 2022 analysis of what was collected and what the cost was from 2015 to 2021 (Day 4, p. 84) and confirmed that he saw no evidence of any such exercise having been done before 2022 or ever having been done when the surcharge interest rate was set back in 1993 (Day 4, p. 93).
22. Mr. Virji claimed that the evidence showed that what was charged in surcharge interest was "there or thereabouts of given the costs" (Day 4, p. 104). He was challenged on this by counsel for the defendant, as the bank's income had been discounted when they gave surcharge interest charged back to the defaulting customer or had not collected it from the defaulting customer at all. Those factual situations were accepted by Mr. Virji but he suggested that it was "maybe not entirely because they don't want it, but perhaps because they can't collect it". He went on to acknowledge that, without granular data, he could only comment (based apparently on the 2022 retrospective analysis) that "on average, [the bank] get less than it costs them" (Day 4, p. 105).
23. Mr. Virji's explanation for why the bank might have returned surcharge interest charged or not collected it, was speculative. His expertise (as set out at para. 16 above) does not qualify him to give an expert opinion on why this bank chose to return some surcharge interest charged to a defaulting customer and did not collect other surcharge interest, thereby affecting its overall income from surcharge interest as versus what it could have obtained had all surcharge interest charged been both retained and recovered.
24. There was no basis for Mr. Virji's assertion (as set out at para. 20 above) that the evidence in this case "broadly" showed the bank having looked back in time to work out what the cost might be in the future and trying to hit the zero on average. That may well be, as Mr. Virji opined, how surcharge interest is generally charged elsewhere but there was no evidence of any such exercise having been done in this case, either when the bank sought permission for an increase in surcharge interest to 9% per annum in 1993 or when they began to charge that rate in 2008. Neither was there any evidence that this bank, at any time prior to its retrospective analysis of 2022, did what Mr. Virji referred to as "the best that a bank can do" at para. 19 above in determining the surcharge interest by ascertaining the average cost to the bank.
25. I conclude from Mr. Virji's evidence that what he says was general practice and the best way a bank might estimate surcharge interest, was not done by this bank when the surcharge interest rate was struck in 1993 and/or 2008. This was despite the bank having developed policies and procedures over the years to manage defaulting customers (witness statement of Mr Lauhoff at 2.3 and 5.1).
26. The bank's failure to follow general practice to ensure its surcharge interest rate might, as Mr. Virji said, "hit the zero on average" (Day 4, p. 83) suggests firstly a low level of commitment to cost recovery and secondly that the rate it struck was not a genuine pre-estimate of that cost. This conclusion is supported by the bank's practice of never having changed its rate of surcharge interest since 2008 despite Mr. Virji's view that the rate would be expected to increase or decrease depending on the bank's experience of having overcharged or undercharged. The bank's own figures confirm that income from surcharge interest varied significantly over some years, for example the bank's income from surcharge interest for mid-book loans, such as the defendant's was, moved from c.3.3m in 2016 to 10.4m in 2017 (back up documentation to witness statement of Mr. McGrath, Group Financial Controller of the bank, tab 4, p. 21).
27. Mr. Virji, having given his view as to how the rate of surcharge interest should be calculated (i.e. based on looking at past experience) then went on to accept that the bank could have looked at the cost of administering defaulting borrowers, worked out an average cost and relied on that in setting the surcharge interest rate (Day 4, p. 94). He questioned the wisdom of such a look-back exercise as he said that he did not know how significant the answer would be (Day 4, p. 95) for a number of reasons: the cost of administering defaulting borrowers would be "difficult data", one would have to be diligent in collecting it, it would have to be collected over a "prolonged period of time" (Day 4, p. 96) such as five years (Day 4, p. 114) and the exercise would only be possible if the bank had kept the data (Day 4, p. 98).
28. Mr. Virji opined that monitoring the work done by the bank's employees in relation to an individual defaulting customer would not be practical because of the volume of data, the diligence required to ensure proper allocation of cost (Day 4, p. 100) and because of many people doing what he referred to as "little jobs" (Day 4, p. 102). He said no other financial institution applied such a practice. He accepted it could be done in principle (Day 4, pp. 104 and 106), as had the bank's witness Ms. Dervan who has worked in the Customer Loans Solutions (CLS) department since 2010.
29. Mr. Virji's experience does not include working in anything like the bank's CLS department. He did not say in his report or his evidence that he had ever visited or engaged with the CLS department to review their work or methodology. When asked about the rationale for the distinction between overdraft interest, surcharge interest and the business loan or term loan interest, he said he had not seen the "different datasets" and repeated that he had not seen "the different data" (Day 4, p. 106). He did clarify that he was not suggesting that the data exists, and he had not been given it. His expert report of 12 June 2024 confirms, at appendix B, the documentation he was given which is similar to the documentation made available to the Court, including an account of the extensive work done on the defendant's defaulting loans over many years including but not limited to the defendant's default of his 2017 loan agreement.
30. The limits of Mr. Virji's actual knowledge about what goes or went on in the bank's CLS department, or in any similar department in a lending institution managing defaulting borrowers, was apparent when, having accepted that he had not worked in a similar organisation, he stated:
"...but I can imagine with thousands of defaulters and lots of data points... Now, if there's a software vendor out there that can claim that they can do this in the degree, the minutiae that's required, then there they are. I was asked my opinion as to whether I thought it was practicable, and I don't think it is."
31. There is limited utility to Mr. Virji presenting what he says he can "imagine" as an expert opinion to assist the Court.
32. Mr. Virji accepted the defendant's arithmetic calculation that the surcharge interest was charged to the defendant equated to over 4,000 hours of an employee and 100,000 per annum, working 40 hours per week for 50 weeks of the year (Day 4, p. 108 to 109).
Mr. Greg Allen for the Defendant
33. Mr. Greg Allen has worked in a number of different banking roles in Ireland for nearly 40 years, including in mortgage lending from 1985 to 2001, consulting financial services from 2001 to 2010, head of commercial business in ICS from 2010 to 2012, and, most recently, as head of risk in a large Dublin Credit Union.
34. I address below some of Mr. Allen's hypothesis.
i. Inclusion of cost of default in margin interest rate
35. Mr. Allen referred to the witness statement of Mr. McGrath, the bank's Group Financial Controller, where he said at para. 5.17 "[n]ormal impairment losses are considered in the Bank's pricing of its Retail Ireland products." Mr. Allen opined that this pricing model:
"...means that, at the outset, the bank anticipates and prices for an expected level of loan default and associated write offs and costs. In my opinion, therefore, the bank's core interest rates have a built-in margin to cover anticipated defaults and the costs associated with those defaults." (Mr. Allen's expert report, p. 11)
He placed heavy emphasis on the fact that the bank's pricing model for residential mortgages do not charge surcharge interest but instead have a built-in margin in the interest rate to cover the cost of a defaulting loan. On this basis he challenged the bank's instructions to Mr. Virji that the margin/core interest rate for commercial loans did not include the cost of administering defaulting borrowers and that the bank only sought to recoup those costs from the surcharge interest it recovered. However, there was no evidence before the Court of the bank having included the cost of administering defaulting borrowers in its margin interest rate. At best, Mr. Allen's evidence confirmed his view that the bank could have done that. In the absence of evidence to the effect that the bank included the cost of managing defaulting customers in its margin interest rate, Mr. Allen's views of what could have occurred is of limited utility to this Court. The Court is not tasked with assessing the wisdom of the bank's approach to managing defaulting customers in determining the legal validity of the surcharge interest rate that was charged to the defendant. There is no evidence that the margin interest rate charged to the defendant included the cost of managing his default. According to Mr. Allen, the fact that it could have done so and/or that it is done that way for residential mortgage loans is not relevant to what this Court has to determine. It was, as Mr. Virji said, a decision that the bank made (Day 4, p. 66).
36. The commercial validity of the bank's decision not to include the cost of managing defaulting customers in its margin interest rate, could potentially be relevant to determining whether the surcharge interest charged to the defendant was commercially justifiable, if that is relevant. The bank's 2022 analysis confirms that the bank made decisions not to pursue some customers for the surcharge interest that the bank had charged them and to refund surcharge interest that had been paid to other customers. There was what Mr. Allen called "a low level of commitment" to the recovery of surcharge interest from the defendant arising from the bank's decision in 2019 to accrue for the expected refund of the surcharge interest on the defendant's loan account and not to charge any more surcharge interest after May 2020. However, for the reasons I set out below at para. 75, I do not consider that to be part of the legal test that this Court is bound to apply.
ii. Surcharge interest was to penalise customers
37. A significant area of disagreement between Mr. Virji and Mr. Allen was Mr. Allen's opinion that the purpose of surcharge interest is to both deter customers from defaulting on their repayment obligations and to penalise customers who have defaulted on them. Mr. Allen disputed that the surcharge interest was a genuine pre-estimate of the bank's loss in the event of a customer defaulting on their loan. He highlighted that the interest charged on the defendant's loan balance when he fell into default in 2018, was over three times what had been charged as the margin interest rate on his loan.
iii. Calculating the cost of defaulting customers
38. Mr. Allen acknowledged that it is not currently the practice of Irish banks to track and record the time spent managing defaulting customers, relying instead on surcharge interest to cover the cost of the work done. Nevertheless, he maintained it would be possible for such time to be tracked and a charge levied against the account in respect of the work done. He gave the example of PTSB whose terms and conditions provide for a time management fee of 30 per hour where non-standard services are provided on a loan account. As set out at para. 28 above, Mr. Virji takes a very different view as to the practicality of this. Mr. Allen's experience working in various banking roles, including lending, for many years is more hands on than that of Mr. Virji.
39. Support for Mr. Allen's view as to the possibility of tracking time spent on managing defaulting customers can be garnered from the evidence of Ms. Dervan, who dealt with the defendant's defaulting loan from December 2018 until the file was transferred to the legal and recovery team in November 2019. Ms. Dervan had extensive experience in this type of work in CLS since 2010. She agreed that work done on managing a defaulting customer, such as a telephone call or a letter, could be recorded by reference to the time spent on each task, although it was not the bank's practice to record the time spent. Further support for the possibility of tracking the work done in managing defaulting customers can be seen in the evidence given by the bank's witnesses about all the engagement they had with the defendant and members of his family on his behalf, over the years, comprising of meetings, telephone conversations, emails, letters (including some required by SME Regulations), filling out template forms (such as the standard credit review document and decision memorandums) and recording any change in circumstances and carrying out reviews of his accounts - some of which were generated from scratch but most of which were routine from 2018 onwards. On the request of the Court, the bank was able to assemble the work done on the defendant's account on the 2017 facility starting on 2 January 2018 going up to 25 November 2019 when the decision was made to transfer the file from CLS to Legal and Recovery and identifying the relevant documents related to that work from the papers. The defendant disputed some of the work items the bank included but what the exercise shows is the bank's ability to identify the work that was done, including references to conversations with solicitors, members of the defendant's family and other individuals. This was despite the absence of any policy of tracking the work done at the time and in spite of Mr. Virji's view that it would not be practical to record each task that was performed. Neither the table furnished, nor the supporting documentation, recorded the time spent on each task (although that could be guesstimated from the nature and possibly from the length of the document) but if the performance of the task is capable of being recorded, then the time taken could also have been recorded at the time, without too much difficulty.
40. I prefer Mr. Allen's opinion as to the possibility of tracking work done managing a defaulting customer over the opinion of Mr. Virji that such an exercise would be impractical and difficult. I find Mr. Allen's views to have been corroborated by the evidence of the bank's witnesses set out above at para. 39.
Discussion
A. How the rate of 9% surcharge interest was developed by the bank
41. The documentation showing how or why the rate of 9% was struck is the following correspondence in 1993 and 2012 between the bank and the Central Bank and in 2003 and 2008 between the bank and the Irish Financial Services Regulatory Authority:
(i) A letter from the Central Bank to the bank of 29 July 1993 referring to arrangements for setting bank interest rates which were last reviewed in mid-1991. That letter confirmed that the Central Bank,
"...would not oppose a moderate increase in the present 1/2 per cent. per month surcharge which banks may levy on excesses resulting from unauthorised overdrafts/breaches of term loan agreements, where a definite need for cost recovery could be shown".
(ii) The response from the bank dated 9 September 1993 advising of its intention, "...to implement a surcharge rate of 1% per month on unauthorised excesses on overdrafts, term loans and loans as soon as practicable after the end of September". That letter went on to explain that:
"The Bank sees this as necessary both to discourage breach of agreed limits and to recover some of the very high costs which arise when agreed permissions are not observed".
(iii) The response from the Central Bank dated 15 September 1993 confirming it had no objection to the proposed increase in surcharge interest to 1% per month.
(iv) Further correspondence in September 2003 between the bank and the Irish Financial Services Regulatory Authority in which the bank confirmed:-
"In 1993, the Bank of Ireland received approval from the Central Bank of Ireland for a surcharge rate of up to 1% per month (12% per annum). We currently charge between 0.5% and 0.75% per month (6% and 9% per annum) with the exception of Commercial Property Loans where the charge is 2% per annum. However, the Bank retains the right to increase the interest surcharge rate applied to excesses, overdue or unpaid amounts on current account, overdrafts, loans and mortgage products up to 12% per annum..."
(v) In 2008, the bank wrote to the Financial Regulator advising of its intention to apply a surcharge interest up to the maximum notified level of 1% per month, i.e. 12% per annum. This was noted by the Financial Regulator in their letter back to the bank of 26 June 2009.
(vi) In November 2012, the bank wrote again to the Central Bank to advise the Central Bank that they intended to implement the raise in the rate from 0.75% to 1% for overdrafts.
42. Whilst the Central Bank's agreement to the bank's increase of their surcharge interest rate, as set out in its letter of 29 July 1993, was subject to, inter alia, showing a definite need for cost recovery, Mr. Lauhoff for the bank said (Day 2, p. 144) that he had seen nothing in the correspondence or documentation for that period to confirm that the bank had ever demonstrated that to the Central Bank. The bank did not take any steps to formally identify such a need. They seem to have had their own sense that managing defaulting borrowers involved a significant cost for them, as can be seen from the evidence of Mr. McGrath, who said that they had "a very strong sense" (Day 3, p. 14) of the figures for the cost of managing defaulting customers even before the 2022 analysis. Mr. Lauhoff said he did not know whether the bank had quantified what it described in its correspondence in 1993 as its "very high costs" or had established the cost of any loss prior to the defendant's loan facility in 2017 (Day 2, p. 105). He said that back in 1993 there was much less regulatory obligations than there is now (Day 2, p. 105) although it was never suggested by the bank that additional regulatory obligations necessitated a revisiting of the rate of surcharge interest.
43. In 2008 the bank advised the Financial Regulator of its intention to apply surcharge interest up to what it called "the maximum notified level of 1% per month" on all new loans and term loans (letter dated 7 November 2008). The bank did not seek to explain to the Authority why that increase was necessary or why the previous rate of 0.75% per month was insufficient. Neither did the bank's 2012 letter give any reason for the proposed increase for overdrafts. Mr. Lauhoff said that there was no evidence of any calculations informing the bank's decision at that time to raise the surcharge interest rate or to have a different rate of surcharge interest for overdrafts and term loans. He accepted that there may have been no such calculations (Day 2, pp. 149 to 150).
B. The bank's motivation for setting a rate of 9% surcharge interest
44. In its letter to the Central Bank of 9 September 1993, the bank identified its rationale for an increase in the rate of its surcharge interest as twofold, firstly to discourage breach of agreed limits and secondly to recover the cost of any such breach. The bank's rationale of discouraging breach of agreed limits had not been required by the Central Bank, but neither did the Central Bank challenge it when it wrote back to the bank shortly afterwards by letter dated 15 September 1993 confirming that it had no objection to the proposed increase in surcharge interest.
45. Mr. Lauhoff took issue with the defendant's counsel's description of the bank's wish to discourage a breach as a "deterrent" and described it as "playing on words" (Day 2, p. 145). The Oxford English Dictionary defines "discourage" as "cause (someone) to lose confidence or enthusiasm...prevent or try to prevent (something) by showing disapproval or creating difficulties...persuade (someone) against an action" and defines "deterrent" as "a thing that discourages or is intended to discourage someone from doing something". The bank was clear about its wish to discourage their customers from breaching agreed limits on their loans and in its 1993 correspondence, openly identified that to the Central Bank as one of the reasons for seeking an increase in the rate of surcharge interest it was permitted to charge. In my view that constitutes a deterrent, i.e. a thing that discourages default by the imposition of additional interest.
46. The plaintiff's expert, Mr. Virji, spoke about looking back at past experience over a period of time to work out future loss in calculating a rate of surcharge interest. The bank did not engage in any such exercise until well after the 9% surcharge interest rate the subject matter of these proceedings was struck. That is consistent with the bank, in setting that rate, having been motivated by wanting to discourage a breach of agreed limits as well as recover the cost of default.
47. In these proceedings, the bank asserted the following further motivation for the imposition of surcharge interest that was not mentioned in the bank's correspondence with the Central Bank or the Authority or in any other documentation:
"In addition, the application of surcharge interest is an interim measure, between default and enforcement, which provides the borrower with an opportunity to get back on track with his/her repayments or reach an alternative arrangement such as a refinance to enable them to repay the debt, with the income generated being used to offset in part the direct collection costs of the Bank." (Mr. Lauhoff at para. 2.4 of his witness statement)
The terms and conditions of the 2017 facility allowed the bank to call an event of default and, thereafter, to impose surcharge interest. Mr. Lauhoff described this as "the trigger that we need to engage with the customer ..... to try and make sure that we have, I suppose, contractual ability to bring the customer to the table to have a discussion where we see these warning signings emerging" (Day 2, p. 135). He spoke about how the bank tries to work with customers in financial difficulties:-
"to try and bring the debt back on to a sustainable level. Whether that's in terms of providing more accommodation or forbearance to allow business trade through something, or whether the customer is coming to the table with something, an offer that facilitates them to reduce their debt. That's what I mean in terms of this is an interim measure where we work with customers."
(Day 2, pp. 151 to 152).
Mr. Lauhoff accepted that the bank did not need surcharge interest to engage with a defaulting customer (Day 2, p. 152) but when it was put to him that applying surcharge interest does not help a customer in default, he said:-
"It's part of a sequence of responses in terms of how we can engage with the customer in terms of trying to get to a right solution. So it supports, it covers some of the costs associated with managing accounts that are in default while we are trying to get to an agreed solution.
...
Clearly an additional charge doesn't make someone better off, but I think the papers show the level of engagement with Mr. Boyle to agree and renegotiate the overall facilities to try and get to a solution where the debt could be paid on a sequential basis I think was demonstrated" (Day 2, p. 152 to 153).
48. Evidence was also given about how the bank managed defaulting customers who later got back on track with their loan repayments. Mr. McGrath, Group Financial Controller of the bank, said (at para. 6.7 of his witness statement):
"A refund occurs when a borrower is granted a refund of surcharge interest. For example, if a borrower manages to get back on track with loan repayments, the Bank will consider refunding surcharge interest as part of the agreed repayment plan."
49. Thus, a return to compliance, which understandably is what the bank wants from its customers, gave rise to a possible refund of all or some of the surcharge interest that was paid by the customer while they were in default. The compliant customer is rewarded, and, in contrast, the defaulting customer is penalised. This provides further clarification of the bank's intentions in charging 9% surcharge interest on a customer's defaulting loan. What was described by Mr. Lauhoff as an "opportunity" was part of the bank's motivation set out in its letter to the Central Bank of 9 September 1993, i.e. to discourage breach of agreed limits. The only new opportunity afforded by the imposition of surcharge interest that was not already open to the parties, was an opportunity for the bank to impose the negative consequence of additional interest on a defaulting customer. It was separate both to the bank's already identified purposes of cost recovery and separate to any genuine pre-estimate of the cost of default. It was a discouragement and a deterrent to a customer not to default on their loan and therefore, a penalty.
C. The work done by the bank managing the defendant's default
50. The bank prepared a table of the work it had done on the defendant's defaulting loan over the time the surcharge interest the subject matter of these proceedings was charged, i.e. May 2018 to June 2020. Some of that work was disputed by the defendant as work relating to the enforcement proceedings that were taken against the defendant, which was never intended to be covered by the surcharge interest. There was another table of the work done arising from the defendant's previous default in repaying his 2015 facility as the bank said that was relevant to the court's interpretation of the 2017 facility as part of the factual matrix at the time that the 2017 contract was entered into. The table for the work done in relation to the 2015 default shows more extensive work than was done on the 2017 default.
51. Ms Dervan, one of the bank's witnesses, gave an overview of the amount and nature of the work that was done by the bank in managing the defendant's loan default before and after 2017. Ms. Dervan was the defendant's relationship manager from December 2018 (after he had fallen into default on his 2017 loan agreement in May 2018) until the file was transferred to the bank's legal and recovery team in January 2020. Ms. Dervan set out in detail how the defendant's loan was restructured in March 2015 at paras. 4.4 to 6.10 of her witness statement. She set out the defendant's default of the 2015 facility, the terms of the 2017 agreement and the defendant's later default of that agreement at pp. 6 to 20 of the witness statement. A significant portion of Ms. Dervan's direct evidence was taken up with her account of the work done by the bank in managing the defendant's default both prior to and after May 2018 when surcharge interest was first charged on the 2017 loan agreement.
52. The defendant did make some limited proposals and commitments when he defaulted on his 2017 facility in May 2018, but he did very little in the way of tangible steps to actually address the repayments due. The credit reviews done from this time, on his 2017 default, involved less work than previous credit reviews on the 2015 default, as there was little change in the defendant's overall financial situation before and after the 2017 facility commenced. Ms. Dervan agreed that many of the 2017 default credit reviews involved plugging in the same numbers as before with some updating of figures to take account of accruing interest. The correspondence referred to in the bank's table of work for this time was, in the most part, reviewing a situation in which there was little or no change of circumstances. The work was largely routine and repetitive of work that had been done previously. This is relevant in considering the cost both of the work the bank did on the defendant's 2017 default and the work it could reasonably have expected it might have to do if such a default occurred (i.e. the estimate of the cost of default when the bank entered the 2017 facility with the defendant) against the sum of 204,501.23 that is claimed in these proceedings.
D. The cost, estimated and actual, of that work to the bank
53. As set out above at para. 43, the bank had no evidence of any calculations supporting its request to charge a rate of 9% surcharge interest back in 1993 or at any time up to the 2022 review. Neither was there any evidence of the bank having looked to its past experience of the cost of loan default in setting that rate, which is what its expert Mr. Virji said would normally be done.
54. At the time that rate was struck, defaulting borrowers were managed by the same part of the bank that had managed their loan from inception. Sometime around 2009/2010 the bank established the CLS division to manage its defaulting customers. Until 2022 the bank never conducted any formal analysis of how much it spent on the CLS division or the cost of administering those defaulting customers. There was, therefore, no statistical or evidential basis on which the bank could estimate the cost they would sustain if the defendant defaulted on his 2017 facility, at the time the bank entered into the 2017 loan agreement with him.
55. In 2022, the bank conducted a retrospective analysis of the cost of the CLS division and the income from the surcharge interest that the bank charged and recovered. The review established that gross surcharge interest of c.77m had been received on term lending and 15m on overdrafts, of which c.8.4m was refunded to borrowers and 3.7m refunds were accrued. The costs of administering defaulting customers for the same period were calculated to have been c.89.8m which, when set against surcharge interest that had been received and not returned, led to the bank concluding that it had incurred a net loss of c. 9.4 in managing its defaulting customers. Had the refunds of surcharge interest charged not been made, the bank's calculated loss would have been c.1m. Had the refunds accrued not been discounted from the gross income, the analysis would have confirmed an excess of income over cost i.e. a net gain.
56. The bank's analysis was independently reviewed by PwC to verify the calculations on which the bank's analysis was based. PwC neither validated nor critiqued the bank's decision to exclude surcharge interest repaid or accrued from its calculations or its method of measuring the cost of administering defaulting borrowers.
E. How the cost of the bank's work relates to the surcharge interest that was charged
57. Given that the tasks done in managing the defendant's default have been identified to the Court, both in the aforementioned table and the evidence from Ms. Dervan who brought the Court through the detail of the reviews done on the defendant's account over the relevant period, there is a basis from which the amount of surcharge interest that was charged to the defendant can be assessed by reference to the work done. The defendant's expert, Mr. Allen, opined, based on the bank's own figures, that the surcharge interest that was applied to the defendant's account exceeded any reasonable estimate of the costs of activities on his account (Day 5, p. 39). Mr. Allen had done an estimate based on a higher per person cost (which the bank had confirmed during the evidence to have been a lower cost of c.75,000 per employee) and came up with a maximum cost of 38,000 on a cost recovery basis (Day 5, p. 39 and 40), based on the figure of 204,501.23 that was actually charged. A figure of 4,000 hours was put to Mr. Virji based on a per employee cost of 100,000 per annum (which was Mr. Allen's guesstimate that later turned out to be too high) and Mr. Virji did not dispute the arithmetic, although he did say he could not comment on how many employees were involved and how long they spent on each issue (Day 4, p. 109). A similar question was put to Ms. Dervan, who said she did not know how much time was spent on the account and that other persons may have been working on it as well as the relationship manager assigned to the defendant at the relevant time (Day 2, p. 67).
58. In terms of the quality of the work done and length of time each task took, time was not recorded and so this evidence was not available. However, detailed evidence was given, particularly by Ms. Dervan, in relation to the work done on the defendant's account. Ms. Dervan took the Court through the credit reviews and other review work done in considerable detail. Much of the work done on the defendant's account pre-dated the period for which the surcharge interest, the subject of these proceedings, was charged. The defendant's circumstances did not change substantially since he had first defaulted many years previously. Therefore, whilst credit reviews were done over this time, many of them repeated what had been done previously and, whilst numbers required to be checked, many of reviews only required minor updating. For example, Ms. Dervan agreed that many of the letters were "templated letters" (Day 2, p. 51) in which the letter writer would "plug in the numbers" (Day 2, p. 52) and the reviews had much of the detail pre-filled (Day 2, p. 59), with some of it remaining the same (Day 2, p. 60) and "quite of bit of it you will have to change" (Day 2, p. 60). Ms. Dervan confirmed she never met with the defendant during the time relating to the surcharge interest charged the subject of these proceedings (Day 2, p. 56).
Summary of findings from the evidence
ii) The additional cost likely to arise in the event of a loan defaulting cannot be accurately calculated at the time the loan is drawn down.
iii) The Central Bank's agreement to allow the bank to increase the rate of surcharge interest in 1993 was subject to, firstly, an unauthorised overdraft or breach of a term loan agreement and secondly, a definite need for cost recovery.
iv) Whilst the bank had policies and procedures to manage default loans, there was nothing tangible done to satisfy the Central Bank's requirement that a definite need for cost recovery be shown. The bank operated on their own sense that the cost of managing defaulting customers was significant. No empirical analysis was carried out until the 2022 retrospective exercise.
v) The bank's decision to increase the surcharge interest rate to the current 9% in 2008, for which it sought approval from the Central Bank, was not based on any identified data or empirical evidence at that time.
vi) The bank did not follow what its expert said was the general practice of looking to its past experiences of loss from defaulting loans when the surcharge interest rate was struck in 1993 and/or 2008.
vii) The evidence confirmed the bank's two stated motivations in setting the surcharge interest rate in 1993: firstly, to discourage breach of agreed limits and secondly, to recover the cost of any such breach.
viii) The bank had a low level of commitment to recovery of surcharge interest from some of its customers.
ix) The imposition of surcharge interest on a defaulting customer was a penalty as well as a means of cost recovery, as evidenced by the bank's stated motivation for setting the surcharge interest rate of 9% "to discourage", the bank's low level of commitment to surcharge interest recovery and the bank's practice of refunding surcharge interest paid by a defaulting customer who later got back on track with their loan repayments.
x) The imposition of surcharge interest did not afford a defaulting customer any additional or separate opportunity to engage with the bank in relation to their loan default, that they would not otherwise have had.
xi) The imposition of surcharge interest afforded the bank the opportunity to impose an increased amount of interest charged to a defaulting customer in order to secure the performance of their loan agreement.
xii) The margin interest rate charged by the bank on the defendant's 2017 loan did not include the cost of managing any default on that loan.
xiii) The relevant clause in the 2017 loan agreement is clause 8. Whether other clauses could have been invoked by the bank does not, on the facts of this case, affect the enforceability of the bank's claim for the surcharge interest it charged pursuant to clause 8.
xiv) Whether the amount of surcharge interest charged, or the cost of defaulting customers is significant or not to the bank's overall financial position, does not render the claim any more or less legally enforceable.
xv) The bank was contractually entitled to charge surcharge interest, insofar as that was lawful, on the entire debt due as of the date of default, including principal and interest.
xvi) The surcharge interest charged to the defendant in respect of his default on his 2017 facility was not a genuine pre-estimate of loss as of the date of that agreement.
xvii) Much, though not all, of the work done by the bank in managing the defendant's default of his 2017 loan agreement was a repeat of work already done by the bank in managing the defendant's earlier and related default.
xviii) It would have been apparent to the bank when they entered into the 2017 loan agreement with the defendant, who was a customer who had already defaulted on his previous loans, that any work in managing any default on that loan would involve some repetition of work already done.
xix) The amount of surcharge interest charged to the defendant equated to the cost of over 4,000 bank staff hours. The work done on managing the defendant's default did not require that amount of work or anything close to it. When the bank entered into the 2017 facility with the defendant, it could not have reasonably expected that 4,000 staff hours of work would be required to be done in the event of a further default by the defendant on his repayment obligations.
xx) The bank's 2022 retrospective analysis confirmed that the income from surcharge interest charged and not returned was less than the average cost of managing defaulting customers. Had the income been calculated to include the surcharge interest that was returned, that would still have been less than the cost, but considerably less so. Had the analysis included the surcharge interest that was charged but not recovered, the analysis would have shown the bank's income from surcharge income charged exceeded the cost of managing defaulting customers.
xxi) The role of the independent review carried out by PwC was limited to confirming the accuracy of the arithmetic in the 2022 analysis, and not to the way the bank obtained (or did not obtain) income from surcharge interest charged to defaulting customers.
xxii) It would be possible to record the time spent on each piece of work done by the bank in managing defaulting customers, and to assign a cost to it. This is not done by this bank or any comparable financial institutions.
The law
60. In Pat O'Donnell, the Supreme Court determined that the rule against penalties is governed by the House of Lords decision in Dunlop. The principal function of a penalty clause is "to deter a party from breaking the contract" (as per Finlay Geoghegan J. in ACC Bank Plc v Friends First Managed Pensions Funds Ltd & Ors [2012] IEHC 435 at 81). The law prohibits a penalty clause that, without commercial justification, provides for payment of monies in the event of a breach to secure the performance of the contract rather than to compensate for the loss. By contrast, the law permits a liquidated damages claim which provides for payment of compensation in the event of a breach which is "a genuine covenanted pre-estimate of damage" (as per Lord Dunedin in Dunlop at 86). Thus, on this formulation of the law, the court is required to determine whether the sum charged "is a penalty or liquidated damages" (as per Lord Atkinson in Dunlop at 90). The Supreme Court has approved of those principles in Pat O'Donnell.
61. The decision of the House of Lords in Dunlop is, therefore, the starting point in considering current Irish law. Dunlop involved a price maintenance agreement between the parties for the sale of tyres which provided, inter alia, for a payment by the respondent of £5 for each tyre sold in breach of the agreement. The respondent breached the agreement and the applicant sought damages calculated on the basis of £5 per tyre, as per the agreement. The respondent argued that the clause in the agreement was a penalty clause and, therefore, unenforceable. The claim was upheld as liquidated damages and not a penalty clause. The following dicta from the judgment of Lord Dunedin summarises the relevant principles, and was cited with approval by the Supreme Court in Pat O'Donnell:
"1. Though the parties to a contract who use the words 'penalty' or 'liquidated damages' may prima facie be supposed to mean what they say, yet the expression used is not conclusive. The Court must find out whether the payment stipulated is in truth a penalty or liquidated damages. This doctrine may be said to be found passim in nearly every case.
2. The essence of a penalty is a payment of money stipulated as in terrorem of the offending party; the essence of liquidated damages is a genuine covenanted pre-estimate of damage (Clydebank Engineering and Shipbuilding Co. v. Don Jose Ramos Yzquierdo y Castaneda (1)).
3. The question whether a sum stipulated and penalty or liquidated damages is a question of construction to be decided on the terms and inherent circumstances of each particular contract, judged of as at the time of the making of the contract, not as at the time of the breach (Public Works Commissioner v. Hills (1) and Webster and Bosanquet (2))."
4. To assist this task of construction various tests have been suggested, which if
applicable to the case under consideration may prove helpful, or even conclusive. Such are:
(a) It will be held to be penalty if the sum stipulated for is extravagant and unconscionable in amount in comparison with the greatest loss that could conceivably be proved to have flowed from the breach. (Illustration given by Lord Halsbury in Clydebank Case. (3))
(b) It will be held to be penalty if the breach consists only in not paying a sum of money, and the sum stipulated is a sum greater than the sum which out to have been paid (Kemble v. Farren (4)). This though one of the most ancient instances is truly a corollary to the last test. Whether it had its historical origin in the doctrine of the common law that when A. promised to pay B. a sum of money on a certain day and did not do so, B. could only recover the sum with, in certain cases, interest, but could never recover further damages for non-timeous payment, or whether it was a survival of the time when equity reformed unconscionable bargains merely exercised Jessel M.R. in Wallis v. Smith (5)-is probably more interesting than material.
(c) There is a presumption (but no more) that it is penalty when "a simple lump sum
is made payable by way of compensation, on the occurrence of one or more or all of several events, some of which may occasion serious and others but trifling damage" (Lord Watson in Lord Elphinstone v. Monkland Iron and Coal Co. (6)).
On the other hand:
(d) It is no obstacle to the sum stipulated being a genuine pre-estimate of damage, that the consequences of breach are such as to make a precise pre-estimation almost an impossibility. On the contrary, that is just the situation when it is probable that pre-estimated damage was the true bargain between the parties (Clydebank Case, Lord Halsbury (1); Webster v. Bosanquet, Lord Mersey (2))."
62. Lord Atkinson was clearly engaged with the amount of the money charged by the applicant for the respondent's breach as he found, at p. 92:
"They had an obvious interest to prevent this undercutting, and on the evidence it would appear to me to be impossible to say that that interest was incommensurate with the sum agreed to be paid".
Lord Parker was also focused on the comparison between the sums charged and the damage caused by the breach in saying, at p. 97:
"If, for example, the sum agreed to be paid is in excess of any actual damage which can possibly, or even probably, arise from the breach, the possibility of the parties having made a bona fide pre-estimate of damage has always been held to be excluded, and it is the same if they have stipulated for the payment of a larger sum in the event of breach of an agreement for the payment of a smaller sum".
Lord Parmoor held there could only be judicial interference with what the parties had agreed where there was "an extravagant disproportion between the agreed sum and the amount of any damage capable of pre-estimate" (p. 101). Applying that to the facts, he found the definite sum agreed by the parties "cannot be said to be extravagant or extortionate, having regard to the nature of the contract" (at p. 101).
63. In Pat O'Donnell, an interest clause of 2.5% per month, i.e. 30% per annum, in a contract for the sale of machinery was challenged as a penalty clause and, therefore, unenforceable. The Supreme Court found that the principles to be applied were set out in Dunlop and approved of the dicta of Dunedin L.J. cited above. In recognising the difference between a genuine pre-estimate of damages and an unenforceable penalty clause, Barron J. said, at p. 215,
"These two instances are quite different. In the first case, the damages would be uncertain and there may genuinely be a difficulty in a pre-estimate of the damage which would occur in the event of breach. A latitude is allowed, but even then the sum agreed must not be extravagant or unconscionable in relation to any possible amount of damages that could have been within the contemplation of the parties at the time when the contract was made. If it is, it is regarded as a penalty, and the plaintiff is left to prove the actual damage."
The rate of 30% per annum was found not to be a commercial annual rate and the matter was remitted to the High Court to have the appropriate rate of interest assessed at the commercial rate applicable at the time of the breach.
64. Since that decision, the courts have consistently applied and followed the approach of Barron J., albeit some disquiet with this approach has been apparent. Despite the issue almost making it there, the Supreme Court has not yet had the opportunity to affirm, adapt or replace its previously stated commitment to the principles of Dunlop or to move towards or away from the different approach being adopted in some other jurisdictions along the lines as is urged on this Court by the defendant, i.e. what the defendant describes as the recalibrated approach adopted by the House of Lords in Cavendish Square.
65. The first of the more recent decisions since Pat O'Donnell was ACC Bank. Finlay Geoghegan J. summarised the law as set out in Dunlop and Pat O'Donnell as requiring the court to determine "whether or not the additional sum payable is a genuine pre-estimate of the probable loss by reason of the breach" (at para. 79). She found a surcharge interest rate of 6% in that case to have been a penalty and, therefore, unenforceable. Finlay Geoghegan J. had particular regard to deterrence as a motivation of the contractual provision and cited, with approval, Clarke L.J. in Murray v. Leisureplay plc. [2005] EWCA Civ 963 at para. 81 of her judgment:
"81. The judgment of Colman J. was considered by the Court of Appeal in Murray v. Leisureplay plc. [2005] EWCA Civ 963. Arden L.J. and Clarke L.J. referred with approval to the approach of Colman J., the latter doing so as the "modern approach to Lord Dunedin's test in Dunlop Pneumatic Tyre v. New Garage and Motor Company Ltd., [1915] AC 67, and stated at para. 106:
'It is perhaps no longer entirely appropriate to ask whether a payment on breach was stipulate in terrorem of the offending party but, as Colman J. put it in the Lordsvale case at p. 762G . . .
"'whether a provision is to be treated as penalty is a matter of construction to be resolved by asking whether at the time the contract was entered into, the predominant contractual function of the provision was to deter a party from breaking the contract or to compensate the innocent party for breach. That the contractual function is deterrent rather than compensatory can be deduced by comparing the amount that would be payable on breach with the loss that might be sustained if a breach occurred".'"
66. Finlay Geoghegan J. held that the onus rested on the defendants to establish that the surcharge interest rate of 6% was a penalty (at para. 84). She concluded, on the evidence, that it "should be construed as a deterrent against default and a penalty" (at para. 91), having had particular regard to the following:
a. The application of surcharge interest could be triggered by a default in the payment not only of principal but also of any sum of interest, costs or charges.
b. The rate of default interest charged was a generic one included in standard terms and conditions, whereas the actual loss from a default would vary depending on the nature of the default.
c. The application of default interest increased the agreed margin in the facility letter by a factor of three and almost doubled the applicable interest rate.
67. The actual rate of the surcharge interest is, therefore, an important factor in assessing its enforceability in law. For a surcharge interest rate to successfully discourage a customer from breaching their agreed limits (as I have found was part of the bank's motivation in setting the impugned rate of surcharge interest), the rate would have to present a cost that is significant for that customer. Striking a rate of interest to discourage default is different to striking a rate to reflect a genuine estimate of the cost of the loss in the event of default on the loan, unless the increased rate is because the customer is now known to be a risky borrower. This distinction was discussed by Colman J. in Lordsvale Finance plc v. Bank of Zambia [1996] Q.B. 752 at p. 763:
"Where, however, the loan agreement provides that the rate of interest will only increase prospectively from the time of default in payment, a rather different picture emerges. The additional amount payable is ex hypothesi directly proportional to the period of time during which the default in payment continues. Moreover, the borrower in default is not the same credit risk as the prospective borrower with whom the loan agreement was first negotiated. Merely for the pre-existing rate of interest to continue to accrue on the outstanding amount of the debt would not reflect the fact that the borrower no longer has a clean record. Given that money is more expensive for a less good credit risk than for a good credit risk, there would in principle seem to be no reason to deduce that a small rateable increase in interest charged prospectively upon default would have the dominant purpose of deterring default. That is not because there is in any real sense a genuine pre-estimate of loss, but because there is a good commercial reason for deducing that deterrence of breach is not the dominant contractual purpose of the term.
It is perfectly true that for upwards of a century the courts have been at pains to define penalties by means of distinguishing them from liquidated damages clauses. The question that has always had to be addressed is therefore whether the alleged penalty clause can pass muster as a genuine pre-estimate of loss. That is because the payment of liquidated damages is the most prevalent purpose for which an additional payment on breach might be required under a contract. However, the jurisdiction in relation to penalty clauses is concerned not primarily with the enforcement of inoffensive liquidated damages clauses but rather with protection against the effect of penalty clauses. There would therefore seem to be no reason in principle why a contractual provision the effect of which was to increase the consideration payable under an executory contract upon the happening of a default should be struck down as a penalty if the increase could in the circumstances be explained as commercially justifiable, provided always that its dominant purpose was not to deter the other party from breach."
The court's view was that the increased interest rate is only valid where there is no dominant purpose of deterring the other party from breach. This dicta was approved of by Finlay Geoghegan J. in ACC Bank where she described Colman J.'s decision as "a modern application of [the Dunlop principles] to the banking sector" (at para. 82).
68. In 2015, the UK Supreme Court delivered its judgment in Cavendish Square which took a different approach to Dunlop and Pat O'Donnell. The UK Supreme Court placed an emphasis on commercial justification and the legitimate interests of the party seeking to enforce the impugned clause. Lord Neuberger and Lord Sumption, for the majority, emphasised that the court was not overruling the long-held principle that a penalty clause could not be enforced but went on to criticise how the law had been developed and applied, stating, at para. 31:
"In our opinion, the law relating to penalties has become the prisoner of artificial categorisation, itself the result of unsatisfactory distinctions: between a penalty and genuine pre-estimate of loss, and between a genuine pre-estimate of loss and a deterrent. These distinctions originate in an over-literal reading of Lord Dunedin's four tests and a tendency to treat them as almost immutable rules of general application which exhaust the field.".
Lord Mance said there may be intentions beyond the compensatory justifying an additional financial burden on a defaulting party,
"What is necessary in each case is to consider, first, whether any (and if so what) legitimate business interest is served and protected by the clause, and, second, whether, assuming such an interest to exist, the provision made for the interest is nevertheless in the circumstances extravagant, exorbitant or unconscionable. In judging what is extravagant, exorbitant or unconscionable, I consider (despite contrary expressions of view) that the extent to which the parties were negotiating at arm's length on the basis of legal advice and had every opportunity to appreciate what they were agreeing must at least be a relevant factor. (at para. 152)
Lord Hodge concluded, at para. 255:
"...that the correct test for a penalty is whether the sum or remedy stipulated as a consequence of a breach of contract is exorbitant or unconscionable when regard is had to the innocent party's interest in the performance of the contract. Where the test is to be applied to a clause fixing the level of damages to be paid on breach, an extravagant disproportion between the stipulated sum and the highest level of damages that could possibly arise from the breach would amount to a penalty and thus be unenforceable. In other circumstances the contractual provision that applies on breach is measured against the interest of the innocent party which is protected by the contract and the court asks whether the remedy is exorbitant or unconscionable."
69. The different approach of the UK Supreme Court in Cavendish Square was urged on Haughton J. in the next surcharge interest claim that came before the Irish courts in Sheehan v. Breccia [2016] IEHC 67 and the related case of Flynn v. Breccia [2016] IEHC 68. Haughton J. declined to follow the UK Supreme Court, in spite of the "attractions to the reasoning" therein (at para. 122), as he said it would have been a departure from the jurisprudence established by judges of equal rank. Haughton J. held that the rate of surcharge interest charged was a penalty as it was a generic rate and, on the facts, was not a genuine pre-estimate of loss and the probability of default was factored into the calculation of the ordinary loan interest rate. He concluded that the dominant purpose of this rate of surcharge interest was to deter borrowers from defaulting on their loans.
70. The decision of Haughton J. was appealed to the Court of Appeal but before that came on for hearing, a number of obiter comments were made by McKechnie J. in the Supreme Court to the effect that the Dunlop principles continued to apply and he did not consider any change to the test was necessary nor that the approach of the UK Supreme Court was "necessarily a superior one" (Launceston Property Finance Ltd v. Burke [2017] 2 IR 798 at para. 43). Those comments were cited with approval by Finlay Geoghegan J. in the Court of Appeal decision of Sheehan v. Breccia [2018] IECA 286, a decision that was to be read with that of Flynn v Breccia [2017] IECA 74. Finlay Geoghegan J. also suggested a reconsideration of the Dunlop principles may be desirable but "that remains a matter for the Supreme Court in this jurisdiction" (at para. 21).
71. Breccia had argued before the Court of Appeal that Haughton J. had failed to advert to the "latitude" that Barron J. in Pat O'Donnell indicated should be applied in determining whether a clause is a penalty where it is genuinely difficult to pre-estimate the damage that could arise on a breach. Finlay Geoghegan J. identified the question to be determined as:
"...whether the clause in question properly construed is an agreement for the payment of liquidated damages. The courts have traditionally approached that question by asking the question as to whether the sums stipulated are a genuine pre-estimate of the loss to the innocent party which would result from the relevant breach." (at para. 45).
In reaching that conclusion, Finlay Geoghegan J. set out the following propositions:
a. the Dunlop principles indicate a binary approach; a clause is either a liquidated damages clause or a penalty (para. 29).
b. the functional effect of a liquidated damages clause is to compensate while the functional effect of a penalty is to deter breach (para. 34)
c. a liquidated damages clause is normally a genuine pre-estimate of loss to be suffered by reason of the breach (para. 35)
d. determining whether a clause is a genuine pre-estimate of loss is a question of construction to be resolved having regard to the Dunlop principles (para. 36)
e. the Court may have regard to the potential loss and damage which may be suffered by breach and the extent to which pre-estimation may genuinely be difficult (para. 37)
f. the Court may have regard to the amount claimed in the light of the possible or probable loss to determine whether it is extravagant or unconscionable (para. 38)
g. the Court must be satisfied that the contractual provision is a genuine attempt by the parties to estimate in advance the loss which will result from the breach (para. 44)
72. On the evidence, Finlay Geoghegan J. concluded that the clause imposing surcharge interest on the defendant's default "...was not a genuine attempt to agree upon liquidated damages payable by the borrower on default and hence should be construed as being a penalty" (at para. 56). She found further support for this conclusion in the separate indemnity clause in the loan agreement and found its inclusion, without any attempt to pre-estimate the loss or to set out a manner of its interaction with the default surcharge interest clause, also undermined a construction of that clause being a liquidated damages clause.
73. The defendants in Sheehan were granted leave to appeal to the Supreme Court from the Court of Appeal, having argued that the principles set out in Dunlop should be reconsidered in the light of what they said was the preferred approach taken in Cavendish Square. The appeal did not proceed as the matter was settled. Engagement with the divergence between current Irish and UK jurisprudence on surcharge interest may ultimately be a matter for the Supreme Court but not for this Court, which is bound by the findings of the Court of Appeal.
Application of the current Irish law to the facts of this case
74. There was a cost to the bank from the defendant's default on the 2017 facility. When the parties entered the 2017 loan agreement that additional cost could not have been accurately calculated by the bank, although the bank would have known at that time about the work that it had done previously on related loan default by the defendant and the repetitive nature of some of the work that would require to be done in the future if the defendant were to default on the 2017 facility. I have found on the evidence that the motivation behind the bank's development of its surcharge interest provision was to discourage breach of agreed limits and to recover the cost of any such breach. Because of the motivation to discourage breach and the bank's low level of commitment to recovery of surcharge interest to some of its customers, I concluded that the imposition of surcharge interest on a defaulting customer was a penalty as well as a means of cost recovery. I also found that the surcharge interest charged to the defendant in respect of his default on the 2017 facility was not a genuine pre-estimate of the bank's loss in the event of default. Applying those findings to the law as set out by the Supreme Court in Pat O'Donnell and affirmed most recently and relevantly by the Court of Appeal in Sheehan v. Breccia, the impugned clause clearly offends against the rule against penalty clauses.
75. I found on the evidence that the bank did not follow general practice in looking to its past experiences of loss from defaulting loans when they struck the surcharge interest rate in 1993 and/or 2008. The bank had no validated, empirical basis for the interest rate it charged the defendant upon his default of the 2017 facility. There was no attempt to secure any such data until 2022 when the review referred to above was done, apparently to address concerns about the legal status of surcharge interest that had arisen. That review could not justify the rate of surcharge interest that was charged to this defendant some years prior to the review having been carried out. That, combined with what I found was the low level of commitment the bank had demonstrated to the recovery of surcharge interest recovery by refunding surcharge interest paid by a defaulting customer who later got back on track with their loan repayments and by choosing not to charge surcharge interest to some customers, is relevant to the existence of a commercial justification for the surcharge interest rate that was imposed on this defendant. The bank has not established such a commercial justification here.
76. The additional cost likely to arise in the event of a loan defaulting cannot be accurately calculated at the time the loan is drawn down. The defendant proposed an alternative method of cost recovery for a financial institution which incurs additional costs where a borrower breaches their loan agreement, based on tracking the work done in managing the customer's default and imposing a charge based on the work done. It would have been possible for the bank to have followed this method of cost recovery. However, the law on surcharge interest does not require the bank to manage its recovery of the cost of defaulting loans in a specified way. It must ensure its method of cost recovery does not offend the rule against penalties which, in turn, requires it to engage in a genuine pre-estimate of its loss in the event of a breach. The fact that there may be an alternative way of organising cost recovery does not, in itself, require the bank to do it that way.
77. Much of the work the bank had to do because of the defendant's default on the 2017 facility was a repeat of work already done on the defendant's previous loan default over many years. The sum of surcharge interest of 204,501.23 significantly exceeds the cost of both the staff hours of work that was done and the staff hours of work that the bank could have reasonably expected would require to be done by them in the event of a further default by the defendant when they entered into the 2017 facility with the defendant. I therefore conclude that the imposition of a rate of 9% surcharge interest on this defendant was unconscionable and extravagant.
78. Neither could the 9% rate of interest charged here, which was more than three times the original lending rate of 2.86%, equate to the modest increase that was suggested by the court in ACC Bank and Sheehan v. Breccia.
Decision
79. I find for the defendant and I refuse the plaintiff's application for an order directing the defendant to pay the sum of 204,501.23 in respect of the surcharge interest that was charged on the defendant's default of his loan agreement from August 2018 to May 2020.
80. I will put the matter in for mention before me on 30th April at 10am for the making of final orders.
Counsel for the plaintiff: Kelley Smith SC, Gerard Downey BL.
Counsel for the defendant: John O'Donnell SC, Brian Conroy SC, Julie Maher BL.