White v Davenham Trust Ltd [2010] EWHC 2748 (Ch)

Case No CH/2010/0315[2010] EWHC 2748 (Ch)IN THE HIGH COURT OF JUSTICECHANCERY DIVISIONIN BANKRUPTCYON APPEAL FROM MR DEPUTY REGISTRAR SCHAFFERVenue Royal Courts of Justice, Strand, London, WC2A 2LLDate 01/11/2010
Before
THE HON MR JUSTICE FLOYD
Between
MARK EUGENE WHITEApplicantDAVENHAM TRUST LIMITEDRespondentMARK EUGENE WHITE Applicant (Respondent to the Appeal)- and -DAVENHAM TRUST LIMITED Respondent (Appellant)
Barry Isaacs (instructed by DWF LLP) for AppellantKavan Gunaratna (instructed by Coyle White Devine) for Applicant (Respondent to the Appeal)Hearing Hearing dates: 19 th October 2010
JudgmentMr Justice Floyd :Introduction
[1]This is an appeal, with the permission of Deputy Registrar Schaffer, from his decision dated 27th April 2010 whereby he set aside a statutory demand in the sum of £958,387.93 served by the Appellant, Davenham Trust Limited (“Davenham”) on the Respondent, Mark White on 28th October 2009. Mr White, a former director of the company St George’s Property Services (London) Limited (“St George’s”), was the guarantor of the obligations of St George’s to Davenham under secured loan facility agreements. The Deputy Registrar set aside the statutory demand on the ground set out in 6.5(4)(d) of the Insolvency Rules 1986, which provides that a statutory demand may be set aside if the court is satisfied, on grounds other than those set out in sub-paragraphs (a) to (c), that the demand “ought to be set aside”.

Background

[2]St George’s was incorporated in April 2007. Mr White and a Mr Seamus Finnerty, a bank manager, were the directors. The company was incorporated for the purposes of buying, refurbishing and selling two properties in Fulham, London namely one at Ringmer Avenue (“Ringmer”) and another at Gowan Avenue (“Gowan”).[3]By a first facility agreement dated 27th September 2007 (“the Ringmer agreement”) Davenham made £960,650 available to St George’s for a period of nine months to purchase and redevelop Ringmer. Interest was payable at 1.5% per month. Davenham reserved the right to charge interest at 3% per month (the default rate) if the Company committed a breach of the Ringmer agreement. The monies owed were secured by a charge over Ringmer and by a fixed and floating charge over St George’s property. Mr White entered into a guarantee dated 4th October 2007 (“the Guarantee”) pursuant to which he guaranteed the payment or discharge to Davenham of “all moneys and liabilities which shall for the time being be owing or incurred by [St George’s] to [Davenham]”.[4]By a further agreement dated 6th December 2007 (“the Gowan agreement”) Davenham made a further £834,950 available to St George’s for a period of 9 months for the purchase and redevelopment of Gowan. Interest was payable at 1.6% per month. Davenham again reserved the right to charge interest at a default rate of 3% per month. The monies owed were secured by a charge over Gowan. There is no dispute that the Guarantee applied to sums owing under the Gowan agreement.[5]Davenham’s charge in respect of Ringmer was redeemed on 6th February 2009 when alternative finance was provided by Barclays Bank plc. As a result of the refinancing, some £1.2 million remains owing by St George’s to Barclays in respect of that property. The property is leased to tenants and the income exceeds the interest payments on the new loan.[6]Gowan was leased to tenants for three years on 2nd March 2009. Mr White explains in his evidence that the downturn in the economy, and the impact upon the property market altered St George’s original aim to refurbish and sell the properties. In the result, their aim was to await an improvement in the property market before seeking to sell. The properties were leased out in the interim to obtain an income pending an improvement in the market.[7]In relation to Gowan, the principal sum outstanding at the date of Mr White’s witness statement was £935,334 of which, he said, £185,536 represented default interest. The rental income is not adequate to meet the repayments under the Gowan agreement at the default rate. Attempts to refinance have been unsuccessful.[8]On 18th September 2009 St George’s was placed into administration under the power contained in paragraph 14 of Schedule B(1) to the Insolvency Act 1986. Peter Clark and David Whitehouse, two insolvency practitioners, were appointed Joint Administrators.[9]On 12th November 2009 the Administrators served a Report and Statement of proposals to Creditors. That report revealed St George’s indebtedness to Barclays of £1.2 million and other indebtedness to non-preferential creditors of £800,255. The Administrators stated that they were continuing to review the prospects of an action under section 244 of the Insolvency Act (which concerns extortionate credit transactions – see below). They also stated that they were continuing to review whether the first objective of administration, namely rescuing the company as a going concern, was possible. They pointed out that the only material assets of St George’s were Gowan and Ringmer, and that it was anticipated that there would be insufficient realisations to enable a distribution to non-preferential creditors.[10]On 4th April 2010 Mr White and his co-guarantor applied under paragraph 88 of Schedule B1 for an order to remove the Administrators and to appoint another insolvency practitioner in their place. The grounds of the application were that the existing Administrators were not pursuing an application under section 244 designed to establish that the interest rates were part of an extortionate credit transaction. The application came before Registrar Derrett who refused it. An appeal was allowed by the Chancellor on 14th October 2010. He held that there was an inadequate link between the complaint of the Guarantors (not pursuing the section 244 application) and the remedy sought (appointment of new administrators), see Re St George’s Property Services (London) Limited (in administration): Clark and another v Finnerty and another [2010] EWHC 2539 (Ch). That decision is obviously subsequent to the decision from which this appeal lies.

Rule 6.5(4)(d)

[11]On an application to set aside a statutory demand, rule 6.5(4) of the Insolvency Rules 1986 provides that: “the court may grant the application if-(a) the debtor appears to have a counterclaim, set-off or cross demand which equals or exceeds the amount of the debt or debts specified in the statutory demand; or(b) the debt is disputed on grounds which appear to the court to be substantial;(c) it appears that the creditor holds some security in respect of the debt claimed by the demand, and either rule 6.1(5) is not complied with in respect of it, or the court is satisfied that the value of the security equals or exceeds the full amount of the debt;(d) the court is satisfied, on other grounds, that the demand ought to be set aside.[12]In contrast to grounds (a) to (c), which identify specific facts which must be established, ground (d) gives the court a broad residual discretion. In Budge v A.F.

(d) in this way:

“The real question …. is whether the [the applicant] can show a substantial reason, comparable to the sort of reason one sees in paras (a), (b) and (c) of r6.5(4), why the demand ought to be set aside. ”
[13]In Remblance v Octagon Assets Limited [2009] EWCA Civ 581; [2010] 1 BCLC 10, the majority of the Court of Appeal set aside, under paragraph (d), a statutory demand against a guarantor in a case where it was common ground that the principal debtor had an arguable counterclaim or cross-claim which equalled or exceeded the amount claimed against it. Dyson LJ said this at [33] “The discretion to set aside a statutory demand under r 6.5(4)(d) is a residual discretion which will normally be exercised in "circumstances which would make it unjust for the statutory demand to give rise to [bankruptcy] consequences in the particular case. The court’s intervention is called for to prevent that injustice": see per Nicholls LJ in Re a Debtor (No 1 of 1987, Lancaster), ex p the debtor v Royal Bank of Scotland plc. [1989] 2 All ER 46 at 50, [1989] 1 WLR 271 at 276. Nicholls LJ went on to say that this approach to sub-para (d) is in line with the particular grounds specified in sub-paras (a)-(c) of r 6.5(4). As he said (with reference to sub-para (a)), it would normally be unjust that a person should be regarded as unable to pay a debt if he has a counterclaim, set-off or cross-demand which equals or exceeds the amount of the debt.”[14]That passage forms an important part of the appeal in the present case, as it is said that the combination of arguments under paragraphs (a) or (b) of the sub-rule in combination with the existence of security under the Gowan agreement would have given St George’s an answer to a statutory demand. “In line” with that, it would be unjust to enforce the demand against Mr White. I have no doubt that in some cases that may be the position; but in each case the question is whether the circumstances make it unjust to do so.

The decision of the Deputy Registrar

[15]Before the Deputy Registrar, Mr White sought to set aside service of the demand on four grounds. One ground, concerned with service of the demand, was not pursued, leaving the following grounds which the Deputy Registrar summarised in paragraph 5 of his judgment as follows:
“5.2 Davenham holds security in respect of the debt; 5.3 The facility agreements were extortionate credit bargains within the meaning of Section 244 of the Insolvency Act 1986; 5.4 The default interest sought by Davenham is an unenforceable penalty at common law.”
[16]In paragraphs 15 to 19 of his judgment the Deputy Registrar considered the question of the security which Davenham held over the property of St George’s. He indicated, and it is common ground, that the security which Davenham hold over the property of St George’s cannot be brought into account under rule 6.5(4)(c). The security to which that sub-rule refers is security over the property of the debtor, not that of a third party: see re a Debtor (No 310 of 1988) [1989] 1 WLR 452. The Deputy Registrar went on to consider the evidence of the value of the properties and concluded that, although it came close, it did not show that the security was sufficient to exceed the debt claimed in the demand.[17]In paragraphs 20 to 27 the Deputy Registrar considered whether the Section 244 and penalty points raised a triable cross claim, and he concluded, summarily, that they did not.[18]Having correctly set out the test to be applied under sub-paragraph (d) the Deputy Registrar said this at paragraph 30:
“Injustice can take many forms and the Bankruptcy Court should not be restricted as to how it should use its discretion when determining whether a Statutory Demand should or should not be set aside… In this case: 30.1 Mr White cannot influence any decision the Administrators may make for St Georges in dealing with the property; 30.2 Davenham could, had it so wished, have sought to enforce its security and sell the property whether by securing permission of the Administrators or by applying to the court. For reasons not articulated before me, it has chosen not to do so. 30.3 If it had sold the property the ultimate balance to be discharged by Mr White (see paragraph 7 of the Guarantee) would have been identified and Mr White would have known precisely what payments he had to make to meet the demand.”
[19]The Deputy Registrar’s conclusion is expressed in the following terms:
“Having taken, therefore, all the arguments raised by Mr White into account notwithstanding that I find that St Georges may not have had an arguable defence to the Davenham claims, I do not believe it just Mr White should face bankruptcy on the facts of this case, particularly those which I have identified at paragraph 30 above. I therefore determine in my discretion that the statutory demand should be set aside.”
[20]Davenham appeal the Deputy Registrar’s decision under rule 6.5(4)(d). By a Respondent’s Notice, Mr White contends that the section 244 and penalty points were properly arguable defences for St George’s.

Davenham’s appeal

[21]Mr Isaacs, who appeared on behalf of Davenham, underpinned his argument by emphasising the principle that a creditor is entitled to a free election as to whether to sue the principal debtor or his guarantor. In China and South Sea Bank Limited v Tan Soon Gin [1990] 1 AC 536, Lord Templeman, giving the judgment of the Privy Council on an appeal from Hong Kong, said at 543H: “The surety does not and cannot impugn the validity of the provisions of the guarantee and admits that the moneys claimed by the creditor are due in accordance with the express terms of the guarantee. But the surety claims that the creditor owes the surety a duty to exercise the power of sale conferred by the mortgage and in that case the liability of the surety under the guarantee would either have been eliminated or very much reduced. The Court of Appeal sought to find such a duty in the tort of negligence but the tort of negligence has not yet subsumed all torts and does not supplant the principles of equity or contradict contractual promises or complement the remedy of judicial review or supplement statutory rights."[22]Lord Templeman then reviewed the authorities on the question of when equity intervenes to protect a surety. He cited with approval the rule stated by Quain J in Wulff v Jay (1872) L.R. 7 QB 756 that:
“ if through any neglect on the part of the creditor, a security to the benefit of which a surety is entitled is lost, or is not properly perfected, the surety is discharged.”
[23]He concluded with this important passage:
“In the present case the security was neither surrendered nor lost nor imperfect nor altered in condition by reason of what was done by the creditor. The creditor had three sources of repayment. The creditor could sue the debtor, sell the mortgage securities or sue the surety. All these remedies could be exercised at any time or times simultaneously or contemporaneously or successively or not at all. If the creditor choses to sue the surety and not pursue any other remedy, the creditor on being paid in full was bound to assign the mortgaged securities to the surety. If the creditor chose to exercise his power of sale over the mortgage security he must sell for the current market value but the creditor must decide in his own interest if and when he should sell. The creditor does not become a trustee of the mortgaged securities and the power of sale for the surety unless and until the creditor is paid in full and the surety, having paid their the debt is entitled to a transfer of the mortgaged securities to procure recovery of the whole or part of the sum is paid to the creditor. “The creditor is not obliged to do anything. If the creditor does nothing and the debtor or declines into bankruptcy the mortgaged securities become valueless and the surety decamps abroad, the creditor loses his money. If disaster strikes the debtor and the mortgaged securities but the surety remains capable of repaying the debt than the creditor loses nothing. The surety contracts to pay if the debtor does not pay and the surety is bound by his contract. If the surety, perhaps less in London or less well protected than the creditor, is worried that the mortgaged securities may decline in value than the surety may request the creditor to sell and if the creditor remains idle than the surety may bustle about, pay off the debt, take over the benefit of the securities and sell them. No creditor could carry on the business of lending if he could become liable to a mortgagor and to a surety or to either of them for a decline in value of the mortgaged property, unless the creditor was personally responsible for the decline.”
[24]The principle, to which Lord Templeman refers, that a mortgagee has no duty at any time to exercise his power to enforce the security, is a well established one and has been recently re-affirmed and explained by the Court of Appeal in Silven Properties Ltd and another v Royal Bank of Scotland PLC and others [2003] EWCA Civ 1409; [2004] 1 WLR 997 at [14]:
“A mortgagee "is not a trustee of the power of sale for the mortgagor". … In default of provision to the contrary in the mortgage, the power is conferred upon a mortgagee by way of bargain by the mortgagor for his own benefit and he has an unfettered discretion to sell when he likes to achieve repayment of the debt which he is owed: Cuckmere Brick Co Ltd v Mutual Finance Ltd [1971] Ch 949, 969G. A mortgagee is at all times free to consult his own interests alone whether and when to exercise his power of sale… It does not matter that the time may be unpropitious and that by waiting a higher price could be obtained: he is not bound to postpone in the hope of obtaining a better price.”
[25]Neither of those cases was concerned with a situation in which a creditor was seeking to present a bankruptcy petition against a surety in respect of a debt which was secured by a mortgage entered into by the principal debtor. But Mr Isaacs draws my attention to a number of decisions in common law countries where the principle evident from China and South Sea Bank has been so applied.[26]Thus in Re McCann [1985] 2 Qd. R 381, a decision of the Supreme Court of Queensland, Demack J held that there was nothing in the Australian Bankruptcy Act which prevents a secured creditor from issuing a bankruptcy notice against a surety. He said at 382 line 9:
“I have found no case in which a bankruptcy notice has been set aside simply because it was issued by a secured creditor. Indeed if that were done it would introduce a considerable constraint upon a secured creditor’s right to pursue his remedies, and such a restriction would have to appear clearly in the Bankruptcy Act.”
[27]In Petratos v Provident Capital Limited [2009] FMCA 1168, Smith FM, sitting in the Federal Magistrates Court of Australia, considered at [25] that:
“Long established authorities have pointed out that the creditor’s remedies in relation to executing on judgements against the debtor, or the surety, include pursuing those persons into bankruptcy, even before securities have been realised to reduce their indebtedness.”
[28]In re Chandraex parte United Overseas Bank Limited HCB 3453/2000 an argument that equity should compel a creditor to realise the security provided by a co-surety before enforcing a remedy in bankruptcy against the guarantor was rejected by the High Court of Hong Kong. After citing the passages from China and South Sea (above) the Deputy High Court Judge said: “It is not the law that a creditor can be compelled to proceed against a solvent principal debtor or a solvent co-surety before he is allowed to place the whole burden of the debt upon a particular surety."[29]On appeal, the Hong Kong Court of Appeal (Rogers VP, Le Pichon JA and Burrell J) declined to set aside the bankruptcy order. Rogers VP said:
“I do not think it is open to this court to hold that the judge was incorrect in her approach that it did not avail the debtor that the creditor had not sued the co-surety and had not sought to rely on its other security.”
[30]In Caisse Populaire Desjardins Saint-Jean Baptiste de Lasalle v 164375 Canada Inc 1999 Can LII 13771, the Court of Appeal of Quebec held that third party guarantees:
“did not in any way preclude the Caisse from proceeding against its principal debtor whether by way of bankruptcy petition or otherwise”
[31]In Re Mastronardi 195 DLR (4th) 631, the bankruptcy judge had relied heavily on the creditor’s alleged failure to make serious efforts to collect the debt in other ways. The Court of Appeal of Ontario held this to be an incorrect approach: “if the petitioner can satisfy the requirements of the [Bankruptcy and Insolvency Act], I see no reason for denying him access to the process and remedies of the Act because there may be other civil routes open to him. The BIA is not a second-rate or fallback statute that can only be invoked if other avenues fail. I agree with Ground J. who said in Re Cappe (1933), 18 C.B.R. (3d) 229 at 235 (Ont. Gen. Div.): “I know of no statutory or common law which requires that a petitioning creditor have exhausted all other remedies available to that creditor to collect the debt owing to him or her before proceeding with a petition for a receiving order. In fact the jurisprudence would seem to be to the contrary””. “I know of no statutory or common law which requires that a petitioning creditor have exhausted all other remedies available to that creditor to collect the debt owing to him or her before proceeding with a petition for a receiving order. In fact the jurisprudence would seem to be to the contrary””.[32]Mr Isaacs submits that a rule which required a creditor to exhaust his security against the principal debtor before resorting to bankruptcy proceedings against a surety would be out of step with the jurisprudence of these common law countries. Moreover, at least some of these cases indicate that there is not seen to be anything unfair or unjust in allowing bankruptcy proceedings to issue in these circumstances, or anything to justify the recognition of an equity to prevent the creditor from pursuing such a remedy. Mr Gunaratna for Mr White points out that these are not cases on the application of rule 6.5(4)(d) of our Insolvency Act, which creates a specific residual discretion to prevent unfairness in a particular case, a factor which I bear in mind.[33]I think the foreign cases relied on by Mr Isaacs are some persuasive authority for the proposition that the mere existence of a secured remedy against another party is not a substantial ground for refusing to allow the creditor to pursue a remedy in bankruptcy against a surety. The liability of the surety is generally co-extensive with that of the principal debtor, not contingent on the security provided by the principal debtor proving to be inadequate. In the present case that is made expressly clear by clause 6 of the Guarantee:
“This Guarantee is to be in addition to and not to prejudice or be prejudiced by any other securities or guarantees … which you may now or hereafter hold from or on account of the Principal…”
[34]Mr Isaacs submits, I think rightly, that the existence of the secured remedy against the principal debtor should not place the creditor in a worse position so far as bankruptcy proceedings against the surety are concerned than if he held no such secured remedy.

The reasons given by the Deputy Registrar

[35]The first reason given by the Deputy Registrar was that Mr White could not influence the decision of the Administrators to sell the property. Mr Isaacs challenges whether this is factually correct given that Mr White has been pursuing an application to remove the Administrators and cause them to bring an application under section 244 which might if successful result in the Company being rescued as a going concern. He contends that, to the extent that Mr White’s efforts have been in that direction they have been directed at influencing the Administrators against selling the properties.[36]I am not persuaded that the Deputy Registrar was wrong to hold that Mr White could not influence the Administrators decision to sell the property. I think he was simply contrasting Mr White’s position with that of Davenham. This becomes clear when the second reason of the Deputy Registrar is considered. As a secured creditor Davenham could at least seek to persuade the Administrators to permit the sale or apply to the Court. Mr White had no corresponding influence.[37]However I am not persuaded that these first two reasons are relevant to whether it is just to bring bankruptcy proceedings against Mr White. They both relate to Davenham’s alternative remedy against the principal debtor, now in administration. I accept Mr Isaacs’ submission that it is by no means clear that Davenham would have obtained the Administrators’ consent or permission to sell the properties. Furthermore it would be wrong to require Davenham to embark on litigation to obtain an order for the sale of the properties when they have an alternative remedy against Mr White. Moreover, as Mr White had not shown that there was sufficient value in the security to extinguish the debt, and interest was accruing at the rate of £28,000 per month, there was no prospect that this alternative remedy would discharge Mr White’s indebtedness to Davenham. Finally, these reasons took no account of the fact the evidence of both parties was that it was not a propitious time to sell, both in view of market conditions and the fact that Gowan was subject to a lease until March 2012.[38]The Deputy Registrar’s third ground was that if Gowan had been sold, the ultimate balance to be discharged by Mr White would be known. He made this point again in paragraph 32 of his judgment:
“True [Mr White] could make a payment but can it be right that it should be for the full sum demanded when Davenham hold but does not seek to realise its security which would have a consequential effect of identifying with particularity exactly how much is due under the Guarantee.”
[39]Mr Isaacs submits that the Deputy Registrar fell into error here by identifying the amount due under the Guarantee as the amount of the principal debt less the security. In the light of the finding that St George’s had no arguable defence to the claim against them, the amount due under the Guarantee is the amount set out in the statutory demand, which Mr White has no difficulty in ascertaining.[40]It follows, not least from this last point, that I consider that the Deputy Registrar took into account matters which he should not have taken into account in exercising his discretion under rule 6.5(4)(d). I am therefore justified in exercising that discretion afresh. Before doing so, it is convenient to consider whether I should do so on the basis of the Deputy-Registrar’s findings about the section 244 and common law penalty.

The Respondent’s Notice

[41]By his Respondent’s Notice Mr White contends that the Deputy Registrar was wrong to reject the points based on Section 244 and common law penalty. I take these in turn.

Section 244 of the Insolvency Act 1986

[42]Section 244 provides so far as material as follows:
“(1) This section applies as does section 238, and where the company is, or has been party to a transaction for, or involving, the provision of credit to the company. (2) The court may, on the application of the office-holder, make an order with respect to the transaction if the transaction is or was extortionate. (3) For the purposes of this section a transaction is extortionate if, having regard to the risk accepted by the person providing the credit – (a) the terms of it are or were such as to require grossly exorbitant payments to be made (whether unconditionally or in certain contingencies) or (b) it otherwise grossly contravenes ordinary principles of fair-dealing; and it shall be presumed, unless the contrary is proved, that a transaction with respect to which an application is made under this section is or, as the case may be, was extortionate. (4) An order under this section with respect to any transaction may contain such one or more of the following as the court thinks fit: (a) provision setting aside the whole or part of the obligation created by the transaction,.. (b) provision otherwise varying the terms of the transaction or varying the terms on which any security for the purposes of the transaction is held, (c) provision requiring any person who is or was a party to the transaction to pay to the office-holder any sums paid to that person, by virtue of the transaction, to the company..” (a) the terms of it are or were such as to require grossly exorbitant payments to be made (whether unconditionally or in certain contingencies) or (b) it otherwise grossly contravenes ordinary principles of fair-dealing; (a) provision setting aside the whole or part of the obligation created by the transaction,.. (b) provision otherwise varying the terms of the transaction or varying the terms on which any security for the purposes of the transaction is held, (c) provision requiring any person who is or was a party to the transaction to pay to the office-holder any sums paid to that person, by virtue of the transaction, to the company..”
[43]The section is modelled on sections 137 to 140 of the Consumer Credit Act 1974. Section 138(2) of that act gives some guidance on what factors may be relevant, to consumer credit bargains under that section:
“(2) In determining whether a credit bargain is extortionate, regard shall be had to such evidence as is adduced concerning- (a) interest rates prevailing at the time it was made, (b) the factors mentioned in subsection (3) to (5), and (c) any other relevant considerations (3) Factors applicable under subsection (2) in relation to the debtor include – (a) his age, experience, business capacity and state of health; (b) the degree to which, at the time of making the credit bargain, he was under financial pressure, and the nature of that pressure. (4) Factors applicable under subsection (2) in relation to the creditor include- (a) the degree of risk accepted by him, having regard to the value of any security provided, (b) his relationship to the debtor..” (a) interest rates prevailing at the time it was made, (b) the factors mentioned in subsection (3) to (5), and (c) any other relevant considerations (a) his age, experience, business capacity and state of health; (b) the degree to which, at the time of making the credit bargain, he was under financial pressure, and the nature of that pressure. (a) the degree of risk accepted by him, having regard to the value of any security provided, (b) his relationship to the debtor..”
[44]In Paragon Finance plc v Nash and another [2001] EWCA Civ 1466; [2002] 1 WLR 685 the Court of Appeal emphasised the stringent nature of the test for an extortionate transaction under the Consumer Credit Act 1974. At [67] Dyson LJ said:
“… the measure of protection that is undoubtedly afforded by the 1974 Act should not be overstated. In Consumer Credit Law and Practice, para 47.26 Professor Goode says: “Nevertheless, it seems clear that the concepts of extortion and unconscionability are very similar. ‘Extortionate’ like ‘harsh and unconscionable’, signifies not merely that the terms of the bargain are stiff, or even unreasonable, but that they are so unfair as to be oppressive. This carries with it the notion of morally reprehensible conduct on the part of the creditor in taking grossly unfair advantage of the debtor’s circumstances. This element of moral culpability, in the form of abuse of power or bargaining position, is well brought out in the judgment of Sir John Donaldson MR in Wills v Wood [1984] CCLR 7: ‘It is, of course, clear that the Consumer Credit Act 1974 gives the widest possible control over credit bargains which, for a variety of reasons, might be considered “extortionate”
. But the word is “extortionate” not “unwise”. The jurisdiction seems to me to contemplate at least a substantial imbalance in bargaining power of which one party has taken advantage” “Nevertheless, it seems clear that the concepts of extortion and unconscionability are very similar. ‘Extortionate’ like ‘harsh and unconscionable’, signifies not merely that the terms of the bargain are stiff, or even unreasonable, but that they are so unfair as to be oppressive. This carries with it the notion of morally reprehensible conduct on the part of the creditor in taking grossly unfair advantage of the debtor’s circumstances. This element of moral culpability, in the form of abuse of power or bargaining position, is well brought out in the judgment of Sir John Donaldson MR in Wills v Wood [1984] CCLR 7: ‘It is, of course, clear that the Consumer Credit Act 1974 gives the widest possible control over credit bargains which, for a variety of reasons, might be considered “extortionate”. But the word is “extortionate” not “unwise”. The jurisdiction seems to me to contemplate at least a substantial imbalance in bargaining power of which one party has taken advantage”[45]In relation to the interest rates under consideration in that case, Dyson LJ said:
“It may be said that they were high, even unreasonably high, but that is insufficient”
[46]The Court of Appeal accordingly held that the defendants would not have real prospect of success at a trial.[47]Mr White contended before the Registrar that St George’s had an arguable case that the Davenham loan agreements were extortionate credit transactions. They accordingly had an arguable cross claim in any action to recover the principal debts. That, of course, would only amount to a partial answer, as the default interest would only reduce the debt to the sum of £750,000. The Deputy Registrar rejected this defence in the following way: “24.1 The facilities cannot be considered extortionate. These were sophisticated lenders and borrowers who, although operating through a newly incorporated company, had as one of its directors a bank manager. This was not a consumer loan. There is no suggestion that the guarantors, including Mr White, did not know or understand the commitment they were entering into on behalf of St Georges. 24.2 St Georges was an SPV incorporated for the developing of two properties. The risk to Davenham was high in advancing 90% of the purchase price of the Gowan property of £800,000. It was not unreasonable for Davenham to link that risk to a commercial interest rate it was seeking to recover from a company with no track record. The rate reflected that higher risk. 24.3 The default interest applied of an additional 1.4% compound per month is not in my view “grossly exorbitant” nor does it contravene ordinary principles of fair dealing. 24.4 The steps taken by Davenham to apply default interest were not unreasonable. St Georges were aware at the time it entered into the facility what rate would be applied in the event of default. It went into the transaction with its eyes open. It was not a question of determining at a later date the rate to meet a particular loan in the event of default – here it was fixed in advance. 24.5 The question whether the facility agreement was exorbitant has to be determined at the date it was entered into by the parties – see by parity of reasoning Goode on Consumer Credit Law & Practice (referred to in the Paragon decision at paragraph 59). 24.6 There is nothing in the facility agreement reached between the two parties which could be said to be so unfair or oppressive. 24.7 The rate charged may have been high but as it was put by Dyson LJ in Paragon at paragraph 69 an unreasonably high rate was insufficient to make it exorbitant.[48]Since the hearing before the Deputy Registrar matters have moved on, as indicated above. Given that the challenge to the appointment of the Administrators has failed, it now seems unlikely that an application under section 244 will be made. The right to make the application is theirs. Thus even if it is in theory possible that an order might be made under section 244 in respect of the default interest, it now seems unlikely that any such steps will be taken. It does not avail Mr White to establish that the Administrators could have obtained an order under section 244, if in practice that is something that they do not intend to do. If they do not take such steps then, subject to the penalty point, the debt remains payable in full.[49]Mr Gunaratna submits that the issues raised by a challenge to an extortionate credit transaction are highly fact sensitive. He also draws attention to the presumption in section 244(3). He submits that the potential section 244 application was not something which was capable of outright summary dismissal in the manner effected by the decision of the Deputy Registrar.[50]I have come to the conclusion that there is no realistic prospect of St George’s bringing a cross claim under section 244. The test for “extortionate” in a commercial transaction of this kind, where the interest rates are spelled out at the outset must is a very stringent one. I agree with the reasons the Deputy Registrar gave, save that I would not have placed emphasis on his fourth reason. Given that the higher interest rates are now being charged, I am not convinced that it matters that they have been waived up to a point. I would add that it would now appear that there is no realistic prospect of such a claim in respect of the default interest actually being made.

Common law penalty

[51]In Davenham Trust plc v Homegold Limited and others (unreported 22nd April 2009), HHJ Hegarty QC had to consider an application by Davenham for summary judgment against guarantors. Davenham lent Homegold sums under a number of facility letters, one of which allowed Davenham to increase the interest rate from 1.5% per month to a default rate 3% per month. Summary judgment was resisted by one of the guarantors on the ground that the rate was penal and unenforceable. HHJ Hegarty rejected that contention and held that the defence had no realistic prospect of success. He relied on a passage from the judgment of Colman J in Lordsvale Finance plc v Bank of Zambia [1996] QB 752:
“In my judgment, weak as the English authorities are, there is every reason in principle for adopting the course which they suggest and for confining protection of the creditor by means of designation of default interest provisions as penalties to retrospectively operating provisions. If the increased rate of interest applies only from the date of default or thereafter there is no justification for striking down as a penalty a term providing for a modest increase in the rate. I say nothing about exceptionally large increases. In such cases it may be possible to deduce that the dominant function is in terrorem the borrower. But nobody could seriously suggest that a 1 per cent. Rate increase could be such. It is in my judgment consistent only with an increase in the consideration for the loan by reason of the increased credit risk represented by a borrower in default.”
[52]Lordsvale was a summary judgment case, and the interest rate rise in question rose from:(a) (i) LIBOR plus (ii) a margin (defined as 1.5%) prior to default, to(b) (i) the cost of obtaining dollar deposits, plus (ii) the margin, plus (iii) an extra 1% after default.[53]It was in that context that Colman J was able to find that the increased rate was only consistent with compensation for increased risk and therefore not, to the summary judgment standard, a penalty.[54]In Davenham v Homegold HHJ Hegarty QC had the benefit of extensive and unchallenged evidence from a director of Davenham concerning market rates at the time of the relevant agreement, the risk factors involved and the rationale for the default rate. It was on the basis of that state of the evidence that he felt able in that case to reject the contention that the rate rise was a penalty.[55]No evidence of the kind adduced in Davenham v Homegold was before the Deputy Registrar in the present case. He dealt with the case on penalty in the following way:
“26. I am persuaded on the facts of this case that an increase in interest on default to 3% per month is not a penalty. The factual matrix between the Homegold decision and the parties here is very similar, secured loans over two properties with two directors giving personal guarantees for a small property company with an interest rate of 1.5% per month increasing to a default rate of 3% per month. Although I do not have here a detailed Witness Statement from Davenham as to the rationale behind the facilities and why the interest rates were set as they were, in my judgment those rates cannot be construed as a penalty when St George’s breached its contractual obligations. Rather more, the interest rate reflected was a reasonable commercial agreement between the parties… 27. I accept that there are shades of grey here, but a rate increase of 1.6% [should be 1.4%] is not so large as would support any claim that the dominant function was to intimidate the borrower in the event of default.”
[56]Mr Gunaratna submits that that is not a decision which the Deputy Registrar could reach by way of summary disposal on the limited material before him. He submits that the Deputy Registrar fell into the trap of looking at an apparently small percentage increase without appreciating that the resultant monthly interest rate when compounded represents a rate of between 40 and 50% a year. He submits that, in contrast to the “modest increase” in Lordsvale, the rate increase is at least arguably “exceptionally large”.[57]While it is tempting to draw on HHJ Hegarty’s judgment in Davenham v Homegold, where the interest rates and other matters were very similar, it is clear that the judge there was heavily influenced by unchallenged evidence from Davenham which was not properly before the Deputy Registrar and is not before me. Authorities are a source of legal principle, but not of evidence.[58]The evidence before the Deputy Registrar was of a different kind. Mr White’s evidence asserted that 36% was a grossly exorbitant rate of interest. He compared the £90,000 per quarter which St George’s had to pay in respect of Gowan with £9,000 per quarter which they had to pay in respect of Ringmer in respect of the Barclays loan. He also gave evidence that the risks that Davenham undertook did not justify that rate of interest given that Davenham were a secured lender who had obtained a valuation of Gowan before the sums were advanced. In addition the Gowan loan provided that Davenham could look to Ringmer for additional security. At the date of execution of the Gowan facility, there was unused equity in Ringmer of between £50,000 and £100,000. Davenham also had personal guarantees. In these circumstances he maintained that interest of 3% a month was wholly out of step with the industry.[59]The evidence in answer came from a solicitor instructed by Davenham. Her affidavit made the points accepted by the Deputy Registrar concerning the commercial nature of the transactions, the high proportion of loan to value, the fact that the terms were well known to Mr White. There is, however, a marked lack of any evidence directed to the rationale for the substantial increase in interest rate on default, as opposed to the reason for the initial interest rate.[60]In these circumstances, it appears to me that there was a genuinely triable issue that the increase in interest rate from 18 to 36% per annum, or taking into account monthly compounding, from something in excess of 20% to something in excess of 40% was a penalty.

How should the discretion be exercised?

[61]Mr Isaacs submitted that a finding that St George’s had an arguable defence to the default interest on the ground that it was an unenforceable penalty at common law, should make no difference. The sum for which St George’s would unarguably be liable would still be in excess of £750,000, and well in excess of the £750 bankruptcy limit. Davenham should still be free to proceed with their statutory demand in the full sum, and leave Mr White, or his Trustee in bankruptcy, to recover from the Administrators.[62]As I have foreshadowed above, Mr Gunaratna submitted that St Georges could rely, in any claim against them by Davenham, on the combination of an arguable defence in respect of the default interest and security in respect of the rest. He submits that as a statutory demand against St George’s could be set aside on that basis, so should the statutory demand against Mr White. The residual discretion under rule 6.5(4)(d) should be exercised so as to “in line” with the operation of rules (a) to (c) in the case of a statutory demand against St George’s. He emphasised at the outset that it was not in every case that a statutory demand could be set aside on this basis, but in the present case it would be just to do so.[63]Depite Mr Gunaratna’s highly able submissions, I am unable to accept them. In the ordinary case, the fact that a statutory demand is for an excessive sum is not a ground for setting it aside if there is a debt which exceeds the bankruptcy limit to which there is no answer. The debtor has the option in those circumstances to pay the undisputed amount, and rely on sub-paragraphs (a) or (b) to show that the balance is disputed. If he chooses not to do so, then his failure to meet the statutory demand is treated as evidence that the debtor is unable to pay, and bankruptcy proceedings may follow. It seems to me that Mr White is in precisely that position. It was open to him to pay the amount of the statutory demand which represented principal and ordinary interest and dispute the amount of the balance on the ground that it was an irrecoverable penalty. He would then have been in a comparable position to the surety in Remblance v Octagon (supra) where the debt was subject to a cross-claim which would, if good, extinguish it. He has not taken this step, but chosen instead to seek to set aside the statutory demand in full.[64]Mr Gunaratna drew attention to clause 7 of the Guarantee, which prevents Mr White from taking over any security held by Davenham over the property of St George’s until Davenham were paid in full. He maintained that it was unjust that he should be left to prove in the administration as an unsecured creditor were he to make part payment in respect of the undisputed sum. However, Mr White, by accepting to guarantee the obligations of St George’s, would not have been able to complain if he had found himself in a situation where St George’s were wholly unable to meet their obligations to Davenham. I cannot see that it is unjust that he should have a limited right to recoup in respect of the obligations of the company which he has undertaken to meet.[65]Mr Gunaratna rightly pointed out that clause 6 of the Guarantee merely provides that the Guarantee is not to be prejudiced by the existence of other security. Mr White was not using the existence of security to avoid liability under the guarantee, he was using it influence the type of proceedings which Davenham could bring to enforce it. Mr Isaacs contended that if the speedy remedy by way of bankruptcy was prevented by the existence of third party security, then the Guarantee was prejudiced by the existence of security as it was rendered less easily enforceable. I prefer Mr Isaacs’ submission. It is, I think, an odd result if the existence of security makes it more difficult for the Guarantee to be enforced.[66]A further material consideration is that the evidence showed Mr White to be a very wealthy man indeed, who had the potential to avoid bankruptcy. In his first witness statement he said that at the time of entering into the Guarantee he told Davenham that he owned properties and a shareholding in building company amounting to total assets in excess of £2 million. In his second statement he said that the equity in various properties was over £800,000; he had cash reserves of £330,000 and his 20% ownership of the building company was worth a further £2.2 million. In addition he had been advised that he could draw on the cash standing in fixed term accounts which stood at in excess of £1.5 million in Jan 2010. Accordingly Mr White could have avoided the consequences of the statutory demand by making the payment of the undisputed sum as I have indicated above. Alternatively, he is plainly in a position to secure the debt himself, and seek dismissal of the petition on that basis: see section 271(3) of the Act. Whilst ability to pay is not determinative (see Remblance v Octagon supra), it is in my judgment a further indication that the case for setting aside the demand is not a substantial one.[67]Notwithstanding the fact that, unlike the Deputy Registrar, I consider that there is an arguable defence to part of the claim, the evidence does not persuade me that this is a case where the court ought to set aside the demand under rule 6.5(4)(d). I will accordingly allow the appeal.

Cited in 2 later judgments