Friday, August 17, 2012

Prepayment fees in loan transactions


It is common practice for loan agreements to provide for a fee/ premium where a loan is repaid earlier than its contractual due date. The said fee is designed to compensate the lender/s for the loss of anticipated income from the transaction and is usually expressed as a percentage of the principal amount prepaid. While the loan agreement sets out the circumstances in which the prepayment fee will be payable, usually it is in cases of voluntary prepayment by the borrower and does not include situations where the prepayment is compulsory/ mandatory, e.g. acceleration of the loan due to occurrence of an event of default etc.
While this should normally be easily decipherable from the loan agreement itself, a recent decision of the English High Court (QBD/ Commercial Court) in the matter of Aston Hill Financial Inc v African Minerals Finance Ltd, [2012] EWHC 2173 (Comm.) demonstrates that  a potential area of difficulty may arise where the loan agreement is not clear on this matter.
Brief Facts
A facility agreement was executed on February 4, 2011 for a loan of upto US$ 500,000,000 for the development of Phase I of Tonkolili iron ore project in Sierra Leone. On February 11, 2011, the lenders disbursed US$ 417,700,000 to the borrower, African Minerals. On January 31, 2012, it was announced that Standard Bank Group had agreed to refinance the original loan. A syndicated facility led by Standard Bank was signed on February 3, 2012. 
The borrower noted that pursuant to Clause 8.3 of the loan agreement, it was obliged to prepay the loans with any finance proceeds promptly after receipt of such funds and asked for detail as to (among other things) the amount required to prepay the Facility in full on a daily basis from February 7, 2012 to February 9, 2012 inclusive. The facility agent replied by a letter of the same date, stating that the outstanding loan amount of $417,000,000 and details of the accrued interest but making clear that 'any other amounts that may be due under the Finance Documents are not included in this notice'.
On the same day, the lenders' solicitors responded to the borrower, notifying it that if the prepayment was made before February 10, 2012 (the first anniversary of the Closing Date), the borrower was required to pay the prepayment fee referenced in Clause 8.8(d). The letter went on to state that Clauses 8.3 and 8.5 of the Facility were not mutually exclusive and that, as the borrower was aware, prepayment fees were included to compensate the lenders for early repayment of the loan. The letter (i) noted that in this case, the lenders negotiated and agreed the prepayment fee with the defendant in order to ensure that they would be properly compensated for their costs of funds and risks incurred by virtue of entering into the Facility; (ii) stated that the defendant was seeking to obtain more favourable terms by refinancing the loans; and (iii) stated that the failure of the defendant to pay the prepayment fee in the event the Facility was prepaid on or before the first anniversary of the Closing Date would constitute a breach of a contract.
On February 8, 2012 the borrower prepaid the full amount outstanding under the Facility of US$417,700,000. Such prepayment included a prepayment of US$291,100,000 to the claimants in respect of the full principal amounts outstanding in respect of their loans to the defendant under the Facility.
Relevant provisions
It is pertinent at this time to cast a quick glance at the relevant provisions of the Aston Hill loan agreement:
(a) Clause 8.3(a) (Disposal Proceeds and Finance Proceeds) stated that "The Borrower shall prepay, and the Parent shall ensure that the Borrower prepays, the Loans in an amount equal to the amount of Disposal Proceeds or Finance Proceeds promptly upon receipt of any Disposal Proceeds or Finance Proceeds by any member of the Group."
(b) Clause 8.5 (Voluntary Prepayment of the Loan) stated that "The Borrower, if it gives the Facility Agent not less than five Business Days' (or such shorter period as the Majority Lenders may agree) prior notice, may prepay the whole or any part of the Loan (but, if in part, being an amount that reduces the Loan by a minimum amount of $100,000,000)."
(c) Clause 8.8(c) stated that "On prepayment of all or any part of the Loans pursuant to Clauses 8.5 (Voluntary prepayment of the Loan), the Borrower shall pay to the Facility Agent (for the account of each Lender) a prepayment fee on the date of such prepayment, in the following amount: (i) 6 per cent. of the amount prepaid or repaid if the prepayment is made on or before the first anniversary of the Closing Date; and (ii) thereafter, no prepayment fee will be payable."
Court's decision
The court found that the principles of construction are well established and were not in dispute. Both the lenders/ claimants and the borrower/ defendant sought to rely upon the passage in Rainy Sky SA v. Kookmin Bank [2011] 1 WLR 2900; [2011] UKSC 50 at [21] to [30]. Thus, it was common ground that it is necessary when construing a commercial contract to strive to attribute to it a meaning which accords with business common sense and to have an eye on the commercial consequences of a particular construction; and that: "(i)f there are two possible constructions, the court is entitled to prefer the construction which is consistent with business common sense and to reject the other".
The court however found it difficult to come to a decision as regards whether the prepayment was mandatory/ voluntary, as the wording of the agreement was unclear and ambiguous. The two prepayment clauses were difficult to reconcile. While the decision to refinance the original loan was a voluntary decision on the part of the borrower, especially since the Standard Bank facility was more competitively priced, the prepayment could not have happened in the absence of refinancing arrangements contracted to by the borrower. It is therefore attractive to categorize the prepayment as voluntary, with the result that the lender would be entitled to the prepayment fee. On the other hand, Clause 8.3 envisages that if the borrower issues new equity or incurs new debt, prepayment becomes mandatory to the extent of the proceeds received by the borrower.
The court ultimately accepted the latter interpretation and held that the prepayment made was mandatory under Clause 8.3 and hence, no prepayment fee was due. The case highlights the need for clarity around prepayment provisions in loan agreements. From a lender's perspective, this decision is an unattractive precedent as it is more than probable that a borrower interested in prepaying an existing loan would seek to do so from a capital infusion or a new loan (both, in this case, being grounds for mandatory prepayment and hence, not liable to a prepayment fee).

6 comments:

vswami said...

<> The discussion is seen to have, unwittingly or otherwise, omitted to bring to the fore a more fundamental point of difficulty: That is, whether, at all,regardless of the contract agreement in terms specifically providing or not, or the terms and conditions being clear or not, charging a fee for prepayment of a borrowing is even otherwise truly justified.

It may not be out of context to note that, the RBI, as the concerned regulatory authority, overseeing the banking sector in India has been heard to have, considering it prudent rather logical to do so, lately come out with a directive that there should be no such charge by any bank, being its constituents, for a loan prepayment; subject to satisfying certain conditions.

Mention also requires to be made of not an unrelated matter. That concerns the banking practice known to be in vogue in respect of premature withdrawal of a Term Deposit (be it short or long term), The reference is to the banks,claiming to be a matter of policy, routinely making an additional deduction, by way of 'pre-closure charge; which is over and above withdrawing excess interest for the unexpired period, The RBI , despite a strong protest aired in some limited quarters, has thus far remained mute, by failing to look into the genuine grievance of the term deposit holders and come out with a suitable directive to the banks. Incidentally,according to one's information, such pre-closure charge has been permitted; also allowed to be continued, even in cases where, as on the date of opening of such deposits, there had been no term or condition on paper providing for any such extra (ab extra ?) charge. To be precise, the poser is, - is it not highly unethical, verging on a fraud perpetrated with no qualms on the gullible deposit holders? In one's conviction, it is indisputably tantamount to permitting bank (s) to make a newly introduced term or condition on a particular date, - which going by, besides common sense, the basic principle of contract law itself, -cannot but apply/ be made applicable to only Deposits placed and accepted after that date; certainly not before.

All said but everyone concerned (not only the RBI and its Ombudsman, but also the other regulatory authorities) still left clueless or unconcerned, the posers raised off and on, and being loudly trumpeted all around, but left unanswered, with no solution in sight, are,: WHITHER transparency or accountability', 'checks and balances', and more importantly 'good governance'??....

Satyajit Gupta said...

Vswami - Thank you for your valuable comments. The rationale behind a bank charging a fee for prepayment of moneys borrowed (albeit only from the perspective of a lender) has been set out in the first paragraph itself - "The said fee is designed to compensate the lender/s for the loss of anticipated income from the transaction..." Whether such payments are truly justified in all senses of the word remains open to debate and was not intended to be covered by this blogpost (and was not unwittingly or otherwise missed). Separately, RBI's decision to prohibit charging of pre-payment fees is limited to certain categories of loans applicable to individuals and not corporate borrowings. The intent therein is undoubtedly one of social welfare.

vswami said...

SGupta
Of course, I am fully aware of the 2 points sought to be made by you.

In an attempt at self-vindication, let me assure you that, all my such feedback comments are purely intended to,sincerely aimed at,- as has always been my wont in pursuit of my long driven passion for interaction in such matters,-to provoke more thoughts,especially out-of-box and multidimensional ones, on the part of everyone really concerned ; especially from a larger societal welfare / public interest point of view.

My explanations should, hopefully, set at rest misapprehension or misconception, if any, that my comments may have unwittingly given rise to.Anyway, thanks for the trouble taken in keying in a rejoinder.
In fact, the very same viewpoints I happen to have stressed even before, in some of the related Blogs @vswaminathan-swamilook.blogspot.com.

vswami said...

@vswami
In the previous comment (August 18), a reference has been made to a more fundamental point of difficulty; that is, whether, at all, ,regardless of what any contract agreement in terms provides, either specifically or otherwise, or fails to so do, a fee for prepayment of a borrowing is even otherwise truly justified.
To briefly clarify:
According to a school of thought, based on conventional thinking even in legal circles (among lawyers, CAs, so on), for examining and advising or deciding, or adjudicating, on the merits or demerits of any dispute between parties to a contract agreement, its recitals and the terms and conditions, either express or necessarily implied, should be regarded the most essential criteria of all. For that matter, such a new school of thought has come t have a role to play even in tax cases, in which the government, despite being a third party to any contract agreement of a commercial nature, nonetheless has come to ‘look at’ or through’ it so as to serve its own purpose; giving rise to a fresh spate of controversy and battle of wits.
However, in recent times, there have been one or more instances, which has driven / forced one to believe that a new school of thought has growingly set in; though not, by and large, consciously made a serious note of:
To readily recall a few such instances:
1. Realty sector: Order of the CCI in re. DLF. In that case, on the basis of its findings to the effect that the terms and conditions in the contract agreement drafted and used for effecting transactions of sale of apartments were one –sided, the seller was directed to redraft it. Of course, DLF has taken up the matter further and is, so far as known, pending in appeal.
For a narration, refer, besides others, the Blog @ http://vswaminathan-vswaminathan-swamilook.blogspot.in/2011/08/cci-slaps-penalty-notice-on-nse-times.html
2. Law of Arbitration (consumer rights):
Judgments of Apex Court in the cases of , -Union of India Vs Krafters Engineering; and Government of Orissa Vs G.C.Roy
The power of an arbitrator to award interest pendent lite was questioned. Court held, the function of award of interest is to compensate a party for deprivation of money to which the claimant was entitled during the pendency of the litigation. And where agreement between parties does not provided for but not prohibit grant of interest.
(Also, refer comment on a related ICL blog)
3. Tax case: The most memorable but controversial of all, being the one in re: Vodafone; the dispute turning on- what should prevail; is it the Form or Substance, (of a transaction, though evidenced by contract agreement (s)).
Pithily stating: One would strongly urge, not without merit that in cases where the deciding criterion should primarily have regard to the aspects of social welfare or public interest, the written contract should be permitted to be written down.
Incidentally, not entirely without context, one remembers tax cases in which courts have chosen to follow the doctrine of ‘writing -down’ even a provision of law, on equitable OR other like grounds, if so warranted by applying principles of natural justice.
The foregoing reflect merely one’s own individual thoughts; but intended that it is for experts to study and devote more useful / insightful thoughts, to the end of coming to a profoundly incisively satisfactory conclusion.

vswami said...

@vswami
By way of reiterating and reinforcing the previous comments:
>This refers to a related story published in the Businessline, Issue of 9th Sept., titled- "Bank pulled up for ‘deficient documentation"

TO NARRATE THE FACTS:
A home loan was given under an agreement dated 30 august 2005. As per the festival offer it was a concessional fixed roi of 7.50 per cent. Date of the loan agreement was August 30, 2005. Later on, however, in November 2011, claiming that as per its internal guidelines, roi on home loans was to be reset every three years, raised an additional demand. The complaint of the borrower has been favourably decided by the concerned Ombudsman. The ground of the decision is that there were no enabling clauses in the agreement to reset the interest periodically.
In defence the bank’s plea was despite there being an internal circular on August 16, 2005, the branch did not incorporate it in the loan documents by oversight. The additional demand was raised after the said omission was pointed out by its internal audit in November 2011.
The Ombudsman, as is reported, rejecting the defence, in one’s firm view rightly so, held that the bank’s action of revising the rate without prior notice to the borrower was arbitrary and contractually not binding.”

So far so fair and good. But what really calls for a comment is the foot Note:

Q
Disclaimer: The Reserve Bank of India does not vouch for the correctness, propriety or legality of orders passed by Banking Ombudsman. The object of placing this in the public domain is merely to disseminate information on the working of the Banking Ombudsman Scheme.)
UQ

<> The contents / purport of the said "Disclaimer", in one's perception, based on logical thinking, cannot be accepted to be sound or legally valid. For the officer designated as Ombudsman is, admittedly, a creature / an appointee of the RBI. As a regulatory authority, RBI has control and responsibility for the proper functioning/ conduct of its constituents, so called good governance. On both grounds, to claim that it has no obligation, be it by way of responsibility, answerability or accountability for any irregular practice by banks has no leg to stand on. Same way, in case of a dispute, there can be no valid denial or disclaimer by RBI that it has the authority, hence the ultimate responsibility to the customers- be he a borrower or deposit holder,- for any wrong decision of an Ombudsman . For, any such denial or disclaimer prima facie offends its own code of ethics/conduct laid down for banks to diligently follow; also betrays its abject ignorance , real or feigned, of its own powers or authority to supervise , audit, and oversee on a regular basis, the practices , many times wrong practices, indulged in by banks, in such matters, gravely to the detriment/discontent of the serviced public at large; prejudicial to public interest in its profound sense.
In Short , justly, it is not to be bypassed or lightly taken to be a simple instance of 'deficient documentation' as described; but truly speaking, is a case of an 'offence' criminal in nature; being of a breach of contracted terms, perpetrated and committed, without transparency / devoid of knowledge of the customers, so much so verges on a 'fraud' in its strict legal sense.

By and large,it has become almost a routine, more a modern day fashion, to,on any matter / point of law or otherwise, having stated what is one's individual opinion or view, with the same breath, qualify it by inserting a 'disclaimer'. Such a disclaimer happens to be found even in professional journals and like publications. It is strongly felt that, such a deplorably objectionable practice, which, in any case, in the eyes of law is seemingly quite wrong and hence indefensible. Besides,goes to betray the lack of courage of self conviction.

vswami said...

Attention is invited to a related story since reported by Businessline @(Link)-"Bank pulled up for ‘deficient documentation".

This is seen to amply / more than adequately support the proposition canvassed in the previous post- see penultimate paragraph.