Banking law

Variable interest clausesParagon Finance plc v Nash [2001] EWCA Civ 1466, TLR 25 October 2001 The claimant and defendant were mortgagee and mortgagor.

The defendant fell into arrears and the claimant sought possession.

The mortgage deed contained a variable interest clause.

This clause was central to the two main arguments raised by the defendant before the Court of Appeal in defence of the possession proceedings.

The first line of argument was that the claimant did not have an absolute discretion to vary the interest rate.

The defendant contended that the exercise of the discretion to vary the interest rate was subject to an implied term that the discretion should not be exercised dishonestly, capriciously, arbitrarily, for an improper purpose or in a manner which was so unreasonable that no reasonable lender would have acted in that way.

The Court of Appeal agreed with the defendant.

Thereafter, the defendant alleged that the claimant was in breach of the implied term because the rates that were charged were made without reference to the prevailing market rates.

The evidence showed that the claimant was in serious financial difficulty and the money markets charged it higher rates because it was perceived to be a greater risk than other mortgage lenders.

Those higher costs were passed on to the borrowers.

In those circumstances it was impossible to say that the claimant had exercised its discretion to set the interest rate in an improper manner.

Therefore, the court found the claimant had not acted in breach of the implied term.The second line of argument raised by the defendant was that because of the rates of interest that were subsequently charged, the agreement amounted to an exorbitant credit bargain that ought to be reopened under section 139 of the Consumer Credit Act 1974.

The Court of Appeal had little difficulty in rejecting this argument on the basis that subsequent changes in interest rates were irrelevant to whether the credit bargains were extortionate.

This case is significant, as it sets the parameters within which a mortgagee is entitled to exercise its discretion to vary interest rates in accordance with a variable interest rate clause.

Although the case was concerned with rates of interest chargeable under a mortgage, there is no reason why an identical fetter on the exercise of the discretion to vary an interest rate should not be transposed to other agreements such as, for example, unsecured loans.

The true ambit and extent of the fetter on the discretion to vary interest rates in accordance with a variable interest clause remains to be settled in future litigation.However, it is improbable that the fetter will be an obstacle to lenders relying on ordinary commercial factors when exercising the discretion to vary an interest rate.Simple rate agreementsDirector-General of Fair Trading v First National Bank plc [2001] UKHL 52, TLR 1 November 2001 The defendant bank included in its common form loan documentation for regulated credit agreements a term that interest would be chargeable on the borrower's outstanding balance 'until payment after as well as before any judgment (such obligation to be independent of and not to merge with the judgment)'.

The effect of this term is that interest was payable at the contractual rate on the outstanding principal and accrued interest at the date of judgment until the judgment was discharged by payment.

This type of agreement is known as a simple rate agreement.The director-general argued that the terms of the simple rate agreement were unfair and contrary to regulation 4 of the Unfair Terms in Consumer Contracts Regulations 1994.

The director-general argued that the relevant term operated unfairly in the particular circumstances where judgment is obtained against a borrower under a regulated agreement, an order is made to pay by instalments but no order is made by the court under section 136 of the Consumer Credit Act 1974.

Section 136 enables a court to include in its order any such provision that it considers just for amending any agreement in consequence of a term of the order.

The combination of these circumstances would mean that as a consequence of the simple rate agreement, interest would accrue despite the fact that a debtor paid off arrears in instalments under a court order.The House of Lords held that the terms of the simple rate agreement were not unfair within the meaning of regulation 4.

Lord Bingham even went so far as to state that the absence of such a term would imbalance the contract to the detriment of the lender.

Lord Bingham thought that it was understandable that a borrower might be surprised if he found out that his contractual interest obligation continued to run despite the payment of instalments ordered by the courts.

However, this was not caused by the unfairness of the relevant term but the absence of sufficient procedural statutory safeguards for the borrower at the date of default.As a consequence of this judgment banks and other creditors under regulated agreements will be relieved to find that there will be no restriction on seeking and obtaining contractual interest after judgment in the county courts.

Those advising debtors should clearly ensure that at the time that an order is made against their client an application is made under section 136 of the Consumer Credit Act to seek to amend the terms of a simple rate agreement.

Whether this application will be successful is another matter and perhaps another source of litigation, especially in light of the fact that their Lordships thought a simple rate agreement was not only fair but also vital to ensure an absence of detriment to a lender.Finally, readers will no doubt be aware that the House of Lords have delivered their opinions in Royal Bank of Scotland v Etridge (No.2) [2001] UKHL 44.

This case has been reported in [2001] Gazette, 18 October, 3 and subsequently in [2001] Gazette, 22 November, 24.

By Simon Sugar, barrister, 36 Bedford Row, London