FAIRNESS OF ‘EXCESSIVE’ INTEREST

In a recent appeal before the Supreme Court, the court was called to rule on the enforceability of agreements forming part of a single transaction.

A obtained a loan from B. B finances SMEs where banks are not willing to undertake the risk. B’s business model is to secure a higher rate of return for its investment. The transaction forming the basis for the loan involved two agreements, namely a loan agreement and a royalty agreement. The obligations of A in terms of the transaction was secured by suretyships signed by various sureties.

The loan agreement provided for payment of interest on the loan amount by A. The royalty agreement required A to pay a royalty to B, which was calculated with reference to the future market value of a property owned by A.

When B sued A under the transaction, the question arose as to whether the payment of the royalty, in addition to the payment of interest, was excessive and therefore against public policy (i.e. was the transaction as a whole an unfair agreement). A argued that it was unfair as the royalty was nothing other than a further obligation to pay interest (i.e. the royalty was disguised as interest).

The SCA found that –

  1. A understood the nature and extent of the obligation it undertook when concluding the transaction and in so doing concluded the transaction freely;
  2. The fact that the transaction was a bad bargain for A did not make it an illegal one;
  3. A was bound by the transaction, including the obligation to pay the royalty.

Care should therefore be taken to understand the commercial consequences of obligations that are undertaken, as they will in most instances be enforced once agreed to.