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Case No: QBCMI 98/1027/3
IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM QUEEN'S BENCH DIVISION
COMMERCIAL COURT
(Colman J)
Royal Courts of Justice
Strand, London, WC2A 2LL
Tuesday, 25th January 2000
B e f o r e :
LORD JUSTICE BROOKE
and
LORD JUSTICE SEDLEY
- - - - - - - - - - - - - - - - - - - - -
|
TERENCE
JOHN KITCHEN &
PATRICIA ELSIE KITCHEN
|
Appellants/
Claimants
|
|
-
and -
|
|
|
HSBC
BANK plc
|
Respondent/
Defendant
|
(Transcript of the Handed Down Judgment of
Smith Bernal Reporting Limited, 180 Fleet Street
London EC4A 2HD
Tel No: 0171 421 4040, Fax No: 0171 831 8838
Official Shorthand Writers to the Court)
- - - - - - - - - - - - - - - - - - - - -
Andrew W Baker (appeared pro bono for the
Appellants/Claimants)
Rhodri Davies QC (instructed by Clifford Chance for the
Respondent/Defendant)
- - - - - - - - - - - - - - - - - - - - -
Judgment
As Approved by the Court
Crown Copyright ©
Tuesday, 25 January 2000
JUDGMENT
LORD JUSTICE BROOKE:
This is an appeal by the claimants, Mr and Mrs Kitchen, from an order made by
Colman J in the Commercial Court on 27th March 1998 when he allowed the
defendant bank's appeal against an order of Master Ungley dated 28th January
1998. The judge's order had the principal substantive effect of dismissing the
claimant's claim and granting the bank summary judgment on its counterclaim.
The claimants' contention in these proceedings was that the bank had
consistently overcharged them with interest in a manner not permitted by their
loan agreement with the bank, and that as a consequence they had lost about
£600,000. This sum included the losses they had sustained through not
being able to execute an order which would have saved the business of their
company, which ceased trading in March 1992. The bank counter-claimed sums due
under the loan agreement, as to the detail of which there was no dispute if it
was found that the bank's method of computing interest was indeed permitted by
the agreement. The bank made demand for payment on 14th April 1993.
The dispute between the parties is centred round the true construction of
Clause 5 of a 14-year term loan agreement made between the bank and the
Kitchens on 18th October 1988. Mr and Mrs Kitchen were substantial
shareholders, and a director and the company secretary respectively, of a
company called Sondes Place Engineers Limited which carried on an engineering
business until it ceased to trade. Mr Kitchen had banked with the bank's West
Smithfield branch for 38 years, although it is said in the claimants' skeleton
argument before this court that the loan with which these proceedings are
concerned was not in fact made through that branch.
The purpose of the loan was to refinance the company's existing borrowing
facilities on a long term basis. Interest was to be charged at an interest
rate of 2½% per annum above the bank's base rate from time to time, and
the loan was to repaid by monthly instalments of £413.41, which were, it
is agreed, inclusive of interest. Clause 9 of the agreement gave the bank
power, upon written notice to the Kitchens, to change the amount of the
remaining repayment instalments from time to time if the loan was not fully
drawn down or if there was any change in the interest rate.
Clause 8 provided that:
"On the last day of every Repayment Interval until the Loan is fully repaid
[Mr and Mrs Kitchen] shall pay the Bank a Repayment Instalment which shall be
debited on the due date to a current account of [Mr and Mrs Kitchen] with the
Bank unless the Bank otherwise determines."
Clause 2 contained definitions whereby the Repayment Interval was expressed to
be one month and the Repayment Instalment (subject of course to Clause 9)
£413.41 inclusive of interest.
Clauses 5 and 6 of the agreement carry the marginal note "Interest". They
read:
"5. Interest shall accrue daily and be debited and
compounded in accordance with the Bank's current practice from
time to time. Except during a Fixed Rate period, the Borrower shall pay the
Bank interest on the outstanding amount of the Loan for the time being at the
Interest Rate. (Emphasis added)
6. Accrued interest shall be debited on the due dates to a current account of
the Borrower if the Repayment Instalments are exclusive of interest; if they
are not, accrued interest shall only be so debited during and on the last day
of the Non-repayment Period, if any."
Clause 2 provided that "the Interest Rate" meant "2½% above the Bank's
current published Base Rate from time to time". The "Non-repayment Period", if
applicable, is explained in Clause 8 of the agreement. Its purpose was to give
borrowers a period of grace before repayments of principal become due. In the
case of the Kitchens' agreement the Repayment Period was expressed to be "not
applicable", so that the first "Repayment Instalment" was payable on the last
day of the first month after the "First Drawing Date" (a phrase explained in
Clause 8).
If a borrower wished to have a "fixed rate option", with the effect that
interest would be charged at a fixed rate for such a period of whole years as
he/she might select and the bank might agree, Clause 7 of the agreement
provided what was to happen in that event. In the event Mr and Mrs Kitchen
preferred not to avail themselves of that option.
The resolution of the issues before the judge turned to a considerable extent
on the meaning to be ascribed to the words I have underlined in Clause 5.
These appeared to provide that:
(i) Interest was to accrue daily;
(ii) Interest was to be debited in accordance with the bank's current practice
from time to time;
(iii) Interest was to be compounded in accordance with the bank's current
practice from time to time.
Evidence was given about the bank's current practice, which remained unchanged
throughout the period with which this action was concerned, by Mr John Rogers,
who was branch manager of the bank's West Smithfield branch and concerned with
the Kitchens' accounts at that branch between 1990 and 1996. He said:
"The Bank's current practice in relation to interest at the time the loan was
taken out, as I can say from my own knowledge, was to calculate interest
quarterly for the quarters ending on the first Friday in March, June, September
and December and to debit the interest calculated in this was two weeks after
each of those dates. The bank's method of calculating interest was to arrive
at a daily rate by dividing the rate per annum by 365 and then to apply that
daily rate to the balance outstanding on each day, without compounding
or capitalising the interest except by the quarterly debits. The
practice as just stated has not altered since the loan was taken out."
The bank statements which appear in the papers before the court show that the
bank did in fact follow this practice in the way it administered the loan.
What happened is described by Mr Rogers in schedule form in these terms:
"Practice
Interest is calculated for each quarter year on the first Friday in March,
June, September and December. Accrued interest is debited to the loan account
two weeks after each of those dates.
Subject of calculation
Loan of £30,000 made on 20.10.88 to Mr and Mrs Kitchen with monthly
repayments of £413.41 due on the 20th of each subsequent month.
Applicable interest rates
Annual interest rate from 20.10.88 - 24.11.88 14.5% (12% + 2.5%)
Annual interest rate from 25.11.88 15.5% (13% + 2.5%)
Calculations
1. Interest calculation for period up to 20.11.88:
Interest due = £30,000 x 0.039726% (daily rate) x 32 (days) =
£381.37
Interest not added to account.
2. Payment of £413.41 made on 21.11.88.
3. Interest calculation for period 21.11.88 to 24.11.88:
Interest due = £29,586.59 x 0.039726% (daily rate) x 4 (days) =
£47.01
Interest not added to account.
4. Interest rate changes on 25.11.88.
5. Interest calculation for period 25.11.88 to 2.12.88 (first Friday):
Interest due = £29,586.59 x 0.0424657% (daily rate) x 8 (days) =
£100.51
Interest not added to account.
6. Interest due to 2.12.88 calculated on that date but added to account two
weeks later, ie on 16.12.88.
Total interest for period = £528.89
7. Interest calculation for period 3.12.88 to 15.12.88:
Interest due = £29,586.59 x 0.0424657 (daily rate) x 13 (days) =
£163.33
Interest not added to account.
8. Interest debited to account on 16.12.88.
Balance on account on 16.12.88 = £30,000 - £413.41 (first payment) +
£528.89 (interest) = £30,115.49.
9. Interest calculation for period 16.12.88 - 19.12.88:
Interest due = £30,115.49 x 0.0424657 (daily rate) x 4 (days) =
£51.16
Interest not added to account.
10. Payment of £413.41 made on 20.12.88.
11. Interest calculation for period 20.12.88 - 19.1.89 -
Interest due = £29,702.08 x 0.0424657 (daily rate) x 31 (days) =
£391
Interest not added to account.
12. Payment of £413.41 made on 20.1.89.
13. Interest calculation for period 20.1.89 to 19.2.89:
Interest due = £29,288.67 x 0.0424657 (daily rate) x 31 (days) =
£385.57
Interest not added to account.
14. Payment of £413.41 made on 20.2.89.
15. Interest calculation for period 20.2.89 to 3.3.89:
Interest due = £28,875.26 x 0.0424657 (daily rate) x 12 (days) =
£147.15
Interest not added.
16. Interest calculated for quarter on 3.3.89 (first Friday) =
£1,138.21
17. Interest debited to account two weeks later, ie on 17.3.89."
Two observations can be made about this schedule. The first is that it shows
how interest, which is expressed to be charged at an annual rate (which may be
varied during the year if the bank's base rate changes), accrues daily. The
bank charges interest at a daily rate which is one three hundred and
sixty-fifth part of its annual rate for the time being. Although interest
accrues daily, it is not debited to the account except when the bank's current
practice, or the express terms of the agreement, provides for it to be debited
or otherwise to become payable.
Clause 12 of the agreement, which is concerned with a prepayment right given
to the borrower, and Clause 15, which is concerned with termination, show how
on occasion the agreement creates an immediate liability to pay accrued
interest. Under the former, the borrower may opt, on five days' notice, to
prepay either the outstanding amount of the loan, or not less than one fifth of
the principal sum, together with "all interest accrued on a daily basis to the
date of prepayment", calculated on the principal amount prepaid. Under the
latter, if a termination event occurs the bank may make a written demand
whereupon "all monies for the time being outstanding in respect of the loan
(whether by way of principal, interest ... or otherwise) shall become
immediately due and payable".
If such a demand is made, then under Clause 16:
"... interest at the Interest Rate shall accrue daily (as well after as after
judgment) from such demand until actual payment on the amount of any monies so
demanded and shall be capitalised on the Bank's usual interest charging dates
for the time being."
This provision is, in my judgment, illuminating, because it shows the concept
of "the Bank's usual charging date" (on its case the third Friday in March,
June, September and December) being expressly acknowledged in the agreement.
The second observation I would make is that the bank's schedule shows how
interest is calculated in respect of the Kitchens' account on the first Friday
in December and March. On that occasion it is a mere matter of accounting, but
it presages the fact that the interest thus computed will be capitalised and
added to the Kitchens' overall liability a fortnight later, so that interest at
the contractual rate may be charged thereafter on the new total liability.
Although the amounts of the monthly repayments will remain constant (unless
changed pursuant to Clause 9), the "outstanding amount of the Loan" (see Clause
5 and 12) will alter once interest has been debited on this quarterly basis.
This, on the bank's case, is the effect of Clause 5:
"Interest shall accrue daily and be debited and compounded in accordance with
the Bank's current practice from time to time ... [T]he Borrower shall pay the
Bank interest on the outstanding amount of the Loan for the time being at the
Interest Rate."
The legal basis of a banker's entitlement to charge his customer compound
interest with regular rests (whether annual, half-yearly or, in accordance with
modern banking practice, quarterly) was put beyond doubt by the House of Lords
in National Bank of Greece v Pinios Shipping Co No 1 [1990] AC 631. In
the leading speech Lord Goff showed how frequently the older cases on this
topic made reference to "the ordinary practice", "the usual practice" or, quite
simply, "the practice of bankers". In Paton v IRC [1938] AC 341 Lord
Macmillan referred to the usage [of adding interest to capital with half-yearly
rests] as prevailing as "between bankers and customers who borrow from them and
do not pay the interest as it accrues".
Mr Rhodri Davies QC, who appeared for the bank, showed us some passages in the
11th Edition of Paget's Law of Banking which, he maintained, supported
his contention that there is nothing out of the ordinary about the way his
clients administered the Kitchens' loan. On pp 181-2 appears the passage:
"An express contract for the payment of interest will normally specify the
rate, and it may further specify the method of computing interest and whether
interest is to be compounded.
There are three generally recognised bases of computing annual interest:
1.365/365. Under this method the rate of interest is divided by 365 to produce
a daily interest factor. The number of days that the loan is outstanding is
then multiplied by this factor. Under this method different amounts of
interest are charged for months of different lengths.
.....
The computing of interest must be distinguished form
compounding, which is the capitalisation of interest, so that interest
itself yields interest."
We were also shown the standard condition contained in a specimen letter
granting a medium term loan facility in the Encyclopaedia of Forms and
Precedents, 5th Edition (1986), Vol 4 (Banking Documents):
"3.3 All interest payable pursuant to this Letter shall accrue from day to day
and shall be calculated on the basis of a year of 365 days and shall be paid
... on the date falling at [three-monthly] intervals after the date of this
Letter ..."
This, then, was the bank's case about the meaning and effect of this
agreement. It adopted the approach which would be expected by anyone familiar
with English banking law and practice at the relevant time. The "small print"
had to be completed with reference to the bank's current practice, but there
was nothing in the least unusual about this practice, which merely spelt out
the dates on which interest was to be (a) computed and (b) debited to the
borrowers' account for the purposes of capitalisation. As I have pointed out,
"the bank's usual interest charging dates" are expressly mentioned in Clause 16
of the agreement.
For the sake of completeness, I should add that this term loan agreement is
not a mortgage agreement, as to which different rules will apply so far as
interest is concerned (see Paget, op cit, p 182, citing Daniell v
Sinclair (1881) 6 App Cas 181). The Security Schedule attached to the
agreement referred to a second legal charge on the Kitchens' home, and this was
of course a separate agreement with whose interpretation we are not
concerned.
It is well known that there has been considerable pressure in consumer circles
over the last 30 years to make the interest-charging practices of financial
institutions more transparent to their customers. The Kitchens' contentions
are founded on this desirable philosophy. Their case, put simply, is set out
in these terms:
"... Compound interest, accruing daily, was to be levied at 2½% per annum
above the Defendant's base rate. Ignoring the monthly Repayment Instalments
and assuming a constant base rate, at the end of each day the outstanding loan
balance from the previous day would increase by an amount of interest in such a
way that after a year the loan balance would have increased by (base rate +
2½)%. The daily amount of such interest would be ascertained by applying
a standard compound interest formula familiar to any banker.
In fact, of course, on the first day after payment of each Repayment
Instalment, the previous day's closing balance carried forward would be reduced
by the amount of the Instalment and upon any change in base rate, the annual
interest rate element in the daily interest formula would alter, but again
nothing unfamiliar to any banker."
This case is expressed in an algebraic formula whereby the outstanding amount
of the loan (principal + previously accrued interest) at close of each day is P
x 365v1 + (R ÷ 100), where P is the outstanding amount of the loan
(defined in the same terms) at the close of the previous day, and the defined
Interest Rate is R% per annum.
The Kitchens say that Clause 5 of the loan agreement must be interpreted as if
it read "Interest shall accrue daily and be debited and compounded [that being]
in accordance with the Bank's current practice from time to time"
They complain that on the bank's interpretation of the loan agreement, the
borrower's cost of borrowing is not disclosed in the agreement and is subject
to variation at the bank's whim. The agreement does not oblige the bank to
disclose its practice as to interest rates, or to notify the borrower if it
decides to change its practice. They argue that in these circumstances it
cannot really be an acceptable, sensible interpretation of a term loan
agreement if the borrower is obliged to ask every day whether the bank's
practices have changed if he is to be sure that he knows what his cost of
borrowing is.
These, of course, are the arguments that have led to changes in consumer
credit law and practice. This agreement, however, was not subject to the
Consumer Credit Act 1974 (which did not apply to loans in excess of
£15,000) and although the Director-General of Fair Trading, who became
involved in this dispute in 1993 at the behest of the Kitchens' MP, was
critical of the reference in the agreement to "the Bank's current practice from
time to time", he accepted that as a matter of law the point at issue between
the Kitchens and the bank turned on the interpretation of the contractual terms
of the agreement they had made.
Under the Kitchens' interpretation, therefore, interest will accrue daily,
will be debited daily, and will be capitalised daily.
There are, in my judgment, a number of serious difficulties about accepting
this argument when this agreement is read as a whole.
The first of these difficulties is that their case is based on a supposed
practice, familiar to bankers, of applying a compound interest formula to
calculate and charge compound interest in the manner for which they contend.
The existence of this practice is not supported by any of the discussion about
bankers' practices in the last 200 years which was brought together in Lord
Goff's speech in Pinios. Bankers charged simple interest, with interest
capitalised at intervals. They did not apply a standard compound interest
formula of the type suggested by the Kitchens. In the passage from Paget's
Law of Banking from which I have quoted, none of the three suggested
methods of charging interest bears any resemblance to the method suggested by
the Kitchens.
A second difficulty is that the Kitchens' preferred method of interpreting
Clause 5 deprives the words "in accordance with the Bank's current practice
from time to time" of any content, unless they are supposed to refer to the use
of the suggested standard compound interest formula, notwithstanding the fact
that there is no evidence that in 1988 banks adopted that practice when
charging interest to their customers under an agreement like this. Their
interpretation also involves the introduction of the words "that being", even
though the natural and ordinary meaning of the words as they stand is that
interest is to be both debited and compounded in accordance with the bank's
current practice.
A third, linked, difficulty is that the agreement distinguishes between the
accrual of interest, which is to occur daily, and the debiting and compounding
of interest, which is to take place in accordance with the bank's current
practice. According to the Kitchens' interpretation, interest is not only to
accrue daily, it is also to be debited and compounded daily. This is not what
the agreement provides.
Fourthly, the Kitchens' interpretation does not explain why in Clauses 12 and
15 special provision has to be made for the immediate payment of accrued
interest (in the event of early prepayment or a termination event) because
according to them, interest accrues and becomes payable every day, so that
there is no delay between accrual and liability (for the purposes of
capitalisation).
Fifthly, while the Kitchens' interpretation remains faithful to the idea that
the actual annual rate of interest payable on the loan should be 2½% above
base rate, it does not take account of the fact that repayments which include
capital repayments are being made every month. Accordingly the last part of
Clause 5 would have to be rewritten, as the bank suggests, so that it reads:
"... the Borrower shall pay the Bank interest on the outstanding amount of the
Loan for the time being at [a rate such that, if there were no monthly
repayment instalments, after a year the loan balance would have increased by]
the Interest Rate."
Sixthly, although the Kitchens acknowledge the concept of "the Bank's usual
interest charging dates" in Clause 16 of the agreement, they do not explain why
these dates should be utilised for charging interest during the currency of the
agreement, or why there should be such a marked change in the method of
calculating interest as soon as a termination event occurs.
In my judgment, although many would accept the judge's view that the Kitchens
are contending for a "better" agreement, so far as transparency is concerned,
the agreement they are propounding is not the agreement they made. On pages 10
and 11 of his judgment the judge expressed his views on the interpretation of
Clause 5 of the agreement in these terms:
"The provision in the second sentence of clause 5 that the Borrower is to `pay
interest on the outstanding amount of the loan for the time being at the
Interest Rate' clearly has to be read by reference to the fact that the accrued
interest is to be compounded and having been thus compounded, the outstanding
amount of the loan at any one time will include such interest. The interest
then to be paid in respect of that resultant outstanding amount of the loan is
to be calculated at the Interest Rate as defined. The agreed function of the
Interest Rate is thus to calculate how much interest accrues day by day on the
outstanding balance by applying that rate to each day's balance. The
interest that is to accrue daily is thus interest which is to be calculated at
the defined Interest Rate. The words used are, in my judgment, incapable of
bearing the meaning that one applies to the daily balance any other rate than
that defined as the Interest Rate. Above all, there is nothing to suggest that
the daily accrual of interest has to be limited by the application of a rate
calculated to ensure that in the course of a year the total amount paid by the
borrower will not have been more than would be derived from applying Base Rate
plus 2½ per cent to the aggregate of the outstanding daily balances
throughout that period. That methodology would be radically different from the
concept [of] compounding by periodic rests on a half-yearly basis impliedly
incorporated by usage. It would also involve the use of an extremely complex
series of calculations involving the formula which I have described. In short,
the contract does not bear the meaning that Interest Rate is to be treated as
an APR. On the words used in this context it can only be the rate applicable
to the daily balance and the process of debiting and compounding interest thus
accrued must be in accordance with the Bank's current practice."
I agree. In my judgment, the Kitchens' interpretation of this agreement is
simply inconsistent with the wording of the agreement they signed. Although it
was suggested that leave should be granted to the Kitchens to defend the bank's
counterclaim so that they might have the opportunity of seeing whether through
discovery or interrogatories their case might be improved, I do not consider
that that course would be appropriate, since the bank's interpretation of the
agreement is clearly sound and accords with the common understanding of the
practices of English bankers, at any rate up to the time when this agreement
was made and was being implemented.
Although I am quite clear in my mind about the correct disposition of this
case, I must not leave it without paying tribute to Mr Andrew Baker, who
appeared pro bono to argue the Kitchens' case clearly and tenaciously in
the finest traditions of the English Bar. It was a pleasure to listen to his
able advocacy. I have considered carefully all the points he put to us, but as
I have made clear, I am quite unable to accept that this agreement has the
effect for which he contends.
For these reasons I would dismiss this appeal.
LORD JUSTICE SEDLEY:
I agree that this appeal has to fail for the reasons given by Lord Justice
Brooke.
I do, however, associate myself with his remarks about the lack of
transparency in this form of loan agreement. Although the issue is settled by
the highest authority, it seems to me an unnecessary misfortune that borrowers
are not only compelled in practice to accept whatever terms the bank stipulates
but that, when the bank stipulates an opaque term which depends for its meaning
on how the bank chooses to compute interest, the law fixes the borrower with
whatever burden the bank's practices impose.
The law's assumption that people know what bankers know about the latter's
practices has, I would respectfully think, only limited reality. For many
people, to sign a loan agreement like the present one will be to assume an
indeterminate financial burden, and that in my view is not fair, at least
unless the potential magnitude of the burden is clearly spelt out to them
before they sign.
Order: Appeal dismissed with costs; leave to appeal to the House of
Lords refused.
(Order does not form part of approved judgment).
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