In many if not most general security agreements (GSA), you will find an interest clause, even though the loan agreement supported by the GSA will already have one.
If you have ever negotiated a financing, you would probably never think twice about their mutual existence. And fair enough.
The reasonable business person would see the interest clause in the GSA as providing no more than a generic ‘fall back’ mechanism for calculating interest on the debt owed to the secured lender, in the event that:
- there is, for whatever reason, no separate agreement between the parties as to how interest on the loan should be computed; or
- that agreement is found to be invalid or unenforceable.
As one listed junior miner recently discovered however, in the hands of a vindictive lender, this unsuspecting clause could make or break the company.
The key facts were as follows:
- In March 2013, the company issued a loan note with a face value of $10 million to the lender under a note agreement.
- The note agreement provided that:
- if the loan note was repaid within one year of its issue, an amount of $11.3 million would be payable to redeem the note; and
- if the loan note was repaid between one and two years of its issue, an amount of $12.6 million would be payable to redeem the note.
- The note agreement was silent as to whether this 13% annual premium on the face value of the note, was interest.
- As security for repayment of the loan note, the company granted a charge over all of its assets to the lender under a GSA.
- There was an interest clause in the GSA which relevantly provided:
“The Grantor must pay interest on that part of the Secured Money owing by the Grantor to the Secured Party.”
“Interest must be paid in accordance with any agreement requiring interest to be paid on the Secured Money. If there is no agreement, interest [will be computed in accordance with the remainder of this clause].”
- In January 2015, the company received a notice from the lender in which the lender claimed, in reliance on the above provisions, that it was entitled to interest in the amount of $3.12 million under the GSA, independently of the note agreement.
- The company argued that the lender had no right to claim additional interest and there was already an agreement requiring interest to be paid, namely the effective interest of 13% p.a. on the face value of the note, which was built into the terms of the note agreement.
Not surprisingly, this matter ended up in court.
The court was quick to recognise that the lender’s claim for additional interest was part of an elaborate scheme engineered to disrupt the company’s refinancing and bring about a default that would justify the appointment of a receiver of the company’s assets. However, the court could not readily dismiss the lender’s claim because of the nebulous terms used in the interest provision of the GSA.
In respect of the first paragraph of the interest provision in the GSA, the court found that the word “owing” encompassed any money that the company was obliged to pay to the lender, whether payable now or in future. This meant that under the GSA, interest started to accrue on both the face value of the note ($10 million), as soon as it was advanced, as well as the 13% effective interest already provided for under the note agreement.
In respect of the second paragraph of the interest provision, the court found that the words in the note agreement could not displace the operation of the interest clause in the GSA because:
- the GSA required the company to pay interest on all “Secured Money”, which was defined to mean:
“all money and amounts that are now or in the future, actually or contingently payable by the Grantor to the Secured Party under the [note agreement]”,
- the difference specified in the note agreement between the amount payable by the lender for the note ($10 million) and the additional amount ($2.6 million) payable by the company to redeem the note represented only interest on the face value of the note ($10 million) and not interest on the additional $2.6 million required to redeem the note.
Therefore, contrary to commercial common sense, due to the imprecise nature of the words used in the GSA, it was open on the face of the GSA for the lender to argue that it was entitled to additional interest, notwithstanding that the parties had clearly structured the loan note to include an effective interest rate of 13% p.a.
Ultimately, the court found that it was the parties’ common intention that a single flat rate interest of 13% p.a. would apply to the loan and that the GSA should be rectified to reflect this. Having regard to evidence of the circumstances surrounding the parties' negotiation and signing of the note agreement and GSA, and the apparent objective of the transaction to improve the company’s cashflow (potentially for up to two years) by not requiring any cash payments before redemption of the note, the court held that there was convincing proof that the interest clause as drafted in the GSA did not reflect the common intention of the parties, objectively determined.
Some important take home lessons however stem from this case:
- For a lender: think carefully about when you want the interest clause in your GSA to apply. Should it apply only when the borrower has defaulted in making a payment that is due? Or do you also want to rely on the clause if there is no separate agreement as to interest or that separate agreement is invalid or void?
- For a borrower: if your lender intends for the interest clause to apply to both of the above circumstances, make sure that it operates only when no other agreement as to interest (or effective interest) is in operation. This may mean that your interest clause should be triggered at different times depending on the nature of the money owed the lender and, possibly, at different rates of interest. For example:
- If the money owed is the principal loan and the parties have no other separate agreement as to interest, interest may need to accrue under the GSA as soon as the loan is advanced and only at a commercial rate of interest.
- In contrast, if the money owed is a reimbursement of the lender’s costs under an indemnity, interest should only accrue when the payment is due and not when the claim is first made, and it may be appropriate for a default rate of interest to apply.
- For both parties: do not dismiss what goes into your term sheet, whether binding or not, and make sure that all essential terms are accurately recorded. If there is a dispute as to what the definitive contract means, a court could look to both pre-contractual and post-contractual conduct to rectify the contract to reflect the parties’ common intention, objectively determined.