Torchlight was a private equity fund investing in distressed assets. One of its investments was the purchase of a debt from Bank of Scotland International totalling $185m, of which Torchlight had repaid all but $37m.  Being in a difficult liquidity position to pay off the debt, Torchlight sought bridging finance from a Mr Grill.  Torchlight and Mr Grill entered into a 60-day contract in which Mr Grill would provide $37m to discharge the debt.  In return Torchlight would repay the principal with interest at 5.25% callable on day 60 (a total of $320,000), and an additional $5m due 120 days from the day of the advance.  The contract then stipulated for a 'late fee' of $500,000 per week for each week past the due date in which the principal was not repaid.  Torchlight failed to make repayments and was placed into receivership.  Torchlight then disputed the payment of the 'late fee'.  Two issues arose, namely whether the penalty doctrine was engaged by the 'late fee' clause, and secondly whether the clause was properly described as a penalty instead of a genuine pre-estimate of loss.

The Court considered the clause engaged the penalty doctrine because it was collateral to the breach and therefore an obligation arising secondary to the obligation to repay. The defendant's claim that the fee provided for flexible repayment failed because the debt was callable upon day 60 under the contract. 

Whilst the Court acknowledged the freedom to contract, it ultimately imposed the doctrine and held the clause unenforceable. On interpretation the Court considered the surrounding circumstances and the intention of the parties.  Although reluctant to deem the clause a penalty, the Court considered it was inserted 'in terrorem' for the collateral purpose of enforcing repayment of the principal sum.  Furthermore, the amount stipulated was considered disproportionate to any conceivable loss flowing from a breach.  The clause was deemed a penalty clause and therefore was unenforceable.

It should be noted that this decision applied the law of New South Wales, rather than the law of New Zealand in relation to the penalties issue.  The judgment is under appeal.

See Court decision here.