A recent Singapore case (Hong Leong Finance v Tan Gin Huay  2 SLR 153) has important implications for banks and other financial institutions with regard to enforcing the terms of loan agreement/mortgages in the case of default by the debtor/mortgagee.
The respondents had purchased from a local housing authority the leasehold interest in a food stall for S$116,000. The purchase was financed by the appellant-bank and the respondents executed a mortgage of the property as security. The respondents defaulted in repayment. The appellant began suit in the High Court claiming the amount due with interest, and default interest, and an order for possession.
The High Court dismissed the appellant's application. Instead, it ordered the respondents to pay the appellant the outstanding amount of the loan by instalments. The court also rejected the appellant's claim for default interest as it found this to be a penalty.
On appeal, the Court of Appeal acknowledged that while the appellant was entitled to judgment and an order for possession, there was good reason for staying the execution of the order for possession. The court accepted the respondents' argument that they did not intend to default, but they had gone through a temporary financial crisis and would now resume making instalments. The court, therefore, stayed the execution of the order for possession provided that the respondents continued paying the monthly instalments as ordered by the court below.
In addition, the Court of Appeal struck down the default interest clause as a penalty, thus upholding the High Court's ruling in this aspect. The court found the default rate of 18% to be an "eminently extravagant increase" from the rates of 5% for the first two years of the loan and 6.75% thereafter. As such, the court felt that it did not reflect the "true amount of the loss suffered by the appellant following the respondents' breach".
This case is important for two reasons. First, it appears that creditors must be prepared for intervention by the court when they apply to enforce default clauses. In the Hong Leong Finance Case, the bank expected that its repossession of the food stall according to the agreement would be automatically granted. While this may have been the position in the past, this case indicates that courts are not reluctant to stay the execution of orders for possession if repayment on loans is likely to be resumed.
Second, a provision for default interest in the event the borrower defaults in the payment of instalments, like any other liquidated damage clauses, is liable to be struck down as a penalty clause. Previously, it was thought that commercial contracts entered into at arms' length between businesses and financial institutions would be binding, even if the business was a sole proprietorship. This case illustrates that this is not necessarily so.
Since the Court of Appeals' decision, Hong Leong Finance has revised its default interest rate to 10% and other Singapore financial institutions are reported to be considering following suit.
For further information on this topic please contact Leena Pinsler or Lim Gek Choo at Drew & Napier by telephone (+65 535 0733) or by fax (+65 535 4906) or by e-mail ([email protected] or [email protected]). The Drew & Napier web site can be accessed at www.drewnapier.com .
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