Insights Court of Appeal finds that an “upside fee” payable on default by a borrower under a loan agreement was not an unenforceable penalty.

On appeal from an order of Hamblen J, the Court of Appeal has found that a borrower was liable to a lender for sums due under an “Upside Fee Agreement” (“UFA”) which formed part of a suite of financing agreements supporting the purchase of a group of buildings that formed Banco Santander SA’s headquarters in Madrid.  Lord Justice Moore-Bick, giving the court’s judgment, held that a “payment event” as defined in the agreement had occurred triggering payment of a fee and that payment was not an unenforceable penalty but remuneration payable to the lender for providing the necessary finance.

The UFA provided for the payment of certain fees to the lender as consideration for providing funds that were essential to the completion of the financing arrangements at a time when it was very difficult to raise money in the markets.  They comprised a loan of €200 million to Ramblas Investments BV under a “Junior Loan Agreement” (“JLA”) and a further loan of €75 million to the two businessmen behind the purchase under a “Personal Loan Agreement” (“PLA”).

By clause 2.1 of the UFA a fee was payable to the lender upon the occurrence of a “Payment Event”, which was defined as including:

(a) … the repayment of the Loan … (including any repayment made following acceleration or from the proceeds of any security realisation) or, if earlier, the date on which any such . . . repayment falls to be made pursuant to the [JLA].

The JLA contained a cross-default provision, under which a failure to make a payment under the PLA when it fell due constituted an Event of Default under the JLA.  In June and September 2010 the borrowers failed to make payments of interest due under the PLA.  They also failed to repay the whole amount of the Personal Loan, which fell due on 29 September 2010 as a result of those defaults.  These failures constituted Events of Default under the JLA and as a result, on 30 December 2010 the lender gave notice to accelerate the obligation to repay the Junior Loan. However, the Junior Loan was not repaid.

Amongst other things the borrower argued that the fee (calculated at €91.5 million on appeal) was unenforceable as being a penalty, because it far exceeded any loss that the lender could suffer as a result of the breach of contract in failing to make repayment of the Junior Loan.  Rejecting that submission, Moore-Bick LJ held that, as the recitals and Clause 3.3 of the UFA made clear, the fee was the remuneration payable to the lender for providing part of the finance necessary to complete the purchase of the property.  It became payable on a specified date when the repayment of the Junior Loan fell due.  The event, which constituted an Event of Default under the JLA and caused the loan to fall due for repayment, was not a breach of the JLA itself but a breach of the PLA by the borrowers.  The fee had nothing to do with damages for breach of contract; it was payable on the happening of a specified event.  Accordingly, it did not fall foul of the rules against penalties (Cavendish Square Holding BV v Makdessi [2015] UKSC 67 applied) (Edgeworth Capital (Luxembourg) SARL v Ramblas Investments BV [2016] EWCA Civ 412 (28 April 2016) – to read the full judgment click here).