High Court considers whether the rule against penalties applied to a fee payable to a bank for obtaining financing.

A lender and borrower entered into an “upside fee agreement” which provided that, in consideration for the bank procuring financing, a large fee was payable on the occurrence of certain “payment events”. Individual borrowers defaulted under a related loan agreement and the claimants argued this constituted a cross-default under one of the loan agreements.

The judge held that the obligation to pay the upside fee had been triggered, but crucially that the rule against penalty clauses did not apply. The fee was payable in various circumstances, and even if the relevant loan agreement had been repaid at the end of its term, the fee would still have been due.

The rule against penalties would apply only if the operation of the fee clause had been triggered by a breach of duty owed by the party that claimed relief and in this case, it was a default by related individual borrowers under a separate agreement. The purpose of the fee clause was not deterrence but to compensate the lenders.

The case serves as a reminder that careful drafting of provisions that provide for payments in circumstances not amounting to breach of contract can mean that the rule against penalty clauses does not apply.