Extortionate Credit Transactions – can they be set aside?

Setting aside a transaction on the basis that it was an extortionate credit transaction under the Insolvency Act 1986 (IA 1986 or the “Act”) is difficult.  A bargain may be hard or even unreasonable, but that does not make it extortionate.  The most important term to any credit transaction is usually the interest rate and that is most likely to be subject to scrutiny when considering whether or not a credit transaction contained grossly exorbitant terms.

So, what is an extortionate credit transaction, and how do you prove one exists?

For the purposes of s.244(3) of the Act, a transaction is extortionate if, having regard to the risk accepted by the person providing the credit the terms of it are, or were, such as to require grossly exorbitant payments to be made (whether unconditionally or in certain contingencies) in respect of the provision of credit, or, it otherwise grossly contravened ordinary principles of fair dealing; and it shall be presumed, unless the contrary is proved, that a transaction with respect to which an application is made under this section is or, as the case may be, was extortionate.

The relevant provisions in the Act are based on similar provisions in the Consumer Credit Act 1974, in force at the time the Act was drafted, which allowed debtors to challenge unfair and extortionate terms in credit agreements.  It should be noted that these provisions were repealed and replaced by provisions relating to “unfair relationships” in the Consumer Credit Act 2006, though the 2006 Act has no effect on existing insolvency legislation.

What amounts to “grossly exorbitant”?

Neither the Act nor the Consumer Credit Act(s) give any indication as to a level of interest that would be considered to be grossly exorbitant.  This may appear to be an oversight, but it is considered that were there to be a prescribed level, then creditors may be afforded the opportunity to structure credit terms in such a way as to avoid falling foul of the prescribed level.  In other respects, the setting of a prescribed level may have the effect of stifling credit lending as lenders who would otherwise have lent in high-risk circumstances (albeit, at a higher than usual level of interest) may be discouraged by the possibility of the transaction being adjusted at a later date.  It would be difficult to set a level that would automatically have the effect of avoiding both possible consequences and, in the event, matters have been left to the courts to decide.

That said, there have been cases decided which give some indication as to the mind of the court when deciding these matters.  The highest level of interest to be unsuccessfully challenged was 48% (where the lender took considerable risk lending the money and provided it quickly, but lower rates of interest have been successfully challenged – in cases where good security was given, rates of 42% and 39% have been successfully challenged. In the context of insolvency, the default interest applied of an additional 1.4% compound per month was not considered “grossly exorbitant” nor was it considered to contravene the principles of fair dealing [White v Davenham Trust Limited [2011] EWCA Civ 747].

With no prescribed limit for what the interest should be or what would be considered extortionate for the purpose of s.244, it becomes (1) fact specific and (2) judged by reference to what other lenders were offering at the time.  In that respect the Court will consider the following factors:

• Security - What is the extent of the security, and in what order of priority is the security registered. 
• Risk - This would depend on the credit rating of the insolvent borrower at the time of the loan application and the due diligence carried out by the lender. 
• Urgency - Lastly, a lender may charge a higher interest rate if the funds are required urgently on the basis that it will prevent the lender from carrying out detailed credit checks.

Who may apply?

• A liquidator or administrator of a company may apply to court to set aside any extortionate credit transaction where a loan carries an exorbitant rate of interest
• Similarly, a trustee in bankruptcy may make a similar application in a case of a bankruptcy.

If the liquidator/administrator/trustee considers that a credit transaction or agreement is extortionate, he/she may apply to the court setting it aside.  However, unlike many other provisions relating to the recovery of transactions, the burden of proof in actions to adjust extortionate credit transactions is on the creditor to provide that the transaction was not extortionate or otherwise unfair.

Relevant Time:

The timing of the transaction is an important issue when considering claims by office holders made pursuant to the Act, and extortionate credit transactions are no different. 

• In company cases, the court can review a transaction which was entered into in the period of three years ending on the day on which a company went into liquidation or entered administration.
• In the case of a bankrupt, the period is three years preceding the making of the bankruptcy order.

Summary

Applications for an order that accredit transaction is extortionate are rare and it is easy to see why - lenders will not want to be cited in public judgments where they have been shown to have acted unfairly.  As such, if the office holder considers a credit transaction is extortionate, they should first consider the factors outlined above, and then seek advice from a solicitor.  If a transaction appears to be extortionate, provided it is sufficiently pleaded, then there is a good chance of reaching a settlement with the lender.