Mortgage –– Interest –– Simple or compound –– Deed of priority –– Capital sum and interest thereon –– Whether deed gave priority to sum that included compound interest
By a legal mortgage dated 12 August 1987 a public house was mortgaged to the defendant to secure a loan of £160,000 that provided for compound interest. By a further legal charge dated 15 August 1988 the borrowers charged the public house to the claimant in the sum of £200,000. By a deed of priority, also dated 15 August 1988, the claimant and the defendant agreed that the defendant would have priority for the money secured by its charge to the extent of “a capital sum of £160,000 together with interest thereon to date of payment”. Following defaults by the borrowers, and the sale of the property in 1993 for £250,000, the parties disputed the defendant’s entitlement to interest under the deed of priority. In the court below, the claimant’s contention that the defendant was only entitled to simple, and not compound, interest was accepted. The defendant appealed.
Held: The appeal was allowed. “Interest”, in the context of the deed of priority, meant whatever interest was payable by the third party borrowers to the defendant under the arrangement by them (the underlying transaction). It would therefore include compound interest if payable by the borrowers. Even if, by reason of the arrangement between the defendant and the borrowers, interest was capitalised, it remained interest within the meaning of the deed of priority. The very absence of a specific provision for interest in the deed, either compound or simple, supported the view that it was the underlying transaction that the parties had in mind. The overall intention of the parties was that the interest charges properly made by the defendant to the third party borrowers, in respect of, but not limited to, the capital sum of £160,000 were included in the words “interest”.
The following cases are referred to in this report.
Bank of Credit & Commerce International SA v Blattner unreported 20 November 1986
Bank of New South Wales v Brown (1983) 151 CLR 514
Consolidated Fertilisers Ltd v Deputy Commissioner of Taxation (1992) 107 ALR 456
Inland Revenue Commissioners v Oswald [1945] AC 360
Morris, In re; Mayhew v Halton [1922] 1 Ch 126
National Bank of Greece SA v Pinios Shipping Co (No 1) [1990] 1 AC 637; [1989] 3 WLR 1330; [1990] 1 All ER 78; [1990] 1 Lloyd’s Rep 225, HL
This was an appeal by the defendant, UCB Corporate Services Ltd, against a decision of Scott Baker J in a claim by the respondent, Whitbread plc, against the defendant on a deed of priority.
Brian Dye (instructed by Halliwell Landau, of Manchester) appeared for the appellant; Timothy Hill (instructed by Glovers) represented the respondent.
Giving the first judgment, Pill LJ said: This is an appeal against a decision of Scott Baker J given on 20 July 1999. The judge had been asked to decide a preliminary point in a dispute between Whitbread plc, the claimant, and UCB Corporate Services Ltd, the defendant.
The background can be stated briefly. Mr Robert Belding and Mr James Berry (the borrowers) were publicans at the General Abercrombie Public House in Arundel, West Sussex. They sought loans from more than one source. The defendant lent them the sum of £160,000 for a period of 240 months on an interest-only basis. Monthly interest was to be paid during the term and the capital sum repaid at its
By a legal mortgage dated 12 August 1987 the borrowers charged the public house to secure the moneys due to the defendant. It was an all-moneys mortgage. It covered the loan to which I have referred, which provided for compound interest. By a further legal charge, dated 15 August 1988, the publicans also charged the public house to the claimant in the sum of £200,000.
A dispute has arisen as to the construction of a deed of priority, also dated 15 August 1988, made between the claimant and the defendant. They agreed between them the extent to which the defendant would have priority for the money secured by its charge over and above the money secured by the claimant’s charge. The relevant words in the deed of priority were:
A capital sum of £160,000 together with interest thereon to date of payment.
The dispute is as to the sum in respect of which the defendant is entitled to priority under the deed of priority. The claimant contends that the defendant has priority only for £160,000 and simple interest on that sum, and the defendant contends that it has priority in respect of compound interest. Having made regular monthly payments to the defendant on the interest-only loan, the borrowers defaulted, and also defaulted with respect to their obligations to the claimant.
Receivers were appointed, and when the public house was sold, the proceeds were a little over £250,000. That sum was paid to the defendant late in 1993. The relevance of the dispute is that if the defendant is correct in its contention, no money is due from the defendant to the claimant. The claim based on compound interest and other relevant matters exceeds the proceeds. If, however, the defendant is entitled only to simple interest, a substantial sum is left out of the £250,000 for payment to the claimant. It is that sum that the claimant seeks from the defendant in the proceedings.
The defendant’s legal charge was an all-moneys charge. This was made clear in the deed of priority. The first recital states:
By a Legal Mortgage (“the UCB Mortgage”) dated 12 August 1987 and made between ROBERT FREDERICK ARTHUR BELDING and JAMES FREDERICK BERRY together called (“the Borrowers”) (1) and UCB (2) the premises known as the General Abercrombie Public House Queen Street Arundel (“the Premises”) were charged to the Bank to secure all monies and liabilities for the time being due owing or incurred to the Bank by the Borrower.
It must have been clear to the parties that the obligations of the borrowers to the defendant might include obligations under loans that provided for compound interest (as did the relevant one). It provided for a situation in which, upon a rising balance, there was to be a monthly compounding on the amount then outstanding. Clause 2.1 of the deed provides:
The UCB Mortgage shall rank so as to secure all monies due owing or incurred to UCB by the Borrower such sum not to exceed the capital sum of one hundred and sixty thousand pounds together with interest thereon to date of repayment commission discount costs and other UCB’s charges (“the UCB’s limited debt”). IN PRIORITY to the Brewery Charge as a continuing security for repayment to UCB of all monies secured by the UCB Mortgage whether now owing or incurred to hereafter to become owing or incurred to the UCB by the Borrower on any account or in any manner whatsoever but subject to the said limit and the priority of the UCB Mortgage to the said extent shall not be affected by any fluctuations in the amount from time to time due to UCB by the existence at any time of a credit balance on any account.
The operative clause thus also made clear that the mortgage was an all-moneys mortgage.
Clause 5 of the deed of priority states:
Each of them the UCB and the Brewery hereby acknowledge the right of the other to production and delivery of copies of their respective Charges.
That obligation arose only upon the signing of the agreement.
Scott Baker J found in favour of the claimant. He said:
I am not satisfied that, upon consideration of the full circumstances in which the agreement was made, there would be any clear conclusion that the parties intended the reference to “interest” to be to compound interest. In my judgment, most assistance here is to be obtained from the literal wording of the agreement itself. I have come to the conclusion that the agreement is sufficiently clear on its face to satisfy me that simple interest is the natural construction.
Interest, as a concept, has to have a sum on which to be computed. The word “thereon” shows that it is to be computed on the capital for the time being outstanding not exceeding £160,000. It is not permissible, in my judgment, to make the interest bite on any extra money as would be the case if one construed the reference to “interest” as meaning “compound interest”.
In his submissions on behalf of the claimant, Mr Brian Dye refers to the judgment of Cooper J in the General Division of the Federal Court of Australia in Consolidated Fertilisers Ltd v Deputy Commissioner of Taxation (1992) 107 ALR 456 at p462:
The terms “simple interest” and “compound interest” do not alter the essential character of interest. Rather, the adjective denotes the method of calculation and thus the type of interest. Simple interest is the interest paid on the principal lent or the obligation to pay money. Compound interest is the interest eventually paid on a principal periodically increased by the addition of each fresh amount of interest as it becomes due and remains unpaid.
In that case, the judge applied the decision of the High Court of Australia in the case of Bank of New South Wales v Brown (1983) 151 CLR 514, to which I will refer. Mr Dye refers to the statement in Paget’s Law of Banking (11th ed) at p182:
The computing of interest must be distinguished from compounding, which is the capitalisation of interest so that interest itself yields interest.
He also relies upon cases in which mortgage deeds have been construed as to whether the interest referred to is simple or compound interest: National Bank of Greece SA v Pinios Shipping Co (No 1) [1990] 1 AC 637 and the earlier case of Bank of Credit & Commerce International SA v Blattner unreported 20 November 1986.
The parties agree upon the commercial circumstances in which the deed of priority was made. There was, at the time it was made, an outstanding capital sum of about £160,000 on the interest-only loan that the defendant had made to the borrowers. Both parties clearly had an interest in agreeing priorities, and the claimant had an interest in the sum lent by the defendant to the borrowers not being increased in a way that might defeat the rights of the claimant.
Mr Dye submits that, in the wording of clause 1, the expression “not to exceed the capital sum with interest thereon” necessarily involves a finding that the interest is simple interest. The effect of compounding is to increase the capital sum. That is inconsistent with the agreement that the capital sum shall not be exceeded as far as priority is concerned. The capital sum was fixed at £160,000. Interest imposed on a larger capital sum is not interest on £160,000, but a combination of interest on that sum and interest on the interest thereon. The effect of the wording the parties used is specifically to prevent compounding being covered by the deed of priority. Reliance is also based upon the fact that no basis for the method of compounding is set out in the deed of priority.
It is submitted that reference in an agreement to interest is ordinarily construed as meaning simple interest. If it is intended to provide for compound interest, that would need to be expressed in the document. If reliance needs to be placed upon the contra proferentum principle, Mr Dye submits that the principle operates in the claimant’s favour. It is also submitted that the practice of bankers to charge compound interest cannot be relied upon in this case. The defendant was not a banker in the arrangement first made with the borrowers. There can be no assumption that the practice of bankers applied or that the claimant knew the terms of the arrangements between the defendant and the borrowers.
The defendant’s mortgage deed, which, by clause 5 of the deed of priority, the claimant was entitled to see, did not require payment of compound interest. It was the facility letter that entitled the defendant to charge the borrower compound interest. The sum lent by virtue of the facility letter was secured by the mortgage deed.
Had it been the intention of the parties to provide for the rate of interest that the borrowers had to pay to the defendant, Mr Dye submits that the deed of priority would have provided for the inspection of all documents relating to underlying transactions between the defendant and the borrowers, and not merely the deed of mortgage itself. (Mr Timothy Hill, for the appellant, points out that the obligation to disclose the deed of mortgage only arose after the signature of the deed of priority). Mr Dye submits that the absence of reference to the underlying transactions means that it was simple interest that the parties had in mind, there being no specific provision in the deed of priority for compound interest.
I am not able to accept those submissions, and differ from the learned judge on this point. The word “thereon”, upon which the learned judge relies, is, in my judgment, neutral. It begs the question of whether the “interest thereon” is to be simple or compound interest. When construing the deed of priority, it should be recognised that its object was to determine priorities as between the claimant and the defendant with respect to the rights each of them had against a third party, the borrowers. The deed of priority did not involve or provide for payment of interest between the parties to it. In my judgment, it identifies what capital sum is to be covered by the deed of priority. Such sum is not to exceed the capital sum of £160,000, together with interest thereon.
“Interest”, in my judgment, in context, means whatever interest is payable by the third party to the defendant under the arrangements between them, the underlying transaction. It identifies the starting point from which calculations are to be made. The starting point is readily understandable in the commercial context. £160,000 was the sum owing on the interest-only loan from the borrowers to the defendant at the date of the deed of priority. The capital sum is mentioned to make clear that any further capital sums lent by the defendant to the third party are not covered by the deed of priority. The capital sum was fixed. Whatever interest was payable by the borrowers to the defendant on such additional loan, whether simple or compound interest, would not be covered by the deed of priority. In my judgment, the reference to interest in the deed of priority is to interest in fact paid on the underlying transaction between the defendant and the borrowers. That transaction involves a right to capitalise in the manner described both before and after, as the law provides, any demand for repayment.
Even if, by reason of the arrangements between the defendant and the third party, interest is capitalised, it remains interest within the meaning of clause 2.1. That was the intention of the parties. The fact that the claimant was accepting a scheme of priorities that was open-ended, in the sense that it depended upon the terms of the underlying transaction, does not defeat that construction. In the circumstances of this case there was no presumption that simple interest was intended.
As to the point that no basis for the calculation of compound interest is set out, that reinforces the conclusion that the contract was intended to cover interest as provided in the underlying transaction. The very absence of specific provision for interest in the deed of priority, either compound or simple interest, supports the view that it was the underlying transaction or transactions that the parties had in mind. The calculation of simple interest may also be no easy matter upon the factual situations that could have developed.
This construction is, in my view, reinforced by the reference in clause 2.1 to “commission discount and other UCB costs and charges”. That, too, is open-ended. It plainly contemplates that the claimant, which does not know and cannot know what those other charges may be, is, nevertheless, bound by them as a matter of priority.
In support of his submission, Mr Hill has referred to a case in the High Court of Australia, Bank of New South Wales v Brown, which, unfortunately, was not cited to the learned judge. Unlike the other cases to which reference has been made, the case was concerned with the rights of a third party when the question to be construed was whether interest was simple or compound. It is unnecessary to set out the facts in Brown, which involved the construction of section 112 of the Bankruptcy Act 1966 (Commonwealth). For the purposes of that section, the High Court held that the accrued interest debited should be treated as interest and not capital.
In the course of his judgment, Gibbs CJ referred to English cases at p521:
In Inland Revenue Commissioners v Oswald a mortgage of a reversionary interest in settled funds provided that interest in arrears might at the option of the mortgagee be capitalized and added to the principal. The mortgagee having died, her trustees executed two instruments capitalizing the interest due. Subsequently the respondent, the trustee of the settlement, handed over the mortgagee’s trustees the whole of the funds remaining in his hands and those funds were appropriated in repayment of the principal sum and interest thereon (including capitalized interest). The first question for decision was whether by virtue of the two instruments the unpaid interest thereby capitalized was paid within the meaning of r 21 of the General Rules under the Income Tax Act 1918 (UK). It was held, following Paton v Inland Revenue Commissioners, that no payment of interest was made at the time when the interest was capitalized. The second question for decision was whether the respondent was accountable for tax under r 21 in respect of the funds which were actually handed over by him to the mortgagee’s trustees, and it was held that whatever was paid to the trustees over and above the amount of the original capital loans was in law a payment of interest, so that the respondent was accountable under r 21. In the course of their speeches all members of the House found it necessary to consider the effect of the capitalisation of interest and all expressed approval of the statement of Lord Sterndale MR In re Morris; Mayhew v Halton [1922] 1 Ch 126, at p133. Lord Sterndale MR there stated:
“… when these sums of interest come to be paid at the end of the time when payment is made, although interest has been charged upon them, and although, as a matter of bookkeeping, they have from time to time been added to capital, they do not cease to be interest on money –– that is to say, they are overdue interest upon which interest has been paid.”
Some of their Lordships in Inland Revenue Commissioners v Oswald [1945] AC 360 repeated for themselves the same view. Lord Macmillan said [at p373]:
“The unpaid interest never ceases to retain its character as interest, although it has from time to time been added to the capital indebtedness and has carried interest in turn.”
Lord Porter said [at p379]:
“Capitalisation means no more than that interest, which continues to be interest, shall be treated together with the capital sum due as itself interest-bearing but does not alter its quality as interest.”
Gibbs CJ went on to say that the decision in Inland Revenue Commissioners v Oswald [1945] AC 360 was clear, strong and persuasive authority upon the construction of section 112. He added at p523:
When, in accordance with normal banking practice, accrued interest is debited to a customer’s current account, and itself bears interest, it may be convenient to say that, as between the banker and the customer, and those who stand in their shoes, the interest is treated as capital. In truth, however, the interest is not converted into capital, and the rights of third parties must be determined on the footing that the interest retains its character as such.
The court is here concerned with the rights of a third party, that is, the right of the claimant under the deed of priority in relation to transactions between the defendant and the borrowers. I would have decided the case without reference to Brown for the reasons I have given. Brown and the cases cited in it do, however, in my judgment, lend weight to the case that the expression used in clause 2.1 does not contemplate simple interest only. The capital limit of £160,000, so far as priorities are concerned, does not prevent the relevant sums being treated as interest.
The reasoning in In re Morris: Mayhew v Halton [1922] 1 Ch 126 and Oswald adds weight to the submissions Mr Hill has made that the learned judge reached the wrong conclusion on the construction of clause 2.1.
For the reasons I have given, I would allow this appeal.
Agreeing, Potter LJ said: I agree. In so far as there might otherwise have been any ambiguity in the matter, the terms of clause 2.1
The defendant’s original loan facility, granted to the borrowers in June 1987, one year before the making of the priority deed, was entered into in parallel with a loan made to the borrowers by Scottish & Newcastle Breweries, which was also lending money to finance its public house operation. The defendant lent £160,000 as a capital sum, granting a loan facility that provided for repayment of interest only, such repayments to be made monthly over 240 months, following which the capital sum was repayable.
Scottish & Newcastle entered into a deed of priority in almost identical terms to that that the defendant later entered into with the claimant and with which this court is concerned. About a year after the defendant’s loan facility was granted, the borrowers wished to transfer their loyalties and their parallel loan from Scottish & Newcastle to the claimant. The claimant was to pay off Scottish & Newcastle, and make its own advance, but only on terms that it was able to enter into a similar priority deed with the defendant to that which Scottish & Newcastle had procured. The purpose of that was plainly to ensure that the priority that the defendant should enjoy would be limited to the capital loan it had originally granted, plus any interest payable to the bank in respect of it. Thus, if the defendant elected subsequently to increase the capital sum lent, it should not do so in priority to the rights of the claimant, as parallel lender, as from the date of the claimant’s loan. The deed entered into was plainly taken from the format of the Scottish & Newcastle deed, which had been forwarded to the claimant’s solicitors for that purpose.
In the light of those circumstances, the terms of clause 2.1 are readily understandable, although it also seems to me that the scheme is apparent on the face of 2.1 without resort to the history. It is also plain from the documents that, vis-à-vis the borrowers, the defendant had the right, in respect of the £160,000 capital sum lent, to charge not only the interest repayments expressly provided for under the loan facility, but compound interest, which was also provided for, and entitled to be charged upon any repayments that were the subject of default. The words “interest thereon” in 2.1 are apt, and, as I consider, plainly intended, to include those sums.
The legal charge referred to in the deed of priority was an all-moneys legal charge provided by way of security for payment of all sums due to the defendant. That being so, neither the reference to the charge, nor to the capital sum of £160,000, are sensibly referable to any other intention than that priority should be enjoyed by the defendant as to all sums owing to the defendant in respect of the £160,000 capital sum loaned, including all charges that the defendant was entitled to make in connection therewith.
The words “interest thereon to date of repayment” are immediately followed by and treated as a genus with “commission discount” and “other UCB charges”; all are subsumed within the reference “the UCB’s limited debt”. In those circumstances, it seems to me plain that there was an overall intention that such charges, so categorised, should include the interest charges properly made by the defendant in respect of, but limited to, the capital sum of £160,000.
I, too, would allow the appeal.
Sir Murray Stuart-Smith agreed and did not add anything.
Appeal allowed.
