It is not uncommon for borrowers to dispute the calculation of the effective rate of interest in proceedings for recovery of loan by lenders. If the effective rate of interest is too high, there will be undesirable consequences under the Money Lenders Ordinance (Cap. 163) (MLO).
First, it is illegal for any person (whether a money lender or not) to lend or offer to lend money at an excessive effective rate of interest exceeding 48% per annum (formerly 60% per annum)1. Loan agreement involving excessive effective rate of interest is not enforceable.
Second, a transaction is presumed to be extortionate if the loan involves an effective rate of interest exceeding 36% per annum (formerly 48% per annum)2 and a Hong Kong court may reopen such extortionate transaction so as to do justice between the parties.
In a recent judgment in Sun Entertainment Culture Limited v Inversion Productions Limited (formerly known as TNC Productions Limited) [2024] HKCA 884 (Judgment), the Court of Appeal confirmed that default interest is not taken into account in the calculation of effective interest rate under sections 24 and 25 of the MLO.
Facts of case
The relevant facts of the case were:
The Lender was a Hong Kong company and not a licensed money lender (nor alleged to carry on business as a money lender). The Borrower was also a Hong Kong company.
On 12 December 2014, the Lender and Borrower entered into a loan agreement (Loan Agreement) for the loan amount of US$7.5 million, to be advanced in three tranches. The interest was 10% of the loan or US$750,000. Default interest rate was 4% per month.
The original maturity of the loan was 30 April 2015. The Lender and Borrower extended the maturity date six times by written amendment agreements. In each extension, a further fixed sum of interest was specified and payable on the extended maturity date.
In the fifth extension, the loan amount was increased by US$1 million, which was advanced on 15 March 2019.
In the end, the Borrower would have to repay US$8.5 million as principal, US$750,000 as initial interest and US$6.45 million as additional interest on 30 September 2020, being the last extended maturity date.
On 30 September 2020, the Borrower failed to make any payment of principal or interest to the Lender.
The Lender served three statutory demands on the Borrower with different amounts demanded due to different bases of calculation. The last statutory demand was served on 18 October 2022 demanding the Borrower pays US$8.5 million as principal, US$750,000 as initial interest, US$6.45 million as additional interest and default interest at 4% per month on the principal of US$8.5 million from 1 October 2020.
On 29 November 2022, the Lender finally presented a petition for winding up of the Borrower for the outstanding debt.
Court of First Instance
In the Court of First Instance before Le Pichon J, the Borrower opposed the petition on the ground that the Loan Agreement was illegal and unenforceable under section 24 of the MLO – because taking into account the default interest, it imposed an effective rate of interest exceeding 60% per annum.3
Relying on the Court of Appeal’s judgment in Easy Fortune Property Ltd v Yung Chun Him [2020] 4 HKC 1 (Easy Fortune case), the Lender submitted that default interest should not be taken into account in calculating effective rate of interest.
On the other hand, the Borrower submitted that the Lender’s interpretation of the Easy Fortune case was inconsistent with another Court of Appeal’s judgment in Chan Ping Che v Gao Gunter [2017] HKCA 223 (Chan Ping Che case); which held that taking into account default interest, it was arguable that the effective rate of interest of the relevant loan exceeded 60%.
The Chan Ping Che case was decided shortly after the hearing of the Easy Fortune case but before judgment of the latter was delivered.
The Court of First Instance considered that the Chan Ping Che case was only concerned with whether a triable issue had been shown and did not consider another relevant Court of Appeal decision, namely Kwok Ying Lung v Ko Chi Hung & Anor [2001] 3 HKC 480 (Kwok Ying Lung case). On the other hand, the Easy Fortune case applied principles set out in the Kwok Ying Lung case and was an authority binding on the Court of First Instance.
The Court of First Instance held that the Borrower’s defence based on the MLO was frivolous and an abuse of process; and also rejected the Borrower’s other ground of defence. In the end, the Borrower was ordered to be wound up.
Court of Appeal
The Borrower appealed to the Court of Appeal on the ground (among others) that the default interest should be taken into account in the calculation of the effective rate of interest under section 24 of the MLO, with the following argument:-
- “Interest” as defined in section 2(1) of the MLO should include default interest.
- If default interest is excluded from the calculation of effective rate of interest under section 24 of the MLO, it is easy for a lender who is not a money lender to evade section 24 of the MLO by “end-loading” excessive interest as default interest.4
- The Chan Ping Che case and Easy Fortune case amount to conflicting decisions of the Court of Appeal, which should prefer the Chan Ping Che case (which was favourable to the Borrower) to the Easy Fortune case.
But the Court of Appeal (with Kwan VP, Barma JA and G Lam JA) dismissed the Borrower’s appeal, holding that: (a) the phrase “effective rate of interest” has the same meaning in sections 24 and 25 of the MLO, and (b) the definition of “interest” should not be read in isolation from other provisions in the MLO.
In this case, the issue was whether the effective interest rate exceeded the specified limit under section 24 of the MLO. “Effective interest rate” is defined in section 2(1) of the MLO to mean, unless the context otherwise required, the true annual percentage rate of interest calculated in accordance with Schedule 2 to the MLO. It had been held in the Kwok Ying Lung case that where the interest is capable of being truly expressed in terms of an actual rate, that rate – rather than the deemed rate calculated under Schedule 2 to the MLO – is the effective rate.
But there is obstacle to include default interest into the calculation of effective interest rate under Schedule 2 to the MLO because default interest is typically charged on an open-ended basis and without an end date of the default period, so it is not possible to calculate an average rate covering both the loan period and default period.
Furthermore, where interest rate in a loan agreement is stated or capable of being expressed as an actual rate (and hence Schedule 2 to the MLO is not applicable) and default interest rate is also specified, it strains the language of section 24(1) of the MLO to say that the lender “lends or offers to lend money at an effective interest rate” which combines the actual rate and default interest rate.
Another conceptual difficulty is that if the non-default interest rate is an ordinary low rate but the default interest rate exceeds 60%, would an offence be committed under section 24(1) of the MLO at the inception of the loan – or upon the borrower’s default or at some sufficiently long time after default so that the accrued default interest, when averaged with non-default interest, yields a rate exceeding 60% per annum?
The nature of default interest is “not an agreed price for the use of money as a loan, but stipulated compensation for the wrongful detention of money after the loan has expired.“5
Responding to the Borrower’s argument of possible evasion of section 24 of the MLO by “end-loading” excessive interest as default interest, the Court of Appeal noted:
- Default interest rate charged by licensed money lenders is regulated by section 22(1)(c) of the MLO.
- Transactions involving excessive default interest may be found to be extortionate under either section 25(2)(a) or 25(2)(b) of the MLO and reopened by the court.
- Excessive default interest may be a penalty at common law if “it is not just an adjustment to reflect a change in credit risk or in the cost of administering the loan but imposes a detriment on the borrower out of all proportion to any legitimate interest of the lender in the enforcement of the primary obligation …” 6 and not enforceable by the lender.
Referring to the cited authorities, the Court of Appeal found the Chan Ping Che case was not an authority that conflicts with the Easy Fortune case.
All the Court of Appeal decided in the Chan Ping Che case was that there was a triable issue, so the defendant should be granted unconditional leave to appeal.
It seemed that the Court of Appeal in that case “simply proceeded on an implicit assumption that default interest could arguably be taken into account and held accordingly that there was on the facts an arguable defence.” 7 The Court of Appeal did not make a ruling on the point of law.
In contrast, the Easy Fortune case was a considered decision on point of law and consistent with discussion on the application of section 24 of the MLO to default interest by the Court of Appeal in the present case. Moreover, the Easy Fortune case “has been followed in a number of first instance decisions as having decided that default interest is not taken into account in assessing the effective rate of interest for the purposes of sections 24 and 25, without any concern expressed that there may be something remiss, unjust or impractical about the law.” 8
Conclusion
The Judgment confirmed the position in the Easy Fortune case and the line of authorities relying on it, namely that default interest is not included in calculating effective rate of interest under sections 24 and 25 of the MLO – removing any doubt that might be cast by the Chan Ping Che case.
Nevertheless, lenders should take note that default interest is still regulated by section 22 of the MLO (where the lender is a money lender) and section 25 of the MLO (whether the lender is a money lender or not), as well as the common law doctrine of penalties.
1 Section 24(1) of the MLO. The limit was lowered from 60% to 48% by resolution of the Legislative Council pursuant to section 24(3) of the MLO, effective on 30 December 2022.
2 Section 25(1) and 25(3) of the MLO. The limit was lowered from 48% to 36% by resolution of the Legislative Council pursuant to section 25(9) of the MLO, effective on 30 December 2022.
3 The applicable threshold for this case was 60% per annum, before it was lowered to 48% by resolution of the Legislative Council pursuant to section 24(3) of the MLO, effective on 30 December 2022.
4 On default by a borrower, a money lender can only charge simple interest on due but unpaid principal and interest at an effective rate not exceeding the effective rate payable in respect of the principal apart from any default (proviso to section 22(1) of the MLO).
5 Paragraph 37 of the Judgment.
6 Paragraph 43 of the Judgment.
7 Paragraph 53 of the Judgment.
8 Paragraph 56 of the Judgment.
