Melbourne Linh Son Buddhist Society Inc v Gippsreal Ltd [2017] VSCA 161: The Penalties Doctrine and the Loan Establishment Fee Conundrum

The payment of a loan establishment fee to a lender is an important, and common, feature of loan transactions. It is also a standard drafting technique to require a borrower to pay such a fee as an agreed remedy if she fails to settle her loan. Accordingly, it is of considerable importance for lenders to know where they stand when drafting loan transactions that contain an establishment fee and whether the payment of such a fee on a borrower’s default will withstand scrutiny by way of the penalties doctrine. Whether an establishment fee is punitive was precisely the issue considered by the Court of Appeal of the Supreme Court of Victoria in Melbourne Linh Son Buddhist Society Inc v Gippsreal Ltd [2017] VSCA 161 (23 June 2017). The majority held that the payment of a loan establishment fee as a component of an agreed remedy in circumstances where a borrower, in breach of contract, failed to settle a loan constituted a penalty. This note argues that the general approach adopted by the majority towards the penalties issue ought not be followed. The majority considered whether the payment of the establishment fee as a component of an agreed remedy was punitive by considering whether the fee was legitimate in the sense of being objectively fair or reasonable. It will be demonstrated in this note that the correct approach requires the court to take into account the lender’s expectation interests in the performance of the loan agreement in deciding whether the agreed remedy exacts a punishment on the borrower.