Fresh blow to banks as court sides with loan defaulter

Local banks and other lenders could soon say they are under siege from the judiciary.

Borrowers, on the other hand, could say it’s payback time after years of exploitation. This is on account of what is coming out of court rulings against banks — which could have grave implications to the lending industry.

Last week, High Court Judge Eric Ogola borrowed from criminal justice to rescue a self-confessed defaulter from the auctioneer’s hammer, in a ruling that legal experts say opens lending on security to a new world of uncertainty and unpredictability. 

“Against the tide of legal precedent on this subject, the court introduced a principle that is not only historically unknown to the law but undefinable,” said a litigation and arbitration partner at Mohammed Muigai Advocates, Mr Emmanuel Wetang’ula.

In his ruling, Mr Justice Ogola noted that a court of law is, “apart from being a court of equity, also a court of mercy. Mercy, however, is given to a party who does not deserve any remedy due to his or her culpable conduct.” 

In this, the judge stopped Gulf African Bank Ltd from recovering Sh220 million it had advanced to Al-Jalal Enterprises Ltd, though in the judge’s own admission the latter had failed even to honour court orders on repayment.

The judge said that although Al-Jalal Enterprises defaulted in repaying the loan and failed to obey court orders, the court can still extend a hand of mercy and direct compliance.

The facts of the case and the ruling make this an interesting read: Al-Jalal Enterprises owns two properties in Eastleigh, Nairobi, on which it has developed a shopping mall valued slightly at over Sh650 million.

In June 2012, Al-Jalal Enterprises, which was already experiencing problems repaying a loan advanced to it by NIC Bank, approached Gulf African Bank for a rescue deal. By then, NIC Bank had already put Al-Jalal Enterprises under receivership.

Al-Jalal Enterprises has Mr Farah Mohammed Abdi, Mr Yusuf Mohamud Abdi, Mr Hasssan Mohamed Abdi, and Mr Kheira Omar Maalim as directors and guarantors. Gulf African Bank advanced them Sh220 million, paid directly to NIC Bank to clear the loan.

The change of banks also allowed the parties to alter the nature of the money advanced — from a normal commercial loan attracting interest to a Sharia-complaint deal that is earning profit.

The undisputed fact is that after the disbursement, Al-Jalal Enterprises went into default, with Gulf African Bank saying it “consistently defaulted in the repayment terms despite many reconsiderations and re-negotiations.”

By early this year, Al-Jalal Enterprises had paid back only Sh6.4 million, all of which was, in Sharia-lending jargon, “in terms of profit payment.” No cent had been paid to clear the loan principal — Sh220 million.

At this point, Gulf African Bank appointed Garam Investment Auctioneers to sell the suit premises by way of public auction. Al-Jalal Enterprises then went to court to stop the sale. On May 12, 2014, Mr Justice Ogola ordered Al-Jalal Enterprises to pay Sh30 million before mid-June as a compromise to stop the sale, but the enterprise failed to pay, resulting in the lender re-instituting its orders to Garam to auction the property.

Al-Jalal Enterprises went to court again, raising a number of objections, all of which were dismissed by the judge as lacking basis in law.

In its own admission, Mr Justice Ogola noted, Al-Jalal Enterprises does not deserve any favour from the court to stop the looming auction.

“I am not satisfied that Al-Jalal Enterprises has met the threshold for the grant of equitable remedy of injunction,” Judge Ogola ruled.

He, however, borrowed from criminal justice the principle of mercy to get the company off the hook.

“This court, apart from being a court of equity, is also a court of mercy. Mercy, however, is given to a party who does not deserve any remedy due to his or her culpable conduct. What kind of mercy can this court then extend to the applicant?

“This court, on June 16, 2014, ordered Al-Jalal Enterprises to pay Sh30 million by close of business on June 17, 2014, and to pay the outstanding auctioneer fees. This was an order which provided relief to Al-Jalal Enterprises, and which the enterprise ought to have complied with.

“Al-Jalal Enterprises failed to comply. Instead, it paid only the auctioneers fees. Al-Jalal Enterprises forgot that it was upon the condition of payment of the said amount that this court granted a stay of execution.

“Although Al-Jalal Enterprises defaulted and/or neglected to obey that order, this court can still extend a hand of mercy and direct compliance. That order was flagrantly disobeyed by Al-Jalal Enterprises. The order is still alive. It has not been set aside. It has not been stayed, and it has not been appealed.”

The judge then issued an injunction ordering Al-Jalal Enterprises to “within 10 days from the date of this ruling pay the defendant Sh30 million. To pay “a further Sh30 million within 90 days from the date of this ruling” and ensure that “there is no outstanding arrears on account of the said loan on or before the end of 150 days”.

The bank was then slapped with an order to pay the cost of the suit.

 Landmark cases against local lending institutions

  In May, the Court of Appeal allowed Ms Rose Florence Wanjiru to commence a class action suit against all banks for illegally charging fees.

In her application, she said banks failed to get approval from the Finance Minister as required by the Banking Act.

Section 44 of the Banking Act provides that “no institution shall increase its rate of banking or other charges except with the prior approval of the minister.”

She has sued Standard Chartered Bank. If this lawsuit succeeds, banks could be required to refund hundreds of billions to their customers.

  Last month, the High Court equated financial institutions to a robber “who, after killing his victim, insists on not only attending the funeral, but also carrying the casket to the grave in order to confirm that the victim is dead and buried.”

“I am reminded of a predator who, after killing the prey, is not satisfied to leave the carcass to the vultures, but becomes both the predator and the vulture, killing the prey and gleaning the meat from the carcass to ensure the prey is really dead.”

  In yet another case with similar facts, High Court Judge George Odunga found Housing Finance had unlawfully levied interests on Mr Francis Ichatha, who had borrowed Sh1.5 million towards construction of a house in Karen, Nairobi.

In exercising its statutory power of sale, Housing Finance sold the house upon Mr Ichatha’s failure to pay. He had initially borrowed Sh1.2 million at a rate of 18 per cent per annum in 1991.

However, on additional advance of Sh300,000 in 1992, the interest rate became 19 per cent.

Mr Ichatha had told the court that Housing Finance had, in breach of the agreement, varied the interest to 26 per cent per annum, thereby making it impossible for him to service the loan.

Mr Justice Odunga said Housing Finance had not cited any particular provision in the contractual documents which entitled it to levy charges other than those expressly provided for.

“I have gone through the charge document and I have been unable to find any provision entitling Housing Finance to charge what it termed ‘penalty interest’, ‘interest on arrears’ or ‘default charges’.

The firm ought to have expressly provided for such charges in the charge document in order to entitle it to levy the same. Without any express provision, it is my view that, and I so hold that, any levies could only be made with Mr Ichatha’s consent,” said Judge Odunga.

“A party ought not to mutate the terms of a contract unilaterally to the detriment of the other party to the contract.

This, in my view, is what the people of this republic realised when they enacted unto themselves Article 46(1)(b) and (c) of the Constitution, which provides for the right to the information necessary for consumers of goods and services to gain full benefit from goods and services and to the protection of their health, safety and economic interests.”

 Commentary» Emmanuel Wetang’ula

 Mercy principle ‘unknown historically’

THE RULE of law is not only fashionable; it is also sensible for the good order of society.

An essential component of it is that the law should be certain and regular. Law-abiding citizens need to not only know what the law is in order to align their dealings within it; they also legitimately expect that it will remain so, all things constant.

However, while discussions on the rule of law and legal certainty often have the acts of executive or administrative authorities as their fodder, courts have not been unblemished in interpreting and applying the law.

In Al-Jalal Enterprises Ltd versus Gulf African Bank Ltd, the court entertained an application for an injunction preventing the sale of a property that the enterprise had charged to the lender as security for a Sh220 million loan.

Upon defaulting in repaying the loan, the bank acted to realise the security by initiating the processes of selling it; the enterprise reacted by filing the application.

The court was supposed to decide whether the bank should be prevented from realising the security until the case is concluded.

There is no shortage of such applications in our courts; going by the cases cited in this particular ruling, they have been in existence as early as the 1960s.

Consequently, there has been no shortage of court decisions on such applications, addressing various arguments that defaulting customers contrive. Therefore, though unoriginal, it can fairly be said that the law on such applications is well-settled.

Commodity for sale

The courts have consistently pronounced that once property is offered as a security, it becomes a commodity for sale; a challenge to the validity of the charge instrument is unsustainable; so is a challenge to the amount owed.

Consequently, banks have been fairly confident in advancing money to their customers, the repayment of which is secured by property, because the law has been certain on such transactions.

However, while acknowledging the traditional principles relating to such applications and expressly finding that the enterprise did not merit an injunction, the court in this case held that it is a “court of mercy”.

Paradoxically, it found that although culpable and undeserving of any remedy, mercy could be extended to the loan defaulter. In exercise of the “mercy principle”, the court gave Al-Jalal Enterprises conditions on payment of the arrears within a specified timeframe, failing which the bank could exercise its power of sale.

Against the tide of legal precedent on this subject, the court introduced a principle that is not only historically unknown to the law but undefinable.

What are the parameters for invocation of the ‘mercy principle’? In which instances does it apply?

How is it to be catered for in contractual documents? In the end, the effect is to discourage lending institutions from investing in a sector that is unpredictable and uncertain with the consequence of stifling economic growth, which was dependent on the availability of such facilities.

Mr Wetang’ula is an advocate at Mohammed Muigai Advocates [email protected]