Several times I have wondered, in my short career so far, whether a loan or other commercial agreement which provides for interest at a particular rate should be construed as providing for simple or compound interest. My presumption has been that such a provision would be interpreted to provide for simple interest unless compound interest is specified. Surprisingly, that is not the law; there is no presumption. The question is to be resolved by reference to orthodox principles of ascertaining the parties’ intentions without resort to presumptions of law. In Decorrado v Manoukian [2009] VSC 451, Justice Vickery explained the law, and applied it as follows:
‘Simple or Compound Interest?
57 When one examines the agreements they had common terms relating to interest which are found in clause 4 in each case. Taking the first agreement, clause 4 provided the following as to interest:
The lender shall be paid the whole sum of $50,000 plus interest of three per centum per month, payable in advance of the loan amount advanced.
The second agreement was in similar terms, other than the fact that it referred to the sum of $25,000 and not $50,000.
58 As is clear, the text of both clauses in the loan agreements was silent on the question as to whether or not simple interest should apply or compound interest should apply.
59 Morton v Elgin Strazinsky & Anor[1] was referred to me by Mr Hardy, who appeared as counsel for the first defendant, Mr Manoukian. The case involved a loan at call agreement. The loan agreement in that case included a term relating to interest which was expressed in the following terms:
Interest would be paid at the rate of interest charged by the Commonwealth Bank of Australia for overdrafts in excess of $10,000.
60 As was said by the Court of Appeal in the judgment of Neave JA:[2]
Whatever may have been the case historically today there is no presumption that interest payable on a loan made by a private lender is to be calculated as either simple or compound interest.In Ellington Group Architects Ltd v Attorney General, the New Zealand Court of Appeal said that the question whether interest payable is to be simple or compound interest is to be approached without reference to any predisposition the courts may have demonstrated in favour of simple interest as against compound interest. It is purely one of contractual interpretation. The agreement is to be interpreted so as to give effect to the meaning intended by the parties. Hence any presumption in favour of simple interest is out of place in determining the words in issue.
61 I adopt that statement of principle in analysing the loan agreements in this case.
62 A question arose as to whether or not a term should be implied into the loan agreements in order to give to them business efficacy. As was said by Mason J in Codelfa Construction Pty Ltd v State Rail Authority New South Wales:[3]
The implication of a term is to be compared and at the same time contrasted with the rectification of the contract. In each case the problem is caused by a deficiency in the expression of the consensual agreement. A term which should have been included has been omitted. The difference is that with rectification the term has been omitted and should have been included was actually agreed upon, the implication of the term is one which it is presumed that the parties would have agreed upon had they turned their minds to it. It is not a term that they have actually agreed upon. Thus in the case of an implied term the deficiency in expression of the consensual agreement is caused by the failure of the parties to direct their minds to a particular eventuality and to make explicit provision for it. Rectification ensures that the contract gives effect to the parties’ actual intention. The implication of a term is designed to give effect to the parties’ presumed intention.
63 In this case I am satisfied that the parties did not in fact turn their minds to the question as to the rate upon which interest should be calculated, whether it be on a compound basis or a simple interest basis. A lacunae [sic.] therefore emerges from the agreement, but nevertheless it is one which calls for construction and interpretation.
64 Having considered the matter, I am not able to imply a term one way or the other, nor should I attempt to do that. This case rather involves the construction of an ambiguous term and doesn’t call for implying a term into the agreement to give it business efficacy. A similar approach was taken in Morton where Neave JA said:[4]
In my opinion this is a case where the court was called upon to interpret the relevant term, rather than to decide whether a term could be implied into the contract, requiring interest to be compounded. The reference in the loan agreement to the rate of interest charged by the Commonwealth Bank of Australia is capable of being interpreted as requiring payment of interest on either a compound or a simple interest basis.
65 The conclusion arrived at in the Morton case was expressed in part by Neave JA where her Honour said:[5]
In my opinion the intention of the parties viewed objectively in the light of the circumstances in which the loan was made was that interest should be compounded but the loan agreement was not drafted by lawyers who might have appreciated the difference between a provision relating to the rate of interest and the manner in which interest was to be assessed. In my opinion, a reasonable bystander would have assumed that the reference to the Commonwealth Bank’s rate of interest meant that the interest was to be assessed and paid on the same basis as it would be assessed and paid on a bank loan.
66 In Morton the Court was able to make two important findings of fact. There was evidence that the respondents had previously sought an extension of credit from their banker, the ANZ, and from other banking institutions and must therefore have known that banks charge compound interest on loans. A further finding was made that the respondents would also have been aware that the appellant would have had to pay compound interest on any indebtedness to the bank.
67 However, Morton, is distinguishable from the present case. In Morton what was essential to the finding ultimately made as to the construction of the interest provision was that the term relating to the payment of interest referred to the rate of interest charged by the Commonwealth Bank of Australia for overdrafts in excess of $100,000. No such reference to a banking rate appears in the agreements in question in the present case. It is not possible, therefore, to construe the interest clause as requiring the payment of interest on a compound basis by reference to what is the usual practice of banks or what was known to the parties to be the basis upon which banks charge interest.
68 One is then drawn back to the fundamentals of the agreement. It is to be noted that the agreement provides for a very high rate of interest, that of 3 per cent per month or 36 per cent per annum. In my opinion, given that this is an exceptionally high rate of interest, it was not intended by the parties that the interest be compounded upon those rates. More than likely, given the high level of interest that was chargeable, interest was intended to be chargeable on a simple interest calculation, and I so find.’
