SCA ruling highlights the legal pitfalls of loans among ‘friends’

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A case recently heard in the Supreme Court of Appeal (SCA) again proved that nothing ruins a friendship faster than borrowing money, particularly if the loan is in the region of R15 million.

The SCA judgment handed down in Allied Steelrode (Pty) Ltd v Dreyer and Another late last year underscores the importance of understanding “transacting at arm’s length” under the National Credit Act (NCA), particularly when lending money to family, friends, or even acquaintances.

In the case, the SCA set aside an order of the High Court in Johannesburg after the appeals court concluded that a loan offered as a gesture of friendship, where it is not customary for a person to do so and where no interest is levied, cannot be said to be an arm’s length transaction as provided for in section 4 of the NCA.

The order of the High Court held that a loan agreement entered between parties who shared a close bond and where no interest was levied against the borrower was subject to the NCA, and a subsequent acknowledgement of debt (AOD) constituted a credit agreement under the Act.

Whether this loan agreement falls under the category of a credit agreement determines, among other things, whether the lender should have been registered as a credit provider under the NCA. This, in turn, impacts the lender’s right of recourse if the money is not repaid in that such an agreement may be seen as unlawful.

The facts of the case

In 2013, businessman Paul Dreyer (the respondent) bought out his business partner Tony Cimato’s 50% shares in Lasercraft after a tragic accident involving Dreyer’s son on Cimato’s property. Needing R28m for the buyout but having only R13m, Dreyer accepted a loan of R15m from W V Rippon and A Chadha, the owners of Allied Steelrode (the appellant), a steel-processing company with which Lasercraft did business.

Rippon testified that he had known Dreyer for about 20 years, describing a relationship that went beyond business. They had socialised together, including participating in activities such as a biking rally, and visited each other. Dreyer even asked Rippon to accompany him to identify his son’s body.

The testimony states that, noticing signs of distress in Dreyer, Rippon discussed with Chadha how to help him. Chadha offered to lend Dreyer the money needed to bridge the financial gap. Rippon testified that although he didn’t agree at first he later chose to help, a decision influenced by “emotion”.

The loan was initially informal, agreed upon with a handshake and without interest. The terms of the loan agreement were later formalised in the AOD signed on 1 October 2014. The AOD included a grace period of six months before interest would accrue on mora (a wilful delay or default on terms).

Claims before the court

Although Dreyer and his wife, Aletia (the second respondent), admitted to the existence of the AOD, they invoked the applicability of the NCA and a clause of the AOD.

Allied Steelrode pleaded two alternative claims. The first was repayment of the R15m, based on the signed AOD. The other was that if the court found that the AOD was not compliant with the formalities of the NCA, rendering it unlawful and/or void, then the Dreyers would be “unjustly enriched” to the amount of R15m.

The SCA identified the actual issues in dispute as whether the transaction between the parties was concluded at arm’s length and whether it constituted a credit agreement under the NCA.

Court’s judgment

The SCA found that the loan agreement leading to the AOD was not conducted at arm’s length. This meant the initial conclusion of the High Court, suggesting that the parties engaged in an arm’s length transaction, was flawed and not supported by the evidence.

According to the SCA, the evidence showed that the loan stemmed from an oral agreement, with no interest involved, between parties with a familial relationship, which does not align with arm’s length dealings.

The court held that, on the facts of the case, neither the loan nor the AOD were subject to the NCA.

Furthermore, the judgment highlighted that although the AOD did not fall under the NCA, it still qualified as a credit agreement. The SCA ruled that the High Court’s decision to declare the agreement unlawful and void under section 89 was considered a misdirection.

The High Court was, therefore, in error and its order had to be set aside.

Credit agreements subject to the NCA

At present, any credit agreement above R0.00 loaned to a consumer in South Africa where interest (or similar a charge/fee) is charged on the loan falls within the ambit of the NCA. However, this is subject to certain exceptions or where the parties are not transacting at arm’s length.

Gerrit Viviers, an NCA specialist at Moonstone Compliance and Risk Management, explains that if the credit agreement had been found to be subject to the NCA, Allied Steelrode would have been required to register as a credit provider. However, this was not the case.

Since the loan agreement wasn’t under the jurisdiction of the NCA, the Dreyers could not avoid repaying the debt by arguing that Allied Steelrode did not register as a credit provider.

“In this scenario, it was alleged by the respondent, who is the borrower, that this agreement should have fallen within the application of the NCA and, therefore, because the appellant (Allied Steelrode) was not registered, now, suddenly it’s an unlawful credit agreement. And then on that basis, you forego interest, you forego fees and, worst-case scenario, a court can find that you even forego the principal debt that was borrowed.”

Viviers says not all credit agreements are necessarily subject to the NCA.

“As an example, if you have a credit agreement that is entered into between two juristic persons where the consumer is also a juristic consumer, and that agreement is a large agreement or that juristic consumer’s annual turnover or asset value is more than R1m, then those type of credit agreements will typically fall outside of the NCA.”

Undue enrichment

As touched on in the SCA judgment, whether the credit agreement was subject to the NCA and the AOD constituted a credit agreement were only two among the multiple issues at stake in this case. Another was if there had been undue enrichment.

Undue enrichment refers to a situation where one party benefits unfairly or unjustly at the expense of another party. In the context of a credit agreement, undue enrichment may arise if one party receives a financial advantage or benefit without fulfilling its obligations under the agreement, resulting in an unfair advantage over the other party.

Viviers clarifies that Allied Steelrode claimed it had an AOD, which it sought to enforce to recover the R15m, plus accrued interest.

“As an alternative to the enforcement of the AOD, if the court finds that the AOD is a credit agreement and Allied Steelrode should have been registered as a credit provider under section 40 of the NCA, Allied Steelrode would likely have been able to claim the R15m back as part of the undue enrichment claim.”

When is a transaction at arm’s length?

The concept of “at arm’s length” is loosely defined as a type of transaction where both parties act independently and have no relationship to each other.

Viviers says, normally, the lender strives to obtain “the utmost possible advantage” from that transaction. That usually entails charging a market-related interest rate.

“As soon as somebody says, well, I don’t want any interest – in addition to the fact that it’s one of the elements of credit that’s not present – you could argue this person is clearly not trying to obtain the utmost possible advantage here. So, they’re not dealing at an arm’s length. It’s within an arm’s length, and, therefore, the agreement would fall outside of the application of the NCA.”

Viviers says three aspects stood out in this particular case.

“First of all, there was a type of friendship relationship. Secondly, it was not the appellant’s normal course of business to provide any form of loans whatsoever. And initially, there was not any interest that was negotiated.”

He explains that with credit agreements that fall within the application of the NCA, there are typically two elements:

  • payment that has been deferred and needs to be repaid at a certain point; and
  • interest fees or charges that apply from inception.

“The AOD had an interest component, but the initial agreement had no interest component at all. Logic prevailed, and the SCA made the right call to say there was no intention to obtain the utmost possible advantage.”

However, according to Viviers, that although the NCA provides guidance on determining whether a transaction is conducted at arm’s length, there are many instances where it is subjective and relies on the specific details of each case. He says the final determination ultimately falls to the court to decide.

1 thought on “SCA ruling highlights the legal pitfalls of loans among ‘friends’

  1. This was an extremely useful and informative article. Thank you .

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