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High Court of Australia |
BANK OF NEW SOUTH WALES v. BROWN [1983] HCA 1; (1983) 151 CLR 514
Banks and Banking - Bankruptcy
High Court of Australia
Gibbs C.J.(1), Mason(2), Wilson(2), Brennan(3) and Dawson(4) JJ.
CATCHWORDS
Banks and Banking - Bank and customer - Overdraft - Interest - Debit of account twice yearly - Interest thereafter calculated on total balance - Whether debited interest capital - Insolvency of customer - Statutory postponement of proof for interest in excess of specified rate.Bankruptcy - Proof of debt - Interest - Postponement of claim for interest above stipulated rate - Capitalization of accrued interest between debtor and creditor - Bankruptcy Act 1966 (Cth), s. 112.
HEARING
Perth, 1982, August 24, 25;DECISION
1983, February 8.
2. After the company went into liquidation, the appellant lodged with the
liquidator a proof of debt in an amount exceeding $4 million.
The liquidator
decided that the debt proved included interest, and that such portion of the
debt as represented interest at a higher
rate than 8 per cent (an amount which
he held exceeded $500,000) must be postponed to all of the claims of the other
creditors, in
accordance with s. 112 of the Bankruptcy Act 1966 (Cth) as
amended, which is applicable in the winding up of a company in Western
Australia by virtue of s. 291(2) of the Companies
Act 1961 (W.A.), as amended.
At all times material to this appeal s. 112 of the Bankruptcy Act provided as
follows:
"(1) Where a creditor has proved a debt that is for, or includes,
interest, or is founded on a claim that is for, or includes,
interest, the
interest or claim shall, for the purposes of dividend, be allowed at a
rate not exceeding eight per centum
per annum.
(2) The last preceding sub-section does not prevent the creditor from
receiving a higher rate of interest than eight per centum
per annum after
all claims of the other creditors for valuable consideration in money or
money's worth (including any claim by the
spouse of the bankrupt under the
last preceding section) have been satisfied.
(3) In this section, 'interest' includes a pecuniary consideration in
lieu of interest." (at p518)
3. The sole question for decision is whether the debt proved by the appellant
included interest within the meaning of s. 112. No
question arises as to the
correctness of the calculations made by the liquidator. (at p518)
4. At first sight, the case for the appellant seems scarcely arguable. There is no doubt that the debt for which the appellant lodged its claim included amounts which originally represented interest. However, the appellant's case was that the amounts which, immediately before each was debited to the account, indubitably had the character of interest, underwent a metamorphosis when, in accordance with the practice of the appellant, each was added to the principal sum due on the account. When they were debited in that way they were, it was said, capitalized - i.e., they lost their quality of interest and were converted into capital. It was nevertheless conceded that no interest was capitalized once the mortgage had been given, for the condition under which, in accordance with the terms of the mortgage, capitalization might occur had not been fulfilled. (at p519)
5. The practice of bankers in periodically debiting accrued interest to the
overdrawn current account of a customer, and thereby
securing for themselves
the benefit of compound interest, has been said to be "a usual and perfectly
legitimate mode of dealing between
banker and customer": Yourell v. Hibernian
Bank (1918) AC 372, at p 385 . Interest so debited becomes capital in the
sense that it
thereupon bears interest. The submission on behalf of the
appellant however was that interest thus capitalized becomes a principal
indebtedness for all legal purposes. That this is so was said to be recognized
by authority. The older authorities on which the appellant
relied are fully
discussed in the judgment of Lord Atkin in Paton v. Inland Revenue
Commissioners (1938) AC 341, at pp 348-351 ,
and it is unnecessary for me to
deal with them in detail. Two of those authorities - Lord Clancarty v.
Latouche (1810) 1 Ball &
B
420 and Reddie v. Williamson (1863) 1 Macph 228
(1863 SC 228) - were cases which concerned questions as to the proper method
of
accounting between a bank on the one hand, and, respectively, an executor
and co-obligant of the customer on the other. They no doubt
show that as
between a bank and a customer, or someone standing in the shoes of the
customer, the accrued interest when debited to
the customer's account is
treated as principal, but they do not establish that such a result will follow
for all purposes and so
as to affect the rights of strangers. Two other cases
- Ex parte Bevan [1803] EngR 776; [1803] EngR 776; (1803) 9 Ves Jun 223 (32 ER 588) and Eaton v. Bell (1821)
5 B
& Ald 34 (106 ER 1106) - concerned the operation of the usury
laws which
restricted the rate of interest chargeable. The
effect
of Ex parte Bevan was
stated by Lord Atkin in Paton v. Inland Revenue
Commissioners (1938) AC, at p
348 as follows:
"An antecedent (a priori) agreement for half-yearly rests, and interest
upon the balance, would be void. But if you settle,
i.e., agree the
balance at the end of six months, there is nothing to prevent your making
a fresh start with the total debt
which no doubt includes interest: and
agreeing to forbear from suing for the whole debt at a rate of interest
meantime."
In Eaton v. Bell that case was followed and it was held that a bank which
debited a customer's account with interest at half-yearly
rests, and charged
interest upon the total, did not infringe the usury laws. These old
authorities contain statements that suggest
that interest when debited
periodically in this way is converted into principal. Although there is no
doubt that parties may, as
between themselves, agree that what is in truth
interest shall be regarded as principal, the cases do not decide that such a
transformation
may be effected so as to affect the rights of other persons,
and in Paton v. Inland Revenue Commissioners Lord Atkin (1938) AC, at
p 352
said:
"It may well be that interest is not as finally extinguished as some of
the above decisions seem to suggest . . ." (at p520)
6. Counsel for the appellant relied also on some other authorities. In Parr's
Banking Co. Ltd. v. Yates (1898) 2 QB 460 , a case
under the Statute of
Limitations, it was held that the general rule, that where principal and
interest are due sums paid on account
must be applied first to interests, had
no application to accounts between banker and customer. Vaughan Williams L.J.
said (1898)
2 QB, at p 467 :
"According to the ordinary practice of bankers the interest due is from
time to time added to the principal, and becomes
itself part of the
principal due."
The case was one between a bank and a person who had given a guarantee to
secure the overdraft of a customer, and the dictum of Vaughan
Williams L.J.
cannot be regarded as intended to suggest that the interest becomes part of
the principal for all purposes and against
all persons. Yourell v. Hibernian
Bank (1918) AC 372 was an action by a bank for an account of money due upon
the security of a mortgage,
which contained a proviso that no greater
principal sum than 5,700 pounds should be recoverable on the security. In
keeping the mortgagor's
current account the bank capitalized interest every
half year. Subsequently the bank appointed a receiver of the mortgaged
premises
and paid to the credit of the current account all sums received from
the receiver out of rents and profits and also the proceeds
of sale of part of
the mortgage security sold in exercise of the powers under the mortgage, with
the result that more than 5,000
pounds was appropriated to principal. It was
contended on behalf of the bank, inter alia, than s. 24 of the Conveyancing
and Law
of Property Act 1881 (U.K.) required the surplus on the receiver's
account to be paid in reduction of interest and that the application
of any
part of the surplus as against principal was illegal. It was held by the House
of Lords that s. 24 imposed on the receiver
a duty which was owed only to the
parties interested, and not to the Crown or to the general public (1918) AC,
at p 387 and that
the bank could not object to the appropriation which it had
itself made. It was held that the principal sum secured by the mortgage
was
represented by the debit balance of the current account (which included
accrued interest) (1918) AC, at pp 381, 384, 393 and
that for that reason
every credit to the account reduced the principal sum secured. The decision,
depending as it does on the words
of the mortgage and the conduct of the
parties, is of very limited importance, and it certainly affords no support to
the proposition
that a banker and customer who treat interest as principal may
affect third persons by their actions. (at p521)
7. Finally, the appellant referred to Inland Revenue Commissioners v. Holder (1931) 2 KB 81 . The ground on which that case was decided by the Court of Appeal was held by the House of Lords in Paton v. Inland Revenue Commissioners to be insupportable, and the reasons given by the Court of Appeal, so far as they are material for present purposes, are inconsistent with the judgments in Inland Revenue Commissioners v. Oswald (1945) AC 360 to which I am about to refer. (at p521)
8. In Inland Revenue Commissioners v. Oswald a mortgage of a reversionary
interest in settled funds provided that interest in arrears
might at the
option of the mortgagee be capitalized and added to the principal. The
mortgagee having died, her trustees executed
two instruments capitalizing the
interest due. Subsequently the respondent, the trustee of the settlement,
handed over to the mortgagee's
trustees the whole of the funds remaining in
his hands and those funds were appropriated in repayment of the principal sum
and interest
thereon (including capitalized interest). The first question for
decision was whether by virtue of the two instruments the unpaid
interest
thereby capitalized was paid within the meaning of r. 21 of the General Rules
under the Income Tax Act 1918 (U.K.). It was
held, following Paton v. Inland
Revenue Commissioners, that no payment of interest was made at the time when
the interest was capitalized.
The second question for decision was whether the
respondent was accountable for tax under r. 21 in respect of the funds which
were
actually handed over by him to the mortgagee's trustees, and it was held
that whatever was paid to the trustees over and above the
amount of the
original capital loans was in law a payment of interest, so that the
respondent was accountable under r. 21. In the
course of their speeches all
members of the House found it necessary to consider the effect of the
capitalization of interest (1945)
AC, at pp 370, 372, 373, 378-379, 381 and
all expressed approval of the statement of Lord Sterndale M.R. In re Morris;
Mayhew v.
Halton (1922) 1 Ch 126, at p 133 . Lord Sterndale M.R. there said:
". . . when these sums of interest come to be paid at the end of the time
when payment is made, although interest has been charged
upon them, and
although, as a matter of bookkeeping, they have from time to time been added
to capital, they do not cease to be interest
of money - that is to say, they
are overdue interest upon which interest has been paid."
Some of their Lordships in Inland Revenue Commissioners v. Oswald (1945) AC
360 repeated for themselves the same view. Lord Macmillan
said (1945) AC, at p
373 :
"The unpaid interest never ceases to retain its character as interest,
although it has from time to time been added to the capital
indebtedness and
has carried interest in turn."
Lord Porter said (1945) AC, at p 379 :
"Capitalization means no more than that interest, which continues to be
interest, shall be treated together with the capital
sum due as itself
interest-bearing but does not alter its quality as interest."
The remarks made by their Lordships as to the effect of capitalization were
not mere dicta. They were essential to the reasoning
which led them to
conclude that the act of capitalization did not amount to a payment of
interest, and that the actual payment, when
made, was a payment of interest.
The fact that their Lordships were concerned with a mortgage, and not with the
case of banker and
customer, does not in my opinion provide any ground of
distinction, as indeed they themselves recognized by applying, as they did,
Paton v. Inland Revenue Commissioners (1938) AC 341 , which was a case of
banker and customer. Although, as between the parties,
the right to treat
interest as capital may be affected by the terms of the mortgage, there can be
no reason to distinguish the result
of a capitalization effected by a banker
from that effected by a mortgagee. The decision in Inland Revenue
Commissioners v. Oswald
(1945) AC 360 is a clear and strong persuasive
authority against the appellant's contentions. (at p523)
9. When, in accordance with normal banking practice, accrued interest is debited to a customer's current account, and itself bears interest, it may be convenient to say that, as between the banker and the customer, and those who stand in their shoes, the interest is treated as capital. In truth, however, the interest is not converted into capital, and the rights of third parties must be determined on the footing that the interest retains its character as such. (at p522)
10. There is no legal principal that requires a court, in applying s. 112 of the Bankruptcy Act, to treat a payment which in truth included interest as though it did not. Section 112 is obviously enacted for the benefit of the creditors generally. A banker and a customer cannot, by agreement between themselves, affect the statutory priority which s. 112 affords. It is therefore unnecessary to consider whether, in the circumstances of the present case, there was an account stated between banker and customer, because, even if there were, that would not, for the purposes of s. 112, change the character of the interest which was included in the account. In law, as well as in reality, the debt proved by the appellant in the present case included interest, and the appeal should be dismissed. (at p523)
MASON AND WILSON JJ. The important issue for decision here is whether s. 112(1) of the Bankruptcy Act 1966 (Cth) applies to a proof of debt lodged by a bank so as to restrict interest to a rate not exceeding 8 per cent per annum on unpaid interest which has been capitalized by the bank in its customer's running account. The section was amended by Act No. 12 of 1980 which substituted 12 per cent for 8 per cent, but this amendment does not affect this case. Wallace J. at first instance and on appeal the Full Court of the Supreme Court of Western Australia (Burt C.J. and Wickham J., with Brinsden J. dissenting) answered the question in the affirmative. The appellant, the Bank of New South Wales, now appeals from that decision. (at p523)
2. At the outset it is necessary to summarize the facts. Tom the Cheap (W.A.) Pty. Ltd. was a customer of the bank in the period from 24 September 1970 to 21 March 1975. Throughout this period the company maintained a running account with the bank which was continuously in overdraft. According to the agreed statement of facts the bank conducted the account according to its usual practice in that it charged interest on the daily balance with six-monthly rests. As at each six-monthly rest interest was charged not only on the previous principal sum but also on accrued interest debited to the account. The account was therefore conducted according to the practice, accepted by the company, so that the interest, calculated on the company's daily balance, was debited to the company's account at the expiry of the six-monthly periods. The first of these periods commenced on 30 September 1970, being the date when the account first went into overdraft. (at p524)
3. On 19 May 1975 the company entered into a scheme of arrangement with its creditors. On 21 December 1976 it went into liquidation. Although the company still maintained an account with the bank after 21 March 1975, no further credit was given by the bank to the company after that date. At the date of the company's liquidation it was indebted to the bank in an amount of $4,477,292.20. (at p524)
4. On 10 May 1979 the bank lodged a proof of debt for that amount. The proof
of debt claimed interest at the rate of 13 per cent
per annum on unpaid
interest which had been capitalized. The amount claimed was computed as
follows:
______________________________________________________________________________
__
Date Consideration Amount Remarks
19.5.75 Balance of Account Tom the Cheap
(W.A.) Pty. Ltd. Fixed Account at20.9.75 Interest at 13% 243,841.20
date of Scheme of Arrangement 4,506,697.04
______________
5,008,805.39
Less: Credit 1,556.14 RefundInterest
______________ of Part
5,007,249.25
debited1.4.76 to Debits (ex interest) 168.30
on
20.9.75
5,374,987.87
Less: Balance in security
Realization Account 1,002,709.10
______________
Plus: Contingent leasing liability per______________________________________________________________________________ __ (at p524)
Annexure "B" 105,013.43
______________
$4,477,29.20
______________
5. Prior to June 1974 the company's debt to the Bank was unsecured. In that
month the company mortgaged its real property in favour
of the bank security
for all moneys whether then due and payable or thereafter becoming due and
payable by the company to the bank.
it was a term of the mortgage that the
"moneys hereby secured" should include interest -
". . . at the rate or respective rates agreed upon in writing if any and
in the absence of any such agreement then without
prior or other notice to
the Mortgagor or the Debtor at such rate or rates as the Bank from time to
time determines: except
as otherwise provided by the terms of any
agreement in writing relating to the whole or part of such moneys such
interest shall
accrue from day to day and shall be computed from the day
or respective days of such moneys being paid or disbursed or becoming
owing and at the end of every half year ending on the last days of March
and September in each year or on such other days
as the Bank may from time
to time determine in respect of the whole or any part of such moneys the
interest accrued due to such
day in respect of such half year (if not
paid) shall commence and thereafter so long as the whole or any part
thereof shall
remain unpaid shall continue to carry interest at the rate
aforesaid and such accrued but unpaid interest may at the option
of the
Bank be debited against the Debtor or in the case of interest upon moneys
lent paid or advanced to for or on account of
the Mortgagor or to for or
on account of any other person as aforesaid at the request of the
Mortgagor or for the payment
of which the Mortgagor is liable to the Bank
as hereinbefore stated then against the Mortgagor PROVIDED ALWAYS that
such
unpaid interest upon which interest shall have become so payable
shall not be deemed thereby or by reason of any such debiting
as aforesaid
or by the inclusion of interest with principal in any balance carried
forward or account stated or otherwise
than as hereinafter provided to
have become capitalised or added to principal but the Bank by express
entry to that effect in
its books and without the necessity of giving notice
to the Debtor or the Mortgagor may at any time and from time to time and as
from such date as the Bank shall determine capitalise and add to the
principal all or any such unpaid interest upon which interest
shall have
become so payable and whether such unpaid interest shall have been debited
as aforesaid or not and such debitings of interest
and additions to
principal may be continued and made and the provisions herein contained as
to the moneys on which interest is payable
shall continue to be applicable
so long as any of such moneys remain unpaid . . .. "
It is common ground that since the day on which the account became secured by
the mortgage it was maintained consistently with and
in accordance with its
terms. It is not the fact that "the Bank by express entry to that effect in
its books" had exercised its power
to "capitalise and add to the principal all
or any such unpaid interest". (at p525)
6. By notice dated 18 September 1979 the respondent official liquidator informed the bank that an amount of $500 had been rejected and an amount of $4,476,792.20 had been admitted. Of that sum the sum of $3,892,756.22 was found to rank equally for dividend with the other ordinary unsecured creditors and the sum of $584,035.98 was deferred in priority pursuant to s. 112. It was agreed that the sum of $500 was correctly rejected. The dispute between the parties relates to the liquidator's decision with respect to the amount of $584,035.98. (at p526)
7. It is acknowledged that the liquidator in reaching his conclusion took four main steps. First, he deducted from the amount of $5,374,987.87, the overdraft on the company's fixed account at the date of liquidation, the amount in the security realization account, being the sum of $1,002,709.10. He thereby arrived at a net claim of $4,372,278.77. It is agreed that the liquidator was correct in taking this step. Secondly, he reduced the interest to 8 per cent in all cases where the actual interest exceeded that figure, resulting in his calculation of the amount of $696,598.05 as excess interest. Thirdly, he made an adjustment in order to compute what amount the interest would have been had it been calculated on yearly rests instead of half yearly rests. This calculation resulted in the deduction of a further sum of $21,377. Finally, pursuant to s. 89 of the Bankruptcy Act, he apportioned the proceeds of the security realization account partly to principal, partly to interest at 8 per cent and partly to excess interest. The bank contends that the liquidator erred in taking the second and third steps described above. (at p526)
8. By a summons under s. 279 of the Companies Act 1961 (W.A.) the bank sought an order that the liquidator's decision be reversed in so far as it related to the sum of $584,035.98. The summons was dismissed by Wallace J., his decision being affirmed by the Full Court. The question which now arises for our determination is whether the debt of $4,476,792.20, being the debt proved by the bank, was, within the meaning of s. 112(1) of the Bankruptcy Act "a debt that . . . includes . . . interest". (at p526)
9. Section 112 provides:
"(1) Where a creditor has proved a debt that is for, or includes,
interest, or is founded on a claim that is for, or includes,
interest, the
interest or claim shall, for the purposes of dividend, be allowed at a rate
not exceeding eight per centum per annum.
(2) The last preceding sub-section does not prevent the creditor from
receiving a higher rate of interest than eight per centum
per annum after
all claims of the other creditors for valuable consideration in money or
money's worth (including any claim by the
spouse of the bankrupt under the
last preceding section) have been satisfied.
(3) In this section, 'interest' includes a pecuniary consideration in
lieu of interest." (at p526)
10. The bank's case is that when in a running account between a bank and its
customer the bank on the rest day debits the customer's
account with interest
which has accrued during the period since the last rest day, upon which
interest is thereafter charged, it
is converted from interest into capital and
that it thereupon ceases to be "interest" within the meaning of s. 122. (at
p527)
11. There is, the bank argues, an impressive stream of authority for its major proposition that, on the capitalization by a bank of unpaid accrued interest on a current overdraft account at regular periods, the unpaid interest loses its character as interest and becomes capital. Halsbury's Laws of England, 4th ed. (1973), vol. 3, par. 160, regards the cases as establishing this proposition. (at p527)
12. They begin with the decision of Lord Eldon L.C. in Ex parte Bevan [1803] EngR 776; (1803) 9 Ves Jun 223 (32 ER 588) where his Lordship decided that, although compound interest could not be taken under an antecedent contract because such a contract would infringe the statute of 12 Ann. (2), c. 16 (1713) which prohibited a contract to pay a higher rate of interest than 5 per cent per annum, it was permissible to settle as at the end of a period, this not being part of the prior contract, and then forbear the six months' interest being payable on the entire amount then owing, that amount including the unpaid interest. The Lord Chancellor appears to have had in mind an express agreement to settle accounts. (at p527)
13. In Lord Clancarty v. Latouche (1810) 1 Ball & B 420 Lord Manners L.C., in applying the principle stated by Lord Eldon L.C. in Bevan, took it further. First, he presumed an agreement at the end of every year between banker and customer that interest then due should become principal. Secondly, by saying that unpaid interest became principal he made explicit what was implicit in Lord Eldon's earlier remarks. (at p527)
14. Later, in Eaton v. Bell (1821) 5 B & Ald 34, at pp 40-41 (106 ER 1106 at
p 1108) Abbott C.J. said:
"It is clear from the facts stated, that the defendants assented to that
mode of keeping the accounts, and the bankers who advanced
the money might
have done it on the faith that they should have been permitted to convert
the interest from time to time into capital
. . .." (at p527)
15. The same approach was adopted by the Court of Session in Reddie v.
Williamson (1863) 1 Macph 228 (1863 SC 228) where the issue
was whether the
amount which the banker sought to recover exceeded the limit of 400 which had
been placed on the co-obligor's guarantee.
The court rejected the banker's
argument that the amount sued for contained a substantial interest component
and therefore did not
exceed the limit which was applicable to principal only,
stating that the accumulation of interest at each annual balance converted
the
interest so accumulated into an advance by the bank. Lord Inglis, the Lord
Justice-Clerk, after saying of the capitalized interest
that it "not only
becomes principal, but never thereafter ceases to be dealt with as principal"
(1863) 1 Macph p 236 (1863 SC, at
p 236) , went on to state (1863) 1 Macph at
p 237 (1863 SC, at p 237) :
"The privilege of a banker to balance the account at the end of the year,
and accumulate the interest with the principal, is
founded on this plain
ground of equity, that the interest ought then to be paid, and, because it
is not paid, the debtor becomes
thenceforth debtor in the amount, as a
principal sum itself bearing interest . . . "
and observed that interest was thus converted into principal. (at p528)
16. We put to one side the different view expressed by Lord Cowan (1863) 1
Macph at p 238 (1863 SC at p 238) :
" . . . that the periodical interest at the end of each year is a debt to
be then paid, and which must be held to have been
paid when placed to the
debit of the account as an additional advance by the bank for the
convenience of the obligants."
This view is plainly incorrect. It is unsupported by authority except for a
comment made by Younger L.J. in In re Morris; Mayhew
v. Halton (1922) 1 Ch
126, at p 138 , a comment which was later disapproved by Russell J. in In re
Jauncey; Bird v. Arnold (1926)
1 Ch 471 . In that case Russell J. observed
that "the interest is not capitalized because it is in fact paid, but because
it has
in fact not been paid" (1926) 1 Ch, at p 476 , an observation which was
later approved by the House of Lords in Inland Revenue Commissioners
v. Oswald
(1945) AC 360, at pp 370, 373, 378, 381 . (at p528)
17. Again in Parr's Banking Co. Ltd v. Yates (1898) 2 QB 460 , Rigby L.J. and Vaughan Williams L.J. (1898) 2 QB, at p 467 spoke of capitalized interest becoming principal, and in Yourell v. Hibernian Bank (1918) AC 372 , a case to be discussed shortly in greater detail, the House of Lords took the same view, Lord Finlay L.C. (1918) AC, at p 381 , Lord Atkinson (1918) AC, at p 384 and Lord Parker of Waddington (1918) AC, at p 393 stating that unpaid interest debited by the bank at half yearly rests was principal owing to the customer by the bank. This view also prevailed in Inland Revenue Commissioners v. Holder (1931) 2 KB 81 , where the Court of Appeal held that once interest had been capitalized, according to the regular practice of bankers, it could not ground a deduction for payment of interest due under s. 36 of the Income Tax Act 1918 (U.K.). Lord Hanworth M.R. (1931) 2 KB, at p 94 referred to "the system of bankers in turning interest into capital as usual and binding on the parties who have acquiesced in it". (at p529)
18. The appellant relies strongly on Yourell. There the customer mortgaged land to the banker to secure moneys owing including those on his overdraft account. The mortgage deed contained a proviso that no greater principal sum than 5,700 pounds should be recoverable on the security. In the mortgagor's current account, interest as stipulated was charged from day to day with half-yearly rests, so that the interest was capitalized every half year. The mortgagor eventually owed more than 5,700 pounds. The bank appointed a receiver. The bank paid to the credit of the mortgagor's account moneys received by it from the receiver, appropriating more than 5,000 pounds to the payment of principal. In an action to enforce the security the bank claimed that an account should be taken as between mortgagor and mortgagee and that any surplus on the receiver's account ought to be applied in reduction of interest. The House of Lords, in rejecting this claim, stated that there was no case for re-opening the account, it having been regularly communicated to the mortgagor and assented to by him. Lord Atkinson described it as a "settled account" (1918) AC, at p 392 . (at p529)
19. There are, however, a series of revenue cases which, it has been
suggested, are inconsistent with the approach which we have
outlined thus far.
Of these decisions, three - In re Craven's Mortgage; Davies v. Craven (1907) 2
Ch 448 , In re Morris (1922) 1
Ch 126 and In re Jauncey (1926) 1 Ch 471 might
be distinguished on the ground that the agreement in each instance was merely
to pay
compound interest, there being no agreement express or implied to
capitalize unpaid interest. But the reasoning in two of the judgments
and the
effect of later decisions of the House of Lords throws the validity of the
distinction into serious question. As we have
seen, the comment of Russell J.
in In re Jauncey (1926) 1 Ch, at p 476 was approved in Oswald. Of equal, if
not greater significance,
were the remarks of Lord Sterndale M.R. in Morris
which were also subsequently approved in Oswald. The Master of the Rolls,
speaking
in a context in which capitalization was not expressly provided for,
said (1922) 1 Ch, at p 133 :
"I think that the word 'capitalisation' used in many of the books quoted
is a convenient word, but for the purposes for which
it has been used in
the argument before us it is a fallacious word, because it is taken as
referring to capitalisation for
all purposes, income tax and otherwise. I
do not think that is the meaning of the word. In may opinion . . . when
these sums
of interest come to be paid at the end of the time when payment
is made, although interest has been charged upon them, and
although, as a
matter of bookkeeping, they have from time to time been added to capital,
they do not cease to be interest
of money - that is to say, they are
overdue interest upon which interest has been paid." (at p530)
20. In Paton v. Inland Revenue Commissioners (1938) AC 341 it was decided
that the action of a bank in debiting a customer's account
with unpaid
interest on half yearly rests did not constitute as between the bank and the
customer a payment of interest by the customer
within the meaning of s. 36(1)
of the Income Tax Act 1918 which would have entitled the trustee of the
customer's estate to recover
the amount of income tax thereon. It is important
to note the treatment of the decided cases in the speeches of Lord Atkin and
Lord
Macmillan and the reservations which they expressed. Paton does not
affirm the Bevan principal on the footing that capitalization
works a
conversion of interest into principal so that it ceases thereafter to have the
character of interest for all purposes. In
discussing Bevan Lord Atkin and
Lord Macmillan made no reference to the conversion of interest into principal,
pointing to the difference
between an antecedent agreement and one which is
subsequent involving, as Lord Atkin put it, "making a fresh start with the
total
debt which no doubt includes interest" (1938) AC, at p 348 . His
Lordship went on to say (1938) AC, at pp 351-352 :
"I would only add that the question does not arise in this case whether,
if the debit balance including interest is paid
in the next or succeeding
accounts either in whole, or by a specific appropriation of a sum to the
past interest, that is or is not
a payment of interest for the purposes of
the Income Tsx Act, It may well be that interest is not as finally
extinguished as some
of the above decisions seem to suggest . . . . "
And Lord Macmillan remarked (1938) AC, at p 357 :
"Now it may well be that as between a bank and its customer this method
of dealing may have the result that the accrued
interest which the bank
has with the customer's assent added to the principal loan thereby ceases
to be due or recoverable
as interest, but becomes merged in the principal
loan." (at p530)
21. These comments may be seen as a bridge to the last of the revenue cases,
Oswald (1945) AC 360 , which presents some difficulty
for the appellant's
case. Oswald related, not to a customer's running account with his banker, but
to the question whether capitalization
by a mortgagee of unpaid interest under
a mortgage of a reversionary interest involved "payment of any interest of
money" so as to
impost a liability under r. 21 of the General Rules applicable
to schedules of the Income Tax Act 1918 on the person paying the interest
to
deduct the amount of tax ayable on the amount of that interest. It was held
unanimously that capitalization did not involve payment
of interest. Their
Lordships approved the statement of Lord Sterndale M.R. in Morris and rejected
the argument that any distinction
should in this respect be drawn between
capitalization of interest in a customer's running account with a bank and
capitalization
of interest under a mortgage, regarding the principal applied
in Paton as decisive. (at p531)
22. Lord Macmillan and Lord Porter gave expression ot a proposition
concerning capitalization of interest which is implicit in the
other speeches.
Lord Macmillan said (1945) AC, at p 373 :
"Capitalization means no more than that interest, which continues to be
interest, shall be treated together with the capital
sum due as itself
interest-bearing but does not alter its quality as interest." (at p531)
23. Mr. Meagher, for the appellant, submits that neither the decision in
Oswald nor the principle according to which it was decided
touches the present
case. It was a case involving an account between mortgagor and mortgagee in
which there was no suggestion of
an account stated or settled account.
According to his argument, the principle that capitalization converts interest
into principal
rests at bottom on settled account which takes place
consensually as between customer and banker in relation to the customer's
running
account at each rest period. In this respect he claims that Yourell
has a special significance because it acknowledges that the Bevan
principle
applies between banker and customer on this very footing and it was not
overruled or even discussed in Oswald and Paton.
This, it is suggested,
confirms that, despite the generality of the comments made in the speeches in
Oswald, no reflection on the
Bevan principle as applied in Yourell was
intended. (at p531)
24. The thrust of this argument is blunted by the reservations expressed by Lord Atkin and Lord Macmillan in Paton and by the refusal of Lord Porter and Lord Simonds in Oswald to draw any distinction between capitalization of interest under a mortgage and capitalization of interest between banker and customer according to the custom of bankers (1945) AC, at pp 379, 380 . For our part we are much inclined to agree with this view. (at p532)
25. However, in the ultimate analysis the decision in the present case hinges, as did the decision in Bevan itself, upon the construction of the relevant statute. True it is that in Bevan reliance seems to have been placed on the proposition that unpaid interest on a running overdraft account, once capitalized according to the practice of bankers, ceases to be interest and becomes capital. But the Lord Chancellor's reliance on this proposition was an inessential element in his conclusion that the statute on its true construction did not prohibit the taking of interest on unpaid interest which had been capitalized, notwithstanding that the result of doing so was in effect to secure the payment of interest at a rate exceeding the prescribed maximum. It goes without saying that the reasons which induced his Lordship to take that view of the statute of 12 Ann. (2) c. 16 have little to do with the interpretation of s. 112. (at p532)
26. When we look to s. 112 it is apparent that the section was enacted to protect the general creditors of an insolvent estate against the proof of debts which included claims for interest based on excessive interest rates. This it does by imposing a general limitation on the inclusion in proofs of debt of claims for interest based on a rate exceeding 8 per cent per annum. So long as this limitation is read as applying to amounts included in a proof of debt which originated as interest, whether they have been capitalized or not, the section serves the object which we have ascribed to it. If, however, the limitation is so interpreted that it has no application to capitalized interest included in a proof of debt the object of the section is more obscure. It might still be described as a provision which is designed to protect creditors generally. But the protection which it conferred on them would then be made subject to an exception which would be at variance with the interests of creditors generally. It is an exception which would preserve to any creditor the freedom to agree in a particular case with the bankrupt or the company, as the case may be, that unpaid interest should be capitalized and bear interest, thereby enabling that creditor to prove for an amount that would exceed a return of 8 per cent per annum on the unpaid principal sum. (at p532)
27. In our view the section should be read in conformity with its evident object of protecting creditors generally so that it prohibits the inclusion in a proof of debt of a claim for interest based on a rate of interest exceeding 8 per cent per annum, treating the word "interest" as referring to an amount whose original character was interest, even if it subsequently became capitalized by arrangement between the parties. (at p533)
28. The fact that in the present case there was a settled account between the appellant and the respondent is then of no significance. The importance of the settled account for Yourell was that it precluded the bank from reopening the account with the mortgagor. Here, however, we are concerned to construe and apply a statutory provision. (at p533)
29. In the result we would dismiss the appeal. (at p533)
BRENNAN J. Section 112 of the Bankruptcy Act 1966 (Cth) prescribes a rule for adjusting the rights of creditors inter se. A debt for interest, or a debt that includes interest, or a debt that is founded on a claim that is for, or includes, interest is subject to the adjustment specified in sub-s. (1) until all creditors for valuable consideration in money or money's worth have been satisfied. For the purposes of dividend, the interest or claim is to be allowed at a rate not exceeding 8 per cent per annum. That rule is applied by s. 291(2) of the Companies Act 1961 (W.A.) to the adjustment of the rights of creditors in the winding up of an insolvent company. Tom the Cheap (W.A.) Pty. Ltd. is such a company; the respondent is its liquidator; the appellant bank is a creditor in the sum of $4,476,792.20, an amount representing the balance owing by the company on its overdrawn current account when it went into liquidation on 21 December 1976. The bank had charged interest on the overdrawn current account of the company at a rate in excess of 8 per cent per annum. The bank contends that, prior to June 1974, the interest charged had been capitalized and had lost the character of interest so that the rule has no application; the liquidator contends that the interest charged has retained the character of interest and is to be allowed at only 8 per cent per annum for the purposes of dividend. There is no dispute as to the interest charged after June 1974. In June 1974, the company gave the bank a mortgage to secure its indebtedness and the terms of the mortgage provided that any interest accruing thereafter should not be capitalized or added to principal unless the bank should otherwise determine by express entry to that effect in its books. As the bank did not so determine, interest accruing subsequent to the mortgage is conceded to be subject to adjustment in accordance with the rule expressed in s. 112 of the Bankruptcy Act. (at p533)
2. From 30 September 1970 until June 1974 the company's account was in overdraft. During this time, according to the agreed statement of facts, the bank "conducted the account according to its usual practice in that it charged interest on the (company's) daily balance with six monthly rests. As at each six monthly rest interest was charged not only on the previous principal sum but also on accrued interest debited to the account. The account was accordingly conducted according to the practice, accepted by the (company), such that the interest, calculated on the (company's) daily balance, was debited to the (company's) account at the expiry of the six monthly periods." The question is whether the amounts thus debited on the rest days between 30 September 1970 and June 1974 retained their character as interest after they were so debited. (at p534)
3. How does a debt for interest, or the interest component of a larger debt (i.e., "a debt that includes interest") lose its character as interest? Not merely by allowing the debt to stand as a debit item in a running account. A debt takes its character from the circumstances of its creation and thus the interest which was charged on the daily balance was a debt for interest. The question for determination is whether it remained a debt for interest until discharge of the debt or whether, by some legal alchemy, its character was transformed before discharge. A related question - to which s. 112(3) is relevant - is whether, upon discharge of a debt for interest, another debt or liability which takes its place is a debt or liability of the same character. But since, in my view, that question does not arise upon the facts of this case, I put that question and s. 112(3) aside, and turn to the primary question whether the debt for interest has lost its character so that it is not subject to adjustment in accordance with s. 112. (at p534)
4. The bank submits that it had and exercised the right to capitalize
interest on the rest days and that interest loses its character
on
capitalization. But what is meant by capitalization? There is a sense in which
interest may be said to be capitalized though it
retains its character as
interest. That sense was explained by Lord Sterndale M.R. in In re Morris;
Mayhew v. Halton (1922) 1 Ch
126, at p 132 in a passage which has commanded
assent in later cases:
"The process would be more complicated but would, as it seems to me,
effect the same result, if the interest were not added
to the capital, but
two accounts were kept, one charging interest upon capital year by year,
and the other charging interest
upon the sums of overdue interest which
are not paid from year to year. That however is not the way in which it is
done in
practice. It would be a cumbrous and unbusinesslike way of doing
it. The way in which it is done as a matter of business is
by adding the
interest year by year - namely, the interest for the first year to the
capital sum, the interest for the second
year to the capital sum, plus the
first year's interest. This is commonly and conveniently spoken of as
capitalising the
interest. It is capitalising the interest in a sense, and
in the sense in which Mr. Beaumont put the matter to us. He said that
the
interest should be treated as capital for the purpose of bearing interest;
and in the sense that it becomes a thing which
bears interest itself which
interest, as a rule, does not, it may be said to be capitalised - that is
to say, it may be said
to be put in the same position as capital in the
sense that it is regarded as a thing which bears interest. But it seems to
me
that it is going a very long way beyond that to say that it is made
capital for all purposes, and that when it is paid, at
the expiration of
three, four, five or ten years, it is all paid, with the exception of the
last year, as capital." (at p535)
5. Capitalization which consists merely in subjecting a debt for interest to
a liability itself to bear interest is not the capitalization
upon which the
bank relies in this case. The bank contends that the interest capitalized by
the bank in accordance with its practice
loses its character as interest for
all legal purposes. The authorities on which the bank places reliance and
which have influenced
banking practice begin with a line of cases where it was
held that, on an account stated, a debt for interest was extinguished. To
ascertain from these cases whether and in what manner a debt for interest is
extinguished when it is capitalized by an account stated,
an ambiguity in the
meaning of "account stated" should be resolved. (at p535)
6. An account stated may take either of two forms (per Jordan C.J. in
Commonwealth Dairy Produce Equalisation Committee Ltd. v.
McCabe (1938) 38 SR
(NSW) 397, at p 401 ). The two forms are explained by Viscount Cave in Camillo
Tank Steamship Co. Ltd. v. Alexandria
Engineering Works (1921) 38 TLR 134, at
p 143 :
"The expression 'account stated', as Mr. Jowitt pointed out in his able
argument, has more than one meaning. It sometimes means
a claim to payment
made by one party and admitted by the other to be correct. An account stated
in this sense is no more than an
admission of a debt out of court; and while
it is no doubt cogent evidence against the admitting party, and throws upon
him the burden
of proving that the debt is not due, it may, like any other
admission, be shown to have been made in error. This is the plain result
of
the authorities, such as Perry v. Attwood [1856] EngR 597; (1856) 6 El & Bl 691 (119 ER 1021)
and Laycock v. Pickles (1863) 4 B & S 497
(122 ER
546) . Where the
transaction is of this character, it makes no difference whether the account
is
said to be stated or to
be 'stated
and agreed'; the so-called agreement
is without consideration and amounts to no more than an admission.
There is
a second
kind of
account stated where the account contains items both of
credit and debit, and the figures on both sides
are adjusted between
the
parties and a balance struck. This is called by Mr. Justice Blackburn, in
Laycock v. Pickles (1863) 4 B & S 497, at p 506
(122 ER
546, at p 549) , a
'real account stated', and he describes it as follows: -
'There is a real account stated, called in old law an insimul
computassent, that is to say, when several items of claim are
brought into
account on either side, and, being set against one another, a balance is
struck, and the consideration for the payment
of the balance is the
discharge of the items on each side. It is then the same as if each item was
paid and a discharge given for
each, and in consideration of that discharge
the balance was agreed to be due.'"
Mr. R. M. Jackson, in "The History of Quasi-Contract in English Law"
(Cambridge (1936)) at p. 110 describes the former kind of account
stated as
admissions, the latter as contracts. "The latter," he observes, "should be
discussed within the body of contract law, perhaps
the most convenient place
being in proximity to Accord and Satisfaction." (at p536)
7. Although the former kind of account stated, being an acknowledgment of a debt, infers a promise to pay (per Viscount Haldane in the Camillo Case (1921) 38 TLR, at p 137 ), the existence of the debt can be rebutted (Siqueira v. Noronha (1934) AC 332, at p 337 ). The acknowledgement does not discharge or require the discharge of the items on either side of the account. By contrast, the latter kind of account stated requires the discharge of the items on either side of the account, whatever their character, as consideration for a new liability created in their place. Hereafter, I use "account stated" to mean the contractual kind of account stated. (at p536)
8. It is not necessary that there should be debts or claims on both sides:
all that is required is that there be cross items of
account the liability for
which and the credit for which are discharged by the account stated. In Firm
Bishun Chand v. Seth Girdhari
Lal (1934) 50 TLR 465 , the Privy Council held
that, where a debtor paid various sums towards the discharge of his loan
account,
an account might be stated which discharged the antecedent debt and
created a new liability. Lord Wright, in delivering the judgment
of the board,
said (1934) 50 TLR, at p 468 :
"Indeed, the essence of an account stated is not the character of the
items on one side or the other, but the fact that there
are cross items of
account and that the parties mutally agree the several amounts of each
and, by treating the items so agreed
on the one side as discharging the
items on the other side pro tanto, go on to agree that the balance only is
payable. Such
a transaction is in truth bilateral, and creates a new debt
and a new cause of action. There are mutual promises, the one
side
agreeing to accept the amount of the balance of the debt as true (because
there must in such cases be, at least in the
end, a creditor to whom the
balance is due) and to pay it, the other side agreeing the entire debt as
at a certain figure and
then agreeing that it has been discharged to such
and such an extent, so that there will be complete satisfaction on payment
of the agreed balance. Hence, there is mutual consideration to support the
promises on either side and to constitute the
new cause of action. The
account stated is accordingly binding, save that it may be reopened on any
ground - for instance, fraud
or mistake - which would justify setting
aside any other agreement. . . .
This rule does not depend on the character or the origin of the debts or
credits on either side. . . ." (at p537)
9. When there are debit and credit items in an account and a balance is
struck by one party who sends a written statement of the
balance to the other
and the other raises no objection, is an account stated between the parties to
be inferred? Or is a mere acknowledgment
of debt by the party apparently
liable for the balance to be inferred? These are pure questions of fact but,
generally, the bare
delivery of a written statement of account by one party to
another is insufficient to raise an inference that the balance is due
on an
account stated: see Irvine v. Young [1823] EngR 425; (1823) 1 Sim & St 333 (57 ER 134) . On the
other hand, the passing to and fro of a
bank
pass-book has been regarded as
evidence
of a stated and settled account (see Blackburn Building Society v.
Cunliffe, Brooks,
& Co.
(1882) 22 ChD 61, at pp 71-72 ). (at
p537)
10. A banker and customer, like any other creditor and debtor, may make a
contract by which the balance of an account is agreed
to be the liability
owing by one to the other, liability for the items in the account being
discharged. Whether such a contract should
be inferred from the conduct of the
banker and customer (in the absence of an express contract) is a question of
fact. In Firm Bishun
Chand (1934) 50 TLR, at pp 468-469 Lord Wright referred
to some of the familiar features of the relationship between banker and
customer
as relevant circumstances for consideration in determining whether an
account has been stated:
". . . that relationship is one of debtor and creditor, the banker being
debtor when the account is in credit, and the customer
being debtor when the
account is overdrawn. It has not been doubted that in law there can be a
settled or stated account between
banker and customer: what has been
questioned is whether the acceptance by the customer without protest of a
balance struck in the
pass-book constitutes a settled account, but the
question has had reference merely to the issue whether such a settlement can
be
inferred as a matter of fact from the passing backward and forward of the
pass-book. The legal competence of such a settlement, if
made, is not
questioned." (at p538)
11. If the balance owing after debiting interest on a rest day becomes a new
liability arising upon an account stated, the debt
for the interest so debited
is discharged. If the interest charged by the bank is capitalized in this
sense, there is no debt for
interest, or no debt including interest, to which
the rule in s. 112 of the Bankruptcy Act may apply. But if the debt for
interest
is not discharged, there appears to be no reason why the rule in s.
112 should not apply
to that debt, although it has been "capitalized"
in the
sense that it is subjected to a liability itself to bear interest thereafter.
(at p538)
12. The cases in which "capitalization" has discharged a debt for interest
and those in which the debt for interest has retained
its character when it is
"capitalized" may now be examined. The first, Ex parte Bevan [1803] EngR 776; (1803) 9 Ves Jun
223 (32 ER 588) concerned
the operation of the Usury Law of 1713, 12 Ann. (2)
c. 16, upon interest charged by a
lender at the maximum lawful rate, the
accrued
interest being added to the principal sum after six months and
interest being thereafter
charged upon the whole. Lord Eldon L.C.,
finding an
account stated, upheld the creditor's claim to the whole of the interest
charged.
It was essential to the result that
the debt for accrued interest
should have been extinguished. His Lordship said (1803) 9 Ves Jun
at p 224 (32
ER, at p 588) :
"As to the question of compound interest, it is clear, you cannot a priori
agree to let a man have money for twelve months, settling
the balance at the
end of six months: and that the interest shall carry interest for the
subsequent six months; that is, you cannot
contract for more than 5 per
cent.; agreeing to forbear for six months. But, if you agree to settle
accounts at the end of six months,
that not being part of the prior
contract, and then stipulate, that you will forbear for six months upon
those terms, that is legal.
. . . It is not enough to say in this case, that
these accounts have been settled from half-year to half-year; and therefore
it is
legal to take interest in this way; for the transactions may be
evidence of previous agreement." (at p538)
13. If the lending agreement had provided that accrued interest be added to
the principal sum after six months in order that it
also might bear interest,
there would have been no discharge of the debt for interest. The interest
charged during the second six
months would have included both interest and
interest upon the interest upon the principal sum so that the total interest
during
that period would have exceeded the statutory maximum chargeable upon
the principal sum. The usury statute would have been contravened.
But as Lord
Eldon found that, by an account stated, the parties had extinguished the debt
for principal and the debt for interest
and had created a new liability which
was to remain outstanding for a further six months at interest, the usury
statute was not contravened.
Similarly, in Lord Clancarty v. Latouche (1810) 1
Ball & B 420 , Lord Manners L.C. presumed an account stated at the end of each
year from the acquiescence of the debtor in the annual settlement of the
account. The accounts were drawn up according to the contemporary
custom of
bankers which was thus described in the report (1810) 1 Ball & B, at p 421 :
". . . at particular Periods, Balances of Principal and Interest were
struck, and the consolidated Sum was introduced as the
first Item in the
subsequent Account, and Interest calculated on it."
Lord Manners L.C. said (1810) 1 Ball & B, at pp 429-430 :
"From the Acquiescence of Mr. Conolly I ought to presume an Agreement at
the End of every Year, that the Interest then due,
should become Principal
and carry Interest, which according to Ex parte Bevan [1803] EngR 776; (1803) 9 Ves Jun 223
(32 ER 588) , this Court
will admit of, and that was a Case of Half yearly
Rests. In the Case of a Mortgage
Security, it would be fair for a Mortgagee
to
call for Interest due at the End of the Year, and if not paid, to insist
on its becoming
Principal; but I admit, if this constituted
Part of the
original Contract, it would, according to Bosanquet v. Dashwood (1734) Cases
T Talbot 38 (25 ER 648) , be usurious and
oppressive." (at p539)
14. The same principle explains Eaton v. Bell (1821) 5 B & Ald 34 (106 ER
1106) , although Abbott C.J. spoke as though an account
stated, extinguishing
the debt for interest and creating a new liability, was not an inference to be
drawn from the facts but a legal
entitlement. His Lordship said (1821) 5 B &
Ald, at p 40 (106 ER, at p 1108) :
"As to the question of compound interest, it is now settled, that a party
advancing money to another is entitled to charge interest,
and at the end of
every year, then to add the principal to the interest."
Taken in isolation that proposition may be too widely stated. An entitlement
to add principal and interest so as to create a new
liability must arise upon
the consensual stating of the account; it could not have arisen out of an
antecedent contract without contravention
of the usury laws, as Abbott C.J.
recognized in the next sentence in his judgment:
"In Ex parte Bevan, it was expressly held, that although an antecedent
contract for a loan for twelve months, to settle the balance
at the end of
six months, and that the interest should carry interest for the subsequent
six months, would be bad; yet, that an agreement
at the end of six months to
settle accounts, (that not being part of the prior contract), and then a
stipulation to forbear the balance
then struck for those six months, is
legal."
The entitlement to charge interest upon capitalized interest could be
maintained in the face of the usury laws only upon the hypothesis
that the
debt for interest had been discharged by an account stated. The inference of
an account stated was readily drawn - no doubt
to ameliorate the operation of
the usury laws - but the principle is clear. Capitalization destroyed the
character of a debt for
interest by discharging the debt. (at p540)
15. The next group of cases arose out of the provisions of particular
instruments given to secure the repayment of moneys advanced.
These cases,
turning upon the construction of the respective instruments, were concerned
with the placing of capitalized interest
either within or without a
contractual category, so that the characterization of the debt in each of
these cases was for the purpose
of that instrument, not necessarily for all
purposes. Reddie v. Williamson (1863) 1 Macph 228 (1863 SC 228) arose out of a
joint
and several guarantee for moneys drawn upon the British Linen Company or
due to it to a maximum of 400 pounds with interest. The
guarantee included
what Lord Justice-Clerk Inglis described as an important declaration, namely:
"'that a stated account made out from the books of the said British Linen
Company, signed by their manager,' &c., 'shall
be sufficient
to constitute
and ascertain a balance and charge against us and our foresaids, and that a
suspension shall not pass
on a charge so
ascertained, but upon consignation
only.'"
Thus the measure of the guarantee was to be ascertained by reference to the
books of the lender. How were those books to be kept?
Quoting the declaration,
his Lordship observed (1863) 1 Macph, at p 236 (1863 SC, at p 236) :
"It is thus matter of agreement between the bank and the joint obligants
that an account-current shall be kept in the company's
books, on which the
joint obligants are to be allowed by one of their number to make drafts to
the extent of 400 pounds, and no more,
at any one time. The parties must of
course have had in view that this account-current would be kept in the way,
in which bankers
always keep such accounts, balancing the account at the end
of the year; and, in the event of the interest accruing during the past
year
not being otherwise paid or provided for, placing the amount of such
interest as the last item to the debit of the account,
and accumulating such
interest along with the principal sum due on the account, and bringing down
the balance thus ascertained, consisting
partly of principal, and partly of
interest, to the new account for the ensuing year, and placing the
accumulated balance as the
first article of debit in that new account. Where
an account is kept in this way consistently throughout its whole course, the
interest
thus accumulated with principal, at the end of each year not only
becomes principal, but never thereafter ceases to be dealt with
as
principal." (at p541)
16. His Lordship's reference to the new balance "consisting partly of
principal, and partly of interest" makes it clear that he
was referring to
interest being capitalized or becoming principal in two senses, namely, that
it is part of the principal sum (a)
for which the guarantors were liable only
to the extent of 400 pounds, and (b) which should bear interest, in the sense
explained
by Lord Sterndale, M.R. The question in issue being the extent of
the guarantors' liability for principal, there was no doubt that
if the debtor
had drawn upon the bank to pay the interest, the amount so drawn would have
been added to the principal. "But," asked
his Lordship (1863) 1 Macph, at p
237 (1863 SC, at p 237)
"does it make any difference, that without a cheque the same amount is
placed to the debit of the account, and thereafter dealt
with as a principal
sum drawn out? I think not. The privilege of a banker to balance the account
at the end of the year, and accumulate
the interest with the principal, is
founded on this plain ground of equity, that the interest ought then to be
paid, and, because
it is not paid, the debtor becomes thenceforth debtor in
the amount, as a principal sum itself bearing interest." (at p541)
17. The banker's "privilege", though authorizing the periodic capitalizing of
interest so that the whole debt including capitalized
interest bears interest
thereafter, does not authorize the banker unilaterally to transform a debt for
interest into capital so as
to extinguish the character of the debt. The
judgment of the Lord Justice-Clerk does not establish that a debt for interest
can be
preserved though it ceases to be a debt for interest. Lord Cowan (1863)
1 Macph, at p 238 (1863 SC, at p 238) , however, going further
than the Lord
Justice-Clerk held that the debt for interest was discharged by payment:
"The true view is, that the periodical interest at the end of each year is
a debt to be then paid, and which must be held
to have been paid when
placed to the debit of the account as an additional advance by the bank
for the convenience of the
obligants."
Upon this view, the addition to the principal of the annual debt for interest
extinguished the debt by payment, but his Lordship's
view, to which there will
be occasion to return, has not been accepted. (at p542)
18. In Yourell v. Hibernian Bank (1918) AC 372 , a mortgage had been given to
secure certain indebtedness of the principal debtor
to the bank to a maximum
sum of 5700 pounds with interest thereon. The secured indebtedness was defined
by a covenant in the mortgage
to be -
"the balance which on any account or accounts present or future between
the mortgagor and the bank either alone or jointly
with any other person
or persons shall for the time being be owing by the mortgagor to the bank
on foot of overdrafts, bills
of exchange, promissory notes, loans,
credits, advances, interest, commission, discount, premiums on policies of
assurance,
costs, customary charges or otherwise . . .".
There was a further covenant to pay the interest each half year upon the sum
or sums remaining unpaid. In conformity with these covenants,
the parties
adopted a course of dealing, described by Lord Atkinson (1918) AC, at p 385 in
this way:
"Interest was calculated from day to day on the mortgagor's overdraft on
his current account. On the balancing of this account
each half-year the
amount of this interest was entered on the debit side of the account, a
balance was then struck, and interest
was charged during the next
half-year upon that balance. The bank, by taking the account with these
half-yearly rests, secured
for itself the benefit of compound interest.
This is a usual and perfectly legitimate mode of dealing between banker
and customer."
On these facts it was held that the entire balance including capitalized
interest was the principal sum secured by the mortgage to
a limit of 5700
pounds. Lord Finlay L.C. said (1918) AC, at p 380 :
"The mortgage was to secure the balance of the account between the
mortgagor and the bank, and the amount must be ascertained
on the footing
of the account as in fact kept."
He agreed with Cherry C.J. (who had dissented in the Court of Appeal in
Ireland) that the principal sum due upon the mortgage was
the amount of the
overdraft from time to time. (1918) AC, at p 381 . The proposition was
concisely stated by Lord Wrenbury (1918)
AC, at p 400 :
"The interest upon the overdraft was capitalized half-yearly. The mortgage
was to secure (inter alia) the debit balance of that
account. It follows
that, as against the bank, the capitalized interest must be regarded as
principal for the purpose of the proviso
in the mortgage which limits the
principal sum to be recovered to 5700 pounds."
Thus it was held that capitalized interest became principal in the sense that
it became part of the sum secured by the mortgage being
a sum which itself
bore interest under the mortgage. But the sum secured by the mortgage was
itself defined to comprehend interest
as well as overdrafts, bills of exchange
and the other advances specified in the definition clause. To hold, then, that
the capitalized
interest was to be regarded as principal for the purposes of
the proviso limiting the principal sum was not inconsistent with its
retaining
its character as interest. (at p543)
19. Other issues arose in the Hibernian Bank Case, but they are not relevant to the present case. The Hibernian Bank Case and Reddie v. Williamson were both cases in which it was necessary to determine whether the adding of accrued interest to the balance of the account on the rest day increased the amount secured being the amount which bore interest during the ensuing period. Although it was appropriate to describe such an amount as "principal", it did not follow that that description excluded a debt for interest. In the context of these cases "principal" was not used as the antonym of "interest"; rather, as a term which was wide enough to include it. (at p543)
20. Parr's Banking Co. Ltd. v. Yates (1898) 2 QB 460 has little significance
for the present case. It was there held that when accounts
are kept on the
conventional basis of periodic capitalization of interest, there is no room
for applying the rule that payments made
by the debtor are to be applied first
to interest which is due and then to principal which is due. If principal and
interest are
treated as parts of the general amount due, a payment on account
is credited against that general amount rather than against a part
of it.
Rigby L.J. said (1898) 2 QB, at p 467 :
"I think one must assume that the understanding of all parties was that
the account would be kept as between the person guaranteed
and the bank on
the usual principle with regard to such accounts - that is to say, by
treating moneys paid in from time to
time by the customer as a deduction
from the general amount due from the customer in respect of the loan and
interest thereon,
and at the end of each half-year carrying over the debit
balance to the next half-year as principal."
"Principal" is again used to mean merely the entire amount against which a
payment is to be credited and which is to bear interest
during the ensuing
period, whether or not the components of that amount include interest accrued
due and debited on a rest day. (at
p544)
21. Next there is a group of revenue cases in which it was argued that the
capitalizing of interest by a creditor was a payment
of the interest
capitalized. In Inland Revenue Commissioners v. Holder (1931) 2 KB 81 , a
guarantor of an overdrawn bank account
claimed repayment of tax under s. 36(1)
of the Income Tax Act 1918 (U.K.) in respect of interest periodically
capitalized on the
guaranteed account. The Court of Appeal disallowed the
claim upon two grounds. One ground depended upon the construction of s. 36(1)
and is presently irrelevant. On this ground the House of Lords affirmed the
judgment of the Court of Appeal (1932) AC 624 . The other
ground, not decided
by the House of Lords, was founded upon what Lord Cowan had said in Reddie v.
Williamson (1863) 1 Macph 228 (1863
SC 228) . The Court of Appeal held that
the debt for interest, being capitalized, was discharged by payment and that
the amount added
to the principal sum on the rest day was in truth a fresh
advance of capital applied in payment of the interest debt (1931) 2 KB,
at pp
95, 100 . However, this view was rejected by the House of Lords in Paton v.
Inland Revenue Commissioners (1938) AC 341 and
again in Inland Revenue
Commissioners v. Oswald (1945) AC 360 . In Paton's Case, Lord Atkin laid to
rest Lord Cowan's dictum in Reddie
v. Williamson saying (1938) AC, at pp
350-351 :
"A misfortune in the case is that Lord Cowan, misinterpreting, as I
venture to think, the analogy adopted by the Lord Justice
Clerk, goes
further and says in a passage cited in Holder's Case (1931) 2 KB 81 by
Romer L.J. that the true view is that
the periodical interest must be held
to have been paid when placed to the debit of the account as an additional
advance by the
bank for the convenience of the obligants. This seems to me
contrary to what was said by the Lord Justice-Clerk, and to be
wrong. The
simple fact is that the amount of interest accruing during the half-year
is ascertained at the end of the half-year
and is added to the account as
a debt in precisely the same position as the other debit items whether for
money lent, the price
of securities bought, commission or other source of
debt. It takes its position as part of the whole debt due to the bank,
and, as part of the whole debt, is in the next half-year chargeable with
interest. It is no more paid than are other items
of the total debt. This
is the view, I think, clearly expressed by my noble and learned friend
Lord Russell of Killowen, then
Russell J., in In re Jauncey (1926) Ch 471
. . . ." (at p545)
22. In In re Jauncey; Bird v. Arnold (1926) Ch 1, at p 476 Russell J. had
said that where a provision enables interest to be capitalized,
"the interest
is not capitalized because it is in fact paid, but because it has in fact not
been paid". (at p545)
23. In Oswald's Case Lord Porter, following Paton's Case, said (1945) AC, at
p 379 :
"My Lords, I do not find myself able to distinguish in principle between
that case and the one the House is now considering.
In each case there is a
debt and in each case there is a contract under which, in default of
payment, a so-called capitalization
of interest takes place. It is true that
in the one case the contract is constituted by the custom of bankers and in
the other by
a deed of mortgage, but the substance, though not the
machinery, is the same. Capitalization means no more than that interest,
which
continues to be interest, shall be treated together with the capital
sum due as itself interest-bearing but does not alter its quality
as
interest."
And Lord Simonds said (1945) AC, at p 381 :
"It is not a form of payment: it is not a substitute for payment: the
interest remains unpaid, but it is impressed with a new
quality, viz., that
it carries interest as if it were capital. The interest was always charged
on the security: it adds nothing to
speak of it as a capital charge."
Lord Macmillan (1945) AC, at p 372 expressed his entire concurrence with Lord
Sterndale's statement in In re Morris (1922) 1 Ch,
at pp 131, 133 and, after
referring to what Russell J. had said in In re Jauncey (1926) Ch 471, at p 476
, his Lordship added (1945)
AC, at p 373 :
"The unpaid interest never ceases to retain its character as interest,
although it has from time to time been added to the capital
indebtedness and
has carried interest in turn." (at p545)
24. It follows that the character of a debt for interest is not altered when
it is capitalized in accordance with what Lord Eldon
L.C. in Ex parte Bevan
[1803] EngR 776; (1803) 9 Ves Jun 223 (32 ER 588) called a "previous agreement". It is
immaterial whether the previous agreement
is to be found in
the acceptance of
the custom of bankers (whether an express or implied acceptance), in a bill of
mortgage or in
some other instrument
securing a debt owed to a bank. An
agreement which merely authorizes a bank to add accrued interest to the
principal in order that
the total sum should be secured or should bear
interest does not alter the character of the debt for interest.
The total sum
may
appropriately be described as "principal", but capitalization in this
sense is no legal alchemy for changing the
character of a debt
for interest.
If the debt is discharged, whether by account stated, by payment or by other
means, a liability
which takes its place
will be of a different character. But
that is not the present case. (at p546)
25. In the present case, the several sums of accrued interest, charged on the company's daily balance and debited to the company's account at the expiry of six-monthly periods in accordance with the bank's practice accepted by the company, were debts for interest. The periodic debiting of those sums to the company's account is no evidence either of an account stated between the bank and the company affecting those debts, or of their payment. No inference of an account stated can be drawn from the company's acceptance of the statement of debits and credits and balances furnished by the bank from time to time. The inference to be drawn is that the company acknowledged the correctness of the entries, not that it agreed to discharge the debits and credits. (at p546)
26. The balance owing on the account thus includes interest, and that interest is subject to adjustment in accordance with s. 112 of the Bankruptcy Act. There is no dispute as to the quantum of the adjustment. The appeal should be dismissed. (at p546)
DAWSON J. Tom the Cheap (W.A.) Pty. Ltd. ("the company") was a customer of the applicant bank over a number of years and from 30 September 1970 its account was always in overdraft. The bank conducted the company's account according to its usual practice and charged interest on the daily balance with six-monthly rests. That is to say, at the end of each six-monthly period the interest owing, calculated on the company's daily balance, was debited to the company's account and formed part of the sum upon which interest was calculated for the next six-monthly period. The company accepted this practice whereby interest was compounded at six-monthly intervals. In June 1974 the company mortgaged its real property to the bank as security for all moneys then due and payable and thereafter becoming due and payable by the company to the bank. It is agreed that the application of the terms of the mortgage meant that the bank was thereafter not able to treat interest debited to the company's account as "capitalised or added to principal". (at p546)
2. A scheme of arrangement was entered into by the company with its creditors on 19 May 1975 and on 21 December 1976 it went into liquidation. The company still maintained an account with the bank after 21 March 1975, but no further credit was extended by the bank to the company after that date. (at p547)
3. On 10 May 1979 the bank lodged a proof of debt for the sum of $4,477,292.20, which was calculated upon the basis of an interest rate in excess of 8 per cent compounded in accordance with the bank's usual practice. (at p547)
4. The respondent, the company's liquidator, informed the bank that an amount of $500 had been rejected (for reasons which are not presently material) and that the balance of the amount claimed, namely, $4,476,792.20, had been admitted. Of the amount of $4,476,792.20, the sum of $3,892,756.22 was found by the liquidator to rank equally for dividend with other ordinary unsecured creditors and the sum of $584,035.98 was said to be deferred in priority pursuant to s. 112 of the Bankruptcy Act 1966 (Cth). (at p547)
5. That section, which applied pursuant to s. 291(2) of the Companies Act
1961 (W.A.), at the relevant time provided:
"(1) Where a creditor has proved a debt that is for, or includes,
interest, or is founded on a claim that is for, or includes,
interest, the
interest or claim shall, for the purposes of dividend, be allowed at a
rate not exceeding eight per centum
per annum.
(2) The last preceding sub-section does not prevent the creditor from
receiving a higher rate of interest than eight per centum
per annum after
all claims of the other creditors for valuable consideration in money or
money's worth (including any claim by the
spouse of the bankrupt under the
last preceding section) have been satisfied.
(3) In this section, 'interest' includes a pecuniary consideration in
lieu of interest." (at p547)
6. In ascertaining the amount to be deferred pursuant to s. 112 of the
Bankruptcy Act, the liquidator calculated interest at the
rate of 8 per cent
rather than the higher rate and upon the basis of yearly rests rather
than
six-monthly rests over the whole of
the relevant period and not just for the
last six-monthly period. It is the calculation
of this amount which the bank
disputes, saying
that when on the last occasion before the mortgage was
executed it had, in accordance
with its practice, debited the interest owing
against the company's account (as it had done on previous rest dates), it had
capitalized
that interest so that, on that date, there
was no amount of
interest accruing at all but rather a debt consisting entirely of principal.
On that assumption the bank contends
that s. 112 of the Bankruptcy Act can
only apply to defer so much of the bank's claim as consists of a claim for
interest which accrued
from the last rest date before
the date of the mortgage
and is in excess of the rate of interest allowed by the section. Other
differences
between the parties having
been settled and the figures having
been agreed, the only question in this appeal is whether s. 112 of
the
Bankruptcy Act has any application in relation to the interest which was
debited to the company's account in accordance with
the bank's practice
of
charging compound interest before the execution of the mortgage. (at p548)
7. Even if it is correct to describe the interest which was debited to the company's account on each rest date as having been capitalized, it is still necessary to discern the purposes for which the capitalization took place. And even if the interest became capitalized for all purposes, that would not seem necessarily to determine the case because s. 112 is concerned with a debt which includes interest as well as with interest as such, and it is possible, both as a matter of language and of logic, to conceive of a capital sum which includes interest as one of its components. (at p548)
8. The charging of compound interest of its nature involves periodically
taking the interest which is due and treating it thereafter
as bearing
interest itself in the same way as the original capital bore interest. In this
sense the interest is capitalized, added
to and treated as part of the
capital, although this may signify no more than the adoption of a particular
method of accounting.
In In re Morris; Mayhew v. Halton (1922) 1 Ch 126, at p
132 Lord Sterndale M.R., having described compound interest, said:
"The process would be more complicated but would, as it seems to me,
effect the same result, if the interest were not added
to the capital, but
two accounts were kept, one charging interest upon capital year by year,
and the other charging interest
upon the sums of overdue interest which
are not paid from year to year. That however is not the way in which it is
done in
practice. It would be a cumbrous and unbusinesslike way of doing
it. The way in which it is done as a matter of business is
by adding the
interest year by year - namely, the interest for the first year to the
capital sum, the interest for the second
year to the capital sum, plus the
first year's interest. This is commonly and conveniently spoken of as
capitalising the
interest. It is capitalising the interest in a sense, and
in the sense in which Mr. Beaumont put the matter to us. He said that
the
interest should be treated as capital for the purpose of bearing interest;
and in the sense that it becomes a thing which
bears interest itself,
which interest, as a rule, does not, it may be said to be capitalised -
that is to say, it may be
said to be put in the same position as capital
in the sense that it is regarded as a thing which bears interest. But it
seems
to me that it is going a very long way beyond that to say that it is
made capital for all purposes, and that when it is paid,
at the expiration
of three, four, five or ten years, it is all paid, with the exception of
the last year, as capital." (at
p548)
9. On the other hand, interest may be capitalized for purposes other than
calculating further interest. Whether or not it has been
may be of importance.
The application of a limitation period, the allocation of repayments between
principal and interest or securing
repayment by way of an additional charge
upon property may depend upon the extent to which the parties have agreed that
interest
shall be capitalized. See In re Jauncey; Bird v. Arnold (1926) 1 Ch
471 , Parr's Banking Co. Ltd. v. Yates (1898) 2 QB 460 and In
re Morris (1922)
1 Ch, at p 137 . But compound interest does not, of itself, involve the
capitalization of interest for any purpose
other than the calculation of
further interest. This fact and the fact that there was no agreement between
the company and the bank
for the compounding of interest, other than might be
inferred from the acceptance by the company of the bank's practice, led
counsel
for the bank to submit that the ordinary arrangement between a bank
and its customers, or at least the arrangement between the bank
and the
company in this case, involved not only the charging of compound interest, but
a novation at the end of each period for the
compounding of interest by which
the two pre-existing debts of capital and interest were merged into a single
new debt. (at p549)
10. In support of this argument counsel relied upon a number of authorities
which were decided at a time when the usury laws made
it illegal to stipulate
for the payment of compound interest. In Ex parte Bevan [1803] EngR 776; (1803) 9 Ves Jun 223
(32 ER 588) it was held that,
although the relevant statute (12 Ann. (2) c.
16) reduced the permissible interest
rate to 5 per cent per annum and
effectively rendered
void contracts for the payment of compound interest,
accounts might be settled,
even half-yearly, to achieve the same effect as a
contract for compound interest. The Lord Chancellor, Lord Eldon, said (1803) 9
Ves Jun, at p 224 (32 ER, at p 588) :
"As to the question of compound interest, it is clear, you cannot a priori
agree to let a man have money for twelve months, settling
the balance at the
end of six months; and that the interest shall carry interest for the
subsequent six months: that is, you cannot
contract for more than 5 per
cent.; agreeing to forbear for six months. But, if you agree to settle
accounts at the end of six months,
that not being part of the prior
contract, and then stipulate, that you will forbear for six months upon
those terms, that is legal.
So this is legal between merchants; where there
is no agreement to lend to either; but they stipulate for mutual
transactions; each
making advances; and that, if at the end of six months
the balance is with A., he will lend to B.; and vice versa. That sort of
transaction
has taken place."
See also Lord Clancarty v. Latouche (1810) 1 Ball & B 420 ; Eaton v. Bell
(1821) 5 B & Ald 34 (106 ER 1106) . The origin
of the notion,
to be seen in
these cases, that upon each occasion on which interest is compounded there is
a separate agreement between
debtor and
creditor to treat the unpaid interest
as bearing interest itself, is to be found in the usury laws. An initial, or a
priori,
agreement
for the charging of compound interest would have been
usurious and void because the interest rate provided by the agreement,
calculated
upon a simple interest basis, would have exceeded the permissible
limit. But an agreement each year or half year to settle
accounts
afresh
enabled the interest rate to be kept within that limit. However, the finding
of a fresh agreement, even when based
on the
acquiescence of the debtor, did
not necessarily involve a settlement of accounts amounting to an account
stated. See Lord
Clancarty
v. Latouche (1810) 1 Ball & B, at p 428 . (at p550)
11. After the repeal of the usury laws in 1854, this approach, which had
allowed the benefit of compound interest whilst observing
the letter of the
law, developed into, or was supplanted by, the idea that the compounding of
interest by bankers was to be explained
not only in terms of the
capitalization of interest, but by regarding the capitalization as the
equivalent of payment of interest,
or even payment itself by means of a
further advance by the bank which was then added to the existing debt. In the
Court of Session
in Scotland, in Reddie v. Williamson (1863) 1 Macph 228, at p
237, (1863 SC, at p 237) the Lord Justice-Clerk, Lord Inglis said that
the
invariable practice of bankers was to deal with a debtor to whom they extended
credit as if he:
". . . instead of paying the interest otherwise at the end of the year,
had given the bank a cheque for the amount on the
cash-credit account,
with which the bank extinguished the interest, and then placed the amount
of the cheque to the debit
of the cash account as an ordinary draft."
In the same case Lord Cowan went further and said (1863) 1 Macph, at p 238
(1863 SC, at p 238) :
"The true view is, that the periodical interest at the end of each year is
a debt to be then paid, and which must be held
to have been paid when
placed to the debit of the account as an additional advance by the bank
for the convenience of the
obligants."
To treat compound interest in this way was to regard the capitalization of
interest as being the conversion of the interest into
principal for all
purposes, and not just for the purpose of the further calculation of interest.
(at p550)
12. The charging of compound interest by bankers was recognized as a general practice in Parr's Banking Co. v. Yates but the decision in that case was equivocal as to the effect of the capitalization of interest for the purpose of calculating compound interest. In Yourell v. Hibernian Bank Ltd. (1918) AC 372 , which dealt with the application of payments as between principal and interest, the capitalized interest was treated as principal for this purpose. Counsel for the bank placed great emphasis upon this decision suggesting that it was, in effect, an affirmation by the House of Lords of the submission which he was putting. But in reality it decided no more than that the appointment of a receiver to get in moneys owing on a current account and secured, to a limited extent, by a mortgage, did not entitle the respondent bank, which kept the current account, to change its method of accounting and apply payments in by the receiver in reduction of interest rather than principal. The bank charged compound interest on the debit balance in the current account and it is true, as I have said, that interest which had been debited to this account was regarded as principal for the purposes of the application of payments by the receiver, but this amounted to no more than treating as binding the method of accounting adopted by the bank and accepted by the customer. (at p551)
13. It is also implicit in Yourell v. Hibernian Bank Ltd. (explicit in the speech of Lord Atkinson (1918) AC, at p 392 ) that there was a settled account between the customer and that bank which could not be reopened. But at the end of each rest period the bank had sent to the customer, who was one of the appellants, his pass-book together with a docket, which he signed and returned, stating that he had examined the passbook and acknowledging that he owed to the bank the amount shown. A signature is not necessary to constitute a settled account (see Willis v. Jernegan [1741] EngR 449; (1741) 2 Atk 251 (26 ER 555) ) but some acknowledgment of the balance of the account must be made. Yourell v. Hibernian Bank Ltd. does not establish that periodic accounts stated are involved in the charging of compound interest by a bank even though the customer acquiesces in that practice. In particular, the older cases beginning with Ex parte Bevan which are said to suggest the contrary, were not cited or referred to and Yourell v. Hibernian Bank Ltd. does not support what counsel for the bank sought to draw from those cases.
14. In In re Morris (1922) 1 Ch 126 the question arose whether interest,
which had by express agreement been compounded, retained
its character as
interest so as to be deductible for income tax purposes as interest when paid.
It was held that this was so and
Lord Sterndale M.R. said (1922) 1 Ch, at p
133 :
"I think that the word 'capitalisation' used in many of the books quoted
is a convenient word, but for the purposes for which
it has been used in
the argument before us it is a fallacious word, because it is taken as
referring to capitalisation for
all purposes, income tax and otherwise. I
do not think that is the meaning of word. In my opinion - not to beg the
question -
when these sums of interest come to be paid at the end of the
time when payment is made, although interest has been charged
upon them,
and although, as a matter of bookkeeping, they have from time to time been
added to capital, they do not cease
to be interest of money - that is to
say, they are overdue interest upon which interest has been paid."
See also In re Jauncey; Bird v. Arnold (1926) 1 Ch, at p 471 . (at p552)
15. In Inland Revenue Commissioners v. Holder (1931) 2 KB 81 the Court of
Appeal considered the system of bankers in charging compound
interest, not
pursuant to any express agreement, but with the acquiescence of the customer.
Again, the question was whether interest,
which had been capitalized for the
purpose of the calculation of further interest, lost its character as interest
so as to be no
longer deductible for income tax purposes. The court held that
the regular practice of bankers in compounding interest involved
capitalization
of the interest in such a way that, when the total amount
debited to the customer's account was paid, the payment could not be treated
as including the payment of interest for the purposes of s. 36 of the Income
Tax Act 1918 (U.K.). That section provided in certain
cases for repayment of
income tax in respect of interest paid to banks without deduction of tax out
of taxed profits. In re Morris
was distinguished upon the basis that it had
been decided upon the express terms of an agreement. Romer L.J., relying upon
Ex parte
Bevan, Lord Clancarty v. Latouche, Eaton v. Bell and Reddie v.
Williamson said (1931) 2 KB, at p 100 :
"I am therefore of opinion that, having regard to the method in which,
with the concurrence of the company, the account was
kept by the bank, the
company must be deemed to have paid each half-year the accruing interest by
means of an advance made for that
purpose by the bank to the company.
It is true that the reason that originally induced the banks to keep
accounts in this way has disappeared with the repeal of
the usury laws. But
that repeal cannot, as it seems to me, have changed the nature and effect of
accounts that continue to be kept
in the same way as before."
Upon appeal, the decision in Inland Revenue Commissioners v. Holder was upheld
upon another point, the House of Lords finding it
unnecessary to consider the
effect of the capitalization of interest for the purpose of calculating
compound interest. (at p553)
16. That point did, however, arise for decision by the House of Lords in
Paton v. Inland Revenue Commissioners (1938) AC 341 where
the question was
whether interest, which had been compounded, had been paid within the meaning
of s. 36 of the Income Tax Act 1918
(U.K.). It was held, contrary to the view
expressed by the Court of Appeal in Holder v. Inland Revenue Commissioners,
that it had
not. Having reviewed the earlier authorities to Reddie v.
Williamson, Lord Atkin (1938) AC, at pp 350-351 said:
"As I understand this judgment the Lord Justice-Clerk, so far from saying
that the interest is paid or is deemed to be paid,
is saying that it is
unpaid, and, because unpaid, the customer becomes debtor in the account as a
principal sum. . . . The simple
fact is that the amount of interest accruing
during the half-year is acertained at the end of the half-year and is added
to the account
as a debt in precisely the same position as the other debit
items whether for money lent, the price of securities bought, commission
or
other source of debt. It takes its position as part of the whole debt due to
the bank, and, as part of the whole debt, is in the
next half-year
chargeable with interest. It is no more paid than are other items of the
total debt."
Lord Atkin concluded (1938) AC, at pp 351-352 :
"I would only add that the question does not arise in this case whether,
if the debit balance including interest is paid
in the next or succeeding
accounts either in whole, or by a specific appropriation of a sum to the
past interest, that is or is not
a payment of interest for the purposes of
the Income Tax Act. It may well be that interest is not as finally
extinguished as some
of the above decisions seem to suggest."
Lord Macmillan (1938) AC, at p 357 referred to "this agreeable fiction whereby
debts are to be deemed to be paid without payment",
and said that its origin
might be found in "the ingenuity of lenders in devising a method of obtaining
compound interest without
contravening the usury laws". (at p553)
17. In Inland Revenue Commissioners v. Oswald (1945) AC 360 the principle of
the decision in Paton v. Inland Revenue Commissioners
(1938) AC 341 was
applied to a converse situation and it was held that for income tax purposes
interest, which had been capitalized
in order to charge compound interest, was
paid at the time that the capital sum to which that interest was added was
repaid. Lord
Macmillan said (1945) AC, at pp 372-373 :
"The option to capitalize is an option to exact compound interest. The
effect of an agreement to pay compound interest or to
'capitalize' interest
is stated with perfect clarity by Lord Sterndale M.R., in In re Morris
(1922) 1 Ch, at pp 131-133 , a statement
with which I entirely concur. Such
an agreement merely means that the interest at the stipulated rate as it
falls due if it remains
unpaid is added to the borrower's indebtedness and
itself yields interest at the stipulated rate . . . The unpaid interest
never
ceases to retain its character as interest, although it had from time
to time been added to the capital indebtedness and has carried
interest in
turn." (at p554)
18. In the present case there was no express agreement that the bank should
charge compound interest. The company's account was
conducted according to the
practice, accepted by the company, that interest, calculated on the company's
daily balance, was debited
to the customer's account at the expiry of
half-yearly periods. (at p554)
19. The debiting of the company's account with interest did not amount to payment of the interest by the company (see Paton v. Inland Revenue Commissioners (1938) AC 341 ). If it had, it might have been said with some force that the debit balance, or debt, did not include interest within the meaning of s. 112 of the Bankruptcy Act. (at p554)
20. Nor, in my view, can it be said that there was any novation affected by the periodic debiting of the company's account with interest. Acceptance by a customer of a bank's practice of charging compound interest, as in this case, does not involve a fresh agreement each time a rest occurs and interest is debited to the customer's account. An express agreement between the customer and a bank that compound interest should be charged would not, without more, have that effect and acquiescence in that course, which implies agreement to the same effect, can have no different result. In so far as the older authorities may suggest the contrary, they are based upon an analysis of the arrangement between debtor and creditor or banker and customer which is in each case explicable by reference to the usury laws rather than the actual contractual relationship between the parties. As I have said, counsel for the bank went further and sought to derive support from these authorities for his submission that at each half-yearly rest there was a novation between the company and the bank. But none of the cases stands for the proposition that an account stated or settlement of accounts is necessarily involved in the compounding of interest. See Lord Clancarty v. Latouche (1810) 1 Ball & B, at p 429 , Yourell v. Hibernian Bank Ltd. (1918) AC 372 and Parr's Banking Co. v. Yates. (1898) 2 QB 460 . Nor is there anything in the nature of compound interest which involves periodic accounts stated. (at p555)
21. The capitalization of interest for the calculation of further interest, whilst it does not of itself give rise to an account stated, does not preclude the statement of an account. Thus in the last case cited, which involved the charging of compound interest, the question whether there had been an account stated (as the trial judge held there had) was treated merely as a question of fact. And so it must be because a statement or settlement of account giving rise to a real account stated (and not merely an admission of debt) involves the striking of a balance between the parties to an account. There is a new contract for the payment of the balance, the consideration for which is the discharge of any previous items on either side of the account. See Laycock v. Pickles [1863] EngR 944; [1863] EngR 944; (1863) 4 B & S 497 (122 ER 546) , Camillo Tank Steamship Co. Ltd. v. Alexandria Engineering Works (1921) 38 TLR 134 , Firm Bishun Chand v. Seth Girdhari Lal (1934) 50 TLR 465 . But the practice of charging compound interest, even with the express or implied acquiescence of the debtor, does not without more involve a statement of accounts and in this case upon the facts agreed between the parties there was no more than the observance of a practice by the bank, accepted by the company. (at p555)
22. From the foregoing it is clear, I think, that the interest which was added to the principal debt owing by the company for the purpose of calculating further or compound interest was not paid and did not cease to be owing. It is also clear, in my view, that the compounding of interest in this manner involved no novation either by a statement or settlement of accounts or otherwise. In so far as capitalization of the interest took place, it involved no more than a rearrangement of the accounts to enable interest to be charged upon interest. This was achieved, as must always be the case with compound interest, by periodically adding the interest owing to the principal sum for the purpose of calculating the further interest. The sum added by way of interest remained discernible in its original character as interest. Even if the total sum formed by the addition of interest might be said to have been capital, that does not mean that it did not include amounts which were identifiable in their origin as interest and remained identifiable as such. Indeed, compound interest is properly described as interest upon interest and so to describe it is to assume the continued identity of the component parts of the capital upon which interest is calculated from time to time. (at p556)
23. That is sufficient to dispose of the question whether s. 112 of the Bankruptcy Act applies to the interest which was debited to the company's account half-yearly during the relevant period. For the foregoing reasons, it is my view that the debt of $4,476,792.20 proved by the company includes interest within the meaning of the section so that the section does apply. It is unnecessary to consider what the position would have been had the parties agreed that the interest should have been capitalized for purposes other than the calculation of interest, for there was no such agreement between them. (at p556)
24. I would dismiss the appeal. (at p556)
ORDER
Appeal dismissed with costs.
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