It sometimes happens that, when money has been borrowed, the transaction doesn’t pan out as expected and the parties have to reach a compromise. For an example, the parties might agree that a reduced lump sum need only to be repaid, or that a lowered interest rate will be applied.
What happens when it turns out that the original Loan Agreements were unlawful because they did not comply with the National Credit Act? Will the parties be able to enforce their compromise Agreement or will it also be invalid like the underlying Loan Agreements?
This was the question considered by three Judges in the Western Cape High Court in the matter of Blacher v Josephson 2023 (3) SA 555 (WCC).
In that matter the parties entered into a Loan Agreement where they agreed on repayment terms and the interest that would accrue on the loan. After only a portion of the loan had been repaid, the parties reached a compromise – they agreed on a fixed amount to be repaid and that interest would no longer accrue.
The Loan Agreement amounted to a Credit Agreement and therefore fell under the provisions of the National Credit Act. The lender was not registered as a Credit Provider at the time of the loans and, as a result, the Loan Agreement were unlawful according to the National Credit Act and could not be enforced.
But what of the subsequent compromise Agreement the parties concluded? Could that Agreement be enforced? The Court made the following findings on this issue:
A compromise is commonly defined as an Agreement in terms of which the parties to a dispute, the outcome of which is uncertain, agree to settle it on terms whereby each of them recedes from their positions by conceding something, thereby achieving or receiving less than they intended.
Generally speaking, a compromise is a self-standing Agreement which stands independent of the underlying claim from which the compromise arose. Once a comprise Agreement has been reached, ordinarily a party cannot then seek to enforce the original underlying claim.
However, in certain instances the unlawfulness or illegality of the underlying claim may render the compromise Agreement unenforceable.
Whether the compromise will also be unenforceable depends on the nature of the terms of the compromise agreement. If the compromise simply seeks to enforce the claim from the underlying invalid Agreement or, if a party is, in terms the compromise, attempting to benefit from the prior invalid Agreement, then the compromise Agreement will be unenforceable. In those circumstances allowing enforcement of that type of compromise Agreement would amount to perpetuation of an unlawful act and to allow it would be contrary to public policy.
The Court found that the compromise agreement in question was not “something new and valid”, it merely constituted an agreement to repay a lesser amount than that which was claimed on the prior, existing indebtedness, and set out fresh terms as to when this was to occur.
The Court accordingly found that the compromise Agreement was unenforceable.
Does this mean that the lender, who paid out the loan capital, is simply out of luck?
Not necessarily. The Court pointed out that a Credit Provider under an invalid Credit Agreement could claim his loan capital back based on an enrichment claim (it would not be possible under an enrichment claim, however, to claim the interest that would have accrued if the Loan Agreement were valid).
The Court also pointed out that a compromise Agreement may be valid and enforceable where, in terms of the Agreement, the parties expressly acknowledge that the earlier agreement is invalid, and the terms of the compromise are based on an enrichment claim.
Where parties enter into a Loan Agreement which turns out to be invalid, they cannot remedy the situation by entering into a compromise Agreement which merely seeks to enforce the invalid Loan Agreement. The terms of their compromise will need to be based on an enrichment claim.