Pub­li­ca­tions

Estab­lish­ment fees in pri­vate financ­ing transactions

As the banks have tight­ened their lend­ing cri­te­ria, we have been work­ing with a num­ber of pri­vate financiers who have increased their activ­i­ty to sat­is­fy the demand for debt finance in the SME mar­ket. Most lenders charge bor­row­ers an estab­lish­ment fee to help recov­er the costs of estab­lish­ing a loan facil­i­ty. The gen­er­al posi­tion at law is that if a term of a con­tract is a penal­ty then that term will be unen­force­able. A term is a penal­ty if a par­ty is required to pay an agreed sum which exceeds what a court would con­sid­er to be a gen­uine pre-esti­mate of dam­age like­ly to be caused by a breach. 

In a recent case in the Vic­to­ri­an Court of Appeal (Mel­bourne Linh Son Bud­dhist Soci­ety Inc v Gipp­sre­al Ltd), the court found the estab­lish­ment fee charged for the loan to be a penal­ty. The estab­lish­ment fee was orig­i­nal­ly 1.5% of the loan amount but remained unchanged when the loan amount was reduced (mak­ing the estab­lish­ment fee over 5%). It was held to be a penal­ty because the estab­lish­ment fee was extrav­a­gant, uncon­scionable and out of pro­por­tion with the loss suf­fered, and it did not relate to any pos­si­ble dam­age to, or inter­est of, the lender aris­ing from a breach by the bor­row­er. The court also inferred that the pur­pose of the estab­lish­ment fee was to pun­ish rather than to pro­tect the legit­i­mate com­mer­cial inter­ests of the lender.

In light of this case, there are a few things to bear in mind in rela­tion to estab­lish­ment fees in offer let­ters from lenders:

  1. Avoid mak­ing the estab­lish­ment fee a fixed amount (ie. where the fee remains the same irre­spec­tive of the like­ly loss) 
  2. An estab­lish­ment fee of 1% to 2.5% of the loan amount is cur­rent­ly con­sid­ered accept­able indus­try practice
  3. If the pro­posed estab­lish­ment fee is high­er, it is impor­tant for lenders to retain evi­dence to help estab­lish that the fee is a gen­uine pre-esti­mate of loss
  4. The good­will of the lender and the risk inher­ent in the loan is irrel­e­vant to quan­ti­fy­ing the pos­si­ble loss that might arise from a breach by the borrower
  5. The estab­lish­ment fee should not be designed to pun­ish or penalise a bor­row­er for default­ing or fail­ing to fol­low through with a loan. The pur­pose should be to pro­tect the legit­i­mate com­mer­cial inter­ests of the lender.