Introduction of the in Duplum Rule in Kenya: a Legal Mechanism Of

Introduction of the In Duplum Rule in Kenya: A Legal Mechanism of

Equitable Distribution of Resources or a Poverty Redistribution Initiative?

Introduction of the In Duplum Rule in Kenya: A Legal Mechanism of Equitable Distribution of Resources or a Poverty Redistribution Initiative?

Georgiadis Makadia Khaseke[1]

2008.

“If you lend money to any of my people who are poor among you, you shall not be like a money lender to him; you shall not charge him interest.” (Exodus 22: 25)

“Why then did you not put my money in the bank, that at my coming I might have collected it with interest?” Excerpt from The Parable of the Minas (see Luke 13-26)1

1. Introduction

Sir George Jessel once observed that “if there is one thing more than another which public policy requires, it is that men of full age and competent understanding shall have the utmost liberty of contracting and that their contracts, when entered into freely and voluntarily, shall be held sacred and enforced by courts of justice.”2 These sentiments still hold water now as they were before to the extent that today, courts of law exercise a great measure of caution before interfering with contracts as executed by the parties.3

This trend denotes one of the central attribute of a free market economy, or laissez-faire, as is known in French. In such an economy, “individualism is both fashionable and successful; liberty and enterprise are taken to be the inevitable and immortal insignia of a civilized society”.4 The state plays no role in the control or regulation of commercial affairs as the individuals are left to transact as they deem fit.5

Notwithstanding the above, a pure laissez-faire economy is socially untenable. This is because of the economic realities and the notion that parties to a contract are at arm’s length is not always true. There is always a real or supposed imbalance of bargaining power between the contracting parties.6 Thus, the society has long recognized the need to protect the less strong of its members and to rescue those who find themselves in situations of exploitation.7 This is premised on the fact that whereas private enterprise is the main road to public good, freedom of contract must at times succumb to the exigencies of the state and to the ethical assumptions upon which it is based.8 Therefore the state intervenes in certain circumstances by way of legislation designed to protect its members from the harsh effects of some commercial transactions induced to benefit the commercial people.

It appears that it was in pursuit of such interventionist/protectionist approach in private affairs that the Government finally put a ceiling on the amount of interest that a lender can charge a borrower on a given loan. Consequently, in 2006, vide the Banking (Amendment Act) Act No.9 of 20069 which became effective from the 1st May 200710, the Government effected a raft of amendments to the Banking Act Cap. 486, Laws of Kenya. This came hot on the heels of previous attempts to introduce these measures11 through the Central Bank Act12 Cap. 491, Laws of Kenya, which were thwarted by the banking industry players13 who had successfully urged the constitutional court to declare them illegal and unconstitutional.14 After that decision, there was no choice but to repeal section 39 of the Central Bank Act15, and reintroduce that concept again in Kenya, this time, through the Banking Act.16

This paper specifically concentrates on the amendments introduced to the Banking Act by section 17 of the said Banking (Amendment) Act17 by virtue of which a new section, Section 44A, was incorporated. This section, simpliciter, limits the amount of interest that can accrue on the principal sum/loan lent to a borrower. Though not expressly provided for, this section introduces the in duplum rule in Kenya.18 Therefore, the paper sets out, in extenso, the provisions of the said amendment law, and then it explains the in duplum rule. Thereafter the justification of the said rule will be examined with a view to discerning its limits, if any, as currently introduced in Kenya by legislation. In this regard the impact of the rule on the freedom of contract will be considered. Also, the extent of applicability of the rule in other jurisdictions will be looked at.

Further, a distinction will be drawn between the Common law19in duplum rule and the statutory in duplum as formulated in other jurisdictions where the law is slightly developed on this subject. Finally, the paper will seek to make out, in line with the title; whether the rule, as codified in Kenya, is a banking regulation mechanism, or a consumer protection initiative, as is the case in other jurisdictions. It is imperative to point that this article does not seek to interrogate the proprietary or otherwise of charging interest on loans, which subject is left to the students of morals, ethics and religion20.

2. The Amendment21

As already stated, the Banking (Amendment) Act introduced section 44A in the Banking Act22 which is reproduced here. Section 44A Limit on interest recovered on defaulted loans:

“An institution shall be limited in what it may recover with respect to a non performing loan to the maximum amount under subsection (2).The maximum amount referred to in subsection (1) is the sum of the following: the principal owing when the loan becomes non-performing; interest, in accordance with the contract between the debtor and the institution, not exceeding the principal owing when the loan becomes non-performing; and expenses incurred in the recovery of any amounts owed by the debtor.”

The above cited two subsections formulate what is known as the in duplum rule. It can be seen from paragraph (b) of subsection (2) that the amount of accrued interest on the loan is restricted to equal the amount of the principal amount owing when the loan becomes non-performing. In effect, therefore, the lender cannot recover at any one given time an amount that is more than double the outstanding principal.

3. The In Duplum Rule

a) The Meaning

In duplum is a Latin phrase derived from the word in duplo which means “in double”.23 The rule has its origin in the Roman Dutch law.24 It basically provides that interest stops running when unpaid interest equals the outstanding capital amount.25 Perhaps in more clearer and comprehensive terms, the rule was enunciated by the Zimbabwe High Court in Commercial Bank of Zimbabwe vs. MM Builders and Suppliers PVT Ltd26, as follows;

“It is a principle firmly entrenched in our law that interest, whether it accrues as simple or compound interest, ceases to accumulate upon any amount of capital owing once the accrued interest equals the amount of capital outstanding, whether the debt arises as a result of a financial loan or out of any contract whereby a capital sum is payable together with interest thereon at a determined rate.”27

In Standard Bank of SA Ltd v Oneate Investment (Pty) Ltd 1995(4) SA 510 C28 the Supreme Court of South Africa further explained the rule thus, (at page 31) “when due to payment, interest drops below the outstanding capital, interest again begins to run until it once again reaches that amount.”29

As already pointed out, the rule has its origin in the Roman Dutch law system. However, the same has been given the full force of law in South Africa30, perhaps because of its colonial history with the Dutch, and thus the law relating to this principle is quite developed in that jurisdiction. Therefore, for the purposes of this paper there shall be heavy reliance on South African decisions to expound on the various issues pertaining to the rule.

b) The Justification and Purpose

The rule is based on public policy or public interest.31 It is meant to protect debtors from exploitation by creditors by forcing them to pay unregulated charges, and enforce fiscal discipline on the creditors.32 To better understand the public policy drive behind this rule, one needs to forage through the many cases in Kenya where the amount of interest (or is it usury?) that borrowers have been burdened with by the lenders in the event of default.33 The most abnormal, unconscionable, and extortionist of all was depicted in Pelican Investment Ltd v National Bank of Kenya Ltd34 where a loan of Kenya Shillings 10 Million was alleged to have escalated, more than thirty times, to Kenya Shillings 316 Million!

Such situations have led some judges, when found in such unjust corner, to purport to do “common sense justice” without laying down any principles for their decisions. Such was the scenario in National Bank of Kenya Ltd vs Pipe Plastic Samkolit (K) Ltd & Another35 when O’Kubasu J. (as he then was) exercised his own sense of proportion, without citing any precedent, to reduce an outstanding sum of Kshs. 103 Million on 21 million loan to Kshs. 30 million. The ratio for the decision was his “taking judicial notice” of some commercial practice where banks waive interest.36 In deed such usurious interest37 is unacceptable. Decrying this state of affairs Onyango – Otieno J. (as he then was), way back in the year 2000, while constrained to apply the in duplum rule as was the case in South Africa, advocated for its introduction in Kenya in order to bring the otherwise worsening situation under control. This was in Pelican Investment Ltd v National Bank of Kenya Ltd38(above);

I do agree that such a legal proposition might be I deal in this country as it will ensure that debtors do not suffer the requirements upon them to pay extra large interests caused by the indolence and lapse or deliberate failure by the creditors so as to let the unserviced loans accumulate interest to unimaginable levels. It will protect the debtors as well as ensuring that the creditors get their money back for further circulation and hence the economy will be healthy. However, to introduce this Dutch law by way of a judgment in the common law country will be in my opinion too drastic a step to take as it will not be based on any existing legal authority or statute whatsoever in our country. It is law that had better be introduced by way of legislation.39

In all estimation, it can be rightly argued that the words of the judge as echoed in the South African cases clearly outline the public policy considerations for the in duplum rule in Kenya. No wonder then that immediately he pronounced the above sentiments, they spread like wild fire to the chambers of Parliament and barely had ink dried on the paper where those words were written than the legislature sought by an initial attempt to introduce the rule in Kenya via the Central Bank Act.40

c) The Applicability and Limits

This section looks at the extent to which the rule will be applicable in Kenya. In this connection, both express and implied limitations will be discussed. The point of departure is the section 44A itself.

i) Loans

It is apparent from the wording of section 44A that the in duplum rule as legislated applies to formal loans41 only and not to debts generally. In addition, it only applies to loans given by institutions.42 This is clearly evident from the provisions of section 44A (1);

“An institution shall be limited in what it may recover…..”

It is thus arguable that the rule as introduced in Kenya governs only the banking sector and not other entities which offer other forms of loans or financial facilities.43 This is a variation from the applicability of the rule in South Africa. In the Ethekwini case44 the Supreme Court of South Africa held that the rule “does not only relate to money lending transactions but applies to all contracts where a capital amount that is subject to interest at fixed rate is owing.” It must be said here, however, that the Supreme Court of South Africa was applying the common law in duplum rule and not the statutory in duplum rule since as at the time of that judgment, the National Credit Act45, which codifies the in duplum, had not been legislated.

Since the Act defines “loans” to include advances or a credit facility it is submitted that the rule also applies to overdrafts and credit card accounts.46

ii) Judgment Debts

It is expressly provided under the Act47 that the rule does not apply to limit any interest under a court order accruing after the order is made.48 In effect, therefore, interest can accrue on a judgment debt more than double the judgment debt. This seems to be contrary to the common law application of the rule.49 A question that begs answer here, is whether interest continues to accumulate, more than the principal sum sued, during the litigation process before the order or judgment is made. The section is silent in respect of this issue as it only deals with interest under a court order accruing after the order is made.50

While faced with this question the Supreme Court of South Africa observed that;

“It appears as previously pointed out that the rule is concerned with public interest and protects borrowers from exploitation by lenders who permit interest to accumulate. If that is so, I fail to see how a creditor who has instituted action can be said to exploit a debtor, who with the assistance of delays inherent in legal proceedings, keeps the creditor out of his money. No principle of public policy is involving in with the protection pendite lite against interest in excess of the double.”51

The court based its view on the fact that a creditor has no control over delays caused by the litigation process.52 It, therefore, held that the in duplum rule is suspended pendite lite53, where the time is said to begin upon service of the initiating process.54 Given that the Kenyan law expressly suspends the applicability of the in duplum rule to judgments, while it is silent as to what happens during the litigation, it is arguable that, taking into consideration the common law justification for suspension of the rule during litigation process, the same principle also applies in Kenya. This argument is lent credence by the provisions of the Civil Procedure Act55 which gives the courts the jurisdiction to award interest on money even for the period before judgment. In this regard Section 26 (1)56 thereof stipulates thus;

“Where and in so far as a decree is for the payment of money, the court may, in the decree, order interest at the such rates as it deems reasonable to be paid on the principal sum adjudged from the date of the suit to the date of the decree in addition to any interest adjudged on such principal sum for any period before the institution of the suit, with further interest at such rate as the court deems reasonable on the aggregate sum so adjudged from the date of the decree to the date of payment or such earlier date as the court thinks fit.” (Emphasis supplied)

It is quite evident from the above that interest is permissible to run even during litigation. And such, there is nothing in the law to stop it getting in excess of the principal amount owing as at the time of instituting suit.57 To this extent the Kenyan legal position is similar to that of the common law rule as propounded in the Standard Bank of South Africa Ltd Case.58

iii) Interest on Principal Owing

According to section 44A (2) (b) the interest recoverable by the lender is limited to the interest as provided by the contract, not exceeding the principal owing when the loan becomes non-performing. It is imperative to discern here whether the “principal owing” is confined only to the actual loan amount advanced to the borrower/ debtor or is it the aggregate of all amounts owed by the debtor to creditor. Financial institutions do levy several charges on the processing of the loan such as legal fees, and administration fees. In some instances lenders do not require the borrowers to pay these charges upfront but they are lumped together with the actual loan amount and thus form an aggregate of the debt due. The question is whether the “principal” owing is confined to the actual loan advanced or the aggregate all the amounts incidental to the loan owed to the lender.

“Principal” in the context used here is defined to mean “the capital sum of a debt or obligation as distinguished from interest or other additions.”59 Going by this definition, it is arguable that the rule only applies to the interest accruing on the actual loan amount as opposed to the sum total of the loan including other charges.60 It is also arguable, looking at the wording of the section, that in fact, interest on the costs of recovery of the amount may be chargeable.

In South Africa, the statutory in duplum rule has been clearly and widely crafted to include not only the principal owing but also other charges or expenses incurred in obtaining the loan61. In this regard, the Act uses the “cost of credit”62 rather than the principal amount.63 The cost of credit includes the principal debt, the initiation fees, the service fee, default administration charges, collection costs, and costs of any credit insurance.64

d) The Operation

In this section the operation of the in duplum rule is examined. To begin with, if we take for instance, a loan of Kshs. 1 Million; the lender is not allowed to get more than 1 million as interest. This is because once interest equals the amount of the loan, i.e. 1million, the in duplum swings into action and the interest is stopped from further accumulating. In such a case, therefore, the lender can recover a maximum of Kshs. 2 million as the amount owing from the borrower. It is, however, imperative to quickly add that the rule does not operate always in such a simple manner. Sometimes the borrower may make payments which will of course reduce the amount owing. In such situations complications rise in which require a clear understanding of the rule.