Paulsen v Slip Knot Investments 777 (Pty) Limited

Slip Knot Investments 777 (Pty) Ltd ('Slip Knot') provided mezzanine financing (short-term bridging finance) of R12 million to Winskor 139 (Pty) Ltd ('Winskor') for a property development portfolio in Pretoria. Mr and Mrs Paulsen (the Paulsens) bound themselves as sureties and co-principal debtors for the loan. The loan agreement provided for guaranteed minimum interest of R17 million and further interest at 3% per month if the capital was not repaid within six months. Winskor defaulted on repayment. The economic downturn prevented the anticipated profit. Slip Knot sued the Paulsens as sureties for the R12 million capital plus interest. The Paulsens argued (1) the agreement was void because Slip Knot was not registered as a credit provider under the National Credit Act 34 of 2005 (NCA), and (2) the in duplum rule limited their liability for interest. The court of first instance (Blignault J) granted judgment for the full amount. The full court limited interest to R12 million applying the in duplum rule. Both parties appealed to the Supreme Court of Appeal.

• Whether Slip Knot was required to be registered as a credit provider under s 40(1) of the National Credit Act
• Whether the loan agreement was void under s 89(2)(d) of the NCA for failure to register
• Whether the NCA applied to large credit agreements with juristic persons exceeding prescribed asset/turnover thresholds
• The proper interpretation of clause 6 of the loan agreement – whether the R17 million was interest or profit share
• The application of the in duplum rule to mezzanine financing arrangements
• Whether interest continues to accrue after the duplum is reached when litigation is commenced
• Whether sureties can be liable for more interest than the principal debtor when the principal debtor has not been sued

The appeal was dismissed with costs, including costs of two counsel. The cross-appeal succeeded with costs, including costs of two counsel. Paragraph 2 of the full court order was amended to order the Paulsens to pay jointly and severally: (a) R12 million capital; (b) R12 million interest up to 10 February 2010; (c) further interest on R12 million capital at 3% per month from 10 February 2010 to 24 February 2012; (d) interest on the total of (a), (b) and (c) at 3% per month from 25 February 2012 to payment, limited to the total of those amounts (applying the in duplum rule); (e) costs on party-and-party scale, including costs of two counsel.

The binding principles established are: (1) Credit agreements excluded from the application of the NCA under s 4(1)(b) (large agreements with juristic persons exceeding prescribed thresholds) are not subject to the provisions of Chapter 5 of the NCA, including s 89(2)(d) which renders certain agreements void. (2) Credit providers who only conclude excluded agreements are not required to register under s 40 of the NCA. (3) The in duplum rule operates to limit unpaid accumulated interest to the amount of the capital debt. (4) Following Oneanate, the in duplum rule is suspended pendente lite: once litigation is commenced by service of process, interest begins to accrue afresh on the capital debt; upon judgment, interest runs on the consolidated judgment debt (capital plus accumulated interest to judgment) until it reaches the duplum again. (5) The accessory nature of a surety's liability relates to the existence and extent of the principal debt, but does not prevent interest from accruing against the surety according to ordinary principles once the surety is sued, regardless of whether the principal debtor has been sued. The surety is entitled to raise defenses available to the principal debtor, but where the principal debtor would have no defense to a claim for interest if sued, the surety has none either.

Wallis JA observed: (1) Mezzanine finance is short-term bridging finance that is high risk and commands commensurately high returns. (2) The concern about large interest amounts is mitigated by the fact that they flow from large loans and commercial parties' choices – borrowers who offer to pay only the capital could avoid further interest liability. (3) The full court's approach would create numerous practical problems, such as forcing creditors to sue insolvent principal debtors, complications where the principal is in liquidation, or where excussion applies. (4) The court questioned but did not finally decide whether the regulatory provisions in Chapter 3 of the NCA (registration requirements) might serve some purpose for providers of excluded agreements. Willis JA (dissenting on cross-appeal) observed: (1) The in duplum rule serves a valuable economic function and protects against a 'domino effect' of insolvencies. (2) Context is critical – Oneanate dealt with ordinary bank overdrafts, not mezzanine financing. (3) The nature of mezzanine financing (short-term, quick defaults) means creditors can quickly obtain judgment before or soon after the duplum is reached. (4) Courts should retain residual discretion to apply the in duplum rule traditionally in appropriate circumstances, particularly in mezzanine financing, to incentivize prompt debt recovery and avoid prejudice to debtors. (5) Paying R72 million on a R12 million loan would be 'inordinately onerous'.

This case is significant for: (1) Clarifying the scope of application of the National Credit Act – excluded agreements under s 4(1)(b) are not subject to Chapter 5 provisions including s 89 on unlawful agreements. (2) Confirming that registration requirements under s 40 do not apply to credit providers dealing exclusively in excluded agreements. (3) Applying the principles from Standard Bank v Oneanate Investments regarding the in duplum rule: the rule is suspended pendente lite, with interest running afresh from service of process and again from judgment on the consolidated debt. (4) Clarifying that sureties' accessory liability relates to the debt's existence/extent, not to the accrual of interest once litigation commences against them. Sureties cannot avoid paying interest by relying on the creditor's failure to sue the principal debtor. (5) Important guidance on mezzanine financing arrangements and the application of common law interest principles to high-risk, short-term commercial lending. The minority view (Willis JA) suggested courts retain discretion to apply the in duplum rule traditionally in appropriate circumstances, particularly in mezzanine financing, but this did not prevail.