Three NSW Supreme Court decisions handed down in July 2026 have confirmed that courts will actively strike out default interest provisions in private lending documents where those provisions cannot be justified. This note explains what the courts decided, the legal test that applies, and what it means for your loan documents.
The Legal Test — What Makes an Interest Clause a Penalty?
The starting point is the High Court’s decision in Paciocco v Australia and New Zealand Banking Group Ltd (2016) 258 CLR 525, which confirmed four governing principles:
Proportionality, not punishment. A provision is a penalty if it imposes a detriment on the defaulting party that is out of all proportion to the legitimate interest of the lender in performance of the obligation. Courts do not simply compare the sum claimed against the loss actually suffered — they ask whether the clause protects a genuine commercial interest.
Assessed at the time of contracting. The test is applied at the moment the contract is made, not with the benefit of hindsight about what actually happened.
The borrower bears the initial burden. The borrower must first establish that the provision is a penalty. However — and this is where the recent cases bite — if the rate increase is large enough, the contract itself may be sufficient evidence to shift the evidentiary burden back to the lender to explain the clause.
Legitimate interest, not actual loss. The question is whether the clause genuinely protects the lender’s commercial position — its cost of funds, its risk exposure, its enforcement costs — not merely whether the borrower suffered a technical breach.
The Three Cases
| Case | Standard Rate | Default Rate | Finding |
|---|---|---|---|
| Blackbird First Mortgage Corporation v Cam Engineering [2026] NSWSC 876 | 2% per month (24% pa) | 4% per month (~60% pa with compounding) | Default rate void — penalty |
| Haiyong Su v 5 Blackman Cres Macquarie [2026] NSWSC 875 | 2% per month (24% pa) | 3% per month (36% pa) | Default rate void — penalty |
| Baker v Dura [2026] NSWSC 881 (interlocutory only) | 7.5% pa on instalments | $250 per day per missed instalment (~876% pa) | Prima facie penalty — auction injuncted |
Blackbird First Mortgage Corporation v Cam Engineering [2026] NSWSC 876. A $575,000 loan at 2% per month. On default, the rate doubled to 4% per month compounding monthly — an effective rate of approximately 60% per annum. The court found the default rate was a penalty and void. The critical lesson was not the rate itself — it was the complete absence of evidence explaining it. When the onus shifted, Blackbird had no cost of funds analysis, no risk pricing rationale, no credit approval note. The evidentiary cupboard was bare, and the lender lost.
Haiyong Su v 5 Blackman Cres Macquarie [2026] NSWSC 875. A $100,000 loan at 2% per month, increasing to 3% per month upon default. The lender labelled the rates “Discount Interest Rate” and “Interest Rate” and argued the higher rate was simply the standard rate. The court rejected that entirely: a rate that increases on default is a default rate, whatever it is called. The claim had grown from $100,000 to over $1.3 million through compounding; once the default rate was struck out, the amount fell to $53,775.
Baker v Dura [2026] NSWSC 881 — interlocutory decision only. A $250,000 instalment loan imposing $250 per day for every day a fortnightly instalment was overdue, with that daily amount also accruing interest. The last six unpaid instalments totalled $62,520; by the hearing date the lender claimed over $445,000. The court halted the mortgagee auction, finding a serious arguable case that the daily charge was a penalty.
Compounding Interest is Independently Vulnerable
These cases also confirmed that the compounding mechanism is assessed separately from the rate. In Ledinh v Trinh, the court varied the contract to delete the compounding provisions, not void the entire interest obligation — the lender retained simple interest at the higher rate but lost the compounding mechanism. Where a $140,000 principal becomes a $1.1 million claim, the compounding provision will almost always fail the proportionality test.
In Su, the compounding mechanism was embedded in the definitional architecture — interest was calculated on “Principal Outstanding,” defined to include all accrued interest. The court treated this as producing the same compounding effect as an express compound interest clause.
Why Our Documents Are Structured Differently
Our standard documentation is drafted in accordance with well-established principles which minimise the likelihood of a penalty characterisation — an approach grounded in caselaw going back to the early 1900s. We take the inverse of the structure used in Su and Blackbird, and it is the structure that courts have consistently distinguished from provisions found to be penal.
The Blackbird Lesson — Good Drafting Is Necessary but Not Sufficient
Even with correctly drafted documents, a penalty challenge is almost expected in contested enforcement proceedings. For every loan you originate, you should have a contemporaneous record documenting: your cost of funds; the risk premium applied and why; the additional costs anticipated in the event of default; and any market intelligence supporting the rate as commercially standard. A well-structured credit approval note prepared at origination will suffice. What it cannot be is something reconstructed after the borrower defaults.
Lender’s Checklist
Justify your rates for every new loan. Record the commercial basis for your standard and higher rates at the time the loan is approved — not after it defaults.
Review your enforcement cost procedures. Legal fees, receiver fees and investigating accountant charges must be supported by actual invoices. Estimated amounts cannot be debited to the loan account without underlying documentation.
Contact us before serving any default notice — particularly where the claimed amount is significantly inflated by a default charge. Baker v Dura raises a live question about whether a grossly overstated default notice can invalidate the entire enforcement process.
This bulletin is prepared for general informational purposes only and does not constitute legal advice. Please contact Baystone Legal for advice specific to your circumstances.