The In Duplum Rule Does Not Apply To Microfinance Institutions

In duplum is a Latin phrase derived from the word in duplo, which means "in double". The rule provides that interest stops running when unpaid interest equals the outstanding principal amount. Therefore, bank lenders should never recover more interest than the principal amount lent to the borrower. The in duplum rule is founded on public policy considerations. In Paulsen and Another v Slip Knot Investments 777 (Pty) Limited [2015] ZACC 5 ("the Paulsen case"), the Constitutional Court stated that "the purpose of [in duplum] is to protect debtors from being crushed by the never-ending accumulation of interest on an outstanding debt ". 

This rule is embedded in our jurisdiction vide section 44 of the Banking (Amended) Act. This section states as follows: 

44A. (1) An institution shall be limited in what it may recover from a debtor with respect to a non-performing loan to the maximum amount under subsection (2) 

(2) The maximum amount referred to in subsection (1) is the sum of the following- 

(a) the principal owing when the loan becomes non-performing; 

(b) interest, in accordance with the contract between the debtor and the institution, not exceeding the principal owing when the loan becomes nonperforming; and 

(c) expenses incurred in the recovery of any amounts owed by the debtor 

(3) If a loan becomes non-performing and then the debtor resumes payments on the loan and then the loan becomes non-performing again, the limitation under paragraphs (a) and (b) of subsection (1) shall be determined with respect to the time the loan last become non-performing. 

This section is in consonance with the Supreme Court of South Africa's sentiments in Standard Bank of SA Ltd v Oneate Investment (Pty) Ltd 1995 and their Banking (Amendment) Act, 2006 (Act No 9 of 2006) section 17, which has developed this principle into their jurisdiction.  

There have been misperceptions as to which institutions fall under the ambit of section 44. The High Court in Petition No. E002 of 2021- Anne J. Mugure & 2 Others v Higher Education Loans Board has declared that the in duplum rule would apply to those lending monies, as it does to banks. However, the Court did not discuss the meaning of those involved in the "lending business." 

However, in the more recent case of Momentum Credit Limited v Kabuiya (Civil Appeal E035 of 2022), the High Court stated: 

For purposes of section 44, it must be established that the appellant is a bank or financial institution. It is not in dispute that the appellant is neither a bank nor mortgage finance company. In order to qualify as a financial institution, the appellant must either be gazetted as such by the Minister or be one that carries on or proposes to carry on financial business as defined under the Banking Act. In order to qualify as a financial institution, it must accept money on deposit from members of the public and employ that money or part of it for lending or investment as contemplated under the Act. 

In the case cited above, the Court held that section 44 only applies to financial institutions as defined by the Act. An Institution refers to a bank, financial institution, or mortgage finance company for purposes of the Banking Act. The Court provided a more explicit interpretation of the section, holding that from the wordings of the section, the rule governs only the banking sector and not other entities which offer other forms of loans or financial facilities, and as such, in duplum rule does not apply to microfinance institutions operating under the Microfinance Act. 

Therefore, while the in duplum rule is embedded into the Kenyan jurisdiction, its application is limited to the banking sector as per section 44 of the Banking (Amended) Act. This rule protects the debtors from unfair practices imposed by banks within the definition of the Act.  

It is also noteworthy that interest does not lose its character as interest even after compounding or restructuring. In National Bank of Greece v Pinions Shipping Co Ltd [1990] 1 All ER 78, the House of Lords held that the basis of any implied contractual right to capitalize interest is the custom and usage of banks. This practice is called compounding, which is the capitalization of interest so that interest itself yields interest (Mark Hapgood, (12th Ed.) Paget's Law of Banking, Butterworths.) If such happens, can the lender then argue that since the interest has been capitalized, it should be treated as the capital sum, and thus, the operation of the in duplum rule is suspended? To put it simply, does interest lose its character as interest when it is capitalized? 

While confronted with this question, the South African Supreme Court clearly stated that the practice of "capitalization" of interest does not result in the interest losing its character as interest as such for the purposes of the in duplum rule (Standard Bank of SA Ltd v Oneate Investment (Pty) Ltd 1995 (4) SA 510. The Court's rationale in coming to this conclusion was that; “If interest were to become capital, the capital amount of the debt would always be increasing, and the bank would run no risk of a lesser capital amount being the subject matter of the rule. Furthermore, if lenders were allowed to employ the expedient of a book entry to convert what is interest into capital, this would be an easy way to avoid the in-duplum rule.” 
Therefore, capitalization of interest does not affect the operation of the rule. When interest is compounded, it just remains interest, and neither the description nor the practice of compounding it affects the nature of the debt. 

CONTRIBUTORS 

Ambrose Waigwa
awaigwa@cmadvocates.com