If you default on a loan agreement, when does the debt prescribe?

Acceleration clauses are commonly found in loan agreements that require debtors to make repayment in instalments. A standard acceleration clause provides that if a debtor fails to pay an instalment, the creditor may elect to terminate the loan agreement and demand payment of the full amount owing under the agreement.

The question of prescription in the context of acceleration clauses arose recently in the Supreme Court of Appeal ("SCA") in the case of Standard Bank of South Africa Ltd v Miracle Mile Investments 67 (Pty) Ltd and Another [2016] 3 All SA 487 (SCA). In particular, the SCA was faced with this question: does prescription on the full amount advanced commence running when the creditor elects to enforce the acceleration clause or when the debtor defaults on payment of an instalment?

In this case, in 2005, the creditor, the Standard Bank of South Africa ("the bank"), advanced a line of credit to an individual debtor to a maximum value of approximately R14-million. The respondents, two companies, stood surety for the principal debt and allowed the registration of certain mortgage bonds over their immovable properties, as security for the principal debt. The loan agreement included an acceleration clause that granted the bank an election to terminate the agreement and accelerate the debt upon breach by the debtor.

The debtor drew on the facility and defaulted. The debtor was then provisionally sequestrated. In 2013, the bank instituted action against the respondents to recover the debt and declare the mortgaged properties specially executable. The respondents then applied for an order directing the bank to consent to the cancellation of the mortgage bonds on the basis that the claim against the debtor, and thus against the respondents, had prescribed in October 2011, three years from the date on which the debtor failed to pay the instalments. The bank denied that prescription had started running.

The parties accepted that a letter by the bank to the debtor, delivered in August 2008 in terms of section 129 of the National Credit Act, 2005, constituted demand on the debtor to bring the overdue account up to date. However, importantly, the bank did not elect in this letter to terminate the agreement and accelerate the debt.

The SCA noted that whether or not the debt had prescribed depended on when it had become "due". Section 12(1) of the current Prescription Act, 1969 provides: "Subject to the provisions of subsections (2), (3), and (4), prescription shall commence to run as soon as the debt is due" (our emphasis).

The SCA found that in cases pertaining to standard acceleration clauses in loan agreements, and contrary to the case law under the previous Prescription Act, 1943, the debt falls "due" when the creditor elects to terminate the loan agreement and accelerate the debt. This is because the election is a necessary precondition of the cause of action for the claim of the full amount due. The SCA found that the policy considerations mentioned in the case law under the previous Prescription Act, which militated against allowing a creditor to delay prescription by delaying its election, did not override the clear wording of the current Prescription Act.

While the creditor decides whether or not to elect to accelerate the debt, prescription commences running on the individual arrear instalments. If the election to accelerate the debt is not exercised, the creditor can wait until all instalments are due before suing the debtor. However, the earlier instalments may have prescribed by the date the action is instituted, as each instalment is a separate cause of action arising as and when it falls due.

The SCA therefore found that if the bank wanted to accelerate the debt, it had to give notice to the debtor to remedy the non-payment and, failing payment by the debtor, the bank had to elect to terminate the facility and claim repayment of the full amount due under the loan agreement. The former notice was provided when the section 129 letter was delivered but the latter notice had not been given.

The election and communication of the election were preconditions of the cause of action and, in this case, they did not occur. The SCA therefore held that as the bank did not elect to terminate the facility and claim repayment of the outstanding balance, prescription did not start running on the claim for the full amount in October 2008. Prescription would only commence on the date that the bank gave notice of the election and claimed the full amount. The appeal was therefore upheld with costs.

What lenders can take from this judgment

Lenders must consider carefully whether the acceleration clauses in their loan agreements provide an election on whether or not to accelerate the debt. If there is an intention to elect to accelerate the debt, the election must be articulated clearly in the loan agreement.

When the debtor defaults, the election must then be exercised by following the procedural preconditions, such as written demand to the debtor for payment or written notice by the creditor of the exercise of the election. Only then will the cause of action be complete (rendering the full amount claimable) and prescription commence running.

While the creditor decides whether or not to exercise the election, prescription commences on the individual instalments that have not been paid. It is important to make the election timeously and not to let the claims on the individual instalments prescribe.

If no election is provided for in the acceleration clause, and the debt is accelerated automatically upon default by the debtor, prescription will commence running on default. Action proceedings for recovery must then be instituted within three years of the date of default.