Law Commentaries

Extortionate Loan Agreement Terms May Be Struck Down or Moderated – Dhiman v Shah (Civil Appeal E380 of 2023) [2025] KECA 1264 (KLR)

The case of Dhiman v Shah (Civil Appeal E380 of 2023) [2025] KECA 1264 (KLR), decided by the Court of Appeal in Kenya on July 11, 2025, represents a significant judicial pronouncement on the doctrine of unconscionability in contract law, particularly in the context of loan agreements with exorbitant interest rates. The court's ruling that terms of a loan agreement resulting in "punitive or extortionate financial consequences" may be struck down or moderated underscores the judiciary's role in safeguarding fairness and equity in contractual relationships. This commentary analyzes the court's reasoning, its application of the unconscionability doctrine, and the broader implications for Kenyan contract law.

Background

In Dhiman v Shah, the dispute arose from a loan agreement where the appellant borrowed Kshs 7,000,000 from the respondent, secured by a Memorandum of Charge over a property (L.R. No. 209/812/2/8). The agreement stipulated a 36% annual interest rate, compounded quarterly. The appellant defaulted, leading to the property's auction and transfer to the respondent following an ex parte judgment in 1999. The Court of Appeal, in a prior ruling in 2015, set aside this judgment, remitting the case for rehearing. The High Court upheld the agreement's enforceability, but the Court of Appeal reversed this decision, finding the agreement unconscionable due to its excessive interest rate, which ballooned the debt to over Kshs 69 billion.

Key Legal Issues

The Court of Appeal addressed several critical issues:

  1. Effect of Setting Aside the Ex Parte Judgment: Whether the 2015 decision setting aside the ex parte judgment invalidated the subsequent property sale and vesting order.

  2. Enforceability of the Loan Agreement: Whether the agreement was unenforceable due to material deviations or illegality under the Banking Act.

  3. Unconscionability of Interest Rates: Whether the 36% interest rate, compounded quarterly, rendered the agreement unconscionable.

  4. Time-Bar on Counterclaim: Whether the appellant's counterclaim for property recovery was time-barred.

This commentary focuses on the court's ruling on unconscionability, as it is the most significant aspect of the judgment.

Analysis of Unconscionability Doctrine

The Court of Appeal's decision to void the loan agreement for unconscionability is grounded in both procedural and substantive elements, as outlined in paragraphs 65–73 of the judgment. The court adopted a two-pronged approach to unconscionability, consistent with Kenyan jurisprudence and comparative law:

Procedural Unconscionability

The court examined the circumstances surrounding the agreement's formation. The appellant argued that he was in dire financial need, and the respondent, introduced by a mutual acquaintance, took advantage of this vulnerability. However, the court noted that the agreement was signed in the presence of a senior lawyer, Mr. Gautama, and the appellant admitted to willingly entering the contract without coercion (para. 58). The absence of evidence of fraud, duress, or undue influence weakened the procedural unconscionability claim. This aligns with National Bank of Kenya Ltd v Pipeplastic Samkolit (K) Ltd & Another [2001] KLR, where courts emphasized that coercion or fraud must be proved to challenge a contract's formation.

Substantive Unconscionability

The court's finding of unconscionability rested primarily on the substantive unfairness of the 36% interest rate, compounded quarterly, which resulted in a debt of over Kshs 69 billion from a Kshs 4 million principal over nearly three decades (para. 77). The court described this escalation as "astronomical," "commercially unreasonable," and "grossly unfair," offending principles of equity, fairness, and proportionality. This finding echoes Aiyy Indravadan Shah v Guilders International Bank Ltd [2000] 1 EA 269, where the court upheld its authority to intervene when agreed interest rates are unconscionable or fraudulent.

The court distinguished this case from Margaret Njeri Muiruri v Bank of Baroda (Kenya) Ltd [2014] KLR, where a high interest rate was upheld because it was negotiated at arm's length. In Dhiman v Shah, the disproportionate financial burden, coupled with the long duration of compounding, justified judicial intervention. The court's reliance on equitable principles to moderate or strike down such terms is consistent with Kenya Commercial Finance Company Ltd v Ngeny & Another [2002] KLR, which allows courts to set aside harsh or oppressive bargains.

Implications for Kenyan Contract Law

The Dhiman v Shah ruling has several implications:

  1. Judicial Oversight of Interest Rates: The decision reaffirms that courts can intervene in loan agreements with excessively high interest rates, particularly when compounded over long periods, even if the parties initially agreed to the terms. This strengthens consumer protection in financial transactions.

  2. Balancing Freedom of Contract and Equity: While Kenyan courts respect freedom of contract (National Bank of Kenya Ltd v Pipeplastic Samkolit), they will not hesitate to invoke equitable doctrines to prevent injustice, as seen in the voiding of the agreement in this case.

  3. Clarity on Consequential Orders: The court's finding that setting aside the ex parte judgment nullified the property sale and vesting order clarifies that all consequential actions dependent on a vacated judgment are void, restoring the status quo ante (para. 49).

  4. Statutory Interpretation: The court rejected the argument that the respondent's lending violated the Banking Act, as there was no evidence that the respondent was operating as a bank (para. 57). This underscores the need for clear evidence when alleging statutory breaches.

Critique

The court's decision is commendable for protecting the appellant from an oppressive financial outcome. However, the lack of explicit reference to "and all consequential orders" in the 2015 judgment (para. 50) highlights the need for precise judicial language to avoid ambiguity in future cases. Additionally, while the court found the interest rate unconscionable, it could have provided clearer guidance on what constitutes an acceptable interest rate threshold, potentially aiding lower courts in similar disputes.

Conclusion

Dhiman v Shah reinforces the judiciary's role in policing unconscionable contracts, particularly those with punitive financial consequences. By voiding the loan agreement due to its extortionate interest rate, the Court of Appeal upheld principles of fairness and equity, aligning with precedents like National Bank of Kenya Ltd and Kenya Commercial Finance Company Ltd.  This ruling serves as a caution to lenders against imposing excessive terms and strengthens the equitable framework of Kenyan contract law.