Court of Appeal in Kenya Strikes Down Contract on Basis of Unconscionability

Introduction

On 11^th July 2025, the Court of Appeal in Kenya delivered a landmark decision in Kanwal Sarjit Singh Dhiman v. Kenshavji Jivraj Shah (Civil Appeal No. E380 of 2023) which judgment marks a significant development in Kenyan contract law, particularly in balancing the doctrine of unconscionability against the principle of freedom of contract. We examine the judgment’s implications, focusing on its application of the unconscionability doctrine, its impact on contractual agreements, and its relevance for businesses, lenders, and legal practitioners in Kenya.

Case Summary

The appeal arose from a High Court judgment upholding a loan agreement with a 36% annual compounded interest rate, secured by a property (L.R. No. 209/8192/8). The appellant, Kanwal Sarjit Singh Dhiman, challenged the agreement’s enforceability, alleging unconscionable terms and an invalid property transfer following an ex-parte judgment. The Court of Appeal set aside the High Court’s orders, declared the agreement void for unconscionability, nullified the property’s vesting order, and ordered the appellant to repay Kshs. 4,000,000 with 12% interest to prevent unjust enrichment. The judgment emphasized equitable intervention in contracts deemed oppressive, while preserving fairness in commercial dealings.

The Unconscionability Doctrine

The Court of Appeal applied the unconscionability doctrine to invalidate the loan agreement, citing its 36% interest rate levied quarterly, which could escalate a Kshs. 4,000,000 balance to over Kshs. 69 billion over three decades.

The Court identified two key aspects of unconscionability:

1. Procedural Unconscionability: Examines the contract formation process, focusing on whether the weaker party had meaningful choice or faced coercion, deception, or unequal bargaining power. In this case, the appellant alleged economic duress, though the Court found he willingly signed the agreement in the presence of counsel.
2. Substantive Unconscionability: Focuses on the fairness of the contract terms. The Court deemed the 36% interest rate, compounded quarterly, as “extortionate” and “oppressive,” citing its disproportionate financial burden. This aligns with precedents like National Bank of Kenya Ltd v. Pipeplastic Samkolit [2001] KLR and Ajay Indravadan Shah v. Guilders International Bank Ltd [2002] 1 EA 269, where courts refused to enforce terms that “shock the conscience.”

The Court emphasized that while parties are free to contract, equity intervenes when terms are so unfair as to offend justice, ensuring contracts are not instruments of oppression.

Freedom of Contract

The principle of freedom of contract, rooted in the autonomy of parties to negotiate terms, was a central issue. The respondent argued that the appellant, a seasoned businessman, freely agreed to the 36% interest rate, and courts should not rewrite “bad bargains.” The High Court initially upheld this view, citing National Bank of Kenya Ltd v. Pipeplastic Samkolit, which held that courts respect agreed terms absent fraud, coercion, or undue influence.

However, the Court of Appeal clarified that freedom of contract is not absolute. Citing cases like Margaret Njeri Muiruri v. Bank of Baroda (Kenya) Ltd [2014] KLR and Kenya Commercial Finance Company Ltd v. Ngeny [2002] 1KLR, the Court affirmed that equitable jurisdiction allows intervention when contracts are “harsh, unconscionable, and oppressive.” The judgment underscores that while parties may negotiate terms, courts can moderate or void agreements that exploit vulnerabilities or impose grossly unfair outcomes.

Implications for Borrowers and Lenders:

1. Review of Loan Agreements: Lenders must ensure interest rates and terms are commercially reasonable. Excessive rates, especially with compounding effects, risk being struck down as unconscionable. Businesses should benchmark rates against market standards.
2. Contract Formation Scrutiny: Procedural fairness is critical. Lenders should document informed consent, ideally with independent legal advice, to mitigate claims of duress or unequal bargaining power. Transparency in negotiations strengthens enforceability.
3. Equitable Remedies: The Court’s order for the appellant to repay Kshs. 4,000,000 at 12% interest reflects equity’s role in preventing unjust enrichment. Lenders should anticipate that courts may adjust terms to balance fairness, even when invalidating contracts.
4. Property Transactions: The nullification of the vesting order highlights that property transfers based on flawed judgments are vulnerable. Businesses must ensure compliance with legal processes, such as timely appeals or applications under the Civil Procedure Rules, to protect acquired titles.
5. Regulatory Compliance: While the Court rejected claims that the respondent violated the Banking Act, individuals lending money should avoid practices resembling regulated banking without a license, as habitual lending could attract scrutiny.

Broader Legal Implications

The judgment reinforces Kenya’s equitable approach to contract law, aligning with global precedents like Commercial Bank of Australia Ltd v. Amadio [1983] 51 CLR 447. It clarifies that courts will intervene when contracts undermine fairness, particularly in loan agreements with punitive terms. This strengthens protections for borrowers, especially in private lending scenarios, while urging lenders to adopt fair practices.