Default Interest ' An Unenforceable Penalty?

• Published date: 08 March 2022
• Subject Matter: Finance and Banking, Litigation, Mediation & Arbitration, Financial Services, Trials & Appeals & Compensation
• Law Firm: DMH Stallard
• Author: James Colvin

In the case of Ahuja Investments Limited v Victorygame Limited [2021] EWHC 2382 (Ch) the court held that a default interest provision in a loan agreement was a penalty clause and therefore unenforceable.

The law of penalties was comprehensively reviewed and restated by the Supreme Court in Cavendish Square Holding BV v Makdessi [2015] UKSC 67, [2016] A.C. 1172. Ahuja v Victorygame provides a clear case study as to how those principles apply to default interest clauses commonly found in finance agreements. The principles are:

• Penalty clauses are secondary obligations.
• Whether a clause imposes a secondary liability upon a breach of contract is a question of substance and not of form.
• Does the clause impose a detriment that is out of all proportion to the legitimate interests of the innocent party or which is exorbitant, extravagant or unconscionable?
• The burden of proof lies on the party alleging that a clause is a penalty to show that the secondary liability is exorbitant extravagant or unconscionable.
• The courts are slow to interfere with parties freedom to contract.

Ultimately, Judge Hodge QC decided that, despite the fact that the default interest provision had been freely-negotiated between two experienced commercial parties both represented by solicitors at the time, the rate of 12% per month compounded monthly and representing a 400% increase in the interest rate applicable prior to default, was properly to be characterised as a penalty.

The Judge went on...