Financial Services Update: Default Interest – Ireland Revisits The Test For Penalty Clauses

In two recent connected cases the Irish High Court found that the charging of default interest at 4% amounted to a penalty and was therefore unlawful. In reaching that decision the judge declined to follow recent case law from England and Wales which had departed from the existing precedent on penalty clauses.

Default interest and penalty clauses were revisited by the Irish High Court recently in two connected cases.

Both cases were taken against Breccia ((1) Sheehan v Breccia & Ors and (2) Flynn & Anor v Breccia) and concerned loans that were originally entered into between the respective plaintiffs and Anglo Irish Bank Plc. The loans were subsequently purchased by Breccia.

The loan agreements provided for the application of surcharge interest at a rate of 4% on amounts unpaid. The relevant provision was contained within the standard terms and conditions for the loans and had the effect of doubling the interest payable.

A central issue in both disputes was whether the inclusion of default interest in the loan redemption figures constituted a penalty and whether the application of any such default interest was, as a result, unlawful and unenforceable.

UK and Irish Precedent

In Ireland, the leading authority on penalty clauses is ACC Bank Plc v Friends First Managed Pension Funds Ltd & others [1] (the "ACC case"). In that case the court found surcharge interest rates to be penal in nature where such rates could not be considered a "reasonable pre-estimate" of likely loss in the event of a default.

More recently and just before the Breccia cases, the UK Supreme Court in the Cavendish decision [2] handed down a divergent judgment on penalty clauses which departed from the long-established "pre-estimate of loss" test.

The Cavendish judgment provides that enforceability comes down to whether the imposition of surcharge interest is unconscionable, extravagant or "out of all proportion to any legitimate interest of the innocent party". It also finds that the penalty rule is an interference with the ability of parties to contract freely.

The Cavendish judgment is now accepted as the definitive position in the UK. In the Breccia cases, the defence argued that Cavendish is also persuasive authority in Ireland, although not binding, and "reflects common sense and commercial reasonableness".

The Decision

Judge Haughton handed down his judgment in both Breccia cases on 5 February...

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