High Court Finds Default Interest Clause In Loan Agreement Is Not An Unenforceable Penalty

• Published date: 24 November 2025
• Subject Matter: Finance and Banking, Litigation, Mediation & Arbitration, Real Estate and Construction, Financial Services, Trials & Appeals & Compensation, Construction & Planning
• Law Firm: Herbert Smith Freehills Kramer LLP
• Author: Andrew Cooke, Ceri Morgan, Emily Barry and Catherine Bagge

The High Court has found that a default interest clause in a short-term loan agreement was not extortionate, exorbitant or unconscionable and therefore not an unenforceable penalty clause, following remittal from the Court of Appeal and reversing its original decision: Houssein & Ors v London Credit Ltd & Anor [2025] EWHC 2749 (Ch). We considered the previous Court of Appeal decision in this blog post.

As a reminder, in assessing whether a clause amounts to a penalty, the three-stage test drawn from Cavendish Square Holding BV v Talal El Makdessi (Rev 3) [2015] UKSC 67 is applicable. This test provides that a liquidated damages clause will not amount to an unenforceable penalty, provided: (1) it is a secondary obligation triggered by a breach of contract (this is a threshold question); (2) the clause is in furtherance of a "legitimate interest" which the innocent party has in the performance of the primary obligation; (3) and the clause is not "extortionate, exorbitant or unconscionable".

The court held that the clause was commercially justifiable in light of the lender's legitimate interests, which included timely repayment of the loan, protection of security, regulatory compliance and credit risk management. While the default rate of 4% compounded monthly was found to be above market norms (3% compounded monthly being found to be typical), the court ruled that it was not extortionate on the facts of the case, including precarious refinancing prospects, the borrower's credit history and the lender's exposure.

The decision will be of interest to financial institutions for its consideration as to: (i) the legitimate interests of the lender the court will consider when assessing whether a default interest rate clause is a penalty clause; and (ii) whether tenders of repayment made by a borrower are effective to stop interest from accruing.

We consider the decision in more detail below.

Background

In 2020, the lender and borrower entered into an agreement for a short-term bridging loan secured against a number of properties, including the family home. The agreement included a default interest rate clause imposing a higher rate of interest (4% compounded monthly, the Default Rate) in the event of default and was supported by personal guarantees from the directors. The Default Rate applied uniformly to all instances of default.

Shortly after drawdown, the lender alleged breach of a non-residence clause in respect of one of the secured properties, and appointed...