Expert Witness Journal Dec 24 - Journal - Page 93
Applying the law to default interest clauses specifically,
the courts have generally recognised that lenders do
have a legitimate interest in ensuring they are paid on
schedule (in fact in Cargill International Trading Pte Ltd
v Uttam Galva Steels Limited [2019] EWHC 476 (Comm)
this was stated to be "self-evident"), and prima facie an
increase in the interest rate in such circumstances
would be proportionate bearing in mind the increased
credit risk to the lender (as riskier credit is more expensive) although courts have found certain default
interest provisions to be unenforceable penalties on
the basis the actual default rate levied by a lender is
high enough to be considered extravagant, exorbitant
or unconscionable.
payment under the Facility Letter which were unpaid
would bear interest at the rate specified in either the
Standard Interest Provision or the Default Interest
Provision, if applicable, until the date of payment.
The Facility Letter provided for an upfront payment
of all interest which would accrue and be payable during the term (at the Standard Rate). This sum was deducted from the loan advanced following the Facility
Letter being signed.
It was not contested that there remained outstanding
amounts to pay as at the scheduled Repayment Date.
The Appellants accepted that, were it not unenforceable as a penalty, the Default Rate would on the face of
the Facility Letter apply to any unpaid sums on and
from the Repayment Date.
Judgment
Here the Court of Appeal determined that the High
Court had failed to apply the correct test to the facts
before them in considering whether or not the Default
Interest Provision was an unenforceable penalty. In
particular, while the "legitimate interest" test was discussed, it was determined to have been incorrectly applied with Farnhill J taking a subjective approach to
the question of which interest the Lender was seeking
to protect. Farnhill J found this to be the interest in
the Barnet Property remaining unoccupied (which interest he felt was illegitimate given it was driven by requirements that did not apply to a corporate
borrower) rather than an interest based on the function of the Default Interest Provision in the context of
the Facility Letter, where to Aplin LJ it seemed inevitable that the function of such clause was to protect
the Lender's legitimate interest in repayment of all
outstanding amounts ahead of the Repayment Date.
She further noted that, having drawn a conclusion
that the Default Interest Provision did not protect any
legitimate interest, the High Court then failed to consider whether it was "extravagant, exorbitant or unconscionable". She declined to form a view on this
question, having not had access to the expert evidence
and cross examination that would have been available
to the High Court, and accordingly referred the
question back to them to be reconsidered.
Accordingly the Court of Appeal turned first to the
question of whether the Default Rate was a penalty
rendering it unenforceable before considering the
issue of whether interest should apply after the Repayment Date – if it could be determined that the Default Interest Provision was enforceable, the parties
would be in agreement that the Default Rate applied,
at least, to the sums that had been outstanding from
the Repayment Date.
The Law on Penalties
Lady Justice Aplin's judgment in this case provides a
useful summary of the English law authorities on
penalty clauses and when such clauses may be found
unenforceable, which has been developed through
case law. The key principles in this area were neatly
distilled in Cavendish Square Holding BV v Makdessi
[2016] AC 1172 by Lord Neuberger JSC and Lord
Sumption JSC as being whether the relevant clause "is
a secondary obligation, which imposes a detriment
on the contract-breaker out of all proportion to any
legitimate interest of the innocent party in the
enforcement of the primary obligation".
Accordingly, when considering if a clause is an
unenforceable penalty clause, one should determine:
l whether the relevant clause is a secondary obligation, i.e. is it only engaged on breach of a primary
obligation
Leaving open that the High Court may determine, in
line with the correct test, that the Default Interest Provision remains an unenforceable penalty, Aplin LJ returned to the question of whether interest was payable
for the period after the Repayment Date and, if so, at
what rate.
l if so, does the non-breaching party have a legitimate
interest in the performance of that primary obligation
l if so, is the secondary obligation proportionate to
such interest, or is it, to use the words featured most
frequently in the relevant case law "extravagant",
"exorbitant" or "unconscionable" in this context?
Aplin LJ noted that the EOD Provision specifically
refers to overdue payments, and states that interest on
such sums will accrue at either the rate set out in the
Standard Interest Provision or the rate set out in the
Default Interest Provision, depending on which was
applicable. A reading of those provisions made very
apparent that they were each intended to apply in
specific circumstances and each would apply individually while those specific circumstances prevailed.
Aplin LJ did not find it possible to interpret the Facility Letter such that if the circumstances for one rate
to apply were not present, the other rate would naturally apply. This meant that if it were found that the
Default Rate was not enforceable in circumstances
where it was expressed to apply, one could not fallback to the Standard Rate as the circumstances in
which it was stated to apply (principally prior to the
As ever, the courts are typically reluctant to interfere
with freedom of contract, and case law has established
that the relevant bargaining strength of the parties
and whether or not they received legal advice on the
terms of the relevant contract could be relevant here.
Similarly, it is clear from a review of the authorities that
the courts are reluctant to provide specific guidelines
on penalties (e.g. that a rate of X% is okay but not Y%)
as what is extravagant or unconscionable will be highly
fact dependent. It is highlighted in many of the relevant judgments that the words "extravagant",
"exorbitant" or "unconscionable" suggest a level of extremity and set the threshold for a penalty to be found
unenforceable reasonably high.
EXPERT WITNESS JOURNAL
91
DECEMBER 2024
