Hello and welcome to the first podcast in a series of banking law briefings under English law. My name is Tomas Gärdfors and I am a banking partner at Norton Rose LLP in London.
This session will focus on default interest under English law.
As you probably know, English courts are reluctant to interfere with a contract that has been entered into freely between parties. One of the great benefits of English law actually is that it provides certainty for commercial transactions. There are, however, exceptions to this rule. In a banking context, one of these exceptions is the rule against penalties. If the court considers that a default interest provision is a way of pressuring the other party not to breach the contract, it may well be struck down.
This should not, however, cause undue alarm - in particular lenders should take comfort from the fact that it is only additional interest payable upon a default that is at risk. Commercial parties are, in fact, free to agree the rate of interest before default.
In a syndicated lending context, a default interest provision is standard. The default interest rate should be based upon the lender’s genuine pre-estimate of the loss that he will suffer if the borrower defaults on his payment. Such loss could include increased cost of monitoring the defaulting borrower as well as increased risks inherent in lending to a borrower in default.
If the default provision is drafted as a deterrent for the borrower not to breach the contract however, it is likely to be considered a penalty and struck down as unenforceable.
The penalty rules only apply though if there is a breach of contract. Where a default interest provision is drafted to apply upon the occurrence of an event of default, such default interest could be upheld as enforceable irrespective of the rate of interest, provided however that the event of default is not linked to a breach of the contract.
In reality, it is market practice that an additional default interest can be set at 1 to 2 per cent above the agreed interest. Having said that, the specific circumstances and the documents in which the default interest is applied should always be taken into consideration.