Key Takeaways
- A default interest clause in a loan agreement is only unenforceable if it is out of all proportion to the lender’s legitimate commercial interests.
- The Court of Appeal in Houssein v London Credit confirmed that a 4% monthly compounding default interest clause was not an unenforceable penalty, setting a high bar for borrowers who wish to challenge such rates.
- Courts apply the Makdessi test when deciding if a default interest clause is a penalty: is it a secondary obligation, does it protect a legitimate interest, and is it exorbitant or unconscionable?
- Borrowers cannot stop default interest from running simply by offering to refinance or settle; a valid tender of payment must be in immediately available funds.
- If you do nothing in response to default interest being charged, you risk significant additional costs and may lose the chance to challenge unfair rates.
- Loan agreements often require disputes over default interest to be raised promptly, so it is vital to act without delay if you think the clause is unfair or unenforceable.
- Lenders should document the commercial reasoning behind their default interest rates to ensure clauses are enforceable if challenged.
- Borrowers should seek advice on the difference between contractual and equitable tender, as only a compliant tender can stop interest running.
Default Interest Clauses and the Court of Appeal’s Latest Word
Disputes over default interest clauses are common in loan agreements for businesses and directors across England and Wales. The law sets a challenging standard for those seeking to strike down steep default rates as penalties. In the recent decision of Houssein v London Credit, the Court of Appeal held that a 4% monthly compounding default interest rate was commercially justifiable and not a penalty, confirming that borrowers face a high bar if they want to challenge these clauses.
This case also clarified when interest stops running in loan disputes: only a proper tender of payment in immediately available funds will suffice—not merely an offer to refinance. The ruling matters for businesses, directors, and lenders in refinancing, payment, or enforcement disputes. Understanding the framework set by the court is key to effectively negotiating, challenging, or defending default interest provisions.
Background: The Facility Agreement and Default
The dispute in Houssein v London Credit started when the borrowers entered a facility agreement with London Credit Ltd (LCL), a commercial lender. A breach of covenant occurred, triggering an event of default under the facility agreement. As is standard, LCL demanded immediate repayment of the loan together with default interest at a rate of 4% per month, compounding monthly.
When the borrowers failed to pay by the repayment date, LCL exercised its rights under the agreement and appointed receivers over the secured property. These steps—default, demand for repayment, and escalating interest—are common features in business lending agreements, especially those involving high-value, riskier bridging finance.
Litigation followed, with the borrowers challenging both the rate of default interest and the fairness of the lender’s actions in seeking rapid repayment and enforcement.
The Litigation History: Four Rounds in the Courts
The legal battle in Houssein v London Credit involved four major hearings:
- First instance (High Court): The High Court initially found the default interest clause to be a penalty, striking it down and limiting LCL to standard interest only.
- First appeal (Court of Appeal): The Court of Appeal held the High Court applied the wrong legal test for penalties, and sent the case back for a proper rehearing.
- Remitted hearing (High Court): The High Court reconsidered and found the clause was not a penalty, concluding the borrowers had not done enough to halt default interest from accruing.
- Second appeal (Court of Appeal): The borrowers appealed again. This time, the Court of Appeal dismissed the appeal, confirming the High Court’s ruling that the default rate was not penal and that interest had not been validly stopped.
Each round refined the law on how penalty clauses are assessed in the context of loan agreements, as well as on what is required to stop default interest from running during negotiations or attempted refinancing.
The Legal Test for Penalty Clauses in Loan Agreements
The leading case for penalty clauses is Cavendish Square Holding BV v Talal El Makdessi [2015] UKSC 67, which set the “Makdessi test”—a three-stage approach that courts now follow:
- Is the default interest clause a secondary obligation triggered by breach?
- The court first asks whether the clause is activated by a breach or default under the contract. Default interest usually is, as it only applies once a payment is missed or another event of default occurs.
- Does the clause genuinely protect a legitimate commercial interest?
- The lender must be able to show the higher rate is intended to compensate for actual, increased risks or costs, not simply to punish the borrower for failing to pay.
- Is the detriment (higher rate or uplift) out of all proportion to that interest?
- The final limb is crucial. Even where there is a business justification, if the clause imposes a rate that is so excessive as to be “extortionate, exorbitant or unconscionable,” it may still be struck down.
The courts focus strongly on the factual and commercial context at the time of the contract—not what might have changed since. Each element must be considered before reaching a conclusion.
Issue 1: When Does Default Interest Stop Running? Tender and Refinancing Disputes
The Borrowers’ Argument
In Houssein v London Credit, the borrowers did not pay off the outstanding loan but explored refinancing to clear the debt. They argued that interest should have stopped running once they had arranged a refinancing deal capable of acceptance, even if not actually completed. The typical scenario is a conditional refinancing offer: the new lender will only release funds if the existing lender first discharges its security over the property.
Borrowers often believe that arranging such a deal (and telling the lender) is enough to halt default interest. The Court of Appeal rejected this.
The Court’s Reasoning
The essential bargain in any loan is that the borrower pays interest for as long as they have use of the lender’s money. Interest continues to accrue unless and until the borrower actually pays back the loan or makes a payment validly stopping further accrual.
The court reaffirmed an old but important equitable principle: only a true tender of payment—actually placing the lender in a position to accept full, unconditional repayment in immediately available funds—can stop interest accruing if the lender refuses without justification.
What Is a Valid Tender?
A valid tender is not a mere promise, nor an arrangement dependent on further steps or conditions. The borrower must be able to pay the full outstanding amount immediately, with no strings or further requirements, and actually be willing and able to do so.
Where a refinancing offer is conditional, or there remains uncertainty or negotiation, it cannot stop the clock on interest.
The Ҫukurova Argument and the Court’s View
The borrowers relied on Ҫukurova Finance & Anor v Alfa Telecom Turkey Limited [2013] UKPC 20, suggesting that if a lender “should” accept a refinancing offer as a matter of fairness, that could count as tender. The Court of Appeal rejected this idea for several reasons:
- The facility agreement required payment in immediately available funds, which did not exist in this case.
- The concept of a “non-contractual” offer the lender “should” accept is too vague for legal certainty.
- In Ҫukurova, the loan had been discharged and funds set aside. Here, no such step had occurred—there was neither discharge nor funds available to the lender.
Judicial Comment
The court left open a narrow possibility: if a new lender is legally bound to lend (with the only proviso being release of security), that might be enough to count as tender in future cases. Here, the point was theoretical only and did not affect the outcome.
Issue 2: Was the 4% Default Rate a Penalty? Applying the Makdessi Framework
The Court of Appeal’s Approach
Whether a default rate is penal is a question of value judgment for the trial judge. Appellate courts will only interfere if there is a clear flaw, such as logic gaps or material facts ignored, rather than substituting their own view.
The High Court’s Analysis of “Legitimate Interest”
On remittal, the High Court carefully evaluated whether the 4% monthly compounding default rate was “extortionate” in relation to each of LCL’s business interests. The focus was on the “credit risk” to the lender—the increased possibility that, following default, their ability to recover via the borrower’s planned refinancing route could collapse.
Why the Court Upheld a High Default Rate:
- The only realistic way the lender could be repaid was the borrower’s planned refinancing.
- Refinancing was precarious and could easily fall through if new lender terms shifted, or events of default made the loan unattractive.
- The 4% rate was rationally connected to this risk. The court accepted that tying the price of default to the risk that refinancing would become unavailable or unworkable was a responsible commercial practice.
The Borrowers’ Challenge and the Court’s Response
The borrowers argued the judge was wrong and that a very high default rate, even with supporting business logic, should not stand. The Court of Appeal found no flaw in the High Court’s approach.
Key takeaways:
- Facts as known at contract date: The court assessed proportionality and risk on the position at the date of the agreement, not by looking at later events or hypothetical scenarios.
- Not a penalty “per se”: The question is whether the uplift is out of all proportion compared to the lender’s actual risk and business interests—not simply whether there is more than standard interest.
- Deference to commercial judgment: Provided the clause is rooted in business sense and not manifestly punishable or arbitrary, courts are slow to strike it down.
Issue 3: Statutory Interest—No Relief for Borrowers
The Court of Appeal reiterated that statutory interest (potentially available where a contract term is unenforceable) would only become relevant if the default rate was in fact a penalty. As the clause was held not to be penal on the facts of this case, this question simply never arose and did not affect the outcome.
What This Means for Borrowers and Lenders
For Borrowers
- Challenging default rates is hard. The Makdessi test sets a high hurdle. It is not enough to point to a rate being higher than the standard—there must be proof that the uplift is out of all proportion to proper lender interests.
- Legitimate business purpose matters. If the default rate is justified by an elevated risk of non-repayment, such as the risk that refinancing collapses after an event of default, the court is likely to uphold it.
- Refinancing offers rarely stop interest. Only a valid tender in immediately available funds will halt default interest running. Conditional or incomplete offers cannot do so.
- Assess proportionality at contract date. The court analyses what the parties knew and negotiated at the point of signing, not subsequent changes.
For Lenders
- Drafting and record-keeping are key. Enforceable default rates should reflect a clear commercial rationale. Board minutes, market evidence, and documentation of risk can all make the difference if challenged.
- Higher default rates are possible—but not automatic. Courts respect the commercial bargain but will strike down manifestly excessive, punitive rates. Each set of facts is critical.
- Importance of timely action. Enforcement steps often follow swiftly after default. Retain evidence of the need for, and calculation of, any uplifted rate to support enforceability.
When to Seek Legal Advice
Prompt, specialist advice is essential in disputes involving default interest, whether you are a lender or borrower.
Seek guidance if:
- You believe a lender is charging a penalty or excessive default interest.
- You want to make a tender of payment or are renegotiating to refinance.
- A facility agreement is being drafted, reviewed, or enforced, and the terms are unclear.
- There is a prospect of court action, appointment of receivers, or disagreement over interest calculation.
- You need to understand or challenge contractual clauses or respond to High Court or County Court proceedings.
How Our Solicitors Can Help
Our commercial litigation and dispute resolution solicitors have extensive experience handling banking and finance disputes across England and Wales. We provide:
- Strategic drafting and review of default interest and penalty clauses for lenders and borrowers.
- Expert representation in loan agreement and breach of contract disputes in the High Court, County Court, and Business & Property Courts.
- Assistance in all aspects of event of default and security enforcement.
- Support with refinancing disputes, appointment of receivers, and defending or enforcing claims.
- Flexible fee options, including fixed-fee packages and hourly rates, and a price-match guarantee beating like-for-like quotes by 10% or more.
We act for lenders, borrowers, company directors, and shareholders in complex financial matters, including mediation and arbitration where suitable.
To discuss your situation and strategic options, book a free consultation with our expert solicitors or call 0207 459 4037.
Frequently Asked Questions (FAQs)
What is a default interest clause in a loan agreement?
A default interest clause specifies the rate a borrower must pay if they default on obligations under a loan or facility agreement. It is intended to compensate the lender for the extra risk and effort when default occurs.
When could a default interest clause be an unenforceable penalty?
If a default interest rate is disproportionately high and not justified by the lender’s commercial need or risk, it may be classed as a penalty and made unenforceable.
What is the Makdessi test for penalty clauses?
The Makdessi test asks (1) if the clause is triggered by breach, (2) if it protects a legitimate interest, and (3) if the detriment is out of all proportion—extortionate or unconscionable—compared to those interests.
How do I stop interest running on a loan?
Only by making a valid, unconditional tender of full repayment in immediately available funds. A mere offer to refinance, especially if conditional or dependent on discharge of security, does not suffice.
What is a valid tender of payment?
A valid tender requires you to offer the full amount due, unconditionally, and in real, immediately available funds. The lender must be able to receive payment there and then, without further steps.
Can I challenge a default interest rate if I am refinancing?
If you believe the rate is not commercially justified or is out of proportion to risk, you may challenge it in court. However, offers to refinance do not generally stop default interest from accruing unless structured as a true tender.
What is “credit risk interest”?
Credit risk interest is a higher post-default rate reflecting the lender’s increased risk that the borrower will not repay in full or on time because usual routes, like refinancing, may have failed.
How do courts decide if a default rate is extortionate?
Courts examine factual context, the business rationale, and market evidence at the time of contracting. If the uplift exceeds what is justified by risk or cost, they may find it extortionate.
Speak to Our Default Interest Clause Solicitors
For strategic, practical guidance on challenging or enforcing default interest clauses, or for reviewing and drafting robust loan agreements and facility documents, book a free consultation with our specialist team. We are ready to provide clarity and protect your business interests across all finance and contract litigation matters.
