28th February 2011

The risks of charging penal rates of interest

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28th February 2011

The risks of charging penal rates of interest


Contracts for the sale of land invariably specify a rate at which interest is charged if a buyer fails to complete the sale or purchase of a property on a specified date. Provisions to this effect are enforceable to the extent that they represent a genuine forecast of a seller’s loss where the buyer fails to observe or perform its contractual obligations.  A contractual rate of interest which is excessively high will however, be deemed to be a penalty and as such will be unenforceable.

Defining what amounts to an excessively high rate of interest is not entirely straightforward. In the case of Taiwan Scott Co. Limited v The Masters Golf Company Limited the Court of Appeal held that a contractual rate of 15{ba3215b0bf35eaeb06be458b3396ffbfc50bb9db10c9ff1594dfc3875e90ea48} agreed in 2001 wasn’t a penalty.  By contrast, the decision of the High Court of Northern in the case of Fern Hill Properties (Northern Ireland) v Mulgrew was that a 15{ba3215b0bf35eaeb06be458b3396ffbfc50bb9db10c9ff1594dfc3875e90ea48} rate of interest agreed in 2007 was excessive and a penalty.

There were a number of differences in the background to the two cases (the Taiwan case concerned two companies whereas one of the parties in the Fern Hill Properties case was an individual).  The key to the distinguishing the judgements however, is that the prevailing rates of interest in the lending market at the time each of the contracts were put in place were very different.

Contractual rates of interest must be reasonable when seen in the context of prevailing rates at the date of the contract. Where a contract contains an unusually high rate of default interest, the seller will need to consider whether it would be able to justify that interest rate by reference to the rates at which it is ordinarily able to borrow money.

Fixed rates of default interest are unlikely to offer much real comfort in the light of the Fern Hill Properties judgement (particularly when combined with the current historically low bank base rates). Sellers should asses the strength of their contractual positions as a whole in the light of this case to determine whether the comfort they’re able to obtain from interest charging provisions alone provide them with adequate comfort in the event of default by a buyer.

If you require any further information on any of the points raised by this blog please contact Mark Withers at mark.withers@parissmith.co.uk.