Bridging Loans – Does a Bridging Lender’s Default Interest Rate Constitute an Unenforceable Penalty?

In January 2024 we published an article about the case of the case of Houssein & Ors v London Credit Ltd & Ors [2023] EWHC 1428 (Ch) where the High Court held that a default interest rate in a bridging loan agreement secured by residential property constituted a penalty clause and was unenforceable – “Bridging Lender’s Default Interest Rate: High Court Deems 4% Default Interest an Unenforceable Penalty Charge”

In summary, the High Court held that the default interest rate (4% per month) did not protect any ‘legitimate interest’ of the bridging lender and that it was an unenforceable penalty.  The Court further declared that interest at the standard contractual rate (1% per month) was payable by the borrower instead on any unpaid sums after the specified repayment date. 

The Court of Appeal has recently found that the High Court erred in his application of the correct test to determine whether a default interest clause amounted to an unenforceable penalty: Houssein v London Credit Ltd [2024] EWCA Civ 721.

The Court of Appeal followed the decisions in Cargill International Trading PTE Ltd v Uttam Galva Steels Ltd [2019] EWHC 476 (Comm) and the 3-stage test set down in Vivienne Westwood v Conduit Street [2017] EWHC 350 (Ch). Applying those three stages: 

1. When deciding whether a provision amounts to a penalty, the threshold question was whether the default rate of interest was a secondary obligation engaged by breach of a primary contractual obligation. The High Court Judge did not deal with this threshold question, but it was implicit that it was crossed (i.e. the obligation to pay default interest arose upon a breach of the primary obligation in the bridging lender’s facility letter). 

2. Whether a legitimate interest of the bridging lender is protected in having the primary obligation performed (and if so, what was the extent and nature of the legitimate interest). The Court of Appeal held that the High Court Judge had fallen into error. Although it had not been in issue between the parties, the Judge had looked for a legitimate interest of the Bridging lender in imposing default interest, and had done so by investigating the subjective intentions of the parties. The Court of Appeal held that the conclusion of the High Court Judge that the default rate did not protect a legitimate interest of the bridging lender was wrong – stating that “it is inevitable that a legitimate interest in the enforcement of the primary obligation to repay the Loan, all interest, fees and commissions on the Repayment Date arises here.” 

3. If such a legitimate interest is held to exist, the court must then consider whether the sum required to be paid is nevertheless exorbitant, extravagant or unconscionable in amount or in effect? The Court of Appeal held that the High Court Judge had not asked this important question, and was instead looking to see whether the bridging lender had a justification for the default rate. That was the wrong approach. 

The Court of Appeal referred the issue of whether the default interest rate constituted a penalty back to the first instance judge to decide on application of the correct test. 

The Court of Appeal also held that the High Court was wrong in finding that interest continued to accrue after the repayment date at the non-default rate of 1% per month, and that in the absence of default interest being payable, the non-default rate under the facility letter was not payable. The Court of Appeal’s interpretation of the facility letter was that the default interest rate became applicable if an event of default occurred or if the borrower failed to repay any amount on its due date, but there was no mechanism for the interest rate to revert to the non-default rate in circumstances where the default rate would apply but the provision is found to be unenforceable (the non-default rate and the default rate were mutually exclusive). The Court said that if the default rate of interest is found to be a penalty, in the circumstances of this case, the non-default rate of interest would not apply on the sums outstanding after the repayment date. However, the court acknowledged that the lender could choose to pursue their counterclaim for statutory/equitable interest in such circumstances. 

The case provides a reminder of the 3 stage test to be applied to establish whether a default interest rate is unenforceable as a penalty and it will be interesting to see whether the High Court, when it applies the correct test, reaffirms that the default interest rate in this case constitutes a penalty. 

The construction of the facility letter was determined on the particular terms found in that particular contract. But the Court’s decision demonstrates that a standard rate of interest will not automatically be applicable simply because a default rate of interest is a penalty and is therefore unenforceable. 

Bridging Loan Default Solicitors – Contact Us

Should you have any queries about this topic please contact Senior Litigation Partner David Burns by email at D.Burns@rfblegal.co.uk or by phone on 07762318409.