The High Court has clarified how the penalty rule applies to default interest clauses in Houssein v London Credit Ltd [2025] EWHC 2749 (Ch). The dispute arose in relation to a year-long bridging loan where certain defaults – critically, not just non-payment – entitled the lender to charge a 4% default interest rate which compounded monthly. Following default, the Housseins claimed that this default rate was not enforceable.
This judgment clarifies that the validity of penalty clauses in an interest context hinge on proportionality to legitimate interests, not merely on whether they seem punitive, and that default interest clauses can be triggered by non-monetary defaults.
Background
The claimants acted as personal guarantors to a £1.881m loan from London Credit Ltd (LCL) under a facility letter secured against a portfolio of properties. In the ordinary course interest was charged at 1% per month but rose to 4% per month on the occurrence of certain defaults, including non-payment, misrepresentation, non-residency, failure to maintain security, and deterioration of credit status.
Comparing statutory and market norms
By the repayment date, the loan remained unpaid, triggering the lender’s right to apply the 4% monthly default interest rate. The claimants argued this was penal and unenforceable, contending LCL should instead be limited to statutory interest – simple interest at 8% per annum above the Bank of England base rate under the Late Payment of Commercial Debts Act.
To put this in context, bridging loans typically impose monthly compounded default rates of around 3% (about 36% annually). LCL’s 4% monthly rate was therefore above market norms. Deputy Judge Farnhill noted that while dynamic default rates – varying by type of default – are theoretically possible, they are rare; most lenders apply a uniform rate.
The journey through the courts
Initially the High Court held that the default rate was a penalty and unenforceable. However, the Court of Appeal held that the first instance judge had misapplied the test set down in Cavendish Square Holdings BV v Makdessi [2015] UKSC 67. Under that test, the court must ask:
- What legitimate commercial interest does the innocent party seek to protect through performance of all primary obligations. In other words, what is the lender trying to safeguard?
- Is the consequence of breach of those primary obligations to impose a penalty which is too harsh when compared to that underlying commercial interest? If the penalty is out of proportion to the lender’s legitimate interest – if it is extravagant, exorbitant or unconscionable – it will be unenforceable.
The Court of Appeal confirmed that the lender had legitimate interests to protect (satisfying step 1 of the Cavendish test) and emphasised that a lender has a strong commercial justification for charging default interest following a failure to repay.
It remitted the penalty issue to the High Court to reconsider what triggered the obligation to pay the default rate and whether the default interest charged was in proportion to the lender’s interests (step 2 of the Cavendish test).
High Court reconsideration
On remittal, Deputy Judge Richard Farnhill upheld the clause. While acknowledging that 4% was above typical market norms, he assessed each of the defaults which could lead to default interest being charged.
This was unusual because, unlike standard LMA (Loan Market Association) terms where default interest is triggered only by payment defaults, here it could be triggered by five events (outlined above). Since multiple obligations could activate the default rate, the court had to check whether applying the higher rate for each type of breach was proportionate to the lender’s legitimate interests. If one of the obligation triggers was found to be excessive, the whole clause would fail. The court concluded each was justified, given:
- The lender’s exposure to regulatory risk under the non-residency clause which the claimants breached by occupying one of the properties which formed part of the security. The facility letter also contained a representation that the borrowers would comply with all covenants, including the non-residency obligation.
- The borrower’s precarious refinancing position: the borrower’s ability to repay depended entirely on securing new finance, and even a small deterioration in creditworthiness could cause that refinancing to collapse. This made timely repayment critical and justified a strong deterrent.
- The importance of preserving security and incentivising compliance.
Why this matters
This decision confirms that default interest clauses will survive penalty challenges if they are proportionate to legitimate commercial interests. For lenders, it underscores the importance of documenting those interests. For borrowers, it is a reminder that covenant breaches – even non-payment defaults – can trigger significant financial consequences.
