The Court of Appeal dismissed a borrower's challenge to a default interest provision in Houssein v London Credit Ltd and provided useful guidance on the circumstances in which an offer of repayment, or otherwise known as a valid tender, will stop interest from accruing. The Court held that the borrowers' refinancing proposals did not amount to valid tenders of payment and confirmed that the default interest provision, which increased the interest rate from 1% to 4% per month following specified events of default, was enforceable.
Background
The background to the dispute is set out in our previous article: Not a penalty: Default interest clause upheld in Houssein v London Credit Ltd - Stevens & Bolton LLP. In that article, we examined the High Court's reconsideration of whether the default interest provision was unenforceable as a penalty. Having been directed by the Court of Appeal to apply the principles in Cavendish Square Holdings BV v Makdessi, the High Court concluded that the provision was proportionate to the lender's legitimate commercial interests and therefore enforceable.
A second trip to the Court of Appeal
The borrowers' appeal raised three principal issues, which Lord Justice Lewison identified as follows:
- What must a borrower under a secured loan do, short of actual repayment, in order to stop interest running on the loan?
- Was the default interest rate specified by the secured loan documentation in this case a penalty?
- If it was, was the lender nevertheless entitled to statutory interest on the outstanding debt?
Refinancing offers are not enough: the Court on tender
The borrowers argued that the repayment offers they made during the dispute constituted valid tenders of payment. For a tender to be valid, a borrower must offer to repay the full amount due (including any costs), have immediate access to the necessary funds and keep those funds available for payment. The offers here were linked to proposed refinancing transactions with alternative lenders and, in some instances, exceeded the amount then outstanding under the loan (inclusive of interest).
The Court of Appeal rejected the borrowers' tender argument. It emphasised that the mere fact that the borrowers had offered more than was ultimately due did not dispense with the ordinary requirements for a valid tender. For interest to cease accruing, a borrower would generally need to have funds immediately available and set aside for repayment of the debt. The borrowers' refinancing proposals did not satisfy those requirements because no funds had been set aside or were immediately available to discharge the debt. As that had not occurred, the lender remained entitled to continue charging interest.
Default interest survives further scrutiny
The Court of Appeal also reconsidered whether the default interest rate constituted a penalty. In doing so, it was satisfied that the High Court had correctly applied the principles established in Cavendish Square Holdings BV v Makdessi. 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.
In particular, the Court of Appeal accepted that the lender had a legitimate interest in protecting itself against the increased risks arising from default. A key aspect of the High Court judge's reasoning, which the Court of Appeal endorsed, was that the prospects of refinancing were precarious and could be derailed by anything that increased the cost of obtaining replacement finance. In those circumstances, the Court accepted that an above-market default interest rate could reflect the heightened “credit risk” faced by the lender.
In addition, the Court emphasised that the relevant question was not whether the lender's interests were already "adequately” protected by its security and other contractual protections. Rather, the issue was whether the default interest rate was out of all proportion to the legitimate commercial interests the lender sought to protect. On the facts before it, the Court concluded that the threshold had not been crossed. Interestingly, the Court observed that the borrowers' own expert had accepted that a 4% default interest rate was at the borderline of commercial acceptability within the bridging finance market, a factor which supported the conclusion that the provision was not a penalty. The default interest provision was therefore enforceable.
What does this mean for lenders?
The Court of Appeal dismissed the appeal on all grounds. The judgment provides further reassurance to lenders that a default interest provision will not be a penalty merely because the rate specified is significantly higher than the ordinary contractual rate. The focus remains on whether the provision is out of all proportion to the lender's legitimate commercial interests.
The decision also provides useful modern guidance on the law of tender, confirming that a borrower’s refinancing proposals alone will not prevent interest from continuing to accrue where no immediately available funds have been set aside for repayment.
