Default interest: when it’s not always a penalty and when it can be enforced

What is default interest?

A loan agreement usually gives the lender a right to charge default interest should the borrower fail to make a payment when it becomes due. Default interest is charged at a higher rate to compensate the lender for additional costs incurred as a result of the borrower’s failure to pay on time.

Default interest can also be charged if the borrower breaches a clause in the loan agreement which is unrelated to a non-payment.

However, default interest may also be considered a penalty (which means it is unenforceable), if it is out of proportion to any legitimate interest of the affected party. Whether a particular default interest clause is penal depends on the circumstances of each case.

The case: Houssein v London Credit Ltd [2025]

The High Court recently considered in Houssein v London Credit Ltd [2025], if default interest in a facility letter was an unenforceable penalty. The case reviewed:

• The test which was previously reset and clarified in Cavendish Square Holding BV v El Makdessi [2015] (Cavendish) and is commonly used to determine whether a default interest rate is a penalty; and
• The application of the test when the loan agreement states the same default interest rate applies to all events of default. This includes events of default which impacted the credit risk of the borrower, and whether it merited the same default rate as for a non-payment event of default.

Originally, the High Court found a default interest rate of 4 per cent per month was an unenforceable penalty. However, the Court of Appeal later concluded the High Court had incorrectly applied the test in Cavendish, and the case was subsequently redetermined by the High Court.

Using the test in Cavendish, the court considered whether charging a default interest at the rate of 4 per cent per month protected a legitimate interest of the lender and, if so, whether the sum of the default interest payable was ‘extravagant, exorbitant or unconscionable’.

The generally established principle is that there is justification for charging the default interest on a non-payment or other critical defaults. Whereas for a default which does not affect repayment immediately, but might indicate the borrower is in financial difficulty, it was not immediately obvious whether the lender was able to charge the default interest on the whole amount owed at the date of the default.

What the court determined

The court found that the possibility of the borrower not being able to refinance the loan at the end of the term of the loan would be a real credit risk for the lender. It concluded that a default which could lead to a potential new lender finding the borrower uncreditworthy would merit the same default interest rate as a repayment default. Therefore, the default interest rate was protecting a legitimate interest of the lender, and the sum payable was not extravagant, exorbitant or unconscionable.

Why default interest clauses matter

This case demonstrates when negotiating a loan agreement, the importance for the parties to examine each separate event of default and how it reflects a need to protect the lender’s legitimate interest. Otherwise the default interest provisions in the loan agreement may not be enforceable in all circumstances.

How Hamlins can help

Our Real Estate Finance team acts for both borrowers and lenders and can assist with loan agreement negotiations. We aim to ensure all transactions are swift, expertly facilitated and remain on track to a satisfactory conclusion. Please get in touch to find out how we can help.