An issue which often comes up when a borrower defaults is establishing what can be recouped by a lender in the course of enforcement. In order to redeem a loan, both the capital made available and interest accrued must be repaid to the lender. However, how do the courts view other items such as default interest when it comes to redeeming a loan?
The treatment of default interest remains a sticking point for lenders, borrowers and their advisers and one that is treated differently between the Irish and English courts. Care must be taken when drafting these clauses. Such provisions will generally provide that default interest will apply to a sum due but unpaid under a loan agreement for the period that the sum remains unpaid stating the default rate that will apply.
Recently1 the Irish High Court (as affirmed by the Court of Appeal) considered a clause applying to a loan agreement which provided for a default interest rate of 4% above the normally applicable interest rate (of 2%) to be applied to any due but unpaid sum. The Court's decision was that the clause amounted to a penalty clause on the basis that:
- The default rate was not a genuine pre-estimate of the loss which would be incurred by the lender in the event of default; and
- The additional default interest rate was intended to discourage a breach of the agreement by the borrower.
It should be noted that the English court's approach to this issue2 is more flexible in that such a clause will only be held to be a penalty if the detrimental effect of the default rate on the borrower is completely disproportionate to the loss incurred by the lender.
- The Breccia cases sought to rely on a default interest provision contained in the standard terms and conditions issued at origination. Such a standard clause will most likely not be considered to be a genuine pre-estimate of loss. Lenders would be advised to include a bespoke default interest clause in the facility letter.
- The Court of Appeal declined to consider the English approach in The Irish position is unlikely to change until the Irish Supreme Court has the opportunity to consider this issue.
- In the event that the lender's claim for default interest fails, the lender can still recover the capital and interest owing.
1. Sheehan v Breccia and Flynn v Breccia (HC, judgment granted in Court of Appeal on 30 July 2018)
2. Cavendish Square Holding BV v El Makdessi (UK Supreme Court)
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