Penalties In Loan Contracts

Introduction

In the current inflationary market, lenders are changing the terms on which they are willing to lend money to both individuals and businesses. For most borrowers, the key variable is interest rates.

Can an interest rate under a loan ever be so high that a court will refuse to enforce it? Yes, if the interest rate is found to be a penalty. However, courts in NSW are only willing to find that an interest rate charged under a loan is a penalty in limited circumstances. Typically, courts will allow lenders to recover interest and other amounts owing on their loans.

What is a penalty?

A penalty is a contractual provision which is intended to ensure that a party performs a contract by severely punishing a breach of the contract. When a contract provision is a penalty, the "punishment" is out of all proportion to the other party's legitimate commercial interest and not a genuine pre-estimate of the other party's loss.