Is Your Default Interest Clause Enforceable?

The vast majority of loan agreements will contain a default interest provision which provides a contractual sanction against non-payment of a sum of money. Care must be taken however in the lender's choice of default rate and the manner in which it becomes payable, otherwise such provision may risk being invalid as a penalty. Recent case law has confirmed the new approach which a court will adopt when considering whether a particular provision can be regarded as a penalty (and will consequently be void and unenforceable).

When deciding whether or not a contractual term is penal, the traditional approach of the courts has been that the clause will be enforceable if it does not exceed a genuine attempt to estimate in advance the loss which the claimant would be likely to suffer from a breach of the obligation in question.