Default interest rates: How much is too much?

It is commonplace for lenders to charge interest on late payments. This deters borrowers from delaying repayments and offers creditors increased incentive to lend to or deal with borrowers who represent higher risk of default. Sometimes, a lender’s terms and conditions will provide for an increased rate of interest to apply following a default.

Debtors are afforded some protection against excessive increases in interest rates on default. If the increase is so significant that it can be considered a penalty, that increase can be unenforceable. Importantly, the responsibility is on the debtor alleging that an increase is a penalty to demonstrate that it goes beyond what is acceptable.

What constitutes a fair increase in the interest rate following a default can prove contentious, particularly as numerous businesses have seen their revenues decrease dramatically due to the pandemic. This makes repayments harder to meet and so more businesses may be facing increased interest rates due to default over the next few months.

A recent case, Ahuja Investments Ltd v Victorygame Ltd and another has built upon existing caselaw to provide additional guidance into what can be considered an excessive increase. Following a default by the debtor, the lender increased the interest rate from 3% per month to 12% compounded monthly.

The increase was found to be so significant that it was not even necessary for the debtor to provide evidence of market rates for such an increase to demonstrate that it was a penalty.

Although this case was about the rate of interest payable under a loan agreement, the guidance provided also has wider application to other contracts which may contain penalty clauses, such as those sometimes found in supplier terms and conditions.

Many could find themselves facing increased interest rates after struggling to meet their debts during the pandemic. Our dispute resolution lawyers can assist both creditors and debtors who face a dispute about default interest rates or other forms of penalty.