Penalties: don't be too extravagant

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16 September 2021

In Ahuja Investments Ltd v Victorygame Ltd, Surjit Singh Pandher Judge Hodge QC, sitting as a High Court Judge, was asked to consider whether a default interest rate in a loan agreement constituted a penalty.  Judgment was handed down on 26 August 2021.

Background

The claimant, Ahuja Investments Limited (AIL) brought a claim against the defendant, Victorygame Limited (VL) and the second defendant, Mr Pandher, for misrepresentation.  VL brought a counterclaim for recovery of monies due under a loan agreement, amongst other things. This review considers the arguments relating to the interest provisions on the loan and does not address the court’s decision about the allegations of misrepresentation.

Mr Pandher was the controlling director of VL.  VL agreed to sell the commercial property, as an investment property, to AIL for over £17million.  VL entered into a loan agreement with AIL to assist with AIL’s purchase of the supermarket and the sum lent was £800,000.  

The loan agreement was entered into on completion and AIL submitted during the proceedings that the money was required because the company had overlooked the cost of stamp duty, though that submission was rejected by the judge.

The loan agreement was negotiated by solicitors for both parties and AIL accepted that the high rate of interest provided for in the loan was understood before the agreement was made.

The terms of the loan provided for 4 “interest” payments of 3% per month, each totalling £24,000, during the terms of the loan and further compound interest at the rate of 12% per month.

The Court’s Decision

The court found that a default interest rate of 12% per month, compounded monthly, representing a fourfold (400%) increase in the interest rate applicable before default was a penalty. This meant that default interest at this rate was not recoverable by VL.

The court accepted that a lender does have a legitimate commercial interested in applying a higher rate of interest to borrowers in default because such borrowers are a credit risk. The judge referred to the case of Cargill where Bryan J stated that, “… it is self-evident … that there is a good commercial justification for charging a higher rate of interest on an advance of money after a default in repayment. The person who has defaulted is necessarily a greater credit risk and ‘money is more expensive for a less good credit risk than for a good credit risk’.”

The court confirmed that the key question in such cases is whether the borrower can demonstrate, on the balance of probabilities, that the default interest rate is, extravagant, exorbitant, or unconscionable.

If you read the judgment in this case, you will see that the judge appeared to be unimpressed with the way in which the parties prepared and presented their case at trial.  In respect of this particular issues, the judge noted that there was no evidence before the court about the market interest rates at the time of the loan. The judge also noted that there was limited evidence about the risk factors that had been considered when making the loan, or the rational for setting such a high interest rate.  The judge commented that there was no evidence about whether VL and Mr Pandher, the defendants, genuinely assessed that the default interest rate reflected the creditworthiness of the claimant, AIL.

The judge concluded that AL has discharged the evidential burden commenting that:

“In the absence of any such evidence, in my judgment, Ahuja has discharged the burden of demonstrating that a 400% increase in the primary interest rate on default, when combined with the provision for monthly capitalisation of interest, is so obviously extravagant, exorbitant and oppressive as to constitute a penalty. Whilst I would be prepared to accept, without supporting evidence, an increase of up to 200% in the applicable rate of interest on default to reflect the greater credit risk presented by a defaulting borrower, in my judgment, and as a rule of thumb, I would expect an evidential burden to pass to a lender to adduce evidence to justify any greater increase, at least where the lender enjoys additional personal and real security for its loan.”

Comment

This case is a useful reminder to lawyers preparing cases for trial that if their client is raising an issue at trial, they must scrutinise the evidence available to support it. The judge in this case was critical of the parties’ failure to call potentially key witnesses.

For businesses seeking to include interest clauses in their contracts, this case confirms that there are commercial justifications for charging a higher rate on a default.  The higher rate will reflect the greater credit for the payee and the cost of administering and monitoring a late payer. Businesses should carefully record their commercial thought processes when determining the applicable interest rates because, in the event of a dispute, the court may expect the lender to be able justify its decision.

© Melissa Worth, September 2021

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