Introduction
The judgment in Houssein & Others v. London Credit Ltd[1] provides a useful summary of the English penalty rule and guidance on its application in practice. It is an important reminder that a clause will be struck out in its entirety if any element of it is determined to be penal.
Background
The case concerned a default interest clause in a bridging loan agreement between the third claimant, CEK Investments, and the first defendant, London Credit Limited.
The loan agreement contained two interest rates: a standard rate of 1% compounded monthly and a default rate of 4% compounded monthly, triggered by an event of default. Events of default included CEK failing to make a payment under the loan agreement itself, making a false representation or warranty, and failing to make a payment on a third-party loan or judgment debt.
London Credit alleged that there had been a breach of the loan agreement and sought to charge CEK the default interest rate. CEK claimed that the default interest rate was an unenforceable penalty.
The High Court’s decision
The court set out the now familiar three?stage analysis. First, the penalty rule only applies to secondary obligations arising on breach of a primary obligation. Second, the court must identify the innocent party’s legitimate interest in performance for each primary obligation to which the same secondary remedy applies. Third, the court asks whether the secondary obligation is exorbitant or unconscionable in amount or effect. The judge emphasised that if any element of the clause is penal, the clause is unenforceable in its entirety.
Quoting from the leading Supreme Court decision on penalty clauses, Cavendish Square Holdings BV v. Makdessi[2], the judge reiterated that where a contract has been negotiated between properly advised parties of comparable bargaining power, “the strong initial presumption” is that the parties themselves are the best judges of what is legitimate in a provision dealing with the consequences of breach. At the same time, there is a recognised presumption, “though no more than that”, that a sum is penal if it is payable on event of varying gravity.
In this case, although the agreement was negotiated between sophisticated parties, the same default rate was engaged by multiple primary obligations, prompting the court to analyse the lender’s legitimate interest for each event of default.
The court readily accepted that there was a clear legitimate interest in protecting against the risk of nonpayment, and that a higher rate for nonpayment and other material defaults can, in principle, be justified. The more difficult question concerned defaults not obviously linked to repayment, such as failing to pay unrelated borrowings or judgment debts. The court found that it was not self?evident that the same default rate should apply to such events.
Ultimately, following a detailed, commercial analysis of bridging finance dynamics, the court accepted that a default on other borrowings or outstanding judgment debts would significantly reduce the borrower’s ability to refinance and repay the bridging facility; thereby grounding a legitimate interest for applying the same default rate.
As to the size of the increase in interest rate, while 4% compounded monthly was above the standard market rate, it was not exorbitant or unconscionable in the circumstances and therefore did not fall foul of the penalty rule.
Takeaway
The penalty bar remains a high one, and courts are slow to interfere in negotiated contracts between parties of equal bargaining power. Nevertheless, parties should carefully assess how a single secondary remedy applies across different primary obligations. If a legitimate interest cannot be articulated for imposing the remedy in respect of each obligation, the entire clause risks being struck out. Further, the court’s acceptance of 4% compounded monthly in this case should not be read as blanket approval for that rate in other contexts; penalty analysis is fact-sensitive and contract specific.
[1] [2025] EWHC 2749 (Ch)
[2] [2015] UKSC 67
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