Penalty interest rates in commercial contracts
Penalty interest rates in commercial contracts

The following Commercial practice note provides comprehensive and up to date legal information covering:

  • Penalty interest rates in commercial contracts
  • Introduction
  • The rule against penalties
  • Penalty interest rate clauses
  • Late Payment of Commercial Debts (Interest) Act 1998
  • Conclusion

Introduction

This Practice Note discusses the rule against penalties and how it applies to interest rates in commercial contracts, including a discussion of the late payment legislation in the UK.

As part of the freedom of contract in business to business contracts, parties can prescribe the consequences of a breach of contract. Whether the courts will uphold those provisions in a given factual setting is a different matter.

Where the parties choose to do so, those consequences are commonly an obligation to make a payment of an agreed sum. The sum may be a fixed amount or determined by reference to a formula. Penalty interest rates are an example of the latter.

A drafter of a penalty interest rate clause must ensure that the clause complies with the doctrine of penalties, and, in the context of the supply of goods or services, the Late Payment of Commercial Debts (Interest) Act 1998 (LPCD(I)A 1998).

While this note does not consider it in any detail, the Consumer Rights Act 2015 (CRA 2015) (in force 1 October 2015) is also relevant to penalty clauses (including penalty interest clauses) in business to consumer contracts.

The rule against penalties

In simple terms, a penalty clause is a liquidated damages clause, which the court will not enforce on the basis that, rather than the clause representing, eg a genuine pre-estimate of the loss caused by the breach,

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