Default interest clauses are common in commercial lending agreements, especially in short-term bridging loans. They allow a lender to charge a higher interest rate if the borrower defaults, compensating for increased risk, administration and delay. But there is a limit: such clauses must not cross the line into being unlawful penalties. Striking the right balance has proved difficult and courts have repeatedly been asked to clarify exactly where the boundary lies.
A recent High Court decision has now provided further guidance.
In this blog, we explore the background to the case, what the court decided and what it means for businesses and lenders.
Background of the case
The case of Nuray Houssein & Ors v London Credit Limited & Anor [2025] EWHC 2749 (Ch) concerned a one-year bridging loan of around £1.88 million. The borrowers – Mr and Mrs Houssein and their property company – secured the loan against several residential investment properties, including their family home.
The loan agreement charged 1% per month standard interest, rising to 4% per month compounded (around 60% annually) if an ‘event of default’ occurred. One key covenant was that the borrowers and their ‘related persons’ (including spouses or relatives) would not occupy the family home during the loan term. This protected the lender’s security position and ensured the loan remained unregulated, as London Credit Limited was not authorised to issue owner-occupied residential mortgages.
The borrowers failed to repay on time and also lived in the secured property, breaching the non-occupation covenant. These were both events of default, triggering the 4% default rate. Arguing that the rate was punitive and bore no relationship to any realistic loss, the borrowers said the clause was an unenforceable penalty.
The first High Court decision
In 2023, the High Court agreed with the borrowers. It found that:
- 4% per month did not reflect any clear commercial need
- expert evidence suggested 3% was normal in the market
- the rate applied uniformly to all defaults, regardless of seriousness
On that basis, the court struck down the clause as a penalty and held that only the standard 1% applied after default.
The Court of Appeal
In 2024, the Court of Appeal overturned the decision, holding that the judge had applied the wrong legal test. Instead of focusing on pre-estimates of loss, the court should have applied the test from Cavendish Square Holding BV v Makdessi [2015] UKSC 67, which asks:
- Does the clause protect a legitimate interest of the innocent party?
- If so, is the detriment imposed extravagant, exorbitant or unconscionable in relation to that interest?
Because the first High Court judgment had not properly considered the evidence under this test, the Court of Appeal sent the case back to the same judge for reconsideration.
Legal background on penalties
Under English contract law, a clause that imposes a detriment on a party for breaching a contract (such as a very high default interest rate or a large fee for late performance) may be unenforceable if it is deemed a penalty, meaning its primary purpose is to punish rather than protect a legitimate commercial interest.
When considering whether a clause is an unenforceable penalty, the courts apply a three-stage analysis:
1. Is the provision a secondary obligation? The penalty rule only applies where the clause is triggered by breach of a primary contractual obligation. If the clause is not breach-dependent, the rule does not apply.
2. Does the innocent party have a legitimate interest in the performance of the primary obligation? Legitimate interests may extend beyond simply recovering financial loss. They can include protecting security, managing regulatory risk, controlling credit risk or other commercial needs.
3. Is the detriment imposed proportionate to that interest? A clause will only be unenforceable if it is ‘extravagant, exorbitant or unconscionable’ relative to the interest it seeks to protect. The threshold is deliberately high.
The High Court reconsidered judgment
In October 2025, applying the Makdessi framework correctly, the High Court reached the opposite conclusion from its earlier decision. The judge began by confirming that the default interest clause operated as a secondary obligation, meaning it was triggered by breach of a primary contractual obligation. On the parties’ own characterisation, the interest was payable only on breach and therefore fell squarely within the penalty doctrine and had to be assessed under the Makdessi framework.
The judge then analysed the two key questions:
Did the clause protect a legitimate interest?
The judge identified five legitimate interests, each corresponding to specific categories of events of default under the contract. As noted above, if an event of default occurred, the borrowers would become liable to pay a higher rate of interest.
1. Timely repayment
The lender’s core interest was being repaid on time – the fundamental purpose of the agreement. The judge accepted that this was a legitimate commercial interest. The judge referenced the Court of Appeal’s guidance:
‘Lenders will typically have a very strong interest in timely repayment, such that some default rate will typically be appropriate by reference to the repayment obligation. If that were the only relevant enquiry they would have carte blanche to charge the same rate for much more minor and inconsequential matters; that is not my understanding of how the law does or should operate.’
In other words, while timely repayment justifies some level of default interest, the clause must still be examined in the context of all default scenarios – not just the most serious ones. The High Court did exactly that and concluded the 4% rate was justified across each relevant default event.
2. Accuracy of information
The loan agreement was made based on certain representations and warranties given by the borrowers (for example, statements about their financial condition and the intended use of the property). The lender has a clear interest in those statements remaining true throughout the life of the loan. If the borrowers provided false information or their circumstances changed in a way that breached those warranties, it could affect the lender’s risk assessment and its decisions (like whether to lend or on what terms). The judgment recognised this as a legitimate interest – the lender is entitled to protect itself against the risk of misinformation by imposing a consequence (higher interest) if it turns out the borrower’s representations or warranties were untrue or misleading.
3. Preservation of security
This was a secured loan, which means it was backed by mortgages on the borrowers’ properties. The lender had a strong interest in maintaining the value and enforceability of its security. Certain events of default were tied to protecting this interest, for example, the covenant that the borrowers would not occupy the property (so it would not become a regulated residential mortgage and would remain easy to repossess and sell if needed) or a promise not to grant any further charges over the property to other lenders. Breaches that weakened, diminished or complicated the security (such as unauthorised occupation of the property or granting a second charge to another creditor) directly increased the lender’s risk. The default interest clause was a way to deter such breaches and compensate the lender if its security position was compromised.
4. Regulatory compliance
London Credit Limited was an unregulated lender (not authorised to make ordinary residential mortgages). The loan was extended on the basis that it was a business/investment loan, not a consumer mortgage. One of the events of default was the borrowers breaching the non-residence covenant by moving into the secured property. If the property became an owner-occupied home during the loan term, the lender could have faced regulatory issues (essentially the loan might be considered a regulated mortgage, which the lender was not allowed to offer). So, the lender had a legitimate interest in ensuring the property remained non-residential as agreed. The court accepted that guarding against this regulatory risk was a valid commercial interest. The 4% default rate, applied when the borrowers decided to live in the property, served to strongly discourage that and to compensate the lender for the heightened regulatory and legal risk when it happened.
5. Credit risk stability
The lender had a clear interest in the borrowers’ financial health during the loan term. Events like insolvency, unpaid debts or court judgments were signs of distress that could affect the borrowers’ ability to refinance or repay. Since this was a short-term loan, any dip in creditworthiness could derail repayment plans. The court accepted that applying a higher interest rate in these situations helped compensate for increased risk and encouraged prompt resolution. This was a legitimate commercial interest, not a punishment.
This meant the first part of the test was met: the 4% default interest clause did serve genuine commercial interests of the lender (timely payment, truthful information, intact security, regulatory compliance and borrower solvency), rather than being simply a punishment out of the blue.
Was the clause extravagant or out of proportion?
The court held that 4% per month was high and above typical market rates, but not disproportionate, for the following reasons:
- It fell within the broad range seen in bridging finance, particularly in higher-risk lending. While the typical default rate in the market was around 2–3%, higher rates, including 4%, were also found in the market.
- It applied only to serious defaults affecting core commercial interests, not minor breaches.
- The borrowers were experienced property investors, legally advised and negotiated the terms on a commercial basis. As the judge observed, ‘even very experienced and properly advised parties make mistakes; that does not mean that the court should step in and relieve them from the consequences of those mistakes.’
The judge concluded that although the rate was steep, it was not out of all proportion to the interests it protected. The clause was therefore not a penalty and was enforceable.
Conclusion and outcome
The High Court upheld the lender’s right to charge 4% per month default interest. Applying the Makdessi test, the court confirmed that:
- The clause protected several legitimate commercial interests, including timely repayment, security integrity and regulatory compliance.
- The rate, though high, was not extravagant or unconscionable in the context of the commercial risks involved.
Key takeaways
- Courts will enforce high default rates in commercial lending where they serve genuine business interests.
- The sophistication of the parties, industry practice and the nature of the default matter.
- Lenders must still be prepared to justify default clauses - they will not be upheld automatically.
- Borrowers who are commercially experienced and legally advised should expect limited sympathy from the courts.
How EM Law can help
At EM Law, we regularly advise on contract terms, including interest provisions and the enforceability of clauses that may engage the penalty doctrine. Whether you are drafting an agreement or reviewing existing terms, we can help you assess risk and ensure your documents align with commercial and legal requirements.
If you are facing a dispute over default interest or need assistance structuring enforceable contract terms, get in touch. You can contact us here or speak directly to Neil Williamson or Colin Lambertus. We are here to support you and your business.
