Key takeaways
Court reaffirms approach to penalty clauses
Default interest upheld under legitimate commercial interest test.
Businesses should review loan agreements carefully
Ensure default rates align with enforceability standards.
Penalty provisions must avoid punitive intent
Focus on proportionate compensation, not punishment.
Houssein & others -v- London Credit Ltd & others [2025] EWHC 2749 (Ch)
This was a dispute arising under a loan agreement (Facility Letter) for a loan of around £1.88 million. The Facility Letter provided for a default interest rate (Default Rate) of 4% compounded monthly. At the original trial, the Chancery Court judge held that the Default Rate was a penalty and, therefore, unenforceable.
On appeal, the Court of Appeal held that the judge had applied the wrong test under English law for determining whether a contractual provision amounts to an unenforceable penalty clause. The Court of Appeal remitted the matter back to the judge for reconsideration. Our article on that decision can be found here.
The Chancery Court judge has now, applying the correct legal principles, held that the Default Rate was not a penalty and so was enforceable by the lender from the contractual repayment date.
The decision is relevant specifically to those entering into finance agreements. More generally, it is relevant to commercial contracts that incorporate liquidated damages and default interest provisions.
The background facts
Mr and Mrs Houssein had a portfolio of residential properties that were mostly held as investments. However, one property, 71 Hamilton Road, was the family home. Some of the properties were used as security for various loans.
In June 2020, one of the loans (Bridge Loan) needed to be refinanced. A Facility Letter was entered into between a company owned by the Housseins, CEK Investments Ltd (CEK), and an unregulated lender, London Credit Ltd (LCL).
LCL provided a loan of £1.881 million to CEK. Mr and Mrs Houssein personally guaranteed CEK’s obligations under the Facility Letter. LCL also took charges over certain of the properties in the property portfolio, including 71 Hamilton Road.
The Facility Letter contained a non-residency provision. As an unregulated moneylender, LCL was not authorised to make loans to individuals secured by way of mortgage over the property where they resided. That was also why the loan was taken out by CEK, not Mr and Mrs Houssein.
When the properties were inspected on 29 July 2020, prior to drawdown, an LCL employee was present and became aware that the Housseins continued to reside at 71 Hamilton Road. Nonetheless, the employee dishonestly omitted to inform LCL of this.
Drawdown under the Facility Letter occurred on 7 August 2020. Very shortly thereafter, LCL discovered that the Housseins continued to reside at 71 Hamilton Road. The family was requested to vacate the property in reliance on the non-residency provision. It refused.
LCL appointed receivers to take enforcement action. The Court subsequently found that the enforcement action was void because the LCL employee’s knowledge of the continued residency in the family home was imputed to LCL.
LCL commenced court proceedings, seeking repayment of the loan, together with interest.
The first Chancery Court decision
At the trial, the judge concluded that the contractual Repayment Date was 7 August 2021. Of the capital, £1.2 million had been repaid on 28 May 2021. Other than this repayment, the claimants did not make an effective tender of or otherwise repay or make any offers of payment. Nothing the Housseins had done had stopped interest from accruing.
As to interest, there were two rates: the Standard Rate of 1% per month and the Default Rate of 4% compounded monthly. The total amount outstanding depended, therefore, on which interest rate applied and for which period.
The judge found that the Default Rate was a penalty because it did not protect any legitimate interest of LCL. The reasons briefly being that:
The Standard Rate was increased from 0.7% to 1% due to the Housseins’ credit issues and the judge found it was not clear why the 3% increase was required in respect of subsequent defaults.
This was a well secured loan, such that the credit risk was mitigated.
The same Default Rate applied to breaches of different primary obligations, of varying seriousness and if that rate were extortionate or exorbitant by reference to any of them, the provision as a whole could not be enforced.
The Default Rate was outside what was normal in the market in the case of non-payment.
It was, therefore, unenforceable. The judge further held that the Standard Rate continued to apply if the loan was not repaid on the Repayment Date.
The Court of Appeal decision
The Court of Appeal considered the main authorities on penalty provisions. The key case is the Supreme Court decision in Cavendish Square Holdings -v- Makdessi [2015] UKSC 67, which set out a three-limb test for determining whether a contractual provision amounts to a penalty:
Only a secondary obligation can be a penalty, the rule against penalties does not apply to primary obligations.
If the clause protects or furthers a legitimate interest, it is not a penalty. The Court will take an objective approach to this issue, rather than considering the parties’ subjective intentions.
The clause should not provide for a sum that is out of proportion to the innocent party’s legitimate interest, and the Court will consider whether it is extortionate, exorbitant or unconscionable by reference to that legitimate interest.
The Court of Appeal found that the Default Rate was a secondary obligation and, therefore, potentially a penalty. However, it also highlighted an earlier decision in Cargill International Trading PTE Ltd -v- Uttam Galva Steels Ltd [2019] EWHC 476 (Comm), in which the Court had held that there was a good commercial justification for a lender to charge a higher rate of interest following default because of the increased credit risk to the lender. The Chancery Court judge had not referred to this decision in his judgment.
The Court of Appeal remitted the issue back to the Chancery Court judge, so that he could consider whether, having regard to the legitimate interest in performing the primary obligations, the default interest rate was high enough to be considered extortionate, exorbitant or unconscionable.
The Court of Appeal also held that the Default and Standard Rates were mutually exclusive. Therefore, if the Default Rate was inapplicable, LCL could not then fall back on the Standard Rate of interest.
The second Chancery Court decision
As to whether the Default Rate was a penalty, the question of whether a provision was a penalty and therefore extortionate turned on the facts of each case.
In line with the Court of Appeal’s finding, both parties accepted that the Default Rate was payable only on the breach of a primary obligation. It was, therefore, a secondary obligation and fell to be assessed under the rules on penalties.
The Court identified five legitimate interests in this case:
Repayment Interest i.e. LCL’s legitimate interest in repayment;
Representations Interest i.e. LCL’s legitimate interest in the representations and warranties given by the borrowers being true and correct and noting that this is the basis on which the loan is advanced in the first place;
Security Interest i.e. a secured lender’s legitimate interest in enforcing obligations for the protection of the security;
Non-residence Interest i.e. an unregulated lender’s legitimate interest in seeing a non-residence provision observed; and
Credit Risk Interest; i.e. a lender’s legitimate interest in primary obligations that go to preserve a borrower’s ability to pay the debt when due.
Pursuant to Makdessi, there was a “strong initial presumption” that the parties themselves were the best judges of what was legitimate provided that they were properly advised and of comparable bargaining power. In this case, the claimants had other options to find financing, Mr Houssein and his son (who was involved at all times) were very experienced in property matters and they were advised by both a mortgage broker and experienced conveying solicitor throughout the process. They could, therefore, be taken to have appreciated the significance of the representations and warranties they had given to LCL and to have understood the transaction into which they were entering.
Furthermore, on the expert evidence, the Default Rate was at the upper extremity of the band of commercially acceptable rates and was higher than what other lenders charged. Given the strength of the Repayment Interest, however, it was high but not extortionate. It was not, therefore, penal by reference to the Repayment Interest.
The Court also stated that for an unregulated lender, like LCL, to provide loans to individuals secured on their primary residence could have catastrophic consequences. Penalties under the Financial Services and Markets Act 2000 included unlimited fines and up to two years’ imprisonment. LCL was reasonably entitled to be somewhat more conservative, in protecting its interests, than other lenders. In those circumstances, the Default Rate in respect of the Non-residence Interest did not approach the level of being extortionate.
The Security Interest was also highly significant in principle. It was the lender’s primary protection if there was default in respect of the Repayment Interest.
As to Credit Risk Interest, the Court thought that the facts of Cargill were not analogous and could be distinguished from the Credit Risk interest in this case. In Cargill, the default trigger in each instance was limited to payment defaults, whereas here the Default Rate applied to different primary obligations and legitimate interests, creating a prima facie presumption of a penalty. However, on the facts of this case and the expert evidence, the Court concluded that it was not extortionate for LCL to charge an above market default rate to the Credit Risk Interest.
In particular, the Court highlighted the impact that any default that related to the Credit Risk Interest could have on a potential refinancing. Such refinancing was finely balanced, indeed precarious. LCL had a very strong interest in ensuring that the claimants’ creditworthiness did not deteriorate, even slightly, during the life of the loan, and that if it did shift that the claimants were heavily incentivised to find a solution quickly.
In conclusion, the Default Rate was not a penalty.
Comment
The judge’s comprehensive consideration of the Credit Risk Interest in this case will be very useful to lenders in similar circumstances.
More generally, the Court highlighted that repayment is, from the lender’s perspective, what loans are all about. Secured lending is cheaper than unsecured lending because of the additional risk protection it offers.
