In two recent connected cases the Irish High Court found that the charging of default interest at 4% amounted to a penalty and was therefore unlawful. In reaching that decision the judge declined to follow recent case law from England and Wales which had departed from the existing precedent on penalty clauses.
Default interest and penalty clauses were revisited by the Irish High Court recently in two connected cases.
Both cases were taken against Breccia ((1) Sheehan v Breccia & Ors and (2) Flynn & Anor v Breccia) and concerned loans that were originally entered into between the respective plaintiffs and Anglo Irish Bank Plc. The loans were subsequently purchased by Breccia.
The loan agreements provided for the application of surcharge interest at a rate of 4% on amounts unpaid. The relevant provision was contained within the standard terms and conditions for the loans and had the effect of doubling the interest payable.
A central issue in both disputes was whether the inclusion of default interest in the loan redemption figures constituted a penalty and whether the application of any such default interest was, as a result, unlawful and unenforceable.
UK and Irish Precedent
In Ireland, the leading authority on penalty clauses is ACC Bank Plc v Friends First Managed Pension Funds Ltd & others  (the “ACC case”). In that case the court found surcharge interest rates to be penal in nature where such rates could not be considered a “reasonable pre-estimate” of likely loss in the event of a default.
More recently and just before the Breccia cases, the UK Supreme Court in the Cavendish decision  handed down a divergent judgment on penalty clauses which departed from the long-established “pre-estimate of loss” test.
The Cavendish judgment provides that enforceability comes down to whether the imposition of surcharge interest is unconscionable, extravagant or “out of all proportion to any legitimate interest of the innocent party”. It also finds that the penalty rule is an interference with the ability of parties to contract freely.
The Cavendish judgment is now accepted as the definitive position in the UK. In the Breccia cases, the defence argued that Cavendish is also persuasive authority in Ireland, although not binding, and “reflects common sense and commercial reasonableness”.
Judge Haughton handed down his judgment in both Breccia cases on 5 February 2016. He placed importance on the fact that the surcharge rate of 4% was included in the general terms and conditions applicable to a wide variety of loans and customers. This rendered it a generic rate that could not have been a “genuine pre-estimate of loss” in accordance with the test in the ACC Case and therefore in the Breccia cases it was held to be unlawful. It was found that the ordinary interest rate (being EURIBOR plus the Margin rate) had already built in a pre-estimate of probable loss on an event of default.
Judge Haughton concluded that he was obliged to follow the decision in the ACC Case as a binding Irish precedent unless it could be somehow distinguished. Emphasis was placed on the fact that the ACC Case bore similar facts, it was recent and it had had been subsequently followed in AIB plc. v Fahy in 2014 .
The judge commented that there are many attractions to the reasoning in Cavendish but noted that it was for an appellate court to consider whether it should be followed in Ireland.
In the meantime lenders should be cautious that they may be required to justify any rate of default interest applied as a genuine pre-estimate of loss. Such evidence would likely need to be given by those who originally determined the surcharge rate applied.