The Court of Appeal in the case of Taiwan Scot Co Ltd v The Masters Golf Company Ltd has ruled that a contractual interest rate for late payment of 15% agreed between two companies was not an unlawful "penalty" and was enforceable. At first sight the case seems to suggest that companies could be able to set higher interest rates in their contracts than is currently standard. However, it may be important to consider the rate in the context of the economic climate at the time when it was set. In his ruling Lord Justice Longmore said it did not appear to him that a contractual interest rate of 15% was exorbitant when it was agreed in July 2001.

The Late Payment of Commercial Debts (Interest) Act 1998, provides for interest to be payable at the statutory rate of 8% above the base rate of the Bank of England (BOE). Parties can contract out of the Act's provisions only if they agree a 'substantial contractual remedy' for late payment. A contractual interest rate, which is unreasonably high, may be struck down on the grounds that it is a penalty. Penalties, which bear no relation to potential costs or losses suffered, are generally unenforceable under English and Scots law. Whether or not the obligation to pay a particular sum is a penalty will be assessed by reference to the time when the contract was made.

Taiwan Scot imported golf clubs from China to be sold by the Masters Golf Company in the UK. Taiwan Scot and Masters agreed trading terms in a contract which included a clause setting interest rates for late payment at 15% per year. Subsequently, a dispute arose when Masters informed Taiwan Scot that it was not willing to pay invoices due as customers were complaining that the clubs were of poor quality. At first instance, the judge found Masters was obliged to make the disputed payments but declined to award Taiwan Scot interest at the contractual rate saying that it was an unreasonably high rate and a penalty rather than a genuine estimate of loss. Taiwan Scot appealed on the issue of interest.

The Court of Appeal allowed the appeal and awarded Taiwan Scot interest at the rate of 15%. The agreement was entered into in July 2001 when the statutory rate under the Act would have been 13.25% (8% above the BOE base rate at the time of 5.25%). The Court said that the important factor for consideration was not that interest rates, when the Court was hearing the appeal, were at an all-time low of 0.5% but that they were considerably higher when the agreement was made in 2001. A contractual rate of 15% was not considered to have been exorbitant in 2001. Lord Justice Longmore commented that: "it was a rate agreed by two commercial concerns in the economic circumstances of the time and it should not lightly be set aside".

The Taiwan Scot case reinforces, the well established legal test for a contractual interest rate which is whether the interest chargeable is commercially justifiable in the economic circumstances considering the likely costs and losses to the supplier arising from late payment. Its dominant purpose must not be to simply punish the late payer.