At the end of 2010 the High Court in Northern Ireland declined to enforce a clause providing for interest to accrue on unpaid monies at 15% per annum. The judgment is notable for contracting parties throughout the British Isles as well as those using English law elsewhere.

The case is one of many to arise out of the property boom in Northern Ireland from 2005 to 2007 and the subsequent crash. The facts were simple. The defendant defaulted on a contract to buy an apartment (having bought in good faith but been unable to raise the necessary mortgage finance when the time came). The vendor-claimant obtained a judgment for damages. This included the interest that the claimant had lost on the purchase monies that the defendant had not paid.

The judge (Deeny J) declined to enforce the contractually agreed interest rate holding that: “the high and round figure of 15% was clearly, on the balance of probabilities, a penalty designed to deter a purchaser from defaulting on completion”. When the contract was concluded in April 2007 the Bank of England’s base rate was 5.25%, in contrast to 0.5% when the case was decided. The judge instead awarded the claimant interest to reflect its actual loss finding that “a fair measure” was 5% per annum.

While the courts of Northern Ireland (despite being a separate jurisdiction) have provided cases that have helped develop English law, this judgment is unlikely to be followed in England and Wales because of the following:

  • In a similar case in 2009 the English Court of Appeal held: “a contractual rate of 15% was [not] in any way exorbitant in July 2001 [when the base rate was also 5.25%]” (Taiwan Scott Company Ltd v The Master Golf Company Ltd, at [17]). For Deeny J that judgment was only strongly persuasive, adding that such English judgments may be less relevant to Northern Ireland following the constitutional devolution of justice there.
  • Deeny J distinguished Taiwan Scott because the contract in issue was between two commercial concerns, whereas the contract before him was between a commercial entity and an individual. While the courts may be likelier to find penalty clauses in contracts challenged by individuals (and some appellate authority confirms this), there is no basis under English law for the judge’s distinction. The key is the function of the alleged penalty clause, not whether one of the parties is an individual.
  • In fact, Deeny J felt he did not need to apply the authorities because the claimant-vendor was unable or unwilling to offer evidence that 15% was, in April 2007, a genuine pre-estimate of its loss in the event of non-completion by the purchaser-defendant. The English authorities, at least, put the burden of proof upon the party asserting that a clause is a penalty to show that it is. Furthermore, the English law test for a penalty clause is not simply whether it is or is not a genuine pre-estimate of loss. The test is, as Deeny J confirmed (relying upon previous English judgments): “a matter of construction to be resolved by asking whether at the time the contract was entered into the predominant contractual function of the provision was to deter a party from breaking the contract or to compensate the innocent party for breach”. It is the exorbitant or oppressive nature of a clause that is critical to it being struck down as a penalty clause.

This judgment should not herald greater intervention in clauses judged to be unfair. However, it does show that the historic rule against penalties lives on. In extreme cases clauses will be struck down as penalties (such as the provision for interest at 260% per annum on late payments in the Jeancharm case; for our Law-Now click here. Conversely, while courts and arbitrators look at the substance of clauses (such that describing a provision as a “penalty” is not necessarily fatal), they tend to distinguish between sums payable on a breach (which may fail as a penalty) and sums payable without a breach, such as interest provisions under loan contracts (which are less vulnerable to the rule against penalties). The judgment does, though, highlight litigation risk even when (as in this case) the defendant is unrepresented and “unable to help on the legal issues”.

Reference: Fernhill Properties (Northern Ireland) Ltd v Mulgrew [2010] NICh 20