Dear Clients, Colleagues and Friends,

In the matter of Zeevi Communication Holdings Ltd. and others v. Bank Hapoalim and others, the Israeli District Court ordered the reduction of the default interest rate set out in the bank’s loan agreement on the grounds that it constituted liquidated damages which exceeded the reasonable expectations of the parties to the contract.

In this case, the default interest had been charged by the bank during a period of 7 years following the borrower’s default. The delay stemmed from an extensive receivership period in respect of the security granted by the borrower.

The borrower asserted that imposing a default interest for such an extensive period of time constitutes “liquidated damages”, which, pursuant to Israeli contracts laws, the court is authorized to reduce if it finds the amount of liquidated damages to be unreasonable in relation to the damages for such breach which could have been foreseen by the parties at the time the contract was executed.
 
The Court's Ruling
 
The court accepted the borrower’s claims in part and ordered the reduction of the default interest from 3% to 2.5% (above the agreement interest rate) for part of the receivership period. In accepting the borrower’s claims, the court made the following
determinations:
 
  1. The Israeli Supreme Court has yet to explicitly determine whether the imposition of a default interest in connection with bank loans and credit constitutes “liquidated damages”, as construed under Israeli contracts laws.
  2. Despite no such explicit precedent, in these circumstances the court found that the default interest charged by the bank constitutes liquidated damages. The court accepted, in principle, that the default interest reflects the additional risks which the lender bears as a result of breaches of the loan agreement by the borrower.
  3. Since the default interest constitutes liquidated damages, the court is authorized to reduce the default interest if it finds the default interest to be unreasonable in relation to the damages which could have been foreseen by the parties at the time the parties entered into the contract, as a likely result of the breach of contract.
  4. The court emphasized that the rate of default interest, as opposed to the amount of default interest charged, is the correct parameter to be examined when the default interest is tested for reasonableness, because the accumulated amount of default interest is derived from the amount of the loan. In addition, the court stressed that in claiming liquidated damages one needs not to prove the actual damages caused but rather that the agreed upon damages represent the reasonable expectation of the parties at the time of entering into the contract.
  5. The court evaluated the rate of default interest imposed by the banks and found it to be reasonable; however, the court found that the 7 years receivership period, during which the default interest had been charged by the bank, was unreasonably long and unexpected by the parties. The court stipulated that in radical situations, where default interest is charged for an unusually long period of time, the court may conclude that the default interest exceeds the reasonable expectations of the parties even where the rate of default interest is deemed reasonable.
  6. In concluding its ruling, the court accepted the borrower’s claims in part and ordered the reduction of the default interest from 3% to 2.5% (above the contractual interest rate) for part of the receivership period. The court determined that delay in selling the shares subject of the pledge during the period until completion of the privatization process of Bezeq (the company which issued the pledged shares) and for one year thereafter, was a reasonable receivership period which may have been anticipated by the parties to the loan agreement at the time the contract was executed and accordingly accepted the imposition of the 3% default interest during such period. As for the remaining receivership period, the court reduced the default interest from 3% to 2.5%.