The Court of Appeal’s decision in Houssein & Ors v London Credit Limited [2024] EWCA Civ 721 has drawn significant attention, particularly on the issue of penalty interest and the proper test for its enforceability. This article explores the Court of Appeal’s reasoning, its application of key legal tests, and the background to the case.
Background
The case arose from a dispute between CEK Investments Limited (“CEK”) (which was the third Claimant) and London Credit Limited (“LCL”) regarding a loan facility granted by LCL to CEK. The loan, secured against buy-to-let properties and a family home, was subject to a standard interest rate of 1% per month. LCL argued that the appellants breached the facility by allowing the family home to be occupied, which led to a demand for full repayment and default interest at 4% per month. When the repayment was not made, LCL appointed receivers to sell the properties. The Claimants, in response, secured an interim injunction to prevent the sale, leading to a trial that spanned six days.
High Court’s Decision on Penalty Interest
An important element of the High Court’s ruling was the finding that the default interest clause in the facility agreement was an unenforceable penalty. The judge applied the established legal principles on penalty clauses, determining that the default rate was not proportionate to LCL’s legitimate interest in ensuring timely repayment of the loan.
Appeal and Court of Appeal’s Decision
LCL appealed the High Court’s finding regarding penalty interest. The Court of Appeal agreed with LCL’s arguments, ruling that the trial judge had applied the wrong test when assessing whether the default interest was an unenforceable penalty.
The Court of Appeal, led by Asplin LJ, applied a three-stage test established in earlier case law, particularly Cargill International Trading PTE Ltd v Uttam Galva Steels Ltd [2019] EWHC 476 (Comm) and Vivienne Westwood v Conduit Street ([2017] EWHC 350 (Ch):
- Secondary Obligation: The first step is determining whether the default interest was triggered by a secondary obligation that arose due to a breach of a primary obligation, in this case, the obligation to repay the loan. The Court found this threshold was met.
- Legitimate Interest: The Court then examined whether LCL had a legitimate interest in enforcing the primary obligation through default interest. The trial judge had erred here by focusing on LCL’s subjective intent and failing to identify any legitimate interest. The Court of Appeal held that LCL had an interest in ensuring the timely repayment of the loan, making the default interest justified.
- Exorbitance or Unconscionability: Finally, the Court asked whether the default interest was exorbitant or unconscionable in amount or effect. The trial judge had not addressed this question, instead focusing on whether LCL had a specific justification for the rate. The Court of Appeal concluded that this was the wrong approach, but it did not go as far as to remake the decision itself. Instead, it remitted the matter to the High Court for further determination, requiring additional factual and expert evidence.
Conclusion
The Court of Appeal sets out that while the High Court had correctly identified that LCL was entitled to enforce interest upon breach, it had failed to properly evaluate LCL’s legitimate interest and whether the interest rate was exorbitant. This decision reinforces the principle that penalty clauses must be justified by a legitimate interest and proportionate to the harm caused by the breach.
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