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Interest rate of 15% was not a punishment, rules Court of Appeal

Out-Law News | 30 Jul 2009 | 4:15 pm | 2 min. read

An interest rate of 15% agreed in a contract between two companies was not a penalty and was justified, the Court of Appeal has said. The interest, which had been ruled unlawful, can be charged, said the Court.

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% a year.

Masters delayed payment for goods to Taiwan Scot and the Court of Appeal found that the delay was against the terms of the contract.

The contract said that: "in default of payment as provided in clause 1 above Masters will pay Taiwan Scot interest at the rate of 15% per year from the date on which payment fell due until the date of payment to Taiwan Scot".

The original trial judge had ruled that the interest charges were too high and amounted to a penalty on Masters, which is not allowed. Taiwan Scot appealed that ruling and won.

The Court of Appeal said that the important fact to bear in mind was not that interest rates are at an all-time low now of 0.25% but that they were much higher when the agreement was made in 2001.

The interest rate at the time was 5.25%. The Late Payment of Commercial Debts (Interest) Act allows for the payment of interest at the statutory rate above the base rate. The statutory rate is 8%, meaning that the interest payable would have been 13.25% under those rules.

"One forgets, in these recessionary days, that interest rates were considerably higher in 2001 than they are now," said Lord Justice Longmore in his ruling. "It does not seem to me that a contractual rate of 15% was in any way exorbitant in July 2001."

"It was a rate agreed by two commercial concerns in the economic circumstances of the time and it should not lightly be set aside," said Lord Justice Longmore. "In this respect, I disagree with the [original trial] judge. For my part, I would award interest at the rate of 15%."

The interest that companies can charge each other is controlled, but there are no fixed rules about what is allowed. Litigation specialist Michael Fletcher of Pinsent Masons, the law firm behind OUT-LAW.COM, said that this ruling could give companies a rule of thumb to work by.

"The interest charged in this case was about 10% above the base rate, so companies who are negotiating a rate to put into a contract and stay within 10% of the base rate will probably be okay," he said.

"This is not a specific ruling on what interest is permissible, though," said Fletcher. "The actual test is whether the interest charged is commercially justifiable and its dominant purpose is not to penalise the other company."

Fletcher said, though, that companies agreeing interest rates could adopt a more flexible approach that would not leave them out of pocket when interest rates fluctuate.

"A fixed rate is a gamble. An alternative is to fix the rate at a percentage above the base rate," said Fletcher. "I usually see rates set at between two and four per cent above the base rate."