Parties to contracts must have "substantive connection" with UK before penal interest rules apply

The Late Payment of Commercial Debts Act expressly states that the regime does not apply where there is no substantial connection with the UK and, had the parties not expressly selected English law to govern their contract, foreign law would apply. On the facts of the case, which involved an arbitration award in favour of the Marshall Islands-based owner of a ship chartered by a German company, there was no substantive connection with the UK, the High Court said.

Litigation expert Richard Dickman of Pinsent Masons, the law firm behind Out-Law.com, said that the many international firms who chose English law to govern their contracts would be relieved by the decision.

"Parties frequently choose English law to govern their contracts and English courts or arbitral tribunals to hear their disputes, even when the parties and the contract have little or nothing to do with England," he said. "This is particularly so in international trade, shipping, major construction projects and international finance transactions."

"The Late Payment of Commercial Debts Act makes provision for interest to be payable on qualifying debts arising under contracts for the supply of goods and services. The applicable rate of interest is set by the secretary of state and is currently 8% above base rate. The rate is set at a punitive level to protect suppliers, whose financial position makes them particularly vulnerable if their qualifying debts are paid late; and generally to deter late payment of qualifying debts. As the judge also held, these domestic policy considerations may not be appropriate for international contracts which have no real connection with the UK," he said.

The owner of the ship at the centre of the dispute, United Enterprises, was a Marshall Islands company while the ship itself was registered in Panama and managed by a Liberian company registered in Greece. Martrade, a German company, hired the ship in 2005 via a Greek broker, and the hire fee was payable in US dollars to a bank account in Greece. The charterparty agreement was made and concluded in Antwerp, but contained a clause providing for English law and London arbitration in the event of a dispute.

A number of disputes between the parties were referred to arbitration, most significantly a claim by the owners for unpaid hire. The arbitral tribunal found that United was entitled to an award in respect of the hire, plus interest calculated at the rate of 12.75% per year from 23 September 2005 until the date of payment. Martrade did not appeal the decision itself, but rather the tribunal's award of interest under the terms of the Late Payment of Commercial Debts Act.

Section 12 of the Act states that it does not apply to contracts governed by the law of a part of the UK at the choice of the parties where there is no significant connection between the contract and that part of the UK, and where the applicable law would have been non-UK if the parties had not chosen otherwise. Although the arbitral tribunal was of the view that there was enough of a connection with English law in this case, the High Court disagreed.

In his judgment Mr Justice Popplewell said that factors capable of fulfilling the "significant connection" criteria "must be of a kind and a significance which makes them capable of justifying the application of a domestic policy of imposing penal rates of interest on a party to an international commercial contract". In other words, they must "provide a real connection between the contract and the effect of prompt payment of debts on the economic life" of the UK, he said.

"A London arbitration or English jurisdiction clause cannot be a relevant connecting factor for the purposes of [the Act]," he said. "If the contract would, absent choice, be a foreign law contract ... a choice by the parties of an English forum to determine and apply their rights under the foreign law could provide no logical justification for subjecting them to the domestic policy considerations justifying penal interest under the 1998 Act or indeed to any other substantive obligations which arise as a matter of English law."

"Moreover, if the additional requirements in section 12 would always be met by a choice of English jurisdiction, whether by arbitration or in the High Court, the efficacy of the section in encouraging international businessmen to choose English law and jurisdiction without fear of the application of penal interest rates would be undermined," he said.

The factors identified by the arbitral tribunal as amounting to a significant connection were not in fact sufficient to do so, the judge said. The governing law of the underlying agreement must instead be determined in accordance with the then-applicable Rome Convention, and in this case would most likely be Greek law, he said. The Rome Convention has since been replaced by the Rome I Regulation.

Litigation expert Richard Dickman said that it was worth noting that the 1977 Unfair Contract Terms Act contained similar provisions to those in the Late Payment of Commercial Debts Act.

"The Unfair Contract Terms Act is principally designed to control contractual exclusions of liability for negligence or other breach of duty," he said. "It similarly provides that where English law applies to the contract only because of the parties' choice and, in the absence of that choice, the law of another country outside the UK would apply, then the main provisions of the Act do not apply."

"On the other hand, parties cannot avoid the application of the Act simply by choosing foreign law where one of the parties is a consumer habitually resident in England and the contract was made in England," he said.