A recent High Court decision upheld the ability of a bank to charge default interest on an overdue debt advanced to a commercial organisation.

The court felt in this situation it was important to be consistent with international banking practice. Such a provision in a residential loan arrangement or mortgage may, however, attract different policy considerations.

The Unfair Terms in Consumer Contracts Regulations 1994 might apply to a residential loan. If the regulations apply to the loan agreement, then any provision for payment of additional interest would have to comply with the regulations or it would be unenforceable.

Also, if the Consumer Credit Act 1974 applied to the loan then the provision for charging additional interest would have to be structured so as not to contravene the restriction contained in the Act against charging additional interest to defaulting borrowers.

Lenders would also need to ensure that any advertisements issued in respect of these loans would deal with any arrangements for charging additional interest in such a way as to comply with the Consumer Credit (Advertisement) Regulations.

The decision in the High Court case certainly seems to find the idea of default interest acceptable. However, lenders should be aware that the additional interest should not be too high a rate and the payment for default interest should be no longer than the period of default.

The decision also seems to indicate that the payment of additional interest must be linked to "the increased credit risk represented by a borrower in default," ie the borrower being in arrears not in breach of any other terms of the agreement.

Michael Boyd is a partner at commercial lawyers, Pinsent Curtis

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