Default interest provisions and legitimate interests: the High Court's decision in Houssein v London Credit

Briefing

Summary

On 23 October 2025, the High Court handed down judgment in the case of Houssein & others v London Credit Ltd & others [2025] EWHC 2749 (Ch) re-determining whether a contractual term allowing the lender to charge a default interest rate of 4%, compounded monthly under a one year bridging loan agreement (the Default Rate) constituted an unenforceable penalty. Richard Farnhill, sitting as a Deputy Judge of the Chancery Division, held that the Default Rate was not a penalty and was as a result enforceable, by the lender, London Credit Limited (LCL) following an event of default.

The High Court had previously concluded in 2023 that the Default Rate was an unenforceable penalty. However, the Court of Appeal found that the High Court had incorrectly applied the test in Cavendish Square Holding BV v El Makdessi [2015] UKSC 67 (Makdessi) and remitted the issue for re-determination. The Makdessi test requires the court to consider whether a default rate protects a legitimate interest and, if such an interest exists, whether the sum payable is nevertheless extravagant, exorbitant or unconscionable.

A notable feature of the July 2020 bridging facility letter between LCL and CEK Investments Limited (CEK) (the Facility Letter) was the drafting of the 'Default Interest Provision' which provided, upon the occurrence of an event of default under the facility (Event of Default) and on non-payment, interest would accrue on the overdue amount from the due date until the date of payment at the Default Rate. Any Event of Default (which included breaches of several different primary obligations triggered the application of the Default Rate. At the second High Court hearing, Mr Justice Farnhill conducted a detailed analysis of the Makdessi test as applied to default interest provisions in loans, and more particularly, given the facts, how this test applies to provisions that apply on any event of default. He identified five distinct legitimate interests of LCL, safeguarded by the agreed Events of Default and emphasised that each Event of Default must serve to appropriately protect at least one legitimate interest, or the entire default interest provision risked being unenforceable.

Prior judicial consideration

Original High Court proceedings

We discussed the facts involved in our previous article - A point of (default) interest (which focused on the Court of Appeal decision) - but in short summary, the original case brought before the High Court concerned the Default Interest Provision in the Facility Letter. The loan made available under the Facility Letter was secured by mortgages over properties owned by CEK's directors, Mr and Mrs Houssein, including a property in Barnet, made subject to a prohibition on occupation during the loan term, supported by a representation from CEK that it had no intention to occupy it (the Non-Occupation Requirement). At various points towards the end of 2020, LCL alleged breach of this requirement, claiming an Event of Default and requiring payment of default interest on outstanding sums, and payment not having been received, appointed receivers to enforce its security. CEK and the Housseins subsequently brought proceedings aiming to stop enforcement, with the key issues in such proceedings being:

whether an Event of Default had occurred
if so, whether the Default Rate constituted an unenforceable penalty.

The High Court determined on these issues that:

LCL had been aware, via its agents, that the Houssein family were in occupation of the property in Barnet and accordingly had waived compliance with the Non-Occupation Requirement
the Default Rate was an unenforceable penalty. Interest continued to accrue under the Facility Letter following its scheduled maturity date (in respect of sums which were, at such time, unpaid) at the standard contractual rate of 1% (the Standard Rate) as opposed to the unenforceable Default Rate.

Court of Appeal decision

On appeal and as reported in our previous article, the Court of Appeal determined that the High Court had failed to apply the correct test in considering whether or not the default interest provision was an unenforceable penalty. In particular, while the 'legitimate interest' test was discussed, it was determined to have been incorrectly applied with a subjective approach taken to the question, identifying the protected interest as LCL's interest in the Barnet property not being occupied rather than an interest based on the function of the Default Interest Provision in the context of the Facility Letter. Lady Justice Aplin held that the focus should be on such function, which was inevitably to protect LCL's legitimate interest in repayment of all outstanding amounts before the scheduled repayment date. Aplin LJ further noted that, having drawn a conclusion that the Default Interest Provision did not protect any legitimate interest, the High Court then failed to consider whether it was 'extravagant, exorbitant or unconscionable'. Declining to form a view on this, having not had access to the expert evidence and cross-examination available to the High Court, the question was remitted back to the High Court for further determination.

Second High Court hearing

The question to be considered by the High Court was interpreted as whether "given the existence of a legitimate interest in the performance of the primary obligation, the default interest provision is extortionate, extravagant or unconscionable in amount or effect".

The court applied the established test from Makdessi: "whether the impugned provision is a secondary obligation which imposes a detriment on the contract-breaker out of all proportion to any legitimate interest of the innocent party in the enforcement of the primary obligation". Further, the court referred to the three-stage approach from Vivienne Westwood v Conduit Street EWHC 350 (Ch) adopted by Mr Fancourt QC, and which was followed by the Court of Appeal: first, address whether a stipulation is in substance a secondary obligation engaged upon breach of primary contractual obligation; then identify the extent and nature of the legitimate interest in having the primary obligation performed; finally, determine whether the secondary obligation is exorbitant or unconscionable in amount or effect having regard to that legitimate interest.

The initial presumption (described in Makdessi) that in a negotiated contract between properly advised parties of comparable bargaining power, the parties themselves are the best judges of whether the default rate was legitimate, was also referred to as an appropriate starting point.

It was accepted that both parties characterised the Default Rate as being payable on, and only on, the breach of a primary obligation. As such, it was a secondary obligation and fell to be assessed under the rule on penalties.

The next step was the identification of an obligation and the legitimate interest in its enforcement, followed by an assessment of whether, by reference to that interest, the provision in question was extortionate. This required consideration of all primary obligations to which the Default Rate applied, and the legitimate interests LCL had in enforcing them. It was established that, in principle, it is justifiable to charge a higher rate on a non-payment and other material defaults, however for defaults that may be considered not to immediately affect repayment, it was less clear whether the lender could charge a higher rate on the whole loan amount when that default occurred. Where there were multiple primary obligations subject to a provision such as the Default Rate, it needed to be assessed by reference to each of the primary obligations, or at least by reference to the legitimate interests that underlie them since multiple primary obligations may involve the same interest, and if, by reference to any one interest, the provision were found to be extortionate it would fail in relation to all of them.

The court identified five categories of legitimate interests protected by the Default Rate and was satisfied that the Default Rate was not extortionate in relation to each one:

The Repayment Interest: Under clause 12.2(a), there was an event of default on non-payment. In the court's view a lender has a "very strong interest" in repayment; described as the sine qua non of a loan. The Default Rate was found not to go beyond the upper extremity of commercially acceptable rates.
The Representations Interest: Clause 12.2(h) was the misrepresentation Event of Default. The representations and warranties given at inception were the basis on which the loan was advanced, and LCL therefore was found to have a legitimate interest in them being true and correct in all material respects, to properly understanding the basis on which it was lending. The approach in relation to the repetition of representations was slightly less clear, and said to be more akin to that for the Security Interest and Credit Risk Interest, but in any event the Default Rate was considered to be a market outlier in relation to this interest, but still reasonable given this element goes to the heart of the decision to lend.
The Security Interest: This was a secured loan, and accordingly a lender had a legitimate interest in the security being both intact and realisable to meet any unsatisfied obligations of the borrower. If this interest were threatened, LCL had a strong interest in ensuring steps were taken quickly to remedy the position or to repay the loan. While the Default Rate went beyond what was normal in the market and sat at the upper extremity of what was commercially acceptable, it was found to be within that range.
The Non-residence Interest: As an unregulated lender, LCL was prohibited from lending to individuals where the security was their primary residence. The court accepted that an unregulated lender has a legitimate interest in seeing a non-residence provision observed and was entitled to take a firm approach to deterring breach of the non-residence provision, and the Default Rate in relation to this interest was not at the level of being extortionate.
The Credit Risk Interest: Primary obligations relating to credit risk covered various defaults including on other borrowing, enforcement against CEK's property, and unpaid judgment debts. In principle, a lender was found to have a legitimate interest in obligations that preserve a borrower's ability to repay the debt when due. LCL had a very strong interest in ensuring that CEK and the Housseins' creditworthiness did not deteriorate during the loan's term, even slightly, given the finely balanced structure of the loan, and noting that the preferred exit route from the loan was a refinancing. Any shift in the creditworthiness could impact the applicable interest cover ratio and significantly impact any offering (including the applicable interest rate) from a lender offering refinancing, and result in reduced loan amounts or cause a refinancing to fail. It was also acknowledged that past payment default is likely to correlate with future payment default on the same loans and so offer some evidence of credit risk in a predictive sense. The conclusion on this interest was that, given those factors, it was not extortionate for LCL to attach an above market default rate to the Credit Risk Interest, not wishing the position to deteriorate any further.

In summary, the decision arrived at in relation to the Default Rate relied on an analysis involving the initial presumption (set out in Makdessi) that freely contracting and properly advised parties are the best judges of whether the Default Rate was legitimate, combined with an understanding of the complex structure of the loan and preferred exit route from it via refinancing, together with expert evidence that the rate was in the range of what was considered commercially acceptable as against each identified legitimate interest. This analysis resulted in the court concluding that the Default Rate was not unduly high when assessed against each of the legitimate interests.

Key takeaways

This decision provides important guidance for lenders and borrowers on the drafting and enforcement of default interest provisions, particularly in the context of bridging finance and other short-term lending arrangements. The court's acceptance of the 'Credit Risk Interest' is especially significant for short-term bridging finance, acknowledging that even marginal deterioration in a borrower's credit profile can materially impact refinancing prospects—often the intended exit route for such facilities.
It highlights how the Makdessi test should be applied if a default rate is charged on the occurrence of all or a number of events of default. The decision shows that if the same default rate applies in all situations, then each separate default must reflect a need to protect the lender's legitimate interest, otherwise the entirety of the default interest provision is likely to fail. It provides useful guidance to lenders on carefully calibrating events of default to ensure each protects an identifiable and defensible legitimate interest, and documenting the commercial rationale for default interest provisions particularly in relation to less obvious events of default.
While the conclusion of this case is ultimately favourable to lenders, it does establish exacting standards for the drafting and justification of such provisions. The requirement that each event of default must independently satisfy the penalty test creates a potential vulnerability for broadly-drafted default interest clauses that apply uniformly across materially different types of breach.