Contributed By Winston & Strawn London LLP
A default interest clause may be unenforceable if it is held to be a penalty. A penalty clause is one that obliges the debtor to pay an excessive amount of interest, out of all proportion to any legitimate interest the lender may have in performance. The rule against penalties only applies to default interest; it does not affect interest payable on loans when the paying party is not in breach. Whether a particular provision is penal will depend on the facts of the case, including the interest rate, the market rates at the time of the agreement, whether the agreement is between two commercial parties, the risk involved and the reason for the default rate.
In addition, while there is no mandatory limit on interest rates, extortionate credit transactions can be set aside during insolvency or administration proceedings. However, the powers to do so are seldom used.
Under the terms of the relevant double-tax treaties with the UK, relief from UK withholding tax on interest payments may be denied to the extent that such interest exceeds an arm's length rate.