In an ideal world, it would never be necessary to charge interest on invoices that are paid late as the threat of charging interest would mean that invoices are paid on time. In practice, however, late payment seems to be almost routine. In 2022, suppliers reported being paid late by an average of 7 days for business-to-consumer contracts and 13 days for business to business-to-business contracts (Credit to Intrum's European payment report). Further, according to a report by the Federation of Small Businesses in March this year, 52% of small businesses experienced late payment in the previous three months, with a quarter reporting that late payment was increasing. 

Charging interest is also topical given that the base rate has now risen on 13 occasions in the past 18 months or so, from 0.1% to 5% in the same period, which means that relying on a historically agreed rate of interest may no longer be appropriate.

Given this background, in this article I review the basis for charging interest for late payment of debts and then consider a few examples from case law of the point at which an interest rate might be so high as to be legally unenforceable.

Background

In most business-to-business situations, the interest rate payable on a debt paid late is that specified in the Late Payment of Commercial Debts (Interest) Act 1998 (the “Late Payment Act”), which applies “to a contract for the supply of goods or services where the purchaser and the supplier are each acting in the course of a business”.

In broad terms, the Late Payment Act provides for simple interest to accrue on an unpaid debt at the rate of 8% above the Bank of England base rate applicable at the time that the invoice became overdue. (One of the often-overlooked nuances of the Late Payment Act is that for the purposes of the act, the Bank of England base rate only changes twice per year. Therefore, given the recent frequency of changes to the base rate, the above statement is a convenient simplification.)

Outside the business-to-business context – and particularly relevant in the business-to-consumer context – the starting point is that there is no automatic right to interest. Instead, a party that is paid late would, if the matter went to court, normally ask the court to exercise its discretion to award pre-judgment interest (either under section 69 of the County Courts Act 1984 or section 35A of the Senior Courts Act 1981 (for the High Court)). However, this rate of interest is likely to be relatively low, usually around 1% or so over the base rate. Further, such an order can only be made if proceedings are in fact issued. Therefore, should the invoice be settled prior to proceedings being issued, there is no entitlement to interest.

To consider whether to add to a contract a right to a higher rate of interest than would apply under the Late Payment Act – or to provide for interest to be payable at all – we need to look at the underlying principles regarding the law on “penalties” (as the topic was once described).

The modern statement of the law in this area is given in the Supreme Court case of Cavendish Square Holding BL v El Makdessi and ParkingEye Limited v Beavis [2015] UKSC 67. In accordance with this judgment, a contract term will be invalid if “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”. Put more straightforwardly, this means that a term that imposes an excessive interest rate for late payment is not enforceable.

In the consumer context, the Consumer Rights Act 2015 is also relevant. By section 62(1) of the act, “an unfair term of a consumer contract is not binding on the consumer”. The act gives as an example of a term that might be regarded as unfair “a term which has the object or effect requiring the consumer who fails to fulfil their obligations under the contract to pay a disproportionately high sum in compensation”.

However, neither the decision in Cavendish v Makdessi nor the Consumer Rights Act 2015 explains the exact threshold at which an interest rate is out of proportion and/or unfair to the extent that the right to that rate of interest is unenforceable. Such examples can only be found in case law.

Case law

Perhaps the easiest route to determine what constitutes excessive interest is to work from the highest reported rates of interest downwards.

A clear case of an excessive interest rate can be found in Jeancharm Ltd v Barnet Football Club Ltd [2003] EWCA Civ 58. In this case, which concerned a football club’s liability for late payment to its kit manufacturer, the specified interest rate was 5% per week. To put it another way, the club had agreed to pay interest at 260% per year. Given this rate, it will come as little surprise that the interest rate was held to be unenforceable. Indeed, the Court of Appeal described this rate of interest as “an extraordinarily large amount to have to pay”.

Working down the rates of interest claimed, the next case of note is Ahuja Investments Ltd and Victorygame Ltd [2021] EWHC 2382 (Comm). This case concerned an interest rate of 12% per month, or 144% per year. Again, the court held that such rate of interest was so high as to be an unenforceable penalty.

Another relatively recent case is that of Biosol Renewables UK Ltd v Lovering [2021] EWHC 71 (Comm). The specified interest rate (for late payment following the commissioning and installation of boilers in commercial premises) was 1.5% per month, so 18% per year. In contrast to the other two cases, the judge upheld that interest rate (emphasis added):

In the present case, the provision for interest is unexceptionable. Even in a consumer context the stipulated rate would be unlikely to raise eyebrows. […] Biosol had a legitimate and obvious interest in receiving payment quickly, because its own outlay was very considerable in respect of each contract of supply and it is a relatively small company. A rate of 1.5% per month is clearly not disproportionate to, or extravagant or unconscionable in comparison to, its legitimate interest.

Having then worked through these cases and down the rates of interest, it might have been thought unnecessary to consider whether a rate of interest below 18% per year could be vulnerable to legal challenge. However, there is a cluster of cases that all concern whether an interest rate of 15% per year is enforceable, namely Taiwan Scot Co Ltd and Masters Gold Co Ltd [2009] EWCA Civ 685, Fernhill Properties (Northern Ireland) Ltd v Mulgrew [2010] NICh 20 and Longulf Trading (UK) Ltd v Niyazi Onen Gida San AS [2019] EWHC 1573 (Comm).

In the two business-to-business cases, namely Taiwan and Longulf, the judges each upheld 15% as an enforceable rate of interest. However, the same rate of interest was held to be unenforceable in the business-to-consumer case of Fernhill. The judge, Mr Justice Deeny, noted the potential inconsistency between the decision in that case and the then recent case of Taiwan. However, he held that on the facts, the interest rate of 15% was unenforceable as the claimant had not attempted to justify this amount as a genuine pre-estimate of its loss. (Prior to the decision in Cavendish v Makdessi, this was then a highly relevant factor when considering whether a rate of interest was so high as to constitute an unenforceable penalty.) He further took into account that in the property market in question, the claimant could not have anticipated paying more than 12% interest to its own lenders.

Conclusions

The above cases at least suggest a threshold at which an interest rate will be too high to be enforceable. However, the inconsistency in lower court decisions confirms that a court will still need to make an individual assessment in each case: whether, on the facts, the applicable interest rate is out of proportion to the legitimate interest of the person claiming payment. With an ever-increasing base rate, now would not be a bad time to review contracts to consider whether they provide for an adequate – but not disproportionate – rate of interest.