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Charging interest in contractual relationships

October 11, 2011

Interest rates are important. They can substantially affect the return on investments and have a huge impact on inflation and the economy generally. In a highly geared economy like ours, they can be the difference between boom and bust.

Why is it then that, so often, interest is disregarded in ordinary contractual relationships and as a useful tool in dispute resolution?

Claiming Interest

The basic proposition is that the courts will enforce reasonable contractual interest provisions and have jurisdiction to award interest on most non-contractual claims. Once judgment has been entered in the High Court and, in respect of judgments over £5,000, in the County Court interest accrues at the judgment rate (currently 8% per annum simple interest).

Contractual Relationships

Can you imagine walking into a bank and taking a loan without having agreed a rate of interest? Of course not, the scenario is ridiculous. Yet thousands of businesses effectively enter into loan agreements every day without agreeing a rate of interest.

There is really no excuse for not having a contractual basis for claiming interest, on late payment for example; the courts will traditionally enforce interest rates up to around 30% per annum (subject to a test of reasonableness) and contractual interest can also be compounded – this is not possible if statutory interest provisions are relied upon.

Statutory Provisions

Formerly, the only way to claim non contractual interest was under the County Courts Act 1984 or the Supreme Court Act 1981. Although usually taken as simple interest at 8%, these Acts give the Court the power to award interest rather than creating a right for the parties to claim interest. Interest was therefore discretionary and could not be included in statutory demands.

The Late Payment of Commercial Debts (Interest) Act 1998 (‘the Act’) filled this gap somewhat as it implies a contractual term in business to business transactions allowing interest to be claimed as a contractual right at 8% above base rate. There is also a right to claim a fixed late payment fee intended to help towards the administrative costs of recovery.

Continuing Problems

The Act is significantly under-used in business debt recovery and only implies a term in business to business contracts. It is worth remembering though that the Act implies a contractual right to interest, meaning that the Court has no discretion and, if necessary, interest can be included for the purposes of issuing a statutory demand.

Those dealing on credit terms with consumers or suing consumers for breach of contract must have express terms in the contract (which is subject to a much more stringent test of reasonableness) or they will have to rely on the Court’s power to award interest.

Interest As A Negotiating Tool

It may be in your interests to have a high rate of compounded interest in your standard business to business contracts. Credit control will have a bigger stick to beat the client with (and bear in mind that the amount due will increase on a regular basis), you can write off all or part of the interest, or offer a moratorium for say 30 days on the interest as an incentive to pay prior to the issue of court proceedings. This carrot and stick approach is usually successful.

Going To Court: The All Important Question Of Costs

There are times when Court proceedings are the right choice. Once the debt is safely over the small claims limit (currently £5,000) a claim will usually be allocated to the Fast or Multi track and costs will be recoverable.

As issuing a claim does not prevent contractual interest from accruing, putting in a Part 36 or Calderbank offer to settle at the time you issue a claim will usually give a winning claimant full protection on costs – probably on an indemnity basis. Of course, pointing out to the defendant that the interest and court fees will just continue to increase will put additional pressure on them to reach an early settlement.

Interested?

Most businesses will have standard terms providing for interest. Most businesses will not have considered whether the standard 8% clause provided is appropriate for their particular circumstances. Most businesses would benefit from a regular review of their standard terms. If you don’t want to be ‘most businesses’ contact Ben Hopps, Partner at Sykes Anderson for further details of how your standard terms can make your business stand out.

About the Author

Ben Hopps
Sykes Anderson LLP Solicitors
Bury House
31 Bury Street
London
EC3A 5JJ
http://www.sykesanderson.com

Please note that this area of the law is a complex subject and you should not take or refrain from taking any step without full legal advice on your particular circumstances. The content of this article is of a general nature and no liability is accepted in connection with it or if any reliance is placed on it.