When does a steep default interest rate become an unenforceable penalty? That was the question in Houssein v London Credit Ltd - and the answer matters for anyone dealing with loan agreements, commercial lending, or contract drafting.

Background

London Credit, a prominent lender in the short-term property finance market, lent £1.88 million to CEK Investments, secured against five buy-to-let properties and the family home.

The deal looked straightforward: 1% monthly interest. But if the borrower defaulted, the rate jumped to 4%, compounded monthly.

There was also a condition: no directors or close family members could live in the home. That condition was breached, and when the borrowers missed the agreed repayment date, London Credit applied the higher default rate.

The borrowers argued that the 4% default interest clause was an unenforceable penalty. In their view, the rate was punitive, not compensatory, and far exceeded any real loss London Credit might suffer. Essentially, they wanted the court to strike down the clause and reduce what they owed.

The Trial

The first judge agreed with the borrowers, ruling that the 4% default rate was a penalty - too harsh and not compensatory.

Unsurprisingly, London Credit Ltd wasn’t happy with that outcome. They appealed to the Court of Appeal, arguing that the judge had misapplied the legal test for penalties set out in Cavendish Square Holding BV v Makdessi.

What is the Cavendish/Makdessi Test?

The right question when determining whether a default rate is unenforceable isn’t:
“Is this a punishment?”
The correct question is:
“Does this clause protect a legitimate interest, and is it proportionate?”

This legal test was set out by the Supreme Court in Cavendish Square Holding BV v Makdessi [2015] UKSC 67 (decided alongside ParkingEye Ltd v Beavis).

Before Cavendish, the rule was, on its face, clear-cut: if a clause imposed a sum that was “extravagant and unconscionable” compared to the actual loss, it was a penalty and unenforceable.

Cavendish introduced a structured approach:

1. Is the clause triggered by a breach?
   Penalty rules only apply if the clause kicks in because someone broke a main contract term. If it’s part of the main deal (not a consequence of breach), the penalty rule doesn’t apply.
2. Does the clause protect a real business interest?
   The court looks at why the clause exists. Is it just punishing the other party, or does it protect something important - like credit risk, timely payment, or security?
3. Is the clause way over the top?
   Even if there’s a good reason for the clause, the court checks whether the amount or effect is completely out of proportion to that reason. If it’s “exorbitant or unconscionable,” it won’t stand.

The Court stressed in Makdessi that freedom of contract matters -especially in commercial deals between sophisticated parties. A clause won’t be struck down just because it’s tough; it must be penal in nature, not protective.

The Court of Appeal

In Houssein, the Court of Appeal agreed with the lender, finding that the original High Court decision didn’t correctly apply the Cavendish test.

Aspects of the first judgment were reversed, and so a further hearing in the High Court was needed to determine issues of fact.

The Rehearing

At the rehearing in 2025, the High Court applied the Cavendish/Makdessi test properly. The judge didn’t just look at the numbers - he examined why the lender had included such a steep default rate.

London Credit was able to show five legitimate commercial interests behind the 4% rate:

• Timely repayment – Late payments disrupt cash flow and increase risk.
• Protecting security – The lender needed to safeguard the value of the properties securing the loan.
• Managing credit risk – Higher rates help offset the additional risk when a borrower defaults.
• Regulatory concerns – Compliance obligations can be affected by defaults, so lenders need strong deterrents.
• Avoiding collateral dilution – If the borrower’s position weakens, the lender’s security could lose value.

The judge accepted that these were real and important interests. While 4% per month was undeniably high, it wasn’t “out of all proportion” to those interests. In other words, the clause wasn’t just a punishment - it served a legitimate purpose.

The result? The default interest clause was enforceable.

Why This Case Matters

This decision is an important reminder for anyone involved in commercial lending, whether as a lender or borrower. It reinforces that:

• Default interest clauses aren’t automatically penalties - they can be enforceable if they serve a legitimate purpose and are proportionate.
• Courts will look beyond the numbers to the commercial context.
• For lenders, it’s a reminder to document the reasons behind steep default rates.
• For borrowers, it’s a warning: those clauses might stick, so read the fine print.

Legal disclaimer

The matters contained within this article are intended to be for general information purposes only. This blog does not constitute legal advice, nor is it a complete or authoritative statement of the law in England and Wales and should not be treated as such.

Whilst every effort is made to ensure that the information is correct, no warranty, either express or implied, is given as to its’ accuracy, and no liability is accepted for any errors or omissions.

Before acting on any of the information contained herein, expert advice should always be sought.

© Melissa Worth, January 2026