Penalty or genuine pre estimate of loss?

Clauses in contracts which amount to ‘a penalty’ are not enforceable in law.

The High Court in Northern Ireland recently found that a contractual interest rate of 15% was unenforceable because it was a penalty. A buyer was unable to complete a purchase from a property developer due to lack of mortgage funds. The developer sued, claiming interest on the purchase price at 15%.

The Court said that the figure was not a genuine pre-estimate of the purchaser’s loss. Rather, it was a penalty designed to deter the buyer from breaching the contract. The base rate having been 5.25%, the developer would have to have shown that there was a foreseeable risk of him having to pay 9.75% above base rate for continuing borrowings if the buyer failed to complete.

The case stands in contrast to an English Court of Appeal case, in which it was stated that 15% interest was not a penalty. However, this case involved two companies, rather than a company and an individual. Therefore, it is clear that such cases will be decided on their facts.

The key question is whether the interest rate is a genuine pre-estimate of loss or a figure devised to prevent the contract being broken.