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QBD
1996-03-20
Mr Justice Colman
Times, 1996-04-08 [1996] QB 752
Contract, Banking
The court looked at a provision for prospective increase in the interest rate payable by a borrower, following his default. Held: "The defendants contend that, inasmuch as the constituents of the default interest under article 10.03(A) include at (i) 1 per cent., a rate completely unexplained, in addition to the margin (defined in article 1 as 11/2 per cent) and the cost of obtaining dollar deposits to fund the bank's participation, the 1 per cent is a penalty. It is said to be in terrorem the borrower, its sole function being to ensure compliance with the agreements. . . . " The term provided for a modest increase. It was not a penalty and therefore not invalid. The court analysed the concept of a penalty as follows (following Dunlop): "whether a provision is to be treated as a penalty is a matter of construction to be resolved by asking whether at the time the contract was entered into the predominant contractual function of the provision was to deter a party from breaking the contract or to compensate the innocent party for breach. That the contractual function is deterrent rather than compensatory can be deduced by comparing the amount that would be payable on breach with the loss that might be sustained if breach occurred." A dichotomy between a genuine pre-estimate of damages and a penalty does not always cover all the possibilities. Although the payment of liquidated damages is "the most prevalent purpose" for which an additional payment on breach might be required under a contract "…. the jurisdiction in relation to penalty clauses is concerned not primarily with the enforcement of inoffensive liquidated damages clauses but rather with protection against the effect of penalty clauses. There would therefore seem to be no reason in principle why a contractual provision the effect of which was to increase the consideration payable under an executory contract upon the happening of a default should be struck down as a penalty if the increase could in the circumstances be explained as commercially justifiable, provided always that its dominant purpose was not to deter the other party from breach."
1996-03-20
Mr Justice Colman
Times, 1996-04-08 [1996] QB 752
Contract, Banking
The court looked at a provision for prospective increase in the interest rate payable by a borrower, following his default. Held: "The defendants contend that, inasmuch as the constituents of the default interest under article 10.03(A) include at (i) 1 per cent., a rate completely unexplained, in addition to the margin (defined in article 1 as 11/2 per cent) and the cost of obtaining dollar deposits to fund the bank's participation, the 1 per cent is a penalty. It is said to be in terrorem the borrower, its sole function being to ensure compliance with the agreements. . . . " The term provided for a modest increase. It was not a penalty and therefore not invalid. The court analysed the concept of a penalty as follows (following Dunlop): "whether a provision is to be treated as a penalty is a matter of construction to be resolved by asking whether at the time the contract was entered into the predominant contractual function of the provision was to deter a party from breaking the contract or to compensate the innocent party for breach. That the contractual function is deterrent rather than compensatory can be deduced by comparing the amount that would be payable on breach with the loss that might be sustained if breach occurred." A dichotomy between a genuine pre-estimate of damages and a penalty does not always cover all the possibilities. Although the payment of liquidated damages is "the most prevalent purpose" for which an additional payment on breach might be required under a contract "…. the jurisdiction in relation to penalty clauses is concerned not primarily with the enforcement of inoffensive liquidated damages clauses but rather with protection against the effect of penalty clauses. There would therefore seem to be no reason in principle why a contractual provision the effect of which was to increase the consideration payable under an executory contract upon the happening of a default should be struck down as a penalty if the increase could in the circumstances be explained as commercially justifiable, provided always that its dominant purpose was not to deter the other party from breach."
