Is interest still interesting for the commodities sector?

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[authors: Kyri Evagora, Paul Skeet, Pryderi Diebschlag]

Introduction

The current economic climate has highlighted the importance of cash-flow for businesses in the commodities sector. Fluctuations in the value of commodities may represent significant opportunities for profit, but only to those with funds to invest. It is clear that unpaid debts represent lost opportunities for profit for businesses and their investors.

As it stands today, the law provides creditors with a remedy for late payment of debts in the form of interest, but some participants in the commodities market may question whether the interest rates currently recoverable through the courts on such debts provide adequate compensation for their lost opportunities whilst they are without funds. The law provides no route whereby an investor in an unpaid seller can recover the expected return on its investment directly from a debtor.

This Client Alert looks at the interest payable on pre-judgment debts under contract and statute before considering the post-judgment position. We suggest an explanation for the current state of the law and ask whether this ought to be reassessed in light of changing economic times.

Interest on debts - pre-judgment

Commercial contracts in the commodities sector will commonly include an express clause providing a right to interest on any debts arising thereunder. Such clauses typically specify the interest rate, whether interest is to be simple or compound, and the period for which interest will run. Such terms, once agreed between parties of equal bargaining power, generally remove the question of what interest should be payable on a debt from the discretion of the courts.

What, therefore, is to stop the parties from agreeing in their contract that an unpaid debt will bear interest at a very high rate – sufficient to compensate the creditor for the return on capital it might have expected to earn had it been able to invest the unpaid amount? In fact, even commercial parties do not have complete freedom to agree whatever interest rate on late payments they may wish. The English courts will only enforce an express interest clause that represents a genuine pre-estimate of the expected loss for the creditor, but not a clause that represents a penalty or deterrent attributed to the debtor in the event that it defaults under the contract. In the latter circumstance, the express interest provision will be unenforceable.

Further, what is a reasonable pre-estimate of the creditor’s expected loss will be determined by reference to the cost of borrowing an equivalent sum – but not the expected returns had the unpaid funds been invested by the creditor.

What level of interest or the features of an interest clause which might result in an express interest clause being deemed to be a penalty will turn on the facts of the individual case. Nevertheless, some guidance can be taken from recent cases:

  • Jeancharm Ltd v Barnet Football Club Ltd [2003] EWCA Civ 58 – an interest rate of 260% per annum was described as an "extraordinarily large amount" that could not have been a genuine attempt at pre-estimating loss and hence was held to be unenforceable.
  • Taiwan Scot Co Ltd v Masters Golf Company Ltd [2009] EWCA Civ 685 – an interest rate of 15% per annum between two commercial entities at a time when interest rates were high was held to be enforceable.
  • Fernhill Properties (Northern Ireland) Ltd v Mulgrew [2010] NICh 20 – an interest rate of 15% per annum between a commercial entity and a consumer was unjustified as the claimant’s loss was likely to be significantly lower, hence it was held to be unenforceable.

The enforceability of an interest clause will turn on more than the wording of the clause and will encompass aspects such as the nature of the parties, market practice, the cost of raising funding from alternate sources, and the credit risk borne by the creditor whilst out of the money. In any event, the courts have consistently agreed that "the law relating to penalty clauses is to prevent a plaintiff recovering a sum of money in respect of a breach of contract committed by a defendant which bears little or no relationship to the loss actually suffered by the plaintiff".1 Consequently, an express interest clause must be commercially justifiable, and must bear some correlation to the loss suffered or risk borne by the creditor.2

In the event that an interest clause is held to be unenforceable, or where a contract does not include an express interest clause, the Late Payment Act 1998 and the Senior or County Courts Act may provide the creditor with a remedy for late payment. These are considered separately below.

The Late Payment Act 1998.

Since 7 August 2002, where two businesses have, in commercial circumstances, entered into a contract for the supply of goods or services, the Late Payment of Commercial Debts (Interest) Act 1998 (the "LPA 1998") will imply a term into the contract that simple interest will apply to qualifying debts.3

The statutory rate of interest is set by the Secretary of State and has, since its introduction, remained at 8% per annum above the official dealing rate (the Bank of England base rate).4 Additionally, a further fixed sum, varying from £40 - £100, is applicable depending on the total value of the debt.5

The LPA 1998 provides for a certain amount of judicial discretion as to the interest to be awarded, allowing in section 5 for the court to reduce the rate or period, or indeed entirely deny a creditor the benefit of the implied interest rate. These powers are broadly guided by "the interests of justice" and the conduct of the creditor, including the creditor’s conduct after the debt arose.

Further, where the contract provides for another "substantial contractual remedy", those provisions may be deemed sufficient to compensate the creditor and hence displace the interest otherwise provided for by the LPA 1998. Consequently an express interest clause may well have the effect of contracting out of the contract out of the LPA 1998,6 even without express wording to that effect, provided that the clause provides a sufficient remedy for late payment. In addition, the courts will consider the overarching question of whether it would be fair and reasonable to deprive the creditor of the 8% interest rate provided under the LPA 1998.7

The Senior Courts Act 1981.

In the event that the parties have not agreed to an express interest clause, and the LPA 1998 is inapplicable, the courts have an additional general discretion under the Senior Courts Act 1981 (the "SCA 1981") and the County Courts Act 1984 (the "CCA 1984") to award pre-judgement interest on any debt "at such rate as the court thinks fit"8. This allows the court discretion to award simple (not compound) interest for such period, and at such rate, as it feels is appropriate given the circumstances of the case.

However, somewhat in contrast to the LPA 1998, this discretion aims purely to compensate the creditor for its loss as a result of being deprived of funds, and does not include a deterrent element.9 Further, under the SCA 1981 and CCA 1984, the courts’ approach is influenced by the principle that any claimant must, to the greatest extent possible, mitigate its losses which stem from the defendant’s breach. As a result, in exercising their discretion to award a particular rate of interest, the courts will be focussed on the cost at which the funds could have been obtained by the creditor from lending banks.

Traditionally, the rate of interest awarded by the Commercial Court on debts denominated in Sterling is 1% above the Bank of England base rate, although this presumption can be rebutted where evidence can be adduced to show that applying this rate would be unjust, for example, in the case of small business enterprises that may struggle to borrow from banks.10

Post-judgment Where an express interest clause does not provide that the specified rate of interest shall apply before and after judgment, its application shall be limited to pre-judgment debts. Interest on post-judgment debts is addressed by the Judgments Act 1838 (the "JA 1838"). Section 17 of the JA 1838 has, since 1993, applied an interest rate of 8% for debts in Sterling.11 This rate is, however, not normally applied in commercial disputes, where the courts again use their discretion to set the rate, albeit limited by an apparent cap of 8%.12

Equally, the 8% rate does not apply to sums awarded in foreign currencies. In these limited circumstances, the court may order interest at any rate that it thinks fit. It has become usual (although still subject to discretion) for U.S. dollar awards in commercial disputes to be in line with the U.S. Prime Rate, being the nearest U.S. equivalent to 1% above base rate.

Conclusions

In light of the foregoing, there is uncertainty as to whether express interest clauses awarding higher rates, e.g. 4%-6% above the Bank of England base rate, would be upheld. Depending on the circumstances, creditors may find themselves rewarded with a court erring towards the 8% provided under the LPA 1998, or, given the low current cost of borrowing for large market players, even striking down such a term as an unforceable penalty and utilising their discretion under the SCA 1981 to award a significantly lower interest rate.

Given the uncertainties, weight should perhaps be given to the Law Commission’s 2004 report in which an award of 1% above the Bank of England base rate was suggested as an appropriate starting point for an interest determination, with 8% being described as often providing "over the odds" compensation.15 The Law Commission’s comments are likely to be especially true for larger commercial players, such as those active in the commodities markets, and so should not be ignored when drafting express interest clauses.


1. Export Credits Guarantee Department v Universal Oil Products Co [1983] 2 All E.R. 205, at 224.

2. In recent years such clauses have been subjected to an increasing level of mathematical analysis. See McAlpine v Tilebox [2005] EWHC 281

3.See s. 3 LPA 1998. Additionally, consumer credit agreements and contracts intended to operate by way of mortgage, pledge, charge or other security will not attract statutory interest, s. 2(5) LPA 1998.

4. SI 2002/1675, Article 4

5. See s. 5A LPA 1998.

6. See s. 8(1) LPA 1998.

7. See s. 9 LPA 1998. In doing so, the courts will have regard to the strength of the parties’ bargaining positions, any additional inducements or reasons for agreeing to such terms, and the desire for commercial certainty.

8. See s. 35A SCA 1981 or s. 69 CCA 1984

9. Tate and Lyle Food and Distribution Ltd v Greater London Council [1982] 1 WLR 149.

10. Jaura v Ahmed [2002] EWCA Civ 210, the court awarded a rate of 3% given the size of the business.

11. Judgment Debts (Rate of Interest) Order 1993 (SI 1993/564)

12. Reed Executive plc v Reed Business Information Ltd [2004] EWCA Civ 887, at paragraph 68: "The Judgements Act rate is fixed for the benefit of unpaid judgment creditors. It is not normally an appropriate rate of interest to award in the context of a dispute between two businesses."

13. See s. 44A Administration of Justice Act 1970.

14. Yuanda (UK) Co Ltd v WW Gear Construction Ltd [2010] EWHC 720, the court held that a rate of 0.5% above base rate was not a "substantial remedy" under the LPA 1998 and hence refused to acknowledge it, rather applying the statutory rate of 8% above base rate.

15. Law Com 287, paragraphs 1.12-1.18