The Irish Court of Appeal recently handed down an important decision which will impact default interest provisions in Irish law loan agreements. In Sheehanv Breccia/Flynn and Benray v Breccia, the court considered whether a provision for default interest in a bank's standard terms and conditions should be struck down as a penalty. This is a highly technical question, but one which is important for banks and borrowers, and for other market operators.
The technical issue
Where a bank and a borrower agree that if the borrower defaults (for example, on making a monthly interest payment) the interest rate payable by the borrower will increase, one might reasonably ask why a court should interfere. This is a standard provision in loan agreements, and is, in principle, designed to reflect the increased credit risk represented by a defaulting borrower. However, the common law approach is to treat any sum payable upon a breach as unenforceable if the defaulting party can show that it was not a genuine pre-estimate of the non-defaulting party's loss.
Breccia – overview of facts
In Breccia the borrowers' loans (originated by a bank which failed during the global financial crisis) were purchased by a company controlled by a co-shareholder with whom the borrowers were in dispute. The loan purchaser served a demand for the payment of default interest. The borrowers challenged this on the grounds, among other things, that the provision for the payment of default interest was a penalty.
The court agreed that the provision for default interest was not a genuine estimate in advance of the lender's loss upon borrower default. This was primarily because the provision was contained in the original lender's standard terms and conditions, and therefore clearly had not been individually negotiated.
The court declined to follow recent decisions of the UK Supreme Court (in Makdessi/Parking Eye) and apply a more liberal test which simply asks whether the provision for default interest was unconscionable or disproportionate in the circumstances. The court agreed that the traditional common law principles were far from satisfactory, but indicated that if there was to be a fundamental change of approach, the Irish Supreme Court would have to decide the future direction.
The fall-out from Breccia could be far reaching for Irish law credit agreements. A sizeable proportion of bilateral loans in the consumer and small and medium-sized enterprise (SME) sectors incorporate standard terms providing for default interest. There is now a serious question mark as to the recoverability of such sums. While large Irish corporate loans and syndicated debt are based on Loan Market Association (LMA) precedents which are self-contained contracts and do not incorporate standard terms, standard terms often feature in swaps and prime-brokerage agreements. If those agreements are governed by Irish law, the parties need to review the position. Finally, the decision sits uncomfortably with the strategy of 'Ireland plc' to promote the adoption of Irish law as the governing law of contracts in the financial sector in a post-Brexit world.