What’s the highest rate of interest you can charge?

The starting point

When your company contracts with another business (as opposed to an individual) theLate Payment of Commercial Debts (Interest) Act 1998 automatically comes into play. It allows you to apply a statutory rate of interest to a payment as soon as it becomes late, e.g. 30 days after receipt of the goods or invoice, whichever is the later.

Tip. This statutory rate of interest is set at 8% above the Bank of England’s base rate.

Looking for a little extra?

But the base rate is at an historic low and looks set to stay that way for a while. For most of 2009 it’s been 0.25%, meaning that under the Act all you could currently claim by way of interest is 8.25%. So, with this in mind, when negotiating a new contract you might be tempted to ignore the protection of the Act and impose a much higher rate of contractual interest, e.g. 15%.

Unfair. If you do this, you might encounter a problem. A debtor could later challenge the rate on the basis that it’s a “penalty”. If the court agrees it was too high, it will be unenforceable and you won’t get any interest at all!

Some much needed guidance

Until recently the courts have said very little about what will be deemed an as unacceptable rate of contractual interest.

New case. Thankfully, following the Court of Appeal decision in Taiwan Scot Co Ltd vThe Masters Golf Company Ltd 2009, directors now have some guidelines.

Let’s play golf

Taiwan Scot (TS) imported golf clubs from China and supplied them for sale to the Masters Golf Company (MGC). When their contract was agreed in 2001, it included a clause that set the interest rate for late payment at 15%.

Failed to pay for it. It goes without saying that MGC failed to pay up. TS sued and applied the agreed contractual rate of interest to the debt. But MGC objected, saying it was too high, i.e. a penalty. It argued that it should not have to pay any more than that due under the Act. If correct, this meant that TS was entitled to 8.25%, i.e. the statutory rate at the time the case reached court, as opposed to 15%.

Court of Appeal decision

The Court said that the important factor was not that interest rates were at an all time low, but that they were much higher when the contract was made back in 2001. At that time, the base rate was 5.25%, which made the statutory rate then recoverable under the Act 13.25%. As the contractual rate agreed would have been only 1.75% above this, 15% was reasonable.

Tip. If you want to ignore the Act and set your own rate, this case now gives you a rule of thumb. The interest rate charged here was roughly 10% above base rate, so as long as you stay in this ballpark area, you should be safe.

Trap. Never set a rate that you can’t commercially justify. If you appear too greedy, the court is likely to have little sympathy for you and will view the rate as a form of punishment, rather than a true reflection of your losses.