Default Interest Clause Tested: Key Lessons for Lenders from a Recent Supreme Court Decision

This article considers the recent Supreme Court of New South Wales decision in Crescent Capital Ltd as trustee for the Rockdale Central Security Trust v Chanine [2026] NSWSC 371 on the enforceability of a default interest clause in a commercial construction loan agreement with a non-bank lender.

The Facts

The plaintiff was the security trustee of a private equity investment group.  The defendant was the borrower who was an experienced property developer.

In September 2020, the parties entered into a construction loan agreement.

Ordinary interest was initially 6.10% per annum and later, as a result of an extension to the term of the facility, was increased to 7% per annum.  If the borrower achieved 70% pre-sales, then the interest rate was reduced to 5.85% per annum.

There were two rates of default interest as follows:

• If the loan was not repaid on the repayment date, 10% per annum higher than the ordinary interest rate; and
• For other defaults, 5% per annum higher than the ordinary interest rate.

Interest compounded monthly.

The borrower did not repay the loan on the repayment date.  And the lender issued proceedings against the borrower and the guarantors to recover the debt.

Legal Issue

The court considered whether the provision in the loan agreement providing for default interest of an additional 10% was a penalty.  If the court held that this provision was a penalty, then the lender would be unable to enforce the default interest clause.

Decision

The court held that a default interest rate of an additional 10% was not unenforceable as a penalty.

The key reasons for the court’s decision are as follows:

• The defendant was an experienced property developer who was well placed to assess whether the terms of the loan were commercially acceptable.
• The pricing of the loan was the subject of negotiation between the lender and the borrower and the borrower had plenty of time to consider whether to proceed with the loan (there were 4 months between the signing of the initial Term Sheet and the signing of the loan agreement). In this context, the court held that there must be a good reason to interfere with the agreement reached by the parties.  The court did not find that there was such a reason.
• The borrower had failed to provide evidence to the court to show why the default interest rate was a penalty. In particular, the borrower did not provide any evidence of market interest rates for equivalent loans.  A default interest rate of an additional 10% per annum was not obviously high in the absence of such market evidence.
• A default interest rate of an additional 10% per annum only applied to the borrower’s default to repay the loan on the repayment date. It did not apply to all other defaults to which a reduced rate of default interest applied.  This two-tiered approach reduced the risk of the court finding that the higher default interest rate was a penalty.
• The court accepted the lender’s evidence that the default interest provision protected a legitimate commercial interest of the lender, namely achieving a 20% IRR for its investors.

Practical Implications for Lenders

A default interest provision inherently carries the risk of being challenged by a borrower as an unenforceable penalty.  To reduce this risk, lenders should consider the following:

1. The lender should ensure that it documents the reasons why it has set the default interest rate at the rate contained in the loan documentation (eg: in investment recommendation papers which go to the board or the investment committee of the lender). This documentation will be critical evidence in defending a penalty challenge.
2. A default interest rate which is proportionate to the lender’s legitimate commercial interests, such as its increased credit risk, cost of capital, operational costs and loss of opportunity, is more likely to be upheld by the courts.
3. A clause that applies only to a default on the repayment date, rather than a single default rate which applies to all defaults, is less susceptible to challenge.
4. In the Crescent Capital case, the absence of market rate evidence operated in favour of the lender. However, the lender should not rely on this and should gather market comparators to strengthen its defence.