Default interest clause: sample rate and the penalty test

Sample clause

Written for a business loan to Kerfwell Joinery Pty Ltd from Halden Capital Pty Ltd, both fictional, at a fixed rate of 9 per cent a year.

Default Interest. (a) If the Borrower does not pay any amount on its due date, the Borrower must pay interest on that amount at the Default Rate from the due date until it is paid in full, both before and after any judgment. (b) The Default Rate is the interest rate in clause 4.1 plus 4 per cent a year. (c) Default interest accrues daily on a 365 day year, is not compounded, and is payable on demand or with the next instalment. (d) Default interest applies only to the overdue amount, not to the whole loan balance, unless the Lender has declared the whole balance due under clause 9. (e) The parties agree the Default Rate reflects the Lender's increased credit risk and administration costs while an amount is overdue.

Sample wording, not legal advice.

Variants

What to negotiate

• Keep the uplift modest

  Courts in the UK and Australia have accepted default uplifts of a few percentage points as commercially justified, because a borrower in default is a higher credit risk. Large uplifts, or a rate that applies to the whole balance after a single late payment, attract the penalty argument. Recording the reason for the rate, as the sample does, helps.

• Overdue amount or whole balance

  Applying the default rate only to the amount actually overdue is the fair and safer approach. Applying it to the entire loan because one instalment was late multiplies the cost of a small default and is the kind of term courts scrutinise. Once the loan is accelerated, the whole balance is overdue and the rate can apply to it.

• Simple or compound

  Simple interest is easy to check and harder to attack. Compounding default interest, monthly or quarterly, increases the cost quickly on long defaults. If compounding is agreed, the clause should say the period. Consumers credit contracts carry their own rules on default rates and fees, which this sample does not address.

The risk of leaving it out

Without a default interest clause, a lender or supplier may only recover the ordinary contract rate, or no interest at all on an invoice, until it sues and gets interest under court rules. Late payers then have little reason to prioritise the debt, and the creditor carries the extra risk of a defaulting customer at no extra return.

Default interest and the penalty rule

A clause requiring a payment on breach is unenforceable as a penalty if it is out of all proportion to the innocent party's legitimate interest, the test the UK Supreme Court set in Cavendish Square v Makdessi in 2015. The High Court of Australia's approach in Paciocco v ANZ in 2016 is similar, asking whether the sum is extravagant or unconscionable compared with the greatest loss that could flow from the breach. A modest increase in rate reflecting higher credit risk usually passes. Law checked on 21 October 2026. This page explains how the law works and is not legal advice.

The sample in numbers

Kerfwell Joinery's loan is at 9 per cent a year, so the default rate is 13 per cent. If a $2,000 instalment is 20 days late, default interest is $2,000 times 13 per cent times 20 over 365, about $14.25, on top of the ordinary interest already built into the instalment. The cost is small for a short delay and grows with a longer one, which is what a proportionate default clause should do.

How it relates to late payment interest

In a loan, default interest is an uplift on an existing interest rate. In a supply contract there is usually no interest until payment is late, so the clause sets a rate from scratch, and the late payment interest clause page covers that form. In the UK, business debts carry statutory interest at 8 per cent over the reference rate unless the contract provides a substantial remedy instead.

Where the clause sits in a generated document

Loan agreements, promissory notes and joint venture agreements carry default interest clauses next to the interest and payment clauses. When asking the AI document generator for one, give the base rate, the uplift, whether it applies to the overdue amount or the balance, and whether it compounds.

Documents that carry this clause

Loan agreement templateA Tasmanian foundry is borrowing $180,000 from a private investment company to buy a used induction furnace. The lender is not a bank, so everything a bank would take for granted has to be written down: what has to happen before the money moves, what is registered over what, and how long the borrower gets to fix a default.Joint venture agreement template with contributions and splitAn unincorporated joint venture has no company to fall back on, so everything a company structure would supply has to be written down. This one puts two builders together for a single $14.6 million refurbishment, splits it 55/45, and sets out who funds it, who decides, how a deadlock breaks and how either of them gets out.Promissory note templateA timber company owes $45,000 to a private lender and needs one page that says so. No conditions precedent, no covenants, no security. Only the maker signs, which is what keeps a note short and what lets the holder pass it on to somebody else.

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