Disproportionate amount of contractual default interest and its contradiction with the Constitution

18. 9. 2019

First of all, a distinction must be made between the so-called statutory default interest – corresponding annually to the repo rate set by the Czech National Bank for the first day of the calendar half-year in which the default occurred, increased by 8 percentage points – and contractual default interest – which corresponds to the mutual agreement of the contracting parties and which can be determined not only as a percentage of the outstanding amount, but also as a fixed amount independent of the amount of the unpaid debt (however, the method of its calculation must always be clear and sufficiently certain). By default, there is no need to negotiate statutory interest. In the case of contractual interest, two situations may arise in practice where the agreed amount of default interest is disproportionate. Either it is too low or too high, which may cause litigation in the future.

The first mentioned situation is explicitly regulated by law, the creditor being entitled to claim the ineffectiveness of the arrangement on the default interest in court. If the agreed default interest is too low or completely excluded and disadvantageous and potentially “unfair” for the creditor, the court declares such an arrangement ineffective and either replaces it with statutory default interest or, in the interest of a fair settlement, exercises its moderation right to set a different amount.

A more complicated and further elaborated situation, which is not explicitly dealt with by law, occurs if the amount of the agreed default interest is too high. Although default interest constitutes a legal pecuniary sanction for the debtor’s default, it often involves abuse of law, contravention of good morals and, in some cases, even manifest injustice and contravention of the rule of law (constitutional order). It can also be used in combination with a contractual penalty.

Whether the agreed amount of contractual default interest is proportionate is always assessed in the light of the particular circumstances of the case. Czech courts consider them to be in particular the reasons that led to the agreement on a specific amount of default interest, the positions of the contracting parties (B2B, B2C), the circumstances accompanying the negotiations, proportionality of the sanctions agreed in the contract to be paid by the individual parties and, as the case may be, the effects of acknowledging the agreed default interest on the party against which it is asserted.

If, based on the above assessment, it is concluded that the agreed amount is disproportionate, then, depending on its scope, several applicable legal institutes may be considered, such as deemed non-existence of such agreement, relative or absolute nullity or ineffectiveness of an arrangement with a solution similar to the case where default interest is too low. The definition of the method of solution in judicial practice has not yet been fully resolved; however, the legal specialist deduce the exercise of the court’s moderation right, as is the case with a disproportionately high contractual penalty, and this conclusion is also confirmed by the Constitutional Court’s ruling below.

Regarding the determination of fixed limits of proportionality, this has still not been achieved in the decision-making practice of supreme courts, although the Supreme Court sought to set the interest rate limit at 0.5% of the amount due for each day of default, considering the rate of 1% of the amount due for each day of default to be on principle disproportionate due to contravention of good morals and generally accepted rules of decency and fair dealing. However, the Supreme Court has continuously emphasized the specific circumstances of each case, refusing to set a certain fixed limit. On the other hand, the Constitutional Court tended to set a flat rate limit of 0.5% of the amount due for each day of default. The Constitutional Court also concluded in the past that the agreement on default interest which goes completely beyond the limits of proportionality is unconstitutional. According to the Constitutional Court, a court decision cannot recognize the right to the payment of such default interest, because this performance is prohibited by the constitution.

For this reason, agreement on a disproportionate amount of default interest may also have consequences in the enforcement of a decision. In a relatively recent ruling of the Constitutional Court, it was stated that agreement on default interest in a completely disproportionate amount is such a serious fact that general courts are obliged to examine it as a fundamental defect of writ of execution. Thus, another of a few exceptions was admitted where general courts are obliged to break the declared principle in the settled case-law of the Constitutional Court that objections to defects in the ruling procedure (or, as the case may be, a decision as a result thereof) on principle cannot be transferred to execution proceedings. Ultimately, general courts should grant judicial protection to the person liable and their property in the execution proceedings by establishing the amount of default interest which can still be considered proportionate and constitutional, and by terminating the enforcement of the decision in respect of the disproportionate interest amount, thus ensuring a fair balance in the protection of both the debtor’s and the creditor’s property.

It can therefore be concluded that although each transaction is individual and entails individual contractual documentation, we recommend that extra attention be paid when negotiating contractual default interest, as well as contractual penalties, and, ideally, that the contract be reviewed by an expert before it is concluded. This will help you avoid lengthy court proceedings where the agreed disproportionate default interest could also affect the subsequent execution proceedings and the award of its costs.

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