Agreeing to a Penalty Test: What You Need to Know

Charging or paying interest on outstanding debts can be perplexing. We often get legal advice from friends who aren’t lawyers, which leads us to believe that the way we are doing our business is the right way. Here’s what you need to know when you charge or agree to interest:

If your debtor is in default, interest can be claimed from the date of demand (if there is no penalty interest agreement), or from the date the payment became due (if there is an agreement to pay penalty interest). Compound interest can only be claimed if there is an agreement for compound interest. If there is no agreement, then only simple interest can be claimed.

How much interest?

Penalty interest on outstanding amounts should be charged at the rate that was agreed upon between the parties, provided it doesn’t exceed the maximum legal amount of interest that you can charge.

If an agreement wasn’t made, then the Prescribed Rate of Interest Act 55 of 1975 applies. As at 8 January 2016, the prescribed rate of interest is the South African Reserve Bank repurchase rate plus 3.5% (Repo rate + 3.5%) per year.

What is the maximum interest rate you can agree to?

The National Credit Act provides that the maximum penalty interest that can be agreed to is 2% per month.

When does interest start running?

If there is an agreement to charge interest, then you can start charging interest from the day that the debt becomes overdue.

If there is no agreement to charge interest, then the prescribed rate of interest applies, and you can only start charging this penalty interest from the date of the first demand letter.

When does interest stop running?

Interest usually stops running when the unpaid interest equals the outstanding amount of the initial amount owing. This rule is called the in duplum rule.

Want legal protection when doing business?

Relying on the prescribed rate of interest as your sole recourse for penalty interest is not recommended for a number of reasons:

• It is lower than the maximum amount you can claim in terms of the NCA;
• You need to monitor the South African repo rate and its changes closely to ensure you’re applying the correct penalty interest;
• The charging of interest is delayed until you start collection proceedings.

Protect yourself when you are doing business by getting your legal agreements in writing. Verbal agreements just aren’t good enough when it comes to money and a written contract gives far greater comfort when you are doing business. Take a look at our general terms and conditions templates, as well as our agreements regarding suretyship, cessions and other credit related documents, to make sure you have peace of mind when claiming or paying interest.

Please note that this information is supplied for general information and does not constitute legal advice. It is advisable for you to contact a legal practitioner for guidance in respect of your unique requirements.