I did not think interest applies if I do not pay on time – may I get a discount?

I did not think interest applies if I do not pay on time – may I get a discount?

Yair Aloni, Adv.
December 10, 2021

A start-up company contracted a supplier for the provision of services and after lengthy negotiations agreed under the terms of the contract that each month a small part of the consideration will be paid and the remainder will be accumulated and paid only when the company has revenues. As there is a high risk that the entire project would be canceled, as in any startup, the contract stipulated that the deferred amount would accrue a high interest. The CFO signed the agreement, but when payment was demanded six years later he contended not to have noticed the interest rate and in any case it is not reasonable to charge such a high rate. Is there a justification for a retroactive rate reduction?

A fundamental principle in contract law is “pacta sunt servanda”, or “agreements must be kept" under the view that the parties took upon themselves various obligations with their own free will and after weighing the risks and possibilities involved. Courts do not see kindly arguments such as "I did not know" or "did not understand" made by someone who did not even read the agreement before signing, because usually signing a document indicates that one knew its contents and was aware of its meaning and therefore, can not renounce the agreement.

However, in some cases Israeli law allows the Court to intervene even when there an agreement exists. For example, a Court may, in principle, reduce agreed compensation that was set by the parties in advance. Although the Court will not rush to intervene retroactively, especially in the case of a specific commercial arrangement designed by sophisticated and experienced parties and preceded by lengthy negotiations, it may do so as long as it is convinced that there is no reasonable relation, even a remote one, between the agreed compensation and the damage anticipated at the time of the conclusion of the contract. That is, it must be examined whether at the time of the conclusion of the contract the agreed compensation was reasonable under the circumstances.

For example, in a case decided by the Jerusalem Magistrate Court in January 2015, it was held that Israeli law recognizes the classification of arrears interest as agreed compensation. However, as in that case it was a lease agreement signed between business entities, it was held that there is no room to intervene in the clause according to which overdue payments will result in charge of arrears interest at the rate of excess interest charged at the time by Bank Hapoalim. When it comes to an extended period of time the Court may intervene and limit the period of eligibility if it unreasonably exceeds the expectations of the parties. For example, in a case decided in August, 2020, the Supervisor of Land Registration in Be'er Sheva determined that a management company is entitled to arrears interest of 1% per month of late payment, but due to the length of legal proceedings between the parties, the period will be limited to four years.

In a case decided by the Supreme Court in August, 2015, a bank argued that arrears interest (breach interest) does not constitute agreed compensation but is part of the "contractual price" agreed between the parties in light of the high credit risk. The Court held, inter alia, that as long as it is a pre-determined clause in the contract, which grant one party to the contract the right to receive additional consideration (beyond the "normal" consideration stipulated in the contract) following breach of contract by the other party, without proof of damage, legally this is an agreed compensation clause. In that case, the Court did not reduce the interest for a period required for the realization of collateral, as this is a period that the parties anticipated at the time the agreement was entered into, but reduced the interest for a period where various unforeseen delays occurred due to foreclosure proceedings.

Reverting to the example with which we opened, it is important to emphasize that it is difficult to think of a situation in which the Court - six years after a contract was signed - will tend to accept an argument as to the reasonableness of the interest rate when the CFO admits that he did not bother to read the agreement. But, even if the Court is convinced that it is an agreed compensation determined without any reasonable proportion, the Court's power is to reduce the agreed compensation and not to completely cancel it. Also, the manner in which the parties conducted themselves is also important, including how the infringing party acted when it learned of the interest - whether it immediately paid the debt or ignored it. In any case, as always, it is advisable to seek the assistance of a lawyer with expertise before drafting the agreement, to make sure that all the provisions of the contract are reasonable and reflect the full understandings between the parties, prior its signing.