Interest on Delayed Payment: Contract, Statute and the Court's Discretion

Interest is often a substantial part of a recovery claim, and it is often claimed carelessly. A claim that states the principal accurately but the interest vaguely invites argument about the rate, the start date and whether it is simple or compound. This note explains how interest is claimed on a commercial debt in India, and where the law limits it. It is general information, not advice on a particular claim.

Interest before the suit

If the contract fixes a rate of interest on delayed payment, the claim should use it. A rate that is stated in the contract and was agreed between commercial parties is ordinarily enforced, though a court may reduce one it regards as a penalty (see below). If the contract is silent, there are three common sources of entitlement:

• The Interest Act, 1978. Section 3 allows a court, in proceedings for the recovery of a debt, to allow interest from the date the debt was payable until the date of institution of the proceedings, where a written demand has been made giving notice that interest will be claimed from the date of the demand.
• Usage or course of dealing. Where the parties have regularly charged interest on late payment, a court may treat that as an implied term.
• Statute. The Micro, Small and Medium Enterprises Development Act, 2006 gives a supplier compound interest with monthly rests at three times the bank rate notified by the Reserve Bank of India.

The point about the written demand is worth noting. A demand notice that expressly states that interest will be claimed supports an award of interest from its date even where the contract is silent.

Interest during the suit and after the decree

Section 34 of the Code of Civil Procedure, 1908 deals with the period after the suit is filed. The court may order interest on the principal sum from the date of the suit to the date of the decree, and from the date of the decree to the date of payment. For a commercial transaction, the rate may not exceed the contractual rate or, where there is none, the rate at which nationalised or scheduled commercial banks lend money. For other transactions the Section sets a lower ceiling. The court also has the discretion to decline interest or to reduce it.

Simple or compound

As a general rule, courts award simple interest unless the contract, a statute or an established usage provides for compounding. A claim for compound interest should therefore point to its source. A contractual provision for interest on overdue interest should be set out in the plaint, with the periodic rests specified, so that the computation can be verified.

Penal interest and Section 74

A stipulated rate that is far higher than the commercial rate may be challenged as a penalty. Section 74 of the Indian Contract Act, 1872 entitles a party to reasonable compensation not exceeding the amount named in the contract, whether or not actual loss is proved. Courts look at whether the sum is a genuine pre-estimate of loss or a deterrent out of proportion to it. A lender or supplier relying on a high default rate should be ready to show that it is a rate the market charges for the risk.

Preparing the computation

1. Compile each invoice or instalment with its due date and amount.
2. State the rate, its source, and whether it runs per annum, per month, or on a daily basis.
3. Calculate interest separately for each sum from its own due date, to the date of the claim, and apply any part-payments on the date they were made.
4. Show interest after the claim date as a daily or monthly figure, so the court can compute it to the date of payment.
5. Keep the computation in a form that the other side can check, such as a schedule annexed to the plaint.

Interest is a matter of arithmetic and of authority. A computation that ties each figure to a source, in the contract or the statute, is accepted far more readily than a round sum.