In more detail

Late payment compensation vs. default interest 

While often seen as being conceptually synonymous, it is important to draw an important distinction between these two types of provisions. 

In conventional financing transactions, default interest is typically charged by financiers as a penalty in circumstances where the obligor fails to make payment of outstanding amounts on the due dates. Any default interest owed and collected from an obligor is for the account of the lender. In Shariah compliant financing transactions on the other hand, due to the prohibition of interest, financiers cannot charge penalty interest. However, Shariah compliant financing transactions typically include late payment compensation clauses, which allow the financier to claim late compensation amounts from the obligor should the obligor fail to make payment of outstanding sums on the due dates. Unlike default interest, any late compensation owed and paid by an obligor shall not be for the account of the financier and typically must be donated to a charity selected by the financier's Shariah supervisory board. Late payment compensation provisions are therefore intended to incentivise the obligor to make payments on their due dates as opposed to default interest provisions, which seek to impose a penalty on the obligor.

We have not had access to the underlying transaction documentation that was considered by the Court of Cassation, however, the 8 July Decision casts some doubt on the enforceability of late payment compensation clauses found in Shariah-compliant financing transaction documentation.

Potential impact of unenforceability of late payment compensation

It is not clear from the 8 July Decision whether, in addition to statutory awards of interest not being permitted in relation to Shariah-compliant transactions, late payment compensation clauses are also likely to be held to be unenforceable. We would not expect this to be the case given that Article 473 of UAE Federal Decree Law No 50/2022 seeks to prohibit financiers from charging interest or another 'benefit' in relation to delayed payments, while late payment compensation does not confer any additional benefit on the financiers as the amounts claimed are not, as described above, for the account of the financier itself. 

While financiers may seek to contractually mitigate the risk of late payment clauses not being enforceable, we note that Article 473 expressly states that any agreement contrary to its provisions shall be null and void.

It remains to be seen how the market responds to the 8th of July Decision and whether this will lead to an impact on pricing and the frequency of non-payment events of default (and accelerations in that respect).

Conclusion

Although there is no system of binding precedent in the UAE and it does not necessarily follow that the findings of the 8 July Decision will be applied holistically, the interpretation of Article 473 by the Dubai Court of Cassation and how it may be addressed warrants further analysis and discussion.