The issue of compounded interest rates has long been a subject of debate among banking litigation practitioners in the UAE, with the courts of various emirates adopting different views over the past decades on a banking lender’s right to claim compound interest, which accumulates from the principal sum along with the accumulated interest, as opposed to simple interest which only accumulates from the principal sum of the financing.
The Dubai Courts have in the past accepted a claim of compound interest rate so long as the facility’s contractual provisions allow it (i.e. where the customer consents to it in the loan agreement). The Abu Dhabi Courts have rejected it.
However, and more recently, two federal statutory provisions have come into force prohibiting the application of compounding interest rate.
The first is the legislative amendment of the Central Bank and Organization of Financial Institutions and Activities Law whereby Article 121(4) was introduced to preclude Licensed Financial Institutions from charging “interest on accumulated interest, i.e. compound interests, in respect of the facilities granted…”. This amendment came into force in January 2023.
Secondly, and while also coming into force in January 2023, the Federal Commercial Transactions Code No. 50 of 2022 introduced Article 88 to expressly preclude creditors more generally from claiming compounded interest rates in their commercial dealings.
Based on those two statutory provisions, the Federal Supreme Court ruled on the 10th of January 2024 (in a banking claim deriving out of a 2011 facility arrangement that’s last rescheduling occurred in 2019) to reverse a Court of Appeal ruling that was based on a banking expert report that quantified a defendant’s indebtedness based on the compound interest formula.
The Federal Supreme Court elaborated further in its verdict that any credits into the customer’s account must be adjusted against the principal sum rather than on accrued interest such that, once the principal exposure is extinguished, the applicable interest must then “cease to accrue, and the subsequent credits must then be applied against the [simple] interest and any remaining charges”.
The intricacies of this verdict are multi-fold, as it is perceived to have negative ramifications upon banking lenders and even more generally any other commercial creditors (given Article 88 applies to all forms of commercial interest), whilst some defaulting customers can rejoice knowing that their exposures may be reduced, thereby improving their status at the negotiating table.