Legal Question in Business Law in California

Re: Charging interest on interest

If your agreement said nothing about compounding interest then you probably cannot do so.

It is possible that compounding the interest would be legal under the circumstances of your case. Because you have not described those circumstances I cannot give you a firm answer one way or the other.

Re: Charging interest on interest

Your question concerns whether an interest rate specification in a contract should be interpreted to call for simple interest or compound interest.

In California, the strong preference is to interpret contracts which are silent on whether the interest is to be compounded or not as requiring only simple interest to be paid.

An exception would be where the trade practice in a particular business was that interest would be compounded. If both parties to the contract were in that business, trade or profession and could be presumed to know its customs and practices, then compound interest by trade custom could be imposed by a court.

It's also possible that the language of the contract, while not specifically calling for compounding of interest in so many words, may call for it by obvious implication, i.e. a clause stating that interest in arrears will be added to the principal.

In any event, it would be good practice in the future to ass words such as "compounded annually" to your promissory notes. Also, be sure to avoid ever charging a usurious rate of interest.