Scottish Court of Session Decisions

OUTER HOUSE, COURT OF SESSION [2011] CSOH 153
CA23/07	OPINION OF LORD HODGE in the cause FARSTAD SUPPLY AS Pursuer; against ENVIROCO LIMITED Defender: ­­­­­­­­­­­­­­­­­________________

Pursuer: A M Clark QC, O'Brien; H B J Gateley

Defender: Howie QC, Delibegovic-Broome; Paull & Williamsons

14 September 2011

[1] The pursuer in this action ("Farstad") sued the defender ("Enviroco") for £2,514,761.38 in damages for loss which it sustained when a fire broke out on the oil rig supply vessel, MV Far Service, in Peterhead harbour on 7 July 2002. The action settled on the eve of a proof diet on 23 August 2011. The parties entered into a Joint Minute by which they invited the court to pronounce a decree ordering Enviroco to pay £1,750,000 to Farstad together with interest from 31 December 2002 "at such rate or rates as the court shall think fit."

[2] The issue, which the parties debated, was the appropriate rate of interest under section 1 of the Interest on Damages (Scotland) Act 1958 as amended ("the 1958 Act").

[3] Enviroco had flagged up this issue in its defences in which it averred (in Answer 5) as follows:

"to the extent the defenders are found liable for any loss and damage suffered by the pursuers, the pursuers are not entitled to the interest at 8 per cent a year from 7 July 2002. .... The pursuers are only entitled to that rate of interest which would put them into the same position in which they would have been if they had not suffered loss and damage. The rate of 8 per cent is far in excess of that rate of interest and would provide the pursuers with a bonus, rather than properly compensate them for their loss."

Accordingly, when agreeing the settlement figure in the Joint Minute, Farstad had notice of the challenge which Enviroco has now made.

The statutory provisions

[4] Section 1(1) of the 1958 Act as originally enacted empowered the court to include in a decree for payment of damages an award of interest from the date of citation. This provision was amended by the Interest on Damages (Scotland) Act 1971 to empower the court to award interest for any period between the date when the right of action arose and the date of the interlocutor. Section 1(1) of the 1958 Act as amended provides:

"Where a court pronounces an interlocutor decerning for payment by any person of a sum of money as damages, the interlocutor may include decree for payment by that person of interest, at such rate or rates as may be specified in the interlocutor, on the whole or any part of that sum for the whole or any part of any period between the date when the right of action arose and the date of the interlocutor."

Section 1(2) provides that

"Nothing in this section shall - (a) authorise the granting of interest on interest."

The factual background

[5] For some time insurers and others have been concerned that the judicial rate of interest, which is 8 per cent a year, gives excessive compensation in awards of pre-decree interest under the 1958 Act.

[6] Rule of Court 7.7 contains the default position on the judicial rate of interest . It provides:

"Where interest is included in, or payable under, a decree, it shall be at the rate of 8 per cent a year unless otherwise stated."

It has been the general practice of the Court of Session to award interest due under the 1958 Act at that rate. See Boots The Chemist Ltd v G. A. Estates Ltd 1992 SC 485.

[7] The judicial rate of interest in this jurisdiction has changed over time. In 1965 the rate was set at 5 per cent. It was amended to 7 per cent in 1970, 11 per cent in 1975, and 12 per cent in 1983. Between 15 August 1985 and 1 April 1993 the rate was 15 per cent. Since then the rate has been 8 per cent. While the variations are not inconsiderable, they have been relatively infrequent when compared with the fluctuations in market rates.

[8] In a Joint Minute the parties agreed for the purposes of the debate the terms of two documents setting out historic interest rates. So far as relevant, the first revealed that during 1985, shortly before the judicial rate was increased from 12 per cent to 15 per cent, the minimum band 1 dealing rate fluctuated in the range of 11.375 per cent to 13.875 per cent. By late 1992 the rate was 6.875 per cent and in 1993 it was changed to 5.875 per cent on 26 January and to 5.375 per cent in November. Thus when the judicial rate was reduced to 8 per cent, that was in excess of 2 per cent over the minimum band 1 dealing rate. Between 2003 and October 2008 the Repo rate and then, when it was again renamed, the official bank rate fluctuated between 3.5 and 5.75 per cent. On 6 November 2008 it was reduced from 4.5 per cent to 3 per cent and on 4 December to 2 per cent. The descent to the historically low rates continued in 2009 with the official bank rate falling to 1.5 per cent on 8 January, 1 per cent on 5 February and 0.5 per cent on 5 March 2009, where it has remained thereafter. I will refer to those rates, howsoever named, as "the base rate".

[9] Turning to the Bank of England's table of interest rates of UK monetary financial institutions sterling instant access deposits from households, the agreed document revealed interest rates in the range between 0.76 per cent and 2.1 per cent between 2003 and 2006, with lower rates in 2003 (ranging between 0.76 and 1.08) and higher rates between 2005 and 2006 (ranging between 1.52 and 2.08). Between early 2007 and October 2008 there was a slight rise (with a range between 2.1 and 2.83). Thereafter there was a sharp fall to 0.15 per cent by February 2009, dipping to 0.12 per cent in March 2010; and it had not risen above 0.3 per cent by April 2011.

The contentions of the parties

[10] Mr Howie QC for Enviroco submitted that the principle underlying the payment of interest was that it was to compensate a person for the loss which he incurred from having been kept out of sums of money. Thus, in cases not covered by the 1958 Act, interest was due when money was wrongfully withheld and not paid on the day on which it ought to have been paid: Carmichael v Caledonian Railway Co (1870) 8 M (HL) 119, Kolbin & Sons & Co v Kinnear & Co Ltd 1931 SC (HL) 128. The same principle applied to interest on damages under the 1958 Act: Macrae v Reed and Mallik Ltd 1961 SC 68, James Buchanan & Co Ltd v Stewart Cameron (Drymen) Ltd 1973 SC 285, Wilson v Dunbar Bank plc 2008 SC 457. Once a pursuer had incurred loss by paying for the repairs he was deprived of money which he could have used to generate income. The court should fix the rate of interest to compensate for the loss of income which the money might have generated: Spence v Wilson 1998 SC 433, Wisely v John Fulton (Plumbers) Ltd 2000 SC (HL) 95. The problem in recent years had been that the judicial rate of interest was not compensatory but gave the pursuer a bonus which he could not obtain in the market. The court had a discretion under the 1958 Act to fix a rate or rates of pre-decree interest adopting a "selective and discriminating approach": Smith v Middleton 1972 SC 30. In some cases, but not others, judges had adjusted the rate of interest to take account of changes in the judicial rate during the period covered by the 1958 Act in the particular case. See Starkey National Coal Board 1987 SLT 103 and Tait v Campbell 2004 SLT 187. But that did not address the mischief. In 2006, before the collapse of interest rates, the Scottish Law Commission in its "Report on Interest on Debt and Damages" (Scot Law Com No 203) had recognised (in paragraph 2,21) that use of the judicial rate often resulted in an award of interest which was not truly compensatory because the debtor had to pay interest at a rate higher than the creditor could have obtained in the market.

[11] Mr Howie also referred to the practice of the English courts, which also adopted the fundamental principle that interest was awarded not as a punishment but to compensate a claimant for having been deprived of the money which was due to him: B.P. Exploration Co (Libya) Ltd v Hunt (No. 2) [1979] 1 WLR 783, Robert Goff J at p.845. In the Commercial Court and the Admiralty Court it was normal practice to award interest at 1 per cent over the base rate but a party could seek to persuade the court to award a different rate. The thinking behind that rate was that it was to reflect the rate at which the claimant would have to borrow money to make up for what had been withheld. See Tate & Lyle Food and Distribution Ltd v Greater London Council [1982] 1 WLR 149, Polish Steam Ship Co v Atlantic Maritime Co [1985] QB 41, and Shearson Lehman v MacLaine Watson (No 2) [1990] 3 All ER 723.

[12] He submitted that the court should apply a compensatory rate of interest as a general rule and that, if a particular pursuer sought to argue for a different rate, he could put his own circumstances in issue by pleading them. Farstad had not sought to do so. He therefore invited me either to take an average of the interest rates available on instant access deposits between December 2002 and the date of decree (which he calculated as 1.36 per cent) to reflect what the money could have earned or to adopt the approach of the Commercial Court in England and award base rate plus 1 per cent to reflect the cost of borrowing.

[13] Mr Clark QC for Farstad submitted that I should follow the general practice of the courts in this jurisdiction and award interest at 8 per cent a year from 31 December 2002. He accepted that the court's award of pre-decree interest was in principle compensatory but submitted that it was not the practice of the courts to complicate court actions by an enquiry into what an individual pursuer had lost. Rather, in both jurisdictions the judges took a broad approach by providing a "normal rate which is likely to do rough justice in most cases": Credit Lyonnais SA v Russell Jones & Walker [2003] PNLR 2, Laddie J at pp.27-28. In many English courts judges maintained the normal practice of awarding interest at 8 per cent: Hamilton-Jones v David & Snape [2004] 1 WLR 924, Nicholson v Knox Ukiwa & Co [2008] PNLR 782. There were advantages in promoting predictability and thus facilitating settlements: Wright v British Railways Board [1983] 2 AC 773. While the Law Commission in London in its report, "Pre-Judgment Interest on Debts and Damages" (2004), had recommended the replacement of the 8 per cent judicial rate by a rate of 1 per cent above the Bank of England's base rate and a power to award compound interest, the United Kingdom Government had not accepted its recommendations.

[14] He accepted that Scottish judges also had a discretion as to the appropriate rate of interest to award pre-decree but submitted (a) that there were no reported cases of a judge deviating from the normal rate and (b) that there was not sufficient evidence before the court to justify a departure from the default position in Rule of Court 7.7. He pointed out that, in response to representations from the Forum of Insurance Lawyers, the Rules Council between April 2009 and May 2010 had considered an alteration of the judicial rate of interest but, like the Ministry of Justice in London, had decided to make no change. While the Scottish Law Commission had recommended a judicial interest rate of 1.5 per cent above the Bank of England base rate with no compounding of interest before decree and the Scottish Government had consulted in 2008 on a draft Interest (Scotland) Bill in which it proposed a statutory rate of 1.5% above the official dealing rate, no legislation had been brought forward.

[15] Turning to Scottish case law, he submitted that the rate of interest pre-decree should equate with that awarded post-judgment and both should be broadly compensatory. The judicial rate had sometimes been equated with a legal rate which would apply in contracts if no interest had been specified: Neilson v Stewart 1991 SC (HL) 22, Quinn v Bowie (No 1) 1987 SLT 575. If the court were to alter the normal rate, that ought to be a decision of the Inner House: Kearon v Thomson's Trustees 1949 SC 287, Lord Sorn at p.288. In Boots The Chemist Ltd the Lord Ordinary's decision to adopt the normal practice of applying the judicial rate in the face of an argument as to its appropriateness was not the subject of challenge in the Inner House. He referred also to JM v Fife Council 2009 SC 163 in support of the submission that the judicial rate of interest could protect a person standing out of his money from the effects of price inflation even when the market rates failed to do so.

[16] Mr Clark pointed out that when the 15 per cent rate was introduced in 1985 it was about 3.6 per cent above the base rate and that when the 8 per cent rate was introduced in 1993 it was over 2 per cent above the base rate. The judicial rate therefore was intended only to be broadly compensatory and the maintenance of a fixed rate assisted predictability in tendering. By remaining substantially above both the base rate and the deposit rate it also allowed for the fact that in the market a person could obtain compound interest on his money. He submitted in conclusion that while there was anecdotal evidence that the judicial rate was over-compensatory, the court did not have the information to judge at what point in the years 2002 to 2011 the rate had become so or by how much. The court should therefore apply the judicial rate in accordance with normal practice.

Discussion

[17] The 1958 Act innovated on the common law, which allowed interest on damages only from the date of decree: Flensburg Steam Shipping Company v Seligmann (1871) 9 R 1011, the Lord President (Lord Inglis) at p.1014. While, in the early days after the 1958 Act was enacted, the court adopted a cautious approach to the new power to award interest before the date of decree, with the passage of time the principles governing the application of the statutory power have been clarified.

[18] The position can be summarised in the following propositions. First, the court applies in relation to patrimonial loss the established principles in Carmichael v Caledonian Railway Co and Kolbin & Sons v Kinnear & Co that (i) a pursuer can recover as damages income which he has lost from being deprived of a profit-earning asset and (ii) he can recover interest (apart from contract) where a principal sum has been wrongfully withheld and not paid on the day when it ought to have been paid. See Bell's Sports Centre (Perth) Ltd v William Briggs & Sons Ltd 1971 SLT (Notes) 58, James Buchanan & Co Ltd v Stewart Cameron (Drymen) Ltd, Lord Maxwell at pp. 289-290. While the concept of wrongful withholding has, in cases involving contractual debt, become associated with the date on which a creditor raises legal action - see Elliott v Combustion Engineering Ltd 1997 SC 126 -, the court in exercising its discretion under section 1 of the 1958 Act as amended is not restricted to awarding interest only from the date of the judicial demand.

[19] Thus, secondly, where, as in this case, a claim is for the cost of repairing a damaged asset, interest may be due from the date when the pursuer pays for those repairs as it is from that date that he has been standing out of his money: James Buchanan & Co Ltd, Boots The Chemist Ltd. Thirdly, the award of interest is intended to be compensatory and not penal. In principle, the court seeks to put the pursuer in the position he would have been in if he had not suffered the loss for which damages are claimed. As Lord Mackintosh stated in Macrae v Reed & Mallick Ltd (at p.80) the pre-decree interest under the 1958 Act "compensate[s] him for being kept out of his money and so deprived of its use throughout the progress of a litigation through no fault of his own." See also Wilson v Dunbar Bank plc, Lord Reed at pp. 468-9. This is consistent with the principle that interest should run on a head of loss from the date when that loss was sustained.

[20] Fourthly, the Act gives the court a discretion in fixing pre-decree interest in three respects. It allows the court, if it decides to award interest, to fix that interest (a) at a set rate or different rates, (b) on the whole or any part of the damages awarded and (c) for any period after the right of action arose. Thus, as Lord Emslie stated in Smith v Middleton at p.38, the Act requires the court to adopt "a selective and discriminating approach" in the exercise of the discretion which it confers.

[21] It appears from the cases which counsel cited that the courts in England and Wales adopt a similar principle that an award of interest should be compensatory rather than penal. In Wisely v John Fulton (Plumbers) Ltd Lord Clyde stated (at pp.107I-108A):

"The general purpose of an award of interest at common law is recognised both in Scotland and England as being to compensate the creditor for the loss of enjoyment of the sum to which he was entitled."

Lord Hope (at p.99E-F) stated:

"The current practice in each country is to award interest on loss of wages for the past, and for past outlays, to cover the period between the incurring of these items of loss and the date of the award. The principle which is followed in England was explained in these terms by Lord Denning MR in Jefford v Gee [1970] 2 QB 130] at p.146A: 'Interest should not be awarded as compensation for damage done. It should only be awarded to a plaintiff for being kept out of money which ought to have been paid to him.'"

Lord Hope went on to treat that principle as applicable in both jurisdictions. Where the difficulty arises is not in formulating the principle but in its application, as the courts in both jurisdictions have not adopted the practice of seeking to put a value on the opportunity cost to the individual pursuer or claimant of spending the funds on repairs but have usually sought to apply general rules in the interest of predictability.

[22] The Law Commission in its "Report on Pre-Judgment Interest on Debts and Damages" (2004) has recorded that different courts in England have adopted different approaches. The Commercial Court and the Admiralty Court have had a general practice of awarding interest at 1 per cent over the base rate but the Commercial Court has accepted evidence in support of other rates, particularly in recognition that small businesses typically cannot borrow at that rate. It has been prepared to depart from its norm on hearing evidence as to the rates at which persons with the general attributes of the claimant could have borrowed money: Shearson Lehman, Webster J at p.733. But, in fixing an appropriate rate of interest, it does not hear evidence about the financial circumstances of the particular claimant. Certain other courts, including the county courts, have tended to award interest at the judicial rate. Mr Clark also referred me to cases in which the High Court has awarded interest at the judicial rate - see paragraph [13] above.

[23] There is a clear difference in the assumptions which lie behind (a) an award of interest as compensation for income forgone on funds spent on repairs and (b) an award of interest measured by a cost of borrowing to replace those funds. The former assumes that the pursuer has no borrowings to fund his general expenditure and thus is to be compensated for loss of the income he might have earned from those funds. While, absent a contractual entitlement, compound interest is prohibited in judicial awards, it is legitimate for the court to consider whether a set rate of simple interest provides adequate compensation in circumstances in which a pursuer in possession of the funds would have been able to have obtained compound interest in the market. This is an important consideration if many years have passed between the date on which the pursuer or claimant incurred the loss and the date of decree. I note that the Law Commission in its 2004 report (at paragraph 3.2) pointed out that a simple interest rate of 8 per cent would be the equivalent of a compound rate of 7 per cent after five years, and the equivalent of a 6 per cent compound rate after eleven years. It seems to me that historically the judicial interest rate has generally been above the return which most people can obtain on deposited funds, even on longer term deposits, and may have contained an element of protection against inflation which market rates often do not provide. The award of interest related to the cost of borrowing assumes that the pursuer will have to borrow to make up for the withheld funds. If one assumes that the typical pursuer funds part of his lifestyle or business through borrowing, the cost of further borrowing to make up for his disbursements on repairs may be a better measure of compensatory interest. It is well known that as a general rule a private individual or a small business entity pays more to borrow money than he or it could earn by lending it.

[24] The judicial rate has at best been an approximation of compensation for the loss of the income which the expended funds could have generated and has for several years exceeded what is readily available to the unsophisticated investor in the market. But an award of interest by reference to the rate available on instant access deposits would in my view amount to serious under-compensation in a context in which a pursuer has been involuntarily standing out of his money. The reasonably prudent pursuer, if he knew that he would have to wait several years before he could draw on his funds, would not be likely to invest in such an account. It seems to me that the court can properly take account retrospectively of the period between the date of the loss and the date of decree in its consideration of an appropriate rate or rates of interest. The general practice of the Commercial Court and the Admiralty Court in England and Wales in awarding interest at 1 per cent over base rate also is an approximation as many commercial borrowers would consider themselves very fortunate to be able to obtain funds at that rate.

[25] In both jurisdictions the courts have shown no appetite to complicate legal actions by attempting to calculate the value to the individual claimant of the monies withheld. Both have resorted to broad brush approximations. The difficulty which has arisen is that the market rates on most forms of deposit and on many forms of borrowing have moved so far from the judicial rate that the latter is not an approximation of the loss which pursuers have suffered from standing out of their money.

[26] I do not consider that it is within my power as a Lord Ordinary to award interest on a novel basis, such as at the rate of 1 per cent above the base rate. That would require the sanction of the Inner House or could be part of a wider statutory reform of the law of interest. I think, however, that in exercising the court's discretion under section 1 of the 1958 Act as amended, I can and should take into account the clear mismatch between the judicial rate and market rates in recent years. In doing so, I take account of the general practice of awarding interest at the judicial rate and also the fact that that rate has, on the occasions when it has been changed, been fixed at levels several percentage points above the base rate. I also take account of the need for predictability in tendering. In this case however, as I have said, Enviroco flagged up the challenge to the judicial rate in its defences.

[27] I have to adopt a broad brush approach in identifying a time when the mismatch between the judicial rate and the market rates became so pronounced that I can conclude, without more detailed evidence, that the former was significantly over-compensatory. It appears to me that there was a watershed in late 2008 and early 2009 when the base rate plummeted from 5 per cent in early October 2008 to 0.5 per cent in March 2009. In the circumstances it appears to me that I should apply the judicial rate in accordance with general practice between 31 December 2002 and 4 December 2008, when the official bank rate fell to 2 per cent. Thereafter I consider that the rate should be 4 per cent. The exercise of a discretion under the 1958 Act is one which addresses the circumstances of the particular case but does not require evidence about the circumstances of the particular pursuer. In fixing the rate of simple interest I take account of the fact that Farstad paid for the repairs almost nine years ago and that it lost the ability to earn compound interest on the expended sums over that period. See paragraph [23] above. I also take account of the likelihood that, as a large commercial organisation, it could achieve a better return on the investment of its funds than a private individual. Finally, I observe that 4 per cent is 3.5 per cent above the base rate which has applied from March 2009 onwards.

[28] I see no need to depart from the judicial rate of interest in relation to post-decree interest. While interest in principle should be compensatory, I see no objection to a rate which is mildly penal as a means of encouraging prompt implementation by a defender of an award of damages by the court. Uncertainty over liability or over the proper quantification of a claim, which may explain a defender's delay in meeting a claim before decree, is not a relevant consideration once the issue has been determined by an extra judicial settlement or by a judgment of a court.

Conclusion

[29] I therefore award Farstad interest on the agreed damages of £1,750,000 at the rate of 8 per cent a year from 31 December 2002 to 4 December 2008 and at the rate of 4 per cent a year thereafter until the date of the interlocutor. Interest on the principal sum from the date of the interlocutor will be at the judicial rate in accordance with normal practice. I will have the case put out by order for a discussion of the attached draft interlocutor which is intended to give effect to my decision.