Scottish Law Commission (Discussion Papers)

 


Part 3      The Case for Reform

The purpose of an award of interest: our guiding principles

3.1      The primary purpose of an award of interest is to acknowledge the fact that by being deprived of the use of money, a creditor has either lost an opportunity to benefit from the use of the money or, alternatively, has suffered a further loss as a consequence of not having it to hand.

"… the essence of interest is that it is a payment which becomes due because the creditor has not had his money at the due date. It may be regarded either as representing the profit he might have had if he had had the use of the money, or conversely the loss he suffered because he had not that use. The general idea is that he is entitled to compensation for the deprivation."^[1]

Similar considerations apply to a sum claimed by way of damages: so long as the damages remain unpaid the claimant is deprived of that sum of money. If the claim is for losses incurred in the past, the claimant is in a position analogous to that of the creditor of an unpaid contractual debt. The effect of an award of interest is to compensate the creditor by redressing the balance and, in theory, leaving both parties in the same position as if the debt had been paid when it fell due or, in the case of damages, as if reparation had been made as soon as the loss was sustained. Neither the claimant nor the debtor benefits from delaying settlement or judicial determination of the dispute.

3.2      An award of interest can also, however, be used to encourage early settlement of claims by penalising late payment. This occurs when the rate of interest awarded by the courts exceeds commercial rates so that the debtor ends up worse off by delaying payment than he would have been if he had paid immediately. An example of the use of interest for this purpose is the Late Payment of Commercial Debts (Interest) Act 1998^[2] under which the rate of interest is deliberately set well above bank minimum lending rates^[3] in order to penalise affected businesses who fail to pay their debts timeously. In recent years, the same effect has, in practice, occurred in Scotland in relation to awards of interest at the judicial rate^[4] which has from time to time exceeded commercial rates of interest by several percentage points.
3.3      Prompt payment of debts and other financial claims is to be encouraged and we recognise that the imposition of a punitive rate of interest is one way in which this can be done. However, the terms of our reference do not merely cover situations in which the debtor is acting wrongfully in failing to make payment; they also cover situations in which the debtor may have good reason for not making immediate payment but where payment is subsequently agreed or found by a court to be due. There may have been a legitimate dispute as to whether any sum is due or, if so, how much. The defender in a court action may, for example, be justified in demanding further proof of the incurring of a loss before admitting the claim. In such circumstances, the claimant still deserves to be compensated for loss of use of the money during the period of dispute but the debtor does not deserve to be penalised for refusing to make earlier payment.
3.4      There are therefore two approaches to interest which could be taken as a matter of principle. On the one hand, interest could be set at a punitive rate to encourage early payment subject to a court discretion to mitigate the penal element in appropriate cases by means such as reducing the rate or reducing the period during which interest runs. On the other hand, interest could be set at a compensatory rate subject to any specific exceptions in which it is regarded as proper to use interest as a "weapon" to penalise late payment. We favour the latter approach as being more appropriate to a comprehensive reform of the law of interest on debt and damages. In our view, the general rule should be that entitlement to interest should be neutral as between the parties so that neither benefits from delayed payment. We discuss in this paper whether different considerations apply to interest awarded for a period following the grant of a decree for payment by the court.
3.5      Nor, in our view, should it matter whether the claim takes the form of an action for payment of a debt or an action for damages. The common characteristic is that the claimant is being deprived of the use of money to which he is entitled. The form which his claim must take makes no practical difference to him. Whether the principal claim is for payment of a debt or payment of damages, the claim for interest could be regarded as a claim for damages for late implement of the principal obligation: it seems to us that there is no difference in principle which would warrant a different commencement date for the running of interest or a different rate of interest.
3.6      We would welcome views as to the appropriateness of the following principles as guidance for reform of the law of Scotland relating to interest on contractual and non-contractual debt and on damages:

1. (a) So far as practicable, interest should run on pecuniary claims during the same period and at the same rate regardless of whether the claim takes the form of a claim for payment of a contractual debt, a non-contractual debt or damages.

(b) The primary goal of an award of interest should be the realistic compensation, in commercial terms, of the creditor for loss of the use of money or property. Interest should not as a general rule be payable at a punitive rate.

(c) An award of interest should compensate the creditor for loss of the use of money or property throughout the period during which that loss has subsisted.

Criticisms of the present law

3.7      We have concluded that the present law does not conform to the guiding principles set out above. In the remainder of this part of the paper we set out the reasons why we consider that it fails to conform to the first and third of these principles. Matters concerning the rate of interest are discussed in Parts 7 and 8 below.

Inconsistent treatment of debt and damages

3.8      One of the least satisfactory features of the present law is that there is a significant difference between the treatment of interest on contractual debts and interest on damages. The effect of the Interest on Damages (Scotland) Acts of 1958 and 1971 has been to place injured parties suing for damages in a better position than creditors suing for debt, who will rarely be awarded interest from a date prior to the date of judicial demand. It is anomalous that a pursuer claiming damages for breach of contract may claim interest from the date when the right of action arose whereas a pursuer seeking payment in implement of contract may claim interest only from the date of citation. There seems to us to be no good reason in principle why these two pursuers should have such differing entitlements. It is true that, unlike a claimant for damages, a person who enters into a contract does so voluntarily and may therefore make entitlement to interest a term of the bargain. However, where a debtor defaults on payment, the prejudice to the creditor is the same as that which arises where a claim for damages remains outstanding; it seems undesirable for the legal entitlement to interest to be less generous.
3.9      Differing treatment of different types of claim is not restricted to a distinction between interest on debt and interest on damages. Because of the piecemeal development of the law, the date of commencement of a creditor's entitlement to interest will depend upon the nature of the claim. An example of this is afforded by Winestone v Wolifson,^[5] a case concerning an IOU. If the debt acknowledged by the IOU had been a loan, then interest would have run ex lege from the date of the IOU even in absence of express contractual stipulation. In this case, however, the IOU had been given by one of the former members of a joint trading venture to the other pending a settlement of accounts between them. It was held that in the absence of agreement interest did not run before the date of citation on such an IOU. The point may be made that in the case of a loan the debtor may not be in default merely because the loan remains outstanding: the date for repayment might not yet have arrived. If, however, the purpose of interest is to compensate the creditor for the loss of the use of the sum due, there seems, in principle, to be no good reason to give differential entitlement according to how the debt is characterised as a matter of law. Still less does it seem appropriate to confer an entitlement ex lege to a creditor in circumstances where the debtor is not in default and to decline such an entitlement where a default has occurred.

The wrongful withholding concept

3.10      The concept of wrongful withholding which emerged in the 19^th century as the guiding principle for an award of interest has resulted in anomalies and uncertainties as the law has subsequently developed. Erskine's observation^[6] that "interest is the profit due by the debtor of a sum of money to the creditor for the use of it" has not been followed because in applying the concept of wrongful withholding, the courts have been reluctant to award interest in circumstances where they have been sympathetic to the debtor's reasons for not paying earlier. This was most apparent in the approach to interest on damages prior to legislative intervention, when interest could not be awarded until the claim had been liquidated by a court decree. The problem with the use of the concept in relation to interest on debt seems to us to arise from the fact that it has become inextricably linked with the requirement of a judicial demand so that, in the absence of contractual stipulation, interest will normally run only from the date of the raising of an action and not from the date of any prior formal demand for payment. The consequence^[7] is that during the period prior to the raising of a court action the debtor has the use of the creditor's money without the latter having any right to compensation for that use. It follows, firstly, that the debtor has no inducement (other than avoiding the expense of defending a court action) to pay promptly or, indeed, to pay at all unless and until an action for payment is imminent; and secondly, that even if such an action is raised and prosecuted to a conclusion, the recovery by the creditor will be less than full because he obtains no compensation for loss of the use of the money prior to the date when the action was raised. In this respect Scots law is out of step with most other legal systems which we have examined.^[8]
3.11      Another criticism of the wrongful withholding concept in the particular context of interest on debt, is that it is difficult to predict how it will be applied on a case by case basis. As noted in paragraph 2.23 above, there have been inconsistencies among the decisions in recent case law. To some extent these have resulted from judges attempting to reconcile the concept of wrongful withholding with a more general feeling that a creditor who is being deprived of funds which are eventually held to be due ought to receive redress for such deprivation. As noted above, wrongful withholding is not an equitable principle which permits the court to do justice in the case before it but is a rule of law in terms of which money is deemed to be wrongfully withheld after it has been judicially demanded.^[9] Particular difficulties have arisen in cases where the issue remaining between the parties has been one of quantification. The view has sometimes been taken that until the sum due has been quantified by agreement, certification or otherwise, it cannot be said to be wrongfully withheld.^[10] But even this is not consistent with an entitlement to interest from date of citation: an action for debt might be defended only as regards quantum and this would not prevent the creditor from becoming entitled to interest from the date when the action was raised. It therefore seems artificial to regard the "period of non-payment" as beginning only when the action has been raised.^[11]
3.12      If it were a general principle that money is wrongfully withheld from and after the time when it has fallen due for payment, much could be said in favour of the concept. It would correspond closely to the guiding principles which we set out at paragraph 3.6. Indeed, it may be that this was what those judges had in mind whose obiter dicta introduced the concept into Scots law in the 19^th century.^[12] Read in this way the concept could afford a useful means of distinguishing between situations where a person is in default in failing to make a payment to another and situations where he is not. With the passage of time, however, this is not how the phrase has been interpreted. Its connection with judicial demand by the raising of an action has become so firmly established that the issue seems to be beyond further judicial development.
3.13      As the court appears to have thought in Elliott v Combustion Engineering Ltd,^[13] we take the view that the law in relation to interest on debt is unsatisfactory and requires reform. Reliance upon the concept of wrongful withholding has distorted the true underlying principle that a person who has been deprived of the fruits of his money while another has had the use of it should receive compensation in the form of interest during the period of deprivation. This has led to uncertainty in the development of the law. More importantly, the effect of the application of the concept to debts other than loans has been to delay unduly the commencement of a creditor's entitlement of interest. Except in so far as it has a residual application in English law, it does not feature in any of the legal systems which we have examined.^[14] We think that it has outlived its usefulness and should no longer be the basis of entitlement to interest in relation to any type of claim for payment. A consequence of this proposal would be that the date of judicial demand would lose its significance as the likely commencement date for the running of interest against a debtor.
3.14      In the case of business to business debt, we are mindful of the existence of a remedy for late payment in the Late Payment of Commercial Debts (Interest) Act 1998 and of the fact that that Act, as amended, gives effect to obligations incumbent upon the United Kingdom in terms of a European Council Directive. The interaction of our proposals with the 1998 Act is discussed at paragraph 4.30 below. The interaction of our proposals with other existing statutory provisions which confer an express entitlement to interest is discussed at paragraph 4.32 below.

Interest on damages

3.15      The law regarding interest on damages is also in need of clarification. Although the difficulties which were originally identified in the terms of the amendments made in 1971 to the Interest on Damages (Scotland) Act 1958 have been resolved by a pragmatic approach in the courts, some of the criticisms of the wording of the statute which were made at the time remain justified. For example, section 1(1A) makes reference to an interlocutor decerning for payment of a sum which consists of or includes damages or solatium for personal injuries and then directs the court to exercise the power in section 1(1) to award interest "so as to include in that sum interest on those damages". As Lord Emslie observed,^[15] it is not possible to follow this direction literally. The intendment of the subsection may be reasonably clear but it is not satisfactory that the statutory language has required to be made intelligible by judicial interpretation.
3.16      The post-1958 law in relation to interest on damages has also been coloured by the courts' persistence in applying it against a common law background of identifying a time from which the damages may be said to be wrongfully withheld. This persistence is perhaps understandable given the lack of guidance afforded by the statute beyond the creation of a power to award interest on the whole or any part of the damages for the whole or any part of the period after the date when the right of action arose. Unfortunately, this has led to continuing uncertainty as to the starting date for particular heads of claim. For example, the decision of the Second Division in Boots the Chemist Ltd v GA Estates Ltd^[16] leaves open questions as to when interest will begin to run on out-of-pocket expenses which were quantified or readily ascertainable at a date earlier than the date when the claimant actually incurred them. There has also been a tendency in non-personal injury claims to continue to use the date of citation as a "default" commencement date for heads of claim other than out-of-pocket expenses.
3.17      We consider that these difficulties could be resolved by replacing the existing statutory provisions allowing interest on damages with new provisions which are, so far as possible, aligned with provisions dealing with interest on contractual and other debt. In each case interest would begin to run at an early date to reflect the loss of use of money by the creditor. This would facilitate the future development of the law in relation to interest on debt and on damages along a uniform path. We also consider it desirable to make clear that the concept of wrongful withholding should also cease to influence the courts when awarding interest on damages.

Interest in other circumstances

3.18      So far as interest on claims of a pecuniary nature other than for debt or damages is concerned,^[17] there has in Scotland been a dearth of case law on the basis of which it could be asserted that the law is clear. We suggest that if there is to be a comprehensive reform of the law relating to interest on contractual debt and a re-formulation of the law relating to interest on damages, it would be desirable also to place the law regarding entitlement to interest in certain other circumstances on a statutory basis which conforms with the guiding principles which we have adopted in relation to interest on debt and on damages.

Rate of interest

3.19     There is presently no statutory mechanism for awarding interest at a rate which equates to the loss of use of money suffered by the creditor. As we have seen,^[18] the old "legal rate" began life as a maximum rate and was not generally regarded as equivalent to the loss actually sustained due to late payment. The "judicial rate" at which interest is awarded post-decree is altered only at infrequent intervals and has often been significantly above (or, at times, below) the rate which would compensate the creditor without penalising the debtor. In the absence of any other candidates, it has also been used in recent times as the rate to be awarded in respect of periods prior to the date of decree. If an award of interest is to be truly compensatory, a new system for determining and changing the rate of interest payable to claimants is needed.
Ý
Ü   Þ

Note 1   Riches v Westminster Bank Ltd [1947] AC 390, Lord Wright at 400.    [Back]

Note 2   See para 2.18.    [Back]

Note 3   The rate specified for the 1998 Act is 8 per cent per annum over the official dealing rate of the Bank of England (the official dealing rate being the rate at which the Bank is willing to enter into transactions for providing short term liquidity in the money markets): Late Payment of Commercial Debts (Rate of Interest) (Scotland) Order 2002 (SSI 2002/336), arts 3 and 4.    [Back]

Note 4   Rules of the Court of Session, rule 7.7 as amended; Sheriff Courts (Scotland) Extracts Act 1892, s 9 as amended.    [Back]

Note 5   1954 SC 77. For criticism of this decision, see Professor J Murray, "Interest on Debt" 1991 SLT (News) 305, at 308.    [Back]

Note 6   Institute III.iii.75.    [Back]

Note 7   Except in circumstances where the creditor is entitled to, and does, demand interest under the Late Payment of Commercial Debts (Interest) Act 1998.    [Back]

Note 8   See para 4.11 below.    [Back]

Note 9   Dean Warwick Ltd v Borthwick 1983 SLT 533, Lord Cameron at 535: see para 2.23 above.    [Back]

Note 10   British Railways Board v Ross & Cromarty County Council 1974 SC 27; Farrans (Construction) Ltd v Dunfermline District Council 1988 SC 120; Robertson Construction Co (Denny) Ltd v Taylor 1990 SLT 698; John G McGregor (Contractors) Ltd v Grampian Regional Council 1991 SLT 136.    [Back]

Note 11   Dean Warwick Ltd v Borthwick above. The term "wrongful withholding" has also been used in English case law but is not there equated with the raising of court proceedings. Instead, it is seen as an element in the statutory discretion afforded to the court by what is now the Supreme Court Act 1981, s 35A. See eg Arnott v Redfern (1826) 3 Bing 353, Best CJ at 359; London, Chatham & Dover Railway Co v South Eastern Railway Co [1893] AC 429, Lord Herschell LC at 437; Chadwick v Parsons [1971] 2 Lloyds Rep 49, Mars-Jones J at 62-3 (affd [1971] 2 Lloyds Rep 322).    [Back]

Note 12   Carmichael v Caledonian Railway Co (1870) 8M (HL) 119 and Blair’s Trs v Payne (1884) 12R 104.    [Back]

Note 13   1997 SC 126; see para 1.2 above.    [Back]

Note 14   See paras 4.11-4.12 below.    [Back]

Note 15   Smith v Middleton 1972 SC 30 at 39.    [Back]

Note 16   1992 SC 485.    [Back]

Note 17   Eg claims for repetition, recompense, salvage etc. Certain other types of claim are already dealt with by express statutory provision: see para 4.32 and Appendix B.    [Back]

Note 18   See para 2.1.    [Back]