Scottish Law Commission (Reports)

 


Part 2: Summary and criticisms of the present law

Summary of the present law

Interest on debt

2.1           The historical development of the law of interest on debt in Scotland is described in Part 2 of the Discussion Paper. The law has evolved in a piecemeal fashion and without any general underlying principle. The best that can presently be done is to state the various categories of circumstances in which a sum owed by one person to another will carry interest. These are reasonably clear and are as follows: interest may be due on a debt (a) by agreement; (b) by express statutory provision; (c) by implication at common law; or (d) because the principal sum has been wrongfully withheld. We examine each of these categories below.
2.2           (a) Interest due by agreement: parties to a contract may agree by express contractual provision for the circumstances in which interest will run, the period for which interest is payable and the rate of interest to be paid. The rate agreed may be fixed or fluctuating, simple or compound, although it must not be extortionate,^[1] and it must not be a penalty clause.
2.3           (b) Interest due by express statutory provision: interest due by statute is imposed in a wide range of circumstances.^[2] Statutory provisions cover interest payable in relationships between private persons, between individuals and local or central government and vice versa. The Late Payment of Commercial Debts (Interest) Act 1998^[3] provides for a statutory entitlement to interest to run on the late payment of debts arising from contracts for the supply of goods and services where both parties are acting in the course of a business. This is done by inserting an implied term into contracts within the scope of the Act.^[4] The rate of interest set is punitive, and is designed to act as a deterrent to late payment of debts.^[5]
2.4           (c) Interest due by implication at common law: the circumstances in which entitlement to interest is implied at common law can be broadly grouped into three categories:

Loans: a rebuttable presumption on the right to interest exists from the date on which a loan of money is advanced until the date of repayment.^[6] Where no rate is stipulated, the judicial rate will normally be awarded by the court.^[7] This presumption does not apply to an IOU, unless it can be proved to vouch for a loan of money. Otherwise, interest on an IOU will not run until the date of judicial demand.^[8]

Possession of heritable property without payment: A purchaser is obliged to pay interest on the price to the seller by legal implication from the date of possession until the date of payment.^[9] Good reason for withholding payment does not prevent interest from running.^[10] It is unclear from the case law whether the payment of interest is to be regarded as equivalent to payment of rent by the purchaser for use of the property or as compensation to the seller for not having received the price.^[11]

Use of funds belonging to another: Where a person holds funds in respect of which he has an obligation to account to another person, he will normally be liable to account also for interest which has accrued on the principal during the period for which the funds were held. For example, a trustee must invest trust funds or he will be liable for the interest which should have accrued on the funds.

2.5           (d) Interest due on money wrongfully withheld: Money is "wrongfully withheld" when there has been a judicial demand for payment and the creditor withholds payment. The concept of the "wrongful withholding" of money is based upon two 19^th Century decisions. The first, Carmichael v Caledonian Railway Co, held that interest can be demanded "by virtue of the principal sum of money having been wrongfully withheld and not paid on the day when it ought to have been paid".^[12] This does not (as might first appear) offer a broad discretion to the courts to decide whether money has or has not been wrongfully withheld. It has been qualified by the decision in Blair's Trs v Payne,^[13] which together with the earlier Carmichael dictum created the general rule that money is not considered wrongfully withheld unless and until a judicial demand for payment has been made. Typically, this has led to awards of interest commencing not earlier than the date of citation.^[14] In Dean Warwick Ltd v Borthwick,^[15] it was stated that

"There is here a rule of law, a rule that interest runs from citation, and one which does not admit of modification by the exercise of judicial discretion. The pursuer, ex hypothesi of the court's decree, has been deprived of the use and fruit of the sum for which decree has been granted during the period of non-payment, ie since the formal judicial demand was made, while conversely the defender wrongfully has enjoyed that use and fruit."

Despite this apparently invariable rule, there have been many attempts to identify the date from which money has been wrongfully withheld, leading to inconsistent results. Unascertained debt has caused particular problems, leading to awards of interest running from both before citation and commencing on the date of citation in similar circumstances.^[16] Occasionally, it has been accepted that interest will run before the date of citation upon consideration of the whole circumstances of the case.^[17] An exception to the general rule is that formal intimation to a debtor that interest shall be payable from a certain date on an "open" account can also enable interest to run from the date of intimation.^[18]

Interest on damages

2.6           Before statutory intervention in 1958 and 1971, development of the law of interest on damages followed a path similar to that taken by the law on interest on debt. The courts relied on the concept of "wrongful withholding" and were reluctant to award interest on unascertained claims. This led to interest most commonly being awarded only from the date of decree.
2.7           Statutory intervention.^[19] The Interest on Damages (Scotland) Act 1958 ("the 1958 Act") gave the court a discretion in any action for damages to award interest from a date not earlier than the date of citation "if the circumstances warrant such a course". This test was applied to each individual head of damage. The Act did not change existing rules of law on the granting of interest. As a result the courts interpreted the Act as allowing interest to be awarded from the date of citation provided the quantum of a head of loss was capable of ascertainment prior to the raising of the action.^[20] No interest was awarded on solatium prior to the date of decree.
2.8           The Interest on Damages (Scotland) Act 1971 repealed section 1 of the 1958 Act and replaced it with subsection 1(1) which extended the discretionary scope of the courts to award interest on damages for any period from "the date when the right of action arose". Subsection 1(1A) directed the courts to exercise the new discretionary powers in subsection 1(1) when considering claims for damages and solatium in personal injury cases, unless there were reasons special to the particular case for not doing so. A further new provision, subsection 1(1B), allowed for a tender to be treated as inclusive of interest due to the claimant to whom the tender is made, unless otherwise stated.
2.9           Despite these attempts to clarify the position of interest on damages, the pre-existing reliance on "wrongful withholding" and the difficulty of awarding interest on unquantifiable claims have persisted.
2.10           (a) Damages other than for personal injury. When a court grants decree for payment of damages other than for personal injury, section 1(1) of the 1958 Act grants a wide discretion over all aspects of the award in relation to interest. The interlocutor may include decree for payment of interest, at such rate or rates as may be specified, on the whole or any part of the sum awarded for the whole or any part of the period since the date when the right of action arose. The courts have been reluctant to view this discretion as unqualified and continue to apply the concept of wrongful withholding when establishing the date from which interest can run on damages.^[21] As a result, interest on out-of-pocket expenses may be held to run from the date when these were incurred, or perhaps from the date when they were capable of being quantified.^[22] Interest on loss of past profits will run from the date on which they would have been earned but for the event giving rise to the claim. Other losses may attract interest from the date of judicial demand. The rate of interest in all of these heads of loss will normally be the judicial rate specified in rules of court.^[23]
2.11           (b) Damages for personal injury. Subsection 1(1A) of the 1958 Act directs the court to include an award of interest in terms of subsection 1(1) when granting decree for damages or solatium for personal injury, unless there are reasons special to the particular case not to do so. This direction applies to claims for loss of support, distress and grief in fatal cases as well as claims made by the person who has sustained the injury.^[24] In practice, the court distinguishes between past and future solatium and lost earnings, with interest only applicable to the elements of the award intended to compensate for past losses. Past awards are for a cumulative loss over a period of time since the injury occurred. To avoid excessive compensation to the pursuer, it is common practice where sums have been accruing at regular intervals for interest to be awarded on the whole past sum at half the judicial rate.^[25] Generally, where loss is continuing at the date of decree, interest at half rate will be awarded on past solatium for the whole period since the date of injury. Where, however, the effects of an injury have ceased prior to the date of decree, interest at the full judicial rate may be awarded from the date when the effects of the injury ceased.^[26] Adjustment may be made to an award of interest where an interim payment or award of damages has been made to the pursuer.^[27] Where a sum claimed in a personal injury action includes an element which does not represent damages for personal injury or solatium, such as the cost of repair of a car damaged in a collision, this element is not subject to the special rule in section 1(1A)^[28] and accordingly the power to award interest is at the discretion of the court under section 1(1).

Interest on sums other than debts or damages

2.12           The following sums which can be categorised as neither contractual debts nor damages have been held to bear interest:

(a) Awards in respect of unjustified enrichment. Such authorities as there are on the running of interest on sums due in order to reverse unjustified enrichment suggest that interest will be due from the date when the event giving rise to the claim occurred and not merely from the date of citation.^[29]

(b) Payments relating to ship collisions and salvage. English case law has been applied in admiralty actions to ensure a uniform practice between Scotland and England. Interest has been held to run on the amount of the limitation fund until the date when the fund is paid into court.^[30] Interest on salvage runs from the date of termination of the salvage services.^[31]

(c) Legal rights in a deceased's estate. The general rule under Scots law has been that legal rights carry interest from the date of death. However, the question of entitlement to interest must be distinguished from the question of the appropriate rate of interest. Where there has been delay in payment which is not attributable to any fault on the part of the executors, it has been held that interest should not run at a rate higher than that which the funds have in fact earned.^[32] On the other hand, where a claim has been made, or where there is no doubt that legal rights will be claimed because the claimant has been disinherited, the courts have awarded interest at the "legal rate" (ie 5 per cent), apparently on the basis of wrongful withholding.

(d) Aliment and financial provision on divorce. Under the Family Law (Scotland) Act 1985,^[33] the court has the power to backdate an award of aliment to the date of the bringing of the action, or to such date as the court sees fit – which may, on special cause shown, be set prior to the date of the bringing of the action.^[34] There is no power to award interest on the sum which falls due by reason of the backdating of an award. Interest can, however, be awarded on arrears of aliment. In an action for divorce either party may apply to the court for the payment of a capital sum by the other party. Setting the date from which interest on this sum should run may be done by incidental order. Interest will run at the judicial rate. If interest is to be awarded for a period prior to the date of decree this must be justified by reference to the principles set out in section 9 of the 1985 Act (fair sharing of the net value of matrimonial property etc), and must be reasonable having regard to the resources of the parties.^[35]

Criticisms of the present law

2.13           In our Discussion Paper we identified five areas of concern with the existing law, and concluded that it does not conform to the guiding principles set out in paragraph 1.10 above. We examine each of these in turn.

Inconsistent treatment of debt and damages

2.14           There is a significant difference between the treatment of interest on contractual debts and interest on damages. Injured parties suing for damages may, in terms of the Interest on Damages (Scotland) Act 1958, claim damages from the date when the right of action arose. However, a party pursuing a contractual debt may claim interest only from the date of judicial demand. Whether a claim arises from damages or from debt, the pursuer has lost the use of his or her money from a specific date; and there seems to us to be no principled reason why a legal entitlement to interest is less generous in one type of claim than in another. Our consultees agreed.
2.15           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 may depend upon the nature of the claim. If the debt is a loan, interest runs ex lege from the date when the loan was made. Otherwise, interest will not run until an action for payment is raised.^[36] Again, we see no reason to perpetuate this distinction.

The concept of "wrongful withholding"

2.16           The treatment of interest on contractual debts flows from the development by the courts in the 19^th century of the concept of "wrongful withholding". Interest would not be payable on a debt unless the payment had been wrongfully withheld, and this came to be recognised as the date on which court proceedings commenced. The consequence^[37] 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.
2.17           As we observed in the Discussion Paper, 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. Read in this way, it 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. For this reason, as the court appears to have done in Elliott v Combustion Engineering Ltd,^[38] 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. 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 to interest. Except in so far as it has a residual application in English law, wrongful withholding does not feature in any of the legal systems which we have examined.^[39]

Interest on damages

2.18           Some of the initial difficulties in interpreting the Interest on Damages (Scotland) Act 1958, and the amendments made to it in 1971, which attracted judicial criticism,^[40] have been resolved by a pragmatic approach in the courts. Nevertheless, uncertainty remains with regard to the starting date for interest to run on particular heads of claim. For example, the decision of the Second Division in Boots the Chemist Ltd v GA Estates Ltd^[41] 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. The post-1958 law in relation to interest on damages continues to be 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. 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.
2.19           Our consultees supported the proposal to re-formulate the statutory entitlement to interest on damages although the Faculty of Advocates cautioned that there was a danger that re-formulation would lead to uncertainties and encourage reinterpretation. We address these concerns below.^[42]

Interest in other circumstances

2.20           So far as interest on claims of a pecuniary nature other than for contractual debt or for damages is concerned,^[43] there has been a dearth of case law in Scotland on the basis of which it could be asserted that the law is clear. We suggested in the Discussion Paper 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. Our consultees agreed, provided that due allowance can be made for the equitable nature of some extra-contractual remedies.

Rate of interest

2.21           Presently, the judicial rate does not fluctuate in line with changes to the Bank of England base rate and often may not reflect the real cost of money to the creditor or the debtor. The result is often an award of interest which is not truly compensatory because the debtor may pay interest at a rate higher than the creditor could have obtained in the market. The view which we expressed in the Discussion Paper was that 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. Again, this view was shared by our consultees.
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Note 1   See Consumer Credit Act 1974, ss 137-140, applicable to all "credit agreements" as defined in s 137 and not only to regulated consumer credit agreements.     [Back]

Note 2   A non-exhaustive list is contained in Appendix B of the Discussion Paper.     [Back]

Note 3   The Act as amended is reproduced in Appendix B of this Report. It gives effect to the UK's obligation to implement Directive 2000/35/EC of 29 June 2000 on combating late payment in commercial transactions. The 1998 Act pre-dated the entry into force of the Directive, although it had plainly been influenced by the draft Directive. The Act was brought fully into force in 2002 and amended to render it fully compliant with the Directive.     [Back]

Note 4   Subsections 1(1) and 1(2).     [Back]

Note 5   Section 6.     [Back]

Note 6   See, for example, Neilson v Stewart 1991 SC (HL) 22 at 40 (Lord Jauncey of Tulliechettle).     [Back]

Note 7   Ibid at 35.     [Back]

Note 8   Winestone v Wolifson 1954 SC 77.     [Back]

Note 9   Durie v Ramsay (1624) M 542: "It is against reason and conscience both to retain the money, without paying annual therefor, and to bruik also the whole profits of the land." The principle was applied to compulsory purchase in West Highland Railway Co v Place (1894) 21R 576 and to a contract of excambion in Greenock Harbour Trs v Glasgow & South-Western Railway Co 1909 SC (HL) 49.     [Back]

Note 10   Stirling v Paunter (1627) M 544; Erskine, Institute III.iii.79; Grandison's Trs v Jardine (1895) 22R 925.    [Back]

Note 11   See para 2.21 of the Discussion Paper, fn 95 and fn 96.     [Back]

Note 12   Carmichael v Caledonian Railway Co (1870) 8M (HL) 119 at 131 (Lord Westbury).     [Back]

Note 13   (1884) 12R 104.    [Back]

Note 14   Or, where a claim is added by amendment in the course of proceedings, from the date when the amendment is made and incorporated into the record: HMV Fields Properties Ltd v Skirt 'n' Slack Centre of London Ltd 1987 SLT 2 at 6 (Lord Clyde).     [Back]

Note 15   1983 SLT 533 at 535, followed with some reluctance by an Extra Division in Elliott v Combustion Engineering Ltd 1997 SC 126, in which the context of the expression "wrongfully withheld" in Carmichael v Caledonian Railway Co supra is analysed.    [Back]

Note 16   See para 2.23 of the Discussion Paper.     [Back]

Note 17   Shetland Islands Council v BP Petroleum Development Ltd 1990 SLT 82; Trans Barwil Agencies (UK) Ltd v John S Braid & Co Ltd (No 2) 1990 SLT 182, in which the matter was treated by the Lord Ordinary (McCluskey) as one to be decided on equitable principles.    [Back]

Note 18   See, for example, Linlithgow Oil Co Ltd v North British Railway Co (1904) 12 SLT 421 and other cases referred to at para 2.13 of the Discussion Paper.    [Back]

Note 19   The current statutory provisions are set out in full, as amended, in Appendix B.     [Back]

Note 20   Macrae v Reed and Mallik Ltd 1961 SC 68.     [Back]

Note 21   James Buchanan & Co v Stewart Cameron (Drymen) Ltd 1973 SC 285; Boots the Chemist Ltd v GA Estates Ltd 1992 SC 485.    [Back]

Note 22   Boots the Chemist Ltd v GA Estates Ltd 1992 SC 485.    [Back]

Note 23   Rules of the Court of Session, rule 7.7, as amended; Sheriff Courts (Scotland) Extracts Act 1892, s 9, as amended.     [Back]

Note 24   Plaxton v Aaron Construction (Dundee) Ltd 1980 SLT (Notes) 6; Prentice v Chalmers 1985 SLT 168.    [Back]

Note 25   Smith v Middleton 1972 SC 30.     [Back]

Note 26   See para 2.35 of the Discussion Paper.    [Back]

Note 27   For example Jarvie v Sharp 1992 SLT 350.    [Back]

Note 28   See words in parenthesis in s 1(1)(A), Interest on Damages (Scotland) Act. See also Orr v Metcalfe 1973 SC 57 at 60 (Lord President Emslie).     [Back]

Note 29   Parkhill v Batchelor (1748) M 550; Glasgow Gas-Light Co v Barony Parish of Glasgow (1868) 6M 406; Duncan, Galloway & Co Ltd v Duncan, Falconer & Co 1913 SC 265; cf Countess of Cromertie v Lord Advocate (1871) 9M 988. For a fuller discussion, see para 2.37 of the Discussion Paper.    [Back]

Note 30   The "Olga" v The "Anglia" (1905) 7F 739, following The "Crathie" [1897] Prob Div 178.    [Back]

Note 31   The "Ben Gairn" 1979 SC 98, following The "Aldora" [1975] QB 748.    [Back]

Note 32   Ross v Ross (1896) 23R 802.    [Back]

Note 33   Section 1.    [Back]

Note 34   Family Law (Scotland) Act 1985, s 3(1)(c). The power to backdate has been used sparingly; for an example see Walker v Walker 1991 SLT 649. Power to backdate has been extended to variations of agreements on aliment by s 20 of the Family Law (Scotland) Act 2006 (in force 4 May 2006).     [Back]

Note 35   See paras 2.41 and 2.42 of the Discussion Paper.    [Back]

Note 36   Winestone v Wolifson 1954 SC 77. For criticism of this decision, see Professor J Murray, "Interest on Debt" 1991 SLT (News) 305.     [Back]

Note 37   Except in circumstances where the creditor is entitled to, and does, demand interest under the Late Payment of Commercial Debts (Interest) Act 1998. The interaction of our recommendations with the 1998 Act is discussed at paras 3.37-3.41 below.     [Back]

Note 38   See para 1.2 above.     [Back]

Note 39   See para 3.13.     [Back]

Note 40   See para 2.29 of the Discussion Paper and Smith v Middleton 1972 SC 30.     [Back]

Note 41   1992 SC 485.    [Back]

Note 42   See Part 4.     [Back]

Note 43   Eg claims for repetition, recompense, salvage etc. Certain other types of claim are already dealt with by express statutory provision: see para 2.3.    [Back]