Scottish Law Commission (Reports)

 


Part 7: Rate of interest

Introduction

7.1           The principle underlying our recommendations is that interest should compensate the creditor rather than penalise the debtor. Interest should be applied at a rate which best expresses the creditor's loss. This principle was expressed by Lord Denning MR in Harbutt's Plasticene Limited v Wayne Tank and Pump Co Limited^[1] as follows:

"It seems to me that the basis of an award of interest is that the defendant has kept the plaintiff out of his money; and the defendant has had the use of it himself. So he ought to compensate the plaintiff accordingly."

This principle can be applied quite clearly to a case of debt where a liquid sum has been retained by one party when it should have been paid over to another. It can also be applied to damages where at a point (or points) in time a sum of money would have compensated the pursuer and from that point the pursuer has been kept out of his or her money.

7.2           Applying this principle, the rate of interest should reflect the "cost of money" during the period when interest runs. This can be achieved by making statutory provision specifying a formula for a rate of interest which would vary according to the cost of money during the relevant period. It could, however, be seen as either:

(a) the interest which the creditor would have been likely to earn on the money; or

(b) the cost to the creditor of borrowing money to make up any shortfall.

These two measures of interest are not the same. It generally costs more to borrow money than can be gained by lending it, especially where the borrower is an individual or small business. Any rate, or formula for producing a rate, which is intended to be of universal application must choose one or other of these two measures or, alternatively, attempt to achieve a compromise which takes account of both measures but reflects neither precisely.

7.3           A number of factors affect commercial interest rates. In theory, interest may be broken down into three elements:

(i) a "time preference" element representing the real return on money borrowed and which determines how fast the value of money invested will increase over time;

(ii) an "inflation" element which takes account of the fact that the prices of all other goods and services in the economy will change over time; and

(iii) a "risk" element which will vary according to the lender's assessment of the risk of default on the part of the borrower.

In practice, interest rates for loans and deposits tend to take account of a number of factors, including:

•    the monetary authority's base (nominal) interest rate^[2] and longer-term interest rates on the financial markets which determine the rate at which lenders can borrow in order to lend on to their customers, and which in turn take account of actual and anticipated rates of inflation;

•    the degree of competition among lenders; and

•    the risk of default.

An interest charge may also include an element to allow for the expense of the transaction or a penal element to encourage prompt payment.

7.4           In theory, it would be possible for the courts to apply a rate of interest which is tailored to the circumstances of each case to be decided. For example, where a pursuer had borrowed money to make good a loss, the court might decide to award interest at the actual rate applied to the pursuer's borrowings. We do not, however, favour this approach. As we are proposing the introduction of a statutory entitlement to interest which does not depend upon the raising of court proceedings, it would not in our view be appropriate to leave the rate of interest to be determined by the circumstances of a particular case. Even where an action had been raised it would create uncertainty for litigants. Although various mechanisms for determining the appropriate rate of interest exist in other systems throughout the world, there is invariably prescription of an appropriate rate for all cases. Such a rate will inevitably have a "one size fits all" quality: it may seem generous in some cases, or fail to compensate fully in others. We have likewise taken the view that it is necessary in the interests of certainty that a basis for calculating the rate of interest be prescribed by statute.

The judicial rate of interest

7.5           At present, if no rate of interest has been specified by the parties and if there is no other statutory provision to set a rate of interest, the courts usually apply the "judicial rate" set for post-decree interest. The "judicial rate" is set by rule 7.7 of the Rules of the Court of Session 1994.^[3] It is the same rate as that applying in England and Wales which is set by section 17 of the Judgments Act 1838.^[4] RCS 7.7 states:

"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."

The rate was changed to its current level in 1993.^[5] The position in the sheriff courts is similar to that in the Court of Session. The judicial rate is prescribed by section 9 of the Sheriff Courts (Scotland) Extracts Act 1892. The rate may be amended by Act of Sederunt and was changed to 8% in 1993.^[6] A rate of 8% also applies to awards by Employment Tribunals sitting in Scotland.^[7]

7.6           On the face of it, the rule applies only to interest payable on late payment of a sum due under decree but the rate set is used on other occasions in the absence of any other rate. On a loan, for example, if no interest is stipulated, the court will award interest at the judicial rate.^[8] It is not clear why the judicial rate came to be the rate used when no other rate is available. Reported opinions which touch on the issue suggest that it was the only rate available to the court and it seemed to be fair and just.^[9] There may also be a lingering reliance on the notion of a "legal rate" - a rate of 5% fixed by statute which originated as a statutory maximum rate of interest^[10] and continued to apply for some centuries. Indeed, the rate prescribed by RCS 7.7 is still occasionally referred to as "the legal rate", perhaps to encourage or justify its use for periods other than post-decree,^[11] despite the concept of a fixed "legal rate" having been firmly laid to rest by Lord President Cooper in Kearon v Thomson's Trustees.^[12]
7.7           The main problem with using the judicial rate for awards of interest is that it is amended relatively infrequently and tends not to reflect the true cost of money during a given period. In the annotated edition^[13] of the Rules of the Court of Session^[14] the note to rule 7.7 states:

"It is now sought to maintain a rate of interest which is about 1 per cent above the minimum lending rate of the clearing banks. This is the principle applied by the Lord Chancellor, with the concurrence of the Treasury, for interest on judgment debts (in England and Wales) under the Judgments Act 1838, s 17."^[15]

If this is indeed the principle underlying the rate of 8%, then it has rarely been adhered to in practice. Over the last five years, the judicial rate has been on average 3.34% above the Bank of England rate^[16] despite the fact that the judicial rate can be amended by Act of Sederunt. Further, if the intention had been to link the judicial rate to the Bank of England rate, RCS 7.7 could have been drafted accordingly rather than by simply specifying a fixed rate. We consider that such a principle can best be given effect by replacing the judicial rate by statutory prescription of a fluctuating rate linked to a suitable base.

Prescription of the statutory rate

7.8           The prescribed rate of interest must be capable of universal application but also truly reflect the cost of money. One solution is to specify a fixed rate of interest which, at the time when it is set, is at a suitable level above a base rate such as the Bank of England base rate. This can be prescribed by statutory instrument so that it may be changed promptly if fluctuations in the base rate make this necessary. That is the system which currently applies to post-judgment interest. However, this method of prescription is not sensitive to frequent fluctuations in interest rates which are available in the market. A rate which remains the same throughout a legal dispute, which may last for some years, will not reflect the decline or rise in the real value of money during that period. The cost of money fluctuates and it would seem fairer that the rate to be applied by the courts should fluctuate with it.
7.9           An alternative approach is to specify a fixed rate which changes with sufficient frequency to reflect fluctuations in the market. The rate could be set according to a prescribed formula but the instrument would set out only the result of the formula (ie a specific percentage). For example, legislation could prescribe that the interest rate should be set according to a formula (for example, base rate plus one per cent) every year on a specified date. Alternatively, the rate could be set every six months or even every month. The advantage would be that the rate for a given period would be known to all parties without further calculation. The disadvantage would be that it would not be as sensitive to changes in the cost of money as a rate which fluctuated automatically and was calculated by the parties themselves in each case.
7.10           A further approach is for the legislation to specify only the basis upon which the rate will fluctuate. An example of legislation prescribing a fluctuating interest rate can found in the statutory instrument^[17] which sets the rate of interest payable under the Late Payment of Commercial Debts (Interest) Act 1998, as follows:

"The rate of interest for the purposes of the Late Payment of Commercial Debts (Interest) Act 1998 shall be 8 percent per annum over the official dealing rate in force on the 30th June (in respect of interest which starts to run between 1st July and 31st December) or the 31st December (in respect of interest which starts to run between 1st January and 30th June) immediately before the day on which statutory interest starts to run."

The effect of the above device for setting the interest rate is to fix the relationship between the rate to be used and the "official dealing rate" (defined as the Bank of England rate). The dealing rate will fluctuate and so the rate applying to the 1998 Act will also fluctuate but the extent to which the rate is punitive or compensatory is fixed by the Order. In that example, the rate is intended to penalise late payment of debt. A possible criticism of a fluctuating rate is that it would make the calculation of interest more complicated and time consuming for parties. In personal injury actions separate calculations would be required each time there was a change in the interest rate during the period between the date of the accident and eventual settlement or decree.^[18] The effect could be greater expense with, arguably, an adverse effect on access to the courts. There might also be concern that the rate would be difficult to ascertain at any given time. On the other hand, a fluctuating rate would produce a fairer and more accurate calculation of the pursuer's loss. Concerns of complexity and accessibility are addressed by the availability, discussed below, of an on-line calculator together with printed tables.^[19]

Selection of base rate

7.11           The "Bank of England rate" is not the only rate which could be used as a base. Commercial contracts often use other forms of base rate in an interest clause. The "Bank of England rate", "the official dealing rate" or the "repo rate"^[20] is the rate set by the Monetary Policy Committee of the Bank of England as the rate at which the Bank is willing to enter into transactions for providing short term liquidity in the money markets. The Bank has enjoyed the power to set rates independently of the government since 1997. Although it is not, strictly speaking, a market rate, its attraction is its influence on the market. The market bases its transactions and decisions on what the Bank of England rate is and also on what it anticipates that rate will be in future. It is perhaps the best known interest rate and any changes to it are widely publicised.
7.12           In the Discussion Paper we suggested the following alternative bases:

•    the inflation rate;

•    the LIBOR (London Inter Bank Offer Rate): the rate at which banks offer to lend money to each other;

•    an average of the lending rates of six UK clearing banks;

•    the weighted^[21] standard variable mortgage rate ("SVR"); and

•    the European Central Bank ("ECB") rate.

We expressed the view that the Bank of England rate provides a more appropriate base rate than any of these alternatives. The clearing bank lending rates and the SVR rate are good measures of the cost of money because they reflect interest rates which are available in the market, but the reason they appear to be similar is that both are related to the Bank of England rate. The rate of inflation, however measured, reflects only one element of the pursuer's loss. The ECB rate would not reflect the pursuer's loss unless the euro were to become the UK's currency, in which case it would replace the Bank of England rate. The three-month LIBOR is generally very close to the Bank of England rate but can change on a minute-by-minute basis as market purchasing and selling activity affect the rate. Although monthly averages and end-month figures for the three-month LIBOR can be found on the Bank of England's website, the Bank's own rate is publicised more widely and is easily accessible by businesses and by households. The Bank of England rate is more stable than LIBOR, being agreed once a month at a pre-arranged meeting of the Monetary Policy Committee. Our consultees agreed that the Bank of England rate provided the best available base rate.

7.13           On top of this base rate is to be added a figure so that the total reflects the cost of prudent borrowing. Most of our consultees agreed that the statutory interest rate should not be far above the Bank of England rate, although one was of the view that it should be 3 to 4% above to reflect the cost of borrowing. We agree that the statutory rate should be closely related to the cost of borrowing. A rate of 1.5% above the Bank of England base rate reflects the rate at which larger businesses are able to borrow money. It has been suggested that the rate at which smaller businesses can borrow money is closer to 3% above base. However, individuals are more likely to borrow money by means of a loan secured by standard security and 1% above base would represent a good rate (from the borrower's point of view) in the secured loan market. The rate which an average company is paying on its borrowing is usually similar to the rate which a prudent individual might be able to obtain on a secured loan. There is a close relationship between the SVR rate and the rate at which banks will lend to their corporate customers because both rates are influenced by the Bank of England rate. These rates are all higher than can be obtained on an instant access deposit account or a timed deposit account,^[22] but considerably less than the rates paid on credit cards or unsecured personal loans.^[23] On balance, we have concluded that 1.5% above base would presently be a fair rate of interest to be set in the proposed legislation. It may be, however, that circumstances would change in future, rendering it fairer to increase or decrease the figure added to base. We therefore recommend that:

There should be a prescribed fluctuating rate of interest which is a specified percentage above the official dealing rate of the Bank of England. The percentage above the Bank of England rate could be amended from time to time by statutory instrument.

(Draft Bill, sections 7(1), 16(1) and 16(2))

Calculation of interest on a particular claim

7.14           A consequence of our recommendation is that the interest rate will change more frequently than at present. If the legislation is based on the principle that the rate of interest applied should compensate the creditor or claimant no more or less than their loss, then it will be necessary to apply different rates to portions of the relevant period to deal with fluctuations.^[24] This most accurately compensates the creditor and would certainly be the appropriate way to calculate interest on a debt. Consultees who gave their view on this matter agreed that this was the most accurate way of calculating interest but some expressed concern regarding the complexity of the calculation. In the Discussion Paper we suggested that such concerns could be met by the provision on an appropriate website of a calculator which is kept up to date whenever the base rate changes.^[25] If necessary, printed tables for the calculation of interest could also be made available at appropriate locations such as court buildings and public libraries. In any event, it would always remain open to parties, if they saw fit, to agree a figure in respect of a particular claim which had been calculated to a lesser degree of accuracy. We recommend that:

A computer program for calculating interest according to the prescribed formula should be made available free of charge on a website which can be accessed by the general public. Printed tables for the calculation of interest could also be made available in appropriate places such as court buildings and public libraries.

Judicial discretion

7.15           In those situations where pre-judgment interest is available, there is presently a broad judicial discretion, albeit seldom exercised, to apply a rate higher or lower than 8%. Since under our recommendations pre-judgment interest will run for a longer period (at least in relation to debt), a question arises as to whether there should be a judicial discretion regarding the rate to be applied in the particular circumstances of an individual case. The defender, through no fault of his own, may have obtained no interest, or only a lower rate of interest, on the sum which he is found due to pay. He may have a reasonable explanation of why the funds had not been placed in an account with a higher rate of interest. In such cases, judicial discretion could be exercised to apply a rate of interest which is comparable with the rate which the defender was able to obtain. Conversely, the person holding the funds may have obtained a rate of interest higher than the prescribed rate.
7.16           One argument against the retention of a judicial discretion in a system where interest runs whether or not court proceedings have been raised is that it reintroduces an element of uncertainty as to the parties' entitlement. In the absence of such a discretion, parties to a dispute can be confident that, at the end of the day, interest will be payable at a known rate which generally reflects the rates available in the market. Another is that if the purpose of the award of interest is to compensate the claimant for loss of the use of the funds during a given period, what the debtor has been doing with them during the same period is irrelevant.
7.17           Consultees were divided on this issue but the majority was against retention of a discretion. In our view such a discretion is unnecessary. It will be recalled that we have recommended that there should be a limited judicial power to remit interest in whole or in part if, by reason of any conduct of the claimant, it is in the interests of justice to do so. Subject to our recommendation regarding foreign currency awards below,^[26] we consider that no additional discretion in relation to the rate of interest awarded is necessary. We therefore recommend that:

There should be no judicial discretion to award statutory interest at a rate other than the prescribed rate.

Foreign currency awards

7.18           It is competent for Scottish courts to award decree for a sum of money in a currency other than sterling.^[27] Difficulties could be created if our Recommendation 29 above were to apply to sums to be paid in a foreign currency. The debt (or damages) which the pursuer is seeking to recover is not bearing interest at a rate referable to the Bank of England base rate but rather at a rate referable to the currency concerned. One way of addressing this problem would be to require interest to be awarded at a rate referable to the nearest equivalent for the currency concerned of the Bank of England's official dealing rate. So, for example, where a pursuer sued for payment in euros, the court would award interest at, say, the European Central Bank rate plus 1% instead of a rate based on the Bank of England rate plus 1%.^[28]
7.19           There may occasionally arise circumstances where an appropriate base rate has not existed in relation to the foreign currency throughout the period in respect of which interest is sought: for example, because the currency has gone through a temporary period of hyper-inflation. In such cases, it may be desirable to leave it to the court to fix a rate of interest which is fair to both parties and reasonable in the circumstances. Our consultees supported the grant of a discretion to the court in such cases.
7.20           We therefore recommend that:

(a) Where the court grants decree for payment in a currency other than sterling and the award includes an element of interest, such interest should run at the specified percentage above the currency's nearest equivalent to the Bank of England's official dealing rate.

(b) If the court is unable to identify such an equivalent, interest should be awarded at such rate as appears to the court to be fair and reasonable in the circumstances.

(Draft Bill, section 8)

Post-decree interest

7.21           The "judicial rate" at which interest runs on sums for which decree has been granted is set by the judges of the Court of Session who make the relevant subordinate legislation^[29] as "the Lords of Council and Session". During the period since we received our reference, the rate has been mildly penal.^[30] On one view, a rate which penalises delay in payment after decree is right and proper since it operates as a means of enforcement of the will of the court. This view was supported by some of our consultees, including the Faculty of Advocates. On the other hand, it may be argued that since a system of diligence is available to enforce the will of the court, there is no need also to use interest rates to reward a successful pursuer. Application of our guiding principles would tend to suggest that the rate of interest post-decree should continue to be compensatory only and not penal, and this was the view expressed by others who responded to our questions in the Discussion Paper on this point.
7.22           If it were considered necessary to apply a higher rate of post-decree interest, then it could continue to be set by Act of Sederunt as at present. However, care would require to be taken to ensure that the post-decree rate was at all times higher than the pre-decree rate. This could best be done by setting a judicial rate which also fluctuated with the applicable bank rate. For example, if the formula for pre-decree interest is "1.5% over the official dealing rate", then the formula for post-decree interest could be "2.5% over the official dealing rate", or even higher. A period of fourteen days, or perhaps thirty days, might be allowed after which the higher rate of interest would apply.
7.23           On balance, we are not persuaded that there is a need for post-decree interest to run at a higher rate than the statutory rate which, under our recommendations, will run from the starting date when payment falls due or, in the case of damages, when the head of loss is sustained. The statutory scheme which we are proposing is not intended to operate as a mechanism for enforcing payment; it is simply a means of compensating a claimant for delay in receiving payment. In our view the same principle ought to apply after decree has been granted. In cases where a defender seeks to profit from delay in payment after decree, for example because he will have to borrow at a higher rate than the statutory rate in order to fund payment of the principal sum, the pursuer has remedies in diligence to enforce payment. It will also be recalled that where the parties have agreed a contractual rate of interest, it is, under existing law and under our recommendations, this rate which continues to run after decree. It seems to us to be anomalous to continue the operation of a penal rate in cases where no rate has been agreed. Finally, we are not convinced that the current difference between commercial rates of interest and the judicial rate has been caused by anything other than a failure in recent years to maintain the judicial rate broadly in line with market rates. We recommend that:

Interest after the date of decree should run on the same basis as it does prior to decree and the applicable rate pre- and post- decree should be calculated by the same method.

In our draft Bill, this recommendation is accommodated by the general provision that statutory interest runs until the date or dates of payment of the principal sum. One consequence of the recommendation is that there would no longer be any need for a "judicial" rate of interest to be specified by rules of court.

Rates of interest under other existing statutory provisions

7.24           There are a large number of existing statutory provisions which create an entitlement to interest. Statutory provisions which provide for interest to be paid to or by a public body (such as interest on taxes and financial penalties) lie outside the scope of our reference and are excluded from the scope of the new statutory scheme by the section in our draft Bill^[31] which provides that statutory interest is not payable on a sum if any other enactment makes provision for interest to run on it or, alternatively, makes provision for no interest to run on it.
7.25           On the other hand, we consider that there is merit in standardising the rate of interest payable under a variety of statutory provisions applicable to private law relationships. The existing statutory provisions which we have identified fall into three broad categories:

(i) where the rate of interest is set by reference to the judicial rate, for example, by reference to the rate payable on sheriff court decrees or a rate is specified which is derived from the judicial rate;

(ii) where no rate of interest is specified; and

(iii) where a rate of interest is specified which is peculiar to the provision in question.

We address each of these in turn.

7.26           Judicial rate specified. Examples of legislation in which there is a reference to the judicial rate^[32] include the Debtors (Scotland) Act 1987, sections 50(5) and 55(7),^[33] and the Adults with Incapacity (Scotland) Act 2000, section 81.^[34] An equivalent rate is found in the Bankruptcy (Scotland) Act 1985. In section 51 of the 1985 Act, the "prescribed rate"^[35] is set by the Bankruptcy (Scotland) Regulations 1985.^[36] That rate is not set by reference to the judicial rate but it is set at 8% which was changed from 15% in the same year as the judicial rate was also amended.^[37]
7.27           Section 81 of the Adults with Incapacity (Scotland) Act 2000 provides that where funds have been misused in breach of fiduciary duty by certain specified classes of person, they shall be liable to repay the funds misused with interest at the same rate as that applicable to a sheriff court decree. There is a similar provision^[38] for a deficiency in the accounts of a guardian whereby the guardian is liable, under certain circumstances relating to a deficiency in the estate, to pay interest to the estate at the rate applicable to a decree of the sheriff court in respect of the period for which it appears that the deficiency has existed. Although no specific reason for this interest rate is set out in the Explanatory Notes to the 2000 Act, these provisions appear to be intended to apply the common law fiduciary duties and duties of care to appointees under that Act.
7.28           These provisions would be affected by our recommendations in relation to the rate of interest applicable post-decree in sheriff court actions.^[39] If, as we are proposing, the post-decree rate of interest is aligned with the "compensatory" rate of statutory interest which we have proposed, then this will apply wherever there is existing legislation which provides for interest to run at sheriff court decree rates. In principle, this seems to us to be acceptable: there seems to be no good reason for expressly preserving a special, higher rate in any of the circumstances which we have considered. Formal amendment is needed to existing statutory provisions to achieve this result.
7.29           No rate specified. Examples of legislation in which there is reference to interest being due but with no rate specified include the Bills of Exchange Act 1882, section 57^[40] and the Trusts (Scotland) Act 1921, section 29.^[41] In the absence of other candidates, at present it seems that the most likely rate of interest to be awarded would be the judicial rate. We suggested in the Discussion Paper^[42] that it would be appropriate for the rate of interest due under these provisions to be the new statutory rate which we are proposing. We remain of this view but, contrary to the suggestion in the Discussion Paper, we now recommend that this be achieved by amendment of the existing provisions themselves.
7.30           Rate other than the judicial rate specified. Examples of legislation with its own rate specified include the Partnership Act 1890, sections 24(3)^[43] and 42(1),^[44] the standard conditions in Schedule 3 to the Conveyancing and Feudal Reform (Scotland) Act 1970^[45] and the Insolvency (Scotland) Rules 1986, rule 4.66.^[46] Again, we suggested in the Discussion Paper^[47] that there would be advantages in bringing such statutes in line with our proposals regarding a statutory rate of interest which reflects commercial rates, and we so recommend.
7.31           The statutory provisions which we have identified above may not be the only ones in respect of which it would be advantageous for interest to run at the new statutory rate. On the other hand, there may be provisions which we have not identified where it would be desirable for a rate other than the statutory rate to continue to apply. In order to apply the statutory rate as widely as possible without creating unintended and undesirable consequences, we recommend as follows:

(a) The statutory provisions which we have identified above should be amended to provide for interest to run on any sum due by one person to another at the statutory rate instead of any other rate which may currently apply expressly or by implication.

(b) Ministers should be given a power to amend any enactment by statutory instrument to substitute the statutory rate for another rate (or vice versa).

(Draft Bill, sections 12, 14 and schedule 1)

Compounding of interest

7.32           Historically, compound interest or "interest on interest" has not generally been considered an appropriate method of calculating interest on awards by courts in Scotland. Erskine^[48] and Bell^[49] both stated the principle that there should be no interest on interest but provided little in the way of reasoning to support this position. Judicial opinion has followed a similar pattern, assuming the basic rule against compounding to be so well established as not to require further explanation. What scant reasoning there has been in judgments highlights the perception of compound interest as penal in nature;^[50] only if circumstances are held to be "special and exceptional" will an award of compound interest be considered.^[51]
7.33           On the basis of the reported cases there are three such exceptions to the general rule:

(i) Where there is express agreement that compound interest should apply.^[52] Where interest is to be paid in terms of a contractual agreement, it should be paid according to the contractual obligation.

(ii) In cases of breach of trust or failure in an obligation to invest and accumulate.^[53] This is related to the rule that a person in a position of trust is obliged to collect interest on capital and accumulate further interest on that sum.

(iii) Where there is established commercial usage allowing interest on interest such as in the case of bank accounts or bank loans.^[54]

7.34           The rule against "interest upon interest" also extends to awards of damages.^[55] There is, however, a further exception to the rule against compounding, namely where post-decree interest is added to awards which already contain some element of interest.^[56]
7.35           Compounding of interest is consistent with the second of our guiding principles, namely that the primary goal of an award of interest should be the realistic compensation, in commercial terms, of loss of the use of money or property. Typically, compounding is the way by which financial institutions administer interest on both commercial and consumer debt and credit, whether in the form of an overdraft, credit card, current or savings account. As such, compounding provides the most accurate way to compensate for the pursuer's loss by reflecting the value of interest that would have accrued had the loss never been sustained and the pursuer had retained full use of his money or property.
7.36           If interest is to be applied to a liquidated debt, and the intention is to compensate the claimant for loss of the sum due, then it should run from the date on which the debt fell due and should be compounded at regular intervals - mirroring the frequency at which commercial credit is compounded - until paid. With an award of damages, the intention is to place the pursuer in the same situation as if the loss had not been sustained, and the same argument which justifies compounding interest on a liquidated debt applies to an award for damages: on both occasions realistic compensation for loss of the use of the debt or award should be due from the date it was suffered. The provisional view which we expressed in the Discussion Paper was that statutory interest should be compounded at regular intervals,^[57] and this approach found favour with some of our consultees.^[58]
7.37           Despite the argument that only compound interest provides true compensation and the widely accepted use of compounding in the financial services market, it would seem that it is still viewed with some suspicion as a statutory entitlement. Some consultees expressed concerns about the complexities of administering compound interest, in terms of both the calculations required and the difficulty of creating a system that was easy for both the public and practitioners to understand.^[59] We consider that these difficulties could be overcome by making a computer program available on the internet which would calculate the appropriate interest based on the value of the principal sum and the period outstanding. This could be used both by parties to litigation and to creditors calculating interest on debt in respect of which litigation is not, or not yet, in contemplation. An example of this type of program was made available on the Scottish Law Commission website during the consultation period.
7.38           A further concern, expressed by both the Scottish Consumer Council and Citizens Advice Scotland, was that compounding would convert manageable debt into unmanageable debt by increasing any sum owed more quickly than if a simple rate of interest were applied. Our response to this concern is that the interest rate we propose is different in character from that used by most commercial lenders in that our rate would contain no element of risk. The risk element of a commercial rate reflects the likelihood of the creditor being repaid. If someone has a poor credit history and the risk of non-repayment is high, the interest rate applied to the loan will also be high. It is when these higher rates, including the risk element, are compounded that debt can become unmanageable. Because the rate which we propose is compensatory only, the effect of compounding is not significant unless applied to awards of high value and only after the lapse of a significant period of time. Indeed, the difference between using a compound rate of interest and a slightly higher rate of simple interest (Bank of England Base Rate + 2%) is small, as shown by the graph below.^[60]
7.39           We remain of the opinion that compounded interest is the most accurate way to calculate the value of loss of use of money, but we acknowledge the strength of the concerns which have been expressed with regard to its use. As we have observed, the difference between compound interest and a slightly higher rate of simple interest makes little difference to the amount of interest accruing. In light of this, we are not recommending at this time that statutory interest should be compound. Our proposed scheme does, however, provide for changes to be made to both the rate and formula by which statutory interest is calculated. This would allow the case for compound interest to be reconsidered at a later date and for an entitlement to compound interest to be incorporated into the legislation if that were considered to be appropriate. Subject to what we say in paragraph 7.40 below regarding compounding at the date of decree, we recommend that:

Statutory interest should be simple interest.

(Draft Bill, section 7(2))

Compounding of interest at date of decree

7.40           Under existing practice in relation to damages, where decree is granted for payment of a sum which includes an element of interest accrued to date (for example, on past loss of earnings or solatium attributable to the past), any interest charged post-decree at the judicial rate is in effect awarded upon the accrued interest as well as the principal. Despite the long-standing strictures against "interest upon interest" and the fact that the Interest on Damages (Scotland) Act 1958 explicitly states that nothing in section 1 "…shall…authorise the granting of interest upon interest,…", the courts have held, as a matter of interpretation of section 1(1A), that interest runs from the date of decree until payment on the whole sum awarded in the decree including any element of pre-decree interest.^[61] To put it another way, there is, at the date of decree, a one-off compounding of interest accrued to that date.
7.41           If, as we recommend, post-decree interest and pre-decree interest are set at the same rate, then it could be argued that interest should simply continue to run from the appropriate pre-decree date - or dates - until payment and that the granting of decree ought not to affect it in any way. There would then be no compounding at the date of decree. In our view, however, there are both principled and practical reasons for retaining the existing practice of having a single compounding or "rest" at date of decree. As a matter of principle we consider that it should be recognised that the character of a creditor's claim changes when decree is granted. He is no longer seeking redress for loss sustained but rather implementation of an award made by the court in his favour. From a practical point of view, an award of damages is usually made up of a number of components and it would create a significant complication if, having calculated interest on each of these to the date of decree, parties had then to re-calculate interest on each component up to the date of payment. Another reason is that the amount for which decree has been granted may have to be enforced by diligence. It is necessary for these purposes to know precisely the amount of the award. If interest simply continued to run it would be necessary for the creditor to re-calculate the award at the time when the charge is served. We would regard this as an unsatisfactory side effect of our recommendations and would prefer to avoid it by making express statutory provision for post-decree interest to run on both the principal sum and on any interest accrued on that sum to date of decree.
7.42           Our recommendations elsewhere in this Report afford two further reasons for fixing the amount of the award, including interest to date, at the date of the court order. The first is that the court may have exercised its discretion to remit some or all of the interest which would otherwise have been due.^[62] The factors taken into account by the court will not, however, continue to apply after decree has been granted and so in this situation interest will run differently pre- and post-decree. The second occurs where decree is granted in a foreign currency and the amount, together with interest accrued to date, requires to be converted into sterling. Again the applicable rate of interest may be different.
7.43           We consider that most of these arguments apply equally to interest on debt, and that the current practice of having a single "rest" at date of decree should also apply to court orders^[63] for payment of sums other than damages. It is worth noting in this context that under our recommendations statutory interest will have accrued from the time when payment fell due and not, as is the case at present in relation to contractual debt, merely from the date of citation. Amounts of interest recoverable under decrees are therefore likely to be greater than at present because it will have been running for longer. A significant practical consequence of this change will be that where decree is granted in an undefended action, interest will require to be calculated to the date of decree. We envisage that this task would be carried out by the creditor, prior to instructing enforcement action, rather than by the court.
7.44           We make no recommendation in relation to sums recoverable otherwise than under a decree: for example, sums recoverable under a document which has been registered for execution in the Books of Council and Session or the sheriff court books, or under a foreign judgment or document which is enforceable in Scotland.^[64] Our understanding is that the practice of creditors, in relation to debts upon which compound interest is due in terms of a contract, is to compound the interest at the time when the certificate of indebtedness is registered for execution.^[65] On the other hand, as regards debts upon which simple interest is due in terms of a contract, we understand that it is not usual practice to carry out a one-off compounding when the certificate is registered. (Indeed, it is not easy to identify a legal basis upon which a creditor would be entitled to carry out any such one-off compounding.) We do not consider that registration of a document for execution effects the same change of character of a debt as does the granting of a court order for payment. Nor do the practical considerations discussed above^[66] apply to debts which are enforceable by registration of a document for execution. We therefore propose to leave existing practice in relation to such debts unaltered.
7.45           We recommend that:

Interest should run post-decree on the amount of interest accrued to the date of decree, as well as on the principal sum, until payment.

(Draft Bill, section 7(3))

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Note 1   [1970] 1 QB 447 at 468.     [Back]

Note 2   In the United Kingdom, the Bank of England's repo rate: see para 7.11.    [Back]

Note 3   SI 1994/1443, as amended (although no amendments have been made to RCS 7.7).     [Back]

Note 4   The interest rate in s 17 can be amended by Order using the power in the Administration of Justice Act 1970 (c 31), s 44. The current rate of 8% in England and Wales was set by SI 1993/564.     [Back]

Note 5   SI 1993/770. When the Rules of the Court of Session were consolidated in 1965, the rate was set at 5%. It was amended to 7% in 1970, 11% in 1975, 12% in 1983, and 15% in 1985.     [Back]

Note 6   Act of Sederunt (Interest in Sheriff Court Decrees and Extracts) 1993 (SI 1993/769).     [Back]

Note 7   Art 4 of the Employment Tribunals (Interest) Order 1990 (SI 1990/479). A different statutory instrument sets the rate for discrimination cases heard by Employment Tribunals: The Employment Tribunals (Interest on Awards in Discrimination Cases) Regulations 1996 (SI 1996/2803) applies (in Scotland) the rate specified in Act of Sederunt (Interest on Sheriff Court Decrees and Extracts) 1993 (SI 1993/769). That rate is also 8%.     [Back]

Note 8   See eg Neilson v Stewart 1991 SC (HL) 22 at 35 (Lord President Hope).     [Back]

Note 9   See eg Smith v Middleton 1972 SC 30 at 38 (Lord Emslie).     [Back]

Note 10   See the Discussion Paper, para 2.1.     [Back]

Note 11   See eg Lord Cullen in Quinn v Bowie (No 1) 1987 SLT 575 or Lord Morison in Starkey v NCB 1987 SLT 103.     [Back]

Note 12   1949 SC 287 at 295.     [Back]

Note 13   Published in The Parliament House Book (W Green & Son).     [Back]

Note 14   Act of Sederunt (Rules of the Court of Session 1994) 1994 (SI 1994/1443), as amended.     [Back]

Note 15   Note 7.7.1.     [Back]

Note 16   The average Bank of England base rate between September 1999 and September 2006 was 4.66%.     [Back]

Note 17   Late Payment of Commercial Debts (Rate of Interest) (Scotland) Order 2002 (SSI 2002/336), art 4.     [Back]

Note 18   In these actions a valuation of each head of claim, including the calculation of interest, must be lodged in court (Rules of the Court of Session, rule 43.9 and Form 43.9.     [Back]

Note 19   See paras 7.14 and 7.37.     [Back]

Note 20   In this Report we refer to the Bank of England base rate to encompass the rate set by the bank since its foundation. The current base rate has been referred to officially, since 1996, as the "repo rate", a contraction of "repurchase option".     [Back]

Note 21   The SVR rate is "weighted" because it is compiled by the Bank of England by taking the interest rates offered by a range of financial institutions and the figures for each institution are "weighted" according to market share.     [Back]

Note 22   An account with a minimum notice period for withdrawal, such as three months.     [Back]

Note 23   Graphs comparing all of these rates during the period 1998-2004 are contained in Appendix D to the Discussion Paper.     [Back]

Note 24   As was done with a changing judicial rate in, eg, Preston v Grampian Health Board 1988 SLT 435 and Keicher v NCB 1988 SLT 318.     [Back]

Note 25   A specimen calculator, programmed to calculate compound interest at Bank of England base rate plus 1%, was made available on the Scottish Law Commission website during the period between publication of the Discussion Paper and submission of this Report.     [Back]

Note 26   See paras 7.18-7.20.     [Back]

Note 27   Commerzbank AG v Large 1977 SC 375. See also Miliangos v George Frank (Textiles) Ltd [1976] AC 443.     [Back]

Note 28   If the principal sum is converted to sterling when decree is granted, interest should run thereafter by reference to the Bank of England rate, and the form of interlocutor would require to reflect this.    [Back]

Note 29   See the Discussion Paper, para 7.5.     [Back]

Note 30   The Bank of England base rate was 4.5% from 4 August 2005 until 3 August 2006 when it was raised to 4.75%.     [Back]

Note 31   Sections 2(b) and 2(c).    [Back]

Note 32   That is, reference is made to s 9 of the Sheriff Courts (Scotland) Extracts Act 1892, as amended from time to time by Act of Sederunt. See para 7.5 above.     [Back]

Note 33   Interest on sums paid or repaid under earnings arrestments and current maintenance arrestments; the reference to the sheriff court decree rate is in s 73(1).     [Back]

Note 34   Misuse of funds. See also sch 2, para 8(7) which provides for interest at the same rate where there is a deficiency in the accounts of a guardian.     [Back]

Note 35   Section 51 lists the order of priority in a distribution of the debtor's estate by the permanent trustee. At s 51(1)(g) the order of priority is interest on (i) the preferred debts and (ii) the ordinary debts. The interest rate is the higher of (i) the "prescribed rate" or (ii) the rate which applies to that particular debt (s 51(7)).     [Back]

Note 36   SI 1985/1925, as amended. Relevant amendments were made by the Bankruptcy (Scotland) Amendment Regulations 1993 (SI 1993/439), reg 4.     [Back]

Note 37   Regulation 4 of the Bankruptcy (Scotland) Amendment Regulations 1993 (SI 1993/439) changed the rate in the Bankruptcy (Scotland) Regulations 1985 (SI 1985/1925) from 15% to 8%.     [Back]

Note 38   Paragraph 8 of sch 2.     [Back]

Note 39   Discussion Paper, paras 7.43-7.52.     [Back]

Note 40   Interest recoverable "as damages" on bills dishonoured by non-acceptance or non-payment which may, however, be withheld "if justice require it" (s 57(3)).     [Back]

Note 41   Sums improperly advanced by a trustee on inadequate security.     [Back]

Note 42   Paragraph 7.59.    [Back]

Note 43   On advances by a partner beyond the capital which he has agreed to subscribe: rate of 5% specified.     [Back]

Note 44   Option of outgoing partner to demand interest on his share of assets until paid: rate of 5% specified.     [Back]

Note 45   Creditor performing debtor's obligations entitled to recover expenses and charges (including interest) reasonably incurred: interest runs at rate at which advances are secured under the standard security or, if no rate is specified, at the "bank rate".     [Back]

Note 46   SI 1986/1915, as amended. Creditors' entitlement in the order of priority on distribution: interest is at "the official rate", specified by the Insolvency Act 1986, ss 189(4) and (5), read with rule 4.66(2), as being whichever is the greater of the rate applicable to the debt apart from the winding up and 15%.     [Back]

Note 47   Paragraph 7.60.    [Back]

Note 48   Institute III.iii.81.     [Back]

Note 49   Commentaries, Vol I, 5th edn, 651.     [Back]

Note 50   Eg Maclean v Campbell (1856) 18D 609.     [Back]

Note 51   Roxburgh Dinardo's JF v Dinardo 1992 SC 188.     [Back]

Note 52   Bank of Scotland v Davis 1982 SLT 20.     [Back]

Note 53   Cranston & Hay v Scott (1826) 5S 62; Douglas v Douglas's Trs (1867) 5M 827; Roxburgh Dinardo's JF v Dinardo supra.     [Back]

Note 54   Douglas v Douglas's Trs (1867) 5M 827; Munro's Trs v Murray and Ferrier (1871) 9 SLR 174; Bank of Scotland v Davis supra.     [Back]

Note 55   Interest on Damages (Scotland) Act 1958, s 1(2)(a).     [Back]

Note 56   See para 7.40.    [Back]

Note 57   Discussion Paper, paragraph 8.38 and proposal 41.    [Back]

Note 58   The Faculty of Advocates, Aberdeen University School of Law and Harvey McGregor QC.     [Back]

Note 59   Scottish Consumer Council and Citizens Advice Scotland.     [Back]

Note 60   The graph shows the effect of three different rates of interest on a sum of £10,000 over a five year period between February 2001 and February 2006. During this period the base rate varied between 3.5% (July 2003) and 5.75% (March 2001).     [Back]

Note 61   See eg Smith v Middleton 1972 SC 30 at 39 (Lord Ordinary (Emslie)); Mouland v Ferguson 1979 SLT (Notes) 85 at 86 (Lord Ordinary (Stewart)).     [Back]

Note 62   See paras 5.12-5.13.    [Back]

Note 63   Including orders for payment by tribunals and awards by arbiters.    [Back]

Note 64   Civil Jurisdiction and Judgments Act 1982, s 13(1); Civil Jurisdiction and Judgments (Authentic Instruments and Court Settlements) Order 1993 (SI 1993/604). The Rules of the Court of Session provide that, in application for enforcement of a foreign judgment, details must be given of the rate of interest, the date from which interest is due and the date on which interest ceases to accrue (rule 62.28(2)(e)(ii)).     [Back]

Note 65   Cruickshank v British Linen Co (1834) 13 S 91 provides some old authority for such a practice.    [Back]

Note 66   Paras 7.41-7.42.    [Back]