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You are here: BAILII >> Databases >> The Law Commission >> Pre-Judgment Interest on Debts and Damages (Report) [2004] EWLC 287(4) (23 February 2004) URL: http://www.bailii.org/ew/other/EWLC/2004/287(4).html Cite as: [2004] EWLC 287(4)

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PART IV

SHOULD THE COURTS HAVE A POWER

TO AWARD COMPOUND INTEREST?

4.1     Here we consider the main arguments for and against granting the courts a power to award compound interest on debts and damages. We conclude that the courts should have such a power. Later parts consider more specific questions about which cases the power should extend to, and how it should be exercised.

THE ARGUMENT FOR A POWER TO AWARD COMPOUND INTEREST

4.2     As we said in the Consultation Paper, "the obvious reason for awarding compound interest is that it reflects economic reality": If a claimant should have had the money earlier, and in fact had it later, he or she has either missed an opportunity to invest it, or had to borrow to cover, in either case at compound interest.^[1]
4.3     Compound interest is important in long-running claims, particularly those in which the loss occurred more than fifteen years before payment. Compound interest is also important when interest rates are high. A system which limits interest to simple interest will tend to either over-compensate claimants in short cases, or under-compensate them in long cases (or both).
4.4     The principle of compound interest drew wide support from all categories of respondents, including academics, practitioners, judges and insurers. For example, the Law Society stated that "simple interest never provides a full indemnity for the loss to the litigant". The International Underwriting Association agreed: The current legal position allowing for only simple interest (in the majority of cases) can be inequitable for both consumers and insurers alike. The consumer awaiting payment could have used the money owed to them for investment or borrowing purposes, thus in effect gaining interest on their interest. For insurers it is clear that, presently, the rate of simple interest can often lead to over-payments in cases with short disposal times.
4.5     The Bar Council felt that it was necessary to respond to commercial reality to maintain confidence in the legal system: The introduction of a power to award compound interest would remove one of the blots on the English civil justice system. At present, Claimants are justifiably aggrieved to learn that the law has deliberately set its face against awarding them compensation for what everyone recognises to be the full extent of their losses. This brings the law into disrepute.
4.6     Several respondents drew our attention to arbitration practice, where compound interest is regularly awarded. It was argued that there was no reason why the powers of the courts and the powers of arbitrators should necessarily be the same.^[2] However, the fact that arbitrators already have and use the power to award compound interest – apparently without ill-effect – encourages us to think that the courts should be allowed to do so too.

THE ARGUMENTS AGAINST A POWER TO AWARD COMPOUND INTEREST

4.7     Although the great majority of respondents supported a power to award compound interest, five respondents opposed the idea, while several others sounded notes of caution or concern. They put three arguments against our provisional proposals.

(1) The first, and most important, argument was that compound interest would be unduly complex to calculate. It was feared that it would increase legal costs and could lead to unnecessary disputes. Although only two respondents felt that compound interest would be so complex that it should never be permitted, many judges and others stressed the importance of ensuring that any new system would be simple and easy to operate.

(2) Secondly, it was argued that granting claimants compound interest would add to defendants' costs. The greatest effect of compound interest is in the longest running cases, which in practice tend to be clinical negligence cases.^[3] Clinical negligence defendants opposed compound interest on the grounds that it would add to National Health Service expenditure.

(3) Finally, clinical negligence defendants and the Government expressed concern that in some circumstances compound interest may present claimants with an incentive to delay settlement.

4.8     We do not consider that these concerns should prevent the courts from having the power to award compound interest. However, we do take them seriously and we have borne them in mind in deciding how compound interest should be introduced. We discuss them in more detail below.

Undue complexity

4.9     When the Law Commission considered the issue of interest in 1978 we rejected compound interest on the grounds that it would lead to "undesirable complications".^[4] The world has changed. We now live in an age of widespread access to computers, in which people's ability to carry out complex mathematical calculations has been transformed.
4.10     That said, we do need to pay careful attention to the practical difficulties. Not everyone has access to a computer. Access is especially difficult for those standing in court corridors, attempting to negotiate last minute settlements.
4.11     Furthermore compound interest has the potential to generate disputes. Unlike simple interest calculations (which, if done correctly, produce the same figure), compound interest can be calculated in several different ways. The outcome will depend, for example, on whether one uses annual, quarterly or monthly rests, and whether rests occur on a set date (such as 1 January each year), or on the anniversary of the start of the debt. Different people, calculating compound interest according to different rules, will come up with different figures. A judge told us that this was already a problem when mortgage lenders and borrowers arrive at court each brandishing computer printouts showing that different amounts are owed.
4.12     The practicalities depend on who carries out the calculation. There are three possibilities: that interest should be calculated by the judge; by a court official; or by the parties themselves. We look at each in turn.

Calculations by judges

4.13     The Consultation Paper suggested that, when giving judgment, a judge might turn on a computer programme and type information onto a computerised form.^[5]
4.14     Most of the judges who responded to the paper criticised this suggestion. They argued that typing should not be regarded as a judicial function. They feared that the computer programme would not work. They thought that valuable court time would be wasted as judges type figures in front of the assembled parties. Finally, the court would have no way of verifying the figures.
4.15     We can understand judges' reluctance to type figures into a computer programme at the end of a case, while the parties wait before them. Where judges lack confidence in their typing or computer skills, they fear that this would lead to embarrassing and potentially costly delays. We accept that if compound interest is to be introduced, some other way of carrying out the calculations must be found.

Court officials

4.16     The Consultation Paper suggested that, where interest calculations were too complicated to be made at the time of judgment, they could be referred to a court official for assessment.^[6]
4.17     Judges were unanimous in rejecting this possibility. They told us that court staff were already overworked, and urged us to "take account of the realities of court resources and tight budgetary controls". It was argued that the judgment given at trial should be immediate and final. The parties would have "legitimate grounds for complaint" if delays in calculating interest meant that judgments were routinely postponed.
4.18     We sympathise with the desire to produce final judgments at the end of the case, and we do not wish to add to delays. We agree that calculations should normally be carried out before judgment, rather than by court staff after judgment.

The parties

4.19     The only realistic possibility is that the parties calculate compound interest, either themselves or through their legal representatives. Where the claimant seeks a judgment for compound interest, the onus should be on them to present the calculations to the court.
4.20     Organisations representing the legal profession supported compound interest and suggested that lawyers could carry out calculations without undue difficulties. The Personal Injuries Bar Association, for example, explained that representatives already took responsibility for interest calculations:

On a practical note, in our experience, it is very rare indeed for a judge to undertake interest calculations himself. While judges are frequently asked to rule on points of principle in relation to interest, the calculations are always undertaken by the parties' representatives.

4.21     However, we accept the arguments put to us that compound interest is not suited to every case. The Council of Circuit Judges civil sub-committee argued that many litigants in person would have problems with compound interest. Furthermore, in all small claims, most fast track cases and many multi-track cases the amount of money at stake would not be worth the additional trouble. The Association of District Judges agreed:

The vast majority of cases involve relatively small amounts of money, and are disposed of quite quickly, usually within one year. Most Claimants, we anticipate, would prefer to avoid the complications of computing compound interest by whatever method, and both Claimants and Defendants would prefer not to get involved in a dispute about its calculation.

4.22     We accept that not all claimants will want to carry out compound interest calculations. For example, a large creditor organisation explained that their billing systems could only cope with simple interest, and that it would be too expensive to switch to compound interest. This should not prevent claimants from having the option to claim compound interest in suitable cases. In Part V we argue that compound interest is most appropriate in claims of £15,000 or more, which have been outstanding for at least a year.^[7]
4.23     We have concluded that compound interest would not be unduly complex, provided that it were used at the request of the claimant in suitable cases, with the claimant bearing responsibility for its calculation. It is important to stress that claimants would have a choice. They would not be required to calculate compound interest if they do not think it is worth their while.

The cost to defendants

4.24     The main impact of allowing compound interest will be to permit a more accurate measure of loss in large commercial actions. As discussed in Appendix D, it will very rarely affect debt actions brought against individuals.
4.25     The cost effect on personal injury cases is complex, because interest rules apply differently to the separate heads of damages. This matter is discussed in detail in Part VII, below. In summary, future loss carries no interest; non-pecuniary loss normally carries interest at 2% from the date of claim; and past pecuniary loss often carries interest at half rate, to allow for the fact that losses arise gradually over time. We recommend that compound interest should only apply to past pecuniary losses (which we estimate represent around 16% of total damages in larger claims). This means that the cost of compound interest only starts to become significant in very long running claims, in which the delay between loss and settlement is 15 years or more. In practice, these tend to be clinical negligence claims where the claimant is a child or under a disability, and so is not time-barred in bringing an action. We discuss the figures in paragraphs 7.30-7.43 and Appendix E.
4.26     Where clinical accidents have forced claimants to borrow, or have deprived them of the opportunity to save, they will have lost interest at compound rates. As a matter of principle, compound interest would be a more accurate measure of the loss. However, the burden of the changes will fall primarily on the health service. Whether this is a loss that the taxpayer should meet is a matter of political judgement. If the Government were to decide that compensating accident victims for their loss of investments was not a priority for public expenditure, it would be possible to exempt past clinical negligence claims from the compound interest regime.

The effect on delay

4.27     A few respondents expressed concern about the effect of interest on delay in bringing proceedings to court. The National Health Service Litigation Authority, for example, suggested that the introduction of compound interest would "provide a financial incentive to claimants' representatives to delay settlement". They feared that initiatives introduced to increase the speed of settlement would "be stopped in their tracks and possibly reversed".
4.28     There are many factors influencing delay in court proceedings, including legal costs, bargaining tactics and procedural complexity. In analysing the causes of delay, Lord Woolf suggested that

In the majority of cases the reasons for delay arise from failure to progress the case efficiently, wasting time on peripheral issues or procedural skirmishing to wear down an opponent or to excuse failure to get on with the case.^[8]

4.29     Lord Woolf pointed out that delay sometimes benefited legal advisers, by increasing costs and allowing them to carry excessive caseloads "in which the minimum possible action occurs over the maximum possible timescale".^[9] Delays fed on delays, producing a culture in which opposing sides' legal advisers tended to be "indulgent to each other's misdemeanours", and time-wasting was "too often condoned by the courts".^[10]
4.30     Given the many and varied factors influencing delay, we do not think that interest rates have any great influence in either direction. This view was largely confirmed by the results of a questionnaire sent to professional and commercial organisations in January 2000.^[11]
4.31     That said, in so far as interest rates do influence the time taken to conclude cases, they have a dual effect. Where interest rates are too high, they encourage claimants to postpone settlement in the hope of gaining a windfall investment. Where interest rates are too low, they encourage delay by defendants, who are effectively "borrowing" at cheap rates. To encourage early settlement, the ideal rate would be neutral – that is, one that replicates commercial reality sufficiently closely to provide no strong incentive in either direction. Our policy is to replicate commercial reality as far as is possible within a reasonably simple and certain system. We wish to do this primarily because it would be fair and seen to be fair, rather than because it would necessarily reduce delay. In so far as interest does influence the timing of settlements, however, we think the effect would be beneficial.
4.32     At present, the courts may use interest as a sanction against obvious and deliberate delay. Under the general statutory provisions, judges have discretion to disallow interest during a period of delay by the claimant, or to increase the rate during a period of delay by defendants. Recent decisions suggest that the courts are fully prepared to reduce interest payments where claimants are responsible for unwarranted delay.^[12] We think interest-reduction is a useful weapon in the armoury to prevent delay, and we intend that this discretion should continue. The risk of losing interest should counter-balance any incentive that our proposals may give to claimants to delay settlement.

OUR CONCLUSIONS

4.33     The Consultation Paper summed up the arguments for and against reforms as follows:

In the end, the question is a fairly narrow one. Compound interest is undoubtedly more correct in principle, but the practical gain may or may not be significant enough to justify the effort of the change.

4.34     Most respondents agreed with our provisional conclusion that the practical gains did outweigh the problems. As Lord Justice Dyson put it The present rough and ready system produces a reasonably just solution in many cases, but where the sums involved are large and the period of time in question is long, the awarding of simple interest can work a real injustice.
4.35     We agree with the Bar Council that the present system can leave litigants feeling aggrieved that rules of interest took no account of the commercial realities in which they operate. Interest can be substantial – and may run into tens of thousand of pounds.^[13]
4.36     We therefore recommend that the courts should be granted a power to award compound interest.
4.37     It is important to be alive to the practical difficulties. In particular, any system should meet the following conditions:

(1) Wherever possible the calculations should be carried out by the parties themselves.

(2) Compound interest needs to be calculated in a prescribed way, so as to prevent unnecessary disputes about the calculations. We discuss this in more detail in Part VI.

(3) Compound interest should only be granted where the amount involved justifies the time taken to calculate it. We accept that in some small, short cases the effort may be disproportionate to the sum at stake. We return to this issue in Part V.

4.38     The main impact of compound interest is that it will provide a more accurate measure of loss in large commercial claims. In personal injury claims, the only significant impact will be in the longest running claims. In practice this means clinical negligence cases involving delays of 15 years or more from loss to payment. The cost of paying compound interest in long-running clinical negligence claims is explored in detail in Part VII and Appendix E.

Note 1   Compound Interest, Consultation Paper No 167, at para 4.1.    [Back]

Note 2   Some arbitrators pointed out that arbitration was based on agreement between the parties. It was open to the parties, as “men of commerce”, to confer greater powers on their arbitrators than those granted to the courts.    [Back]

Note 3   See Appendices D & E, below.    [Back]

Note 4   See Interest (1976) Working Paper No 66, para 114 and Report on Interest (1978) No 88, para 156.    [Back]

Note 5   Para 4.53(e).    [Back]

Note 6   Para 4.12.    [Back]

Note 7   See paras 5.29 – 5.40, below.    [Back]

Note 8   Access to Justice: Interim Report to the Lord Chancellor on the Civil Justice System in England and Wales (1995) p 13.    [Back]

Note 9   Ibid, p 12.    [Back]

Note 10   Ibid, p 13.    [Back]

Note 11   See Consultation Paper No 167, para 4.5.    [Back]

Note 12   See Spittle v Bunney [1988] 3 All ER 1031, Corbett v Barking, Havering and Brentwood Health Authority [1991] 2 QB 408 and Beahan v Stoneham 2001 WL 272888. See also para 7.43, below.    [Back]

Note 13   Harvey McGregor QC drew out attention to the patent case, General Tire & Rubber Co v Firestone Tyre & Rubber Co [1975] 1 WLR 819, in which the lower courts awarded £458,000 interest on a damages award of £930,000. The House of Lords reduced the damages award to £215,000 but still awarded £96,000 interest.    [Back]