Part 7		Rate of Interest
1.	
Introduction
1.1	Erskine wrote that interest  is "the profit due by the debtor of a sum of money to the creditor for the use of it."  The principle underlying our proposals 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 is expressed by Lord Denning MR in Jefford v Gee as follows: 
"Interest should not be awarded as compensation for the damage done.  It should only be awarded to a plaintiff for being kept out of money which ought to have been paid to him."
Lord Denning MR had previously expressed this view in a slightly different form in Harbutt’s Plasticene Limited v Wayne Tank and Pump Co Limited:  
"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."
1.2	This principle can be applied quite clearly to a case of debt where a liquid sum has been in the possession of one party when it should have been in the possession of 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. 
1.3	Applying this principle, the rate of interest should reflect 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. 
1.4	Of course, these two measures of interest are not the same.  It 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, is likely to be a compromise between these two measures.  The rate should reflect the "cost of money" during the period when interest runs.  This could 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.  However, as explained below, the cost of money is not the same for all parties and any formula chosen would involve a compromise between the utility of a common rate for all parties and the theoretical desirability of a rate which truly reflects the loss of each pursuer.
The judicial rate of interest
1.5	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.  It is the same rate as that applying in England and Wales which is set by section 17 of the Judgments Act 1838.  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.  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.  The current rate of 8% applies to any decree pronounced after 1 April 1993 regardless of when the action commenced. 
1.6	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% by the Act of Sederunt (Interest in Sheriff Court Decrees and Extracts) 1993. A rate of 8% also applies to awards by Employment Tribunals sitting in Scotland.
1.7	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.  In Neilson v Stewart, Lord President Hope said that "the court will normally award interest on a debt of any period for which interest is due at the judicial rate for the time being, unless there is a contractual rate to which it can give effect."  
1.8	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.  Where the principle of interest is at issue the rate to be applied tends to be the last matter to be decided and very little explanation is given as to why a particular rate is chosen.  In Smith v Middleton, for example, Lord Emslie said: 
"As to the rate of interest the only feasible yardstick is provided by the rate prescribed from time to time by the court for interest on awards of damages.  This rate since January 1969 has been seven per cent and was formerly five per cent.  Since the period in question in this case begins on 28th November 1968, an appropriate guiding rate would be the average of the two rates, viz six per cent."
It is assumed that by "the rate prescribed from time to time by the court for interest on awards of damages" Lord Emslie was referring to the rate prescribed in the Rules of the Court of Session.  (It is hard to see why that rate is the only "feasible yardstick" – it appears to be simply the most convenient).
1.9	In the annotated edition of the Rules of the Court of Session 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." 
If this is the principle underlying the rate of 8 per cent, then it has rarely been adhered to in practice.  Over the last five years, the judicial rate has been on average 3.33% above the Bank of England rate despite the fact that the judicial rate can be amended by a relatively short statutory instrument.  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. 
1.10	There may also be some hangover from the concept of a "legal rate" – a rate of 5% fixed by statute which applied 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 beyond post-decree interest. However, the concept of a fixed "legal rate" has been firmly laid to rest by Lord President Cooper in Kearon v Thomson’s Trustees.  It had been held in the Outer House that interest applied on legitim from the date of death until payment and the rate should be 5%; this was described by Lord Sorn as "legal interest at the standard rate."  Replacing this with a rate of 3%, Lord President Cooper said that the term "legal rate" was "…originally applicable to the maximum rate of 5 per cent fixed by a statute of 12 Anne, long since repealed…", adding that "…it is 250 years since Parliament last intervened to prescribe interest rates, and over 80 years since the Act then passed was repealed." He quoted Lord McLaren in Ross v Ross:

"… there is at present no standard rate of legal interest; five per cent was only a maximum rate, and there is no statutory rule obliging the Court to award five per cent in perpetuity.  It may not be beyond the powers of the Court to reduce the rate usually awarded in case of a permanent fall in the rate of interest obtainable in this country."
Lord President Cooper goes on to question why 5% (having been set as a maximum) should ever have been the "ordinary rule" and to assert that there is no reason why the rate should not fluctuate:
"It was further suggested that interest rates fluctuate, and that, if we were to fix a rate normally appropriate under the circumstances of to-day, we might have to fix a different rate a few years hence and thereafter at brief intervals.  The short answer to this objection is – why not?  Our function is to dispense justice to those who appeal to us, and not to offer as a substitute arbitrary stereotyped rules which may have done justice in the days of Queen Anne, and may yet do justice at some unknown future date, but which do not do justice now."
1.11	We are not seeking to revive the concept of a legal rate. But, as the judicial rate appears to be used for pre-decree interest only in the absence of anything more suitable, it is proposed to replace this with a fluctuating rate prescribed by legislation. 
What does "interest" represent?
1.12	In general terms, outside the context of litigation, interest is income received as a result of a contractual obligation to pay for the use of property.  The need for the payment of interest arises because in an advanced society capital is rarely owned by people who are in the best position to utilise it (for example, elderly people in receipt of a private pension) and interest is, in effect, the price paid by another party to enable that party to control the capital and benefit from its use.  In legal terms, when "interest" is referred to, it is a shorthand expression referring to the interest which would be payable if the sum of money at issue were capital which was subject to a contractual obligation to pay interest. 
1.13	Commercial rates of interest vary according to the nature of the contractual obligation to which they apply.  Rates differ according to the rate of inflation, the anticipated rates of inflation during the period of the obligation, the relative strengths of the parties to a transaction and the risk of non-payment.  A relatively safe investment, for example, may carry a rate of interest which is low and mainly reflects the anticipated rate of inflation.  On the other hand, an unsecured loan with a high risk that it will not be repaid, is likely to include a high rate of interest.  This is because interest can be divided into a number of elements:
(i)	an element to account for the time value of money, or inflation.
(ii)	an element for reward for not having the use of the money: "a reward for foregoing the use of the capital sum for the time being."  In many circumstances, this element can be conflated with the concept of commercial profit and is affected by supply and demand factors which mean that the commercial "going rate" may vary. 
(iii)	an element to account for the risk of non-payment: "a reward for taking a risk of loss or reduction of capital."
An interest charge may also include an element to allow for the expense of the transaction or a penal element to encourage prompt payment.  The appropriate rate of interest in any case will vary according to what proportion of each of these elements is applicable.  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.  However, this approach would create a degree of uncertainty for litigants, and it is also likely that the courts would simply fall back upon use of the current judicial rate.  Although different rates are applied in courts throughout the world, it appears almost universal that a prescribed rate is available to the court.  The problem which arises is: which rate will do justice in most cases?  Whatever rate is chosen will inevitably have a "one size fits all" quality: it may seem generous in some cases, or fail to compensate fully in others.  But whether or not a degree of judicial discretion is necessary to ensure fairness in all cases, we have taken the view that it would assist both courts and litigants if a rate of interest were prescribed by statute. 
Fluctuation and base rate
1.14	If a rate of interest is to be prescribed by legislation, the problem is how to set a rate which can be applied universally but which also truly reflects the cost of money.  One solution is to have a fixed rate of interest which is set 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, it is not particularly sensitive to fluctuations in interest rates which are available in the market.  An interest 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.  
1.15	An alternative approach is to specify a fixed rate by statutory instrument 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.  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.
1.16	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 Late Payment of Commercial Debts (Interest) Act 1998.  That Act empowers the Secretary of State by Order (statutory instrument) to set the applicable rate of interest and the instrument currently in force is the Late Payment of Commercial Debts (Rate of Interest) (Scotland) Order 2002.  Article 4 of that Order provides: 
"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."
1.17	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 pursuers.  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.   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.  If the fluctuating rate is compounded, this is likely to lead to higher payments in long running cases.  Concerns of complexity and accessibility are addressed by the availability, discussed below, of an on-line calculator together with printed tables.  
Selection of base rate
1.18	The "Bank of England rate" is not the only rate which can 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" 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.  However, other rates are available and are considered below:
1.	The inflation rate:  if we assume that interest is paid as compensation due to the loss of value of money caused by inflation then the inflation rate as measured by, for example, the Retail Price Index might be an appropriate base rate.  However, the true cost of the pursuer's loss is not measured by inflation but by the cost of money which the pursuer, in theory at least, had to borrow or, on another view, lost the opportunity to invest. 
2.	LIBOR:  the LIBOR (London Inter Bank Offer Rate) is the rate at which banks offer to lend money to each other.  The five major London banks set daily LIBOR rates at 11 am on every working day but the rate usually referred to as the LIBOR is the three-month LIBOR.  Because it is a rate which is determined by the market, the LIBOR may be a better reflection of available commercial rates than the Bank of England base rate. This rate is sometimes used in legislation, for example:
"12.  - (1) Where the Scottish Ministers intend to recover on demand payment by way of grant in whole or in part in accordance with paragraph 11, they may, in addition, recover interest on that amount at a rate of 1% above LIBOR calculated on a daily basis for the period from the date of payment until the date of recovery."
3.	An average of the lending rates of six UK clearing banks.  This is used as a base for the formula setting the interest rate under section 178 of the Finance Act 1989.  The Bank of England publishes a similar statistic on its website.
4.	The weighted standard variable mortgage rate (the "SVR rate"): Since 1998, this rate has averaged 6.8%. Details can be found readily on the Bank of England website.  However, it does not directly reflect the cost of money at a given time, being an indicator of the market in mortgages and loans secured by a standard security.  On the other hand, it is reasonably close to the average interest rate charged on bank loans to the corporate sector.
5.	The European Central Bank ("ECB") rate: the ECB is the central bank for the euro, the currency of the European Union's third stage of economic and monetary union. The Governing Council of the ECB meets once a month to set an interest rate in a similar way to national central banks such as the Bank of England.  This rate is not used to set the rates of interest used in the UK and is not at present relevant to the UK market.
1.19	Having considered the various rates, we are of the view that the Bank of England rate is the best available base rate.  The 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.  
1.20	On top of this base rate is to be added a figure so that the total reflects the cost of prudent 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.  

1.21	Graph D in Appendix D compares, for a period between September 1998 and June 2004, various interest rates which an ordinary household might pay on loans or receive on deposits.  The graph shows that interest on loans secured by a standard security and mortgages ("the SVR mortgage rate") is charged at a rate about half way between the Bank of England base rate plus 1% and the same rate plus 2%.  These rates are all higher than can be obtained on an instant access deposit account or a timed deposit account, but considerably less than the rates paid on credit cards or unsecured personal loans.   On balance, it is suggested that 1% or 1.5% above base would be a fair rate of interest to be set in the proposed legislation. We therefore invite comment on the following proposal and question:
31.	There should be a prescribed rate of interest which would fluctuate according to the Bank of England base rate.  We propose that the rate of interest prescribed by statute should be a specified percentage, such as 1% or 1.5%,  above the official dealing rate of the Bank of England.
32.	Is there another rate which would be better than the Bank of England base rate as the basis of the prescribed rate? 
1.22	We also invite comment on the alternative approach set out in paragraph 7.15 above:
33.	(a)	A fixed interest rate would be prescribed by statutory instrument at pre-set periods. The rate prescribed would be calculated according to a formula set out in primary legislation but the statutory instrument would specify only the rate produced by this calculation on a given date. 
(b)	Views are also sought on whether the rate should be fixed annually, every six months, every month, or such other periods as consultees may wish to suggest. 
Prescribed rate in other legal systems
1.23	Although not in force in any jurisdiction, Principles of European Contract Law produced by the Lando Commission provides for interest to be paid on money where payment has been delayed. Such interest would be payable at "the average commercial bank short-term lending rate to prime borrowers prevailing for the contractual currency of payment at the place where payment is due."  
1.24	A simple fixed rate of interest is used in many civil law jurisdictions.  For example, the Italian Civil Code provides for a rate of 5%.  In Greece, Luxembourg, the Netherlands, Portugal and Spain the interest rate is set annually by the government.
1.25	The interest provisions in the German Civil Code were amended by the Act to Modernise the Law of Obligations in January 2002.  The rate of interest on a debt payable by virtue of a statute is fixed at 4%.  Interest is deemed payable on a money debt during any period of default at 5% per annum above a basic interest rate which is changed twice yearly.  The reference rate used for changes to the basic rate is based on a European Central Bank rate. The German Commercial Code provides for a default rate of 5% per annum.
1.26	Flexible rates have been introduced in some European jurisdictions.  In Denmark a percentage, fixed every two years by the Minister of Justice, is added to the official discount rate.  In Finland, different rates are applied in various circumstances.  If there is an agreed rate of interest on a debt, then the interest on any delay is 4% above that agreed rate.  In other cases, interest on delay is 7% above an official reference rate set by the Bank of Finland.  In Sweden, 8% is added to the official discount rate.  In France, the rate is calculated by taking the average of the last twelve monthly figures of the official discount rate.
1.27	In Canada, rates of interest applied by the courts differ from province to province. The most detailed examination of the appropriate rate was carried out in British Columbia by the Law Reform Commission of British Columbia in their Report on The Court Order Interest Act in 1987.  They recommended that the basis of pre-judgment interest should be the "prime rate", which was the rate charged by the Canadian Chartered banks to their most creditworthy customers.  It was responsive to the market and fluctuated with inflation.  They considered, and rejected, several other rates including the "bank rate": a rate announced by the Bank of Canada every Thursday which was the rate payable by the Bank of Canada to the Chartered banks for short-term advances.  They considered that the "bank rate" did not reflect the market or correspond to any rate paid by or to litigants.  They also recommended that a rate based on the prime rate should be published monthly.  However, the subsequent Court Order Interest Act 1996 left the rate of pre-judgment interest to the discretion of the court and adopted the prime rate for post-judgment interest.  
1.28	By contrast, in Ontario the prime rate was used until 1984  when it was substituted by the bank rate which was considered to be more readily ascertainable and it remains the basis of  pre- and post-judgment interest.  Manitoba has a similar provision to Ontario but with a different rounding provision.  In other Canadian provinces, there is no particular pattern to the rate applied.  In Saskatchewan, the interest rate is published in the Gazette at a frequency to be determined by the Government.  In Nova Scotia, the applicable rate is at the discretion of the court.  In New Brunswick, the rate is fixed by Rules of Court.  In the Civil Code of Quebec, interest is at "the legal rate" which is fixed at 5% per annum. 
Judicial discretion
1.29	If a rate of interest is prescribed by legislation, it may be perceived that there are occasions when it would be unfair to apply the prescribed rate.  On the other hand, the strength of a prescribed rate, either fixed or fluctuating, would be that it would provide an element of certainty.  Questions may arise as to whether interest is to apply or not but there is some merit in having a rate of interest which will apply to all parties in any circumstances.  
1.30	At present, in those situations where pre-judgment interest is available, there is a broad judicial discretion, albeit seldom exercised, to apply a rate higher or lower than 8%. If pre-judgment interest is to be more widely applied, a question arises whether there should be a greater or a lesser degree of judicial discretion as to the rate to be applied in the particular circumstances of an individual case.  The defender may, through no fault of his own, have obtained only a lower rate of interest on the sums at issue.  There will be cases where someone comes into possession of another person's money without any fault or intention.  The defender may have a good explanation as to why it was not possible to place the funds in an account with a higher rate of interest or may have no experience in financial matters.  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.  It is less clear whether this principle can also be applied in circumstances where the person holding the funds has obtained a rate of interest higher than the prescribed rate.  It is also difficult to envisage other circumstances where a higher rate could be applied by the court without a penal element or without re-introducing the concept of "wrongful withholding". 
1.31	On another view, if a rate is to be prescribed by legislation and that rate is sensitive to the current cost of money, there is arguably no need for judicial discretion.  In the absence of such a discretion, parties to a dispute would be secure in the knowledge that at the end of the day, where interest is to apply, it will apply at a known rate which generally reflects the rates available in the market.
1.32	We invite comment on the following questions: 
34.	(a)	If a rate of interest is prescribed by legislation, should there be judicial discretion to apply a rate other than the prescribed rate? 
(b)	If there is to be judicial discretion to apply a rate other than the prescribed rate, comments are sought on whether discretion should be limited to applying a lower rate than the one prescribed and should not extend to applying a higher rate.

Foreign currency awards
1.33	So far in our discussion we have assumed that the sums of money to be paid, and on which interest is to be awarded, are in sterling. However, it is competent for Scottish courts to award decree for a sum of money in a currency other than sterling.  Difficulties would follow if the recommendation at 31 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 base rate set by the central bank or other authority responsible for monitoring the currency in question.  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%.
1.34	Alternatively, the appropriate rate of interest in any case in which decree is granted in a foreign currency could be left to judicial discretion.  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 circumstances, it may be desirable to leave it to the court to fix a rate of interest which is fair to both parties.   
1.35	We invite comment on the following questions: 
35.	(a)	Where a party seeks an award in a currency other than sterling, and the award includes an element of interest, should the party be entitled to interest at a rate referable to the currency of the principal sum?    
(b)	Where an award is made in a currency other than sterling, should the court have a broad discretion to award interest at a rate other than the prescribed rate? 
Changes to the prescribed rate 
1.36	In actions for damages, where there has been a change in the applicable interest rate (hitherto, the judicial rate) in the period between the cause of action and the date of the award, the court has to decide how to take the different rates into account.  There is no settled view on how this should be achieved and three approaches have been adopted:
(i)	Take an average of the different rates;
(ii)	Apply different rates to portions of the relevant period; or

(iii)	Adjust the date from which interest runs to take account of changes in the rates.
1.37	If legislation applying the principles set out in this paper is enacted, it is likely 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 may be desirable to recommend a preferred method of calculating awards to deal with fluctuations.  The logical position appears to be (ii) above, as this would most accurately compensate the creditor and would certainly be the appropriate way to calculate interest on a debt.  In actions for damages, however, the circumstances may vary considerably and where (ii) is simply too complex to be of use, there is a case for allowing judicial discretion to apply method (i).  Method (iii) seems somewhat arbitrary and while it may have provided a just solution in the circumstances of the case in which it was used, it does not appear to disclose any general principle which could achieve a just result in other cases. 
1.38	We invite comment on the following proposal and question:  
36.	(a)	There should be a preferred method for dealing with changes to the rate of interest.  The most accurate method would be to apply the fluctuating prescribed rate to the appropriate period of the debt or sum due in damages.  
(b)	Should there continue to be judicial discretion to apply different methods to different circumstances?
Method of calculation
1.39	As well as recommending a prescribed rate, we also propose that compound interest should be applied rather than simple interest (see Part 8 below).  If interest is compounded, then the sum calculated will vary according to the method of calculation used.  For example, if the interest is compounded monthly, the result will be a larger sum than if it is compounded every six months.  For this reason it is recommended, at paragraphs 8.40-8.43 below, that there should be a prescribed method of calculating compound interest.  It is also proposed that a means of calculating compound interest by the prescribed method is made available on a website and also that tables setting out the calculations are made available in court buildings.
Interest at half the prescribed rate
1.40	Under the Interest on Damages (Scotland) Act 1958, the court retains a wide discretion as to whether to award interest in damages actions and as to the rate at which it should be awarded.  A "selective and discriminating approach" is taken in respect of rates of interest and the periods to which particular rates apply.  Interest is applied only to the past elements of the claim, not to future loss.  However, past loss, whether for solatium or pecuniary loss, might not all be suffered on one day.  It is more likely to be suffered on a day-to-day basis over a period.  The applicable rate of interest is usually reduced to take account of this.  
1.41	In respect of pre-decree pecuniary loss, the court's practice is to award interest at half the judicial rate from the date the loss began to either the date the loss ceased or the date of decree.  Where the court attributes a portion of solatium to the past, interest is usually set at half the judicial rate from the date of the accident to the date of decree, but it has been awarded at higher than half rate depending on what view is taken of the proportion of suffering relating to the past.    We see no reason why this practice should not continue but we envisage that the prescribed rate of interest would be used as the base rate to be halved where the court considered it appropriate to do so.
1.42	As discussed above, interest may be composed of a number of elements of which one is inflation.  It can be argued that the award of interest at a rate – even a half rate – which is based upon the Bank of England base rate over-compensates the pursuer because it includes such an element of inflation.  The sum awarded by the court by way of solatium reflects the value of money at the date when the award is made.  If a rate of interest which includes an element of inflation is then applied to that award, the consequence is that  inflation is compensated twice.  However, the degree of over-compensation is minimal and, given that an award of solatium is in any event a conventional figure intended to compensate non-pecuniary loss, we do not suggest that the existing practice of awarding interest on past solatium at a half rate should be disturbed.  
Post-decree interest
1.43	As its name implies, the "judicial rate" is set by the judges of the Court of Session who make the relevant subordinate legislation as "the Lords of Council and Session".  At 3.25% above base, the current rate is mildly penal.  On one view, a rate which encourages early payment after decree is right and proper since it acts as a means of  enforcement of the will of the court.  On the other hand, there is a system of diligence available to a pursuer to enforce the will of the court and it can be argued that there is no need to reward a successful pursuer who does not make use of the remedies provided by diligence. 
1.44	The statutes setting the judicial rate provide for simple interest only.  Over shorter periods (up to about a year) and relatively small amounts of money (up to about £10,000), it makes little difference whether simple or  compound interest is applied.  On larger sums over long periods, simple interest can lead to under-compensation of the pursuer.  A judicial rate which is slightly high redresses the imbalance created by applying simple interest, albeit without great precision.  If post-judgment interest were compounded, a judicial rate could be set which was more closely linked to prevailing market rates.  
1.45	If the rate applied post-judgment is intended only to be compensatory and not penal, the question arises whether interest should be treated any differently post- or pre- an award by the court.  If there is a change in the law to the effect that pre-decree interest is available from the date when the right of action arose or from when the pursuer was kept out of his or her money, interest would run from the appropriate date regardless of the date of judgment.  
1.46	If decree is awarded for a sum which includes an element of interest already, (for example, on damages where interest under the Interest on Damages (Scotland) Act 1958 has been awarded), any interest charged post-decree at the judicial rate will be, in effect, a form of "interest upon interest".  Despite the long-standing strictures against "interest upon interest", and despite the fact that the 1958 Act explicitly states that nothing in section 1 "…shall…authorise the granting of interest upon interest,…", the courts have accepted that interest from the date of decree until payment is charged on the whole sum awarded in the decree including any element of pre-decree interest.  When considering, in Smith v Middleton, how to apply interest under the 1958 Act, as amended in 1971, Lord Emslie took the view that once the interest on damages had been calculated and added to the sum of damages, interest would run on the resulting sum:
"What, in my opinion should be done, bearing in mind that any interest elements in an award may be subject to tax is to decern for payment of a sum of damages, assessed in accordance with accepted principles, together with an additional sum derived from interest at specified rates, for specified periods ending with the date of the interlocutor on those parts of the total sum of damages which should bear interest.  Damages would therefore consist of the addition of two sums and on the resulting sum interest would no doubt run from the date of decree until payment."
1.47	Although not stated explicitly, this appears to be the practice followed by the courts after the flurry of cases following the 1971 amendments.  In Mouland v Ferguson, for example, Lord Stewart approved that dictum of Lord Emslie and added:
"If past interest were not included in the amount upon which interest runs from the date of decree, it would be to the advantage of any defender to delay payment of damages containing a substantial past interest element for as long as possible.  I do not consider that subs (2)(a) of s 1 [of the 1958 Act]  has the effect for which counsel for the defender contended.  It is intended to give a warning against the compounding of interest.  When decree is granted for a sum which includes an element of interest which has accrued prior to its date, that decree is, at the date it is pronounced, a decree for a principal sum upon which post-decree simple interest then begins to run at whatever rate is appropriate." 
1.48	If post-decree interest and pre-decree interest are set at the same rate, then it could be said that interest should run from the appropriate pre-decree date until payment and decree would not affect the running of interest one way or the other.  The question of compounding at the date of decree would not arise.  However, a question arises as to whether pre-decree interest should be compounded and if compounding of interest is acceptable pre-decree, there would not be any reason why it should not be acceptable from decree onwards.  If the current general rule against compounding were removed, then there would be no need to compound at the date of decree: interest would be compounded at monthly intervals (or at whatever other period was provided) both before and after decree. 
1.49	Where there is an applicable contractual rate, the present law is that it continues to apply after decree instead of the judicial rate.   No change to this rule is proposed. If parties have agreed a contractual rate or the court has held that the parties have so agreed, it seems logical that that is the rate which should be applied.  If the judicial rate were applied post-judgment and it was significantly different from the contractual rate, one of the parties would pay more or receive less than would have been the case if the contract had not been subject to litigation.  
1.50	If it is considered necessary to apply a high rate of post-decree interest, then this can be achieved by Act of Sederunt, as at present.  However, if a formula for pre-decree interest is prescribed in legislation, it would not necessarily follow that the post-decree rate would always be higher.  To ensure a higher post-decree rate, it would be necessary to specify that the pre-decree formula is varied post-decree so that the rate is higher.  This would retain the advantages of an interest rate which fluctuated with the applicable bank rate and, because the rate would change automatically, there would be less need for judicial involvement.  It would also include an element which encouraged early payment according to the will of the court.  For example, if the formula for pre-decree interest is "1% above base rate", then the formula for post-decree interest could be "2% above base rate" or even higher.  It might be considered harsh to apply the higher rate immediately on decree and it would be logical to allow only compensatory interest for a period of grace after decree: but there would come a point at which the defender would be expected to obtemper the order of the court or face a penal rate of interest.  The courts could set a period of fourteen days, or perhaps thirty days, after which the higher rate of interest would apply.  
1.51	We invite comment on the following treatments of post-decree interest:
37.	Interest:
		(a)	on sums due post-decree should continue to run at a rate to be prescribed in rules of court independently of the rate applicable to pre-decree interest. 
		(b)	on sums due post-decree should run on the same basis as sums due pre-decree and the applicable rate post- and pre- decree should be standardised and calculated by the same method.  The amount of pre-decree interest would be fixed at the date of the award and post-decree interest would then run on that sum until payment. 
		(c)	should run from the appropriate date until payment regardless of whether it is pre- or post- decree and the same rate and method of calculation should apply throughout this period. 

1.52	We also invite responses to the following questions:
38.	(a)	Should post-decree interest run at a higher rate than pre-decree interest in order to penalise late payment?
(b)	If post-decree interest should run at a higher rate, should the higher rate be linked to the formula for determining pre-decree interest (ie if pre-decree interest is 1% above base, post-decree interest could be 2% above base)?  
(c)	If post-decree interest is to run at a higher rate, should there be a period allowed before the higher rate is applied (for example, 14 days after decree)? 
(d)	If pre-decree interest is compounded, should post-decree interest also be compounded?
Interest under the Late Payment of Commercial Debts (Interest) Act 1998 
1.53	Where a claimant is entitled to claim interest under the 1998 Act the rate is calculated by reference to the Bank of England base rate plus 8%.  Section 6 of the 1998 Act provides:
"(1) The Secretary of State shall by order made with the consent of the Treasury set the rate of statutory interest by prescribing—
(a)	a formula for calculating the rate of statutory interest; or
(b)	the rate of statutory interest.
 (2) Before making such an order the Secretary of State shall, among other things, consider the extent to which it may be desirable to set the rate so as to—
(a)	protect suppliers whose financial position makes them particularly vulnerable if their qualifying debts are paid late; and
(b)	deter generally the late payment of qualifying debts."
1.54	The Department of Trade and Industry (and, in Scotland, the Scottish Ministers) have chosen to set the current rate according to section 6(1)(a).  It should be noted that the interest rate applied under the 1998 Act is based on a reference rate (the Bank of England rate) which is fixed for a six-month period.  This is required by article 3(1)(d) of the Directive which provides that "…the reference rate in force on the first calendar day of the half-year in question shall apply for the following six months".  The effect is that the Bank of England base rate on 31 December 2002 was used to calculate the late payment interest rate from 1 January 2003 to 30 June 2003.  The Bank of England base rate for that period was 4%, and consequently the late payment rate was 12%.  For the following two half-yearly periods (1 July 2003 to 31 December 2003 and 1 January 2004 to 30 June 2004) the Bank of England base rate at the relevant days was 3.75% and consequently the late payment rate from 1 July 2003 to 30 June 2004 was 11.75%.  This device is imposed on the regime set up by the 1998 Act by its governing directive but there does not seem to be any advantage in reproducing it for the purposes of setting a formula for interest on debt and damages.  
Rates of interest under other existing statutory provisions 
1.55	We noted in our summary of the present law that there are a large number of existing statutory provisions which create an entitlement to interest.  In this Discussion Paper we are concerned primarily with circumstances in which interest is payable as a matter of private law by one person to another rather than where it is payable to or by a central or local government body.  So far as rates of interest are concerned, the statutory provisions applicable to private law relationships which we have identified fall into three broad categories:
(i)	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)	No rate of interest is specified;
(iii)	A rate of interest is specified which is peculiar to the provision in question.
We address each of these in turn.
1.56	Judicial rate specified.  Examples of legislation in which there is a reference to the judicial rate include the Debtors (Scotland) Act 1987, sections 50(5) and 55(7), and the Adults with Incapacity (Scotland) Act 2000, section 81.  A similar rate is found in the Bankruptcy (Scotland) Act 1985.  In section 51 of the 1985 Act, the "prescribed rate" is set by the Bankruptcy (Scotland) Regulations 1985.  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.

1.57	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 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. 
1.58	These provisions would be indirectly affected by our proposals in relation to the rate of interest applicable post-decree in sheriff court actions.  If the post-decree rate of interest were to be aligned with the "compensatory" rate of statutory interest which we have proposed, then this would 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.  Only formal amendment would be needed to existing statutory provisions to achieve this result.
1.59	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 and the Trusts (Scotland) Act 1921, section 29.  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 think it is appropriate for the rate of interest due under these provisions to be the new statutory rate which we are proposing and express provision should be made in new legislation to this effect.  No amendment would be required to the existing provisions themselves.
1.60	Rate other than the judicial rate specified.  Examples of legislation with its own rate specified include the Partnership Act 1890, sections 24(3) and 42(1), the standard conditions in Schedule 3 to the Conveyancing and Feudal Reform (Scotland) Act 1970 and the Insolvency (Scotland) Rules 1986, rule 4.66.  We have already made recommendations in our Report on Partnership Law in relation to interest on partners' advances and on the value of the share of an outgoing partner which would see the present 5% rate replaced by a commercial rate of interest.  We see advantages in bringing other such statutes in line with our proposals regarding a statutory rate of interest which reflects commercial rates.  We suggest that legislation specifying a rate other than the judicial rate should be reviewed to assess whether it would be appropriate to substitute the statutory rate which we are proposing to be prescribed.
1.61	We invite views on the following questions:
39.	(a)	Where a statute currently provides for interest to run at the post-decree rate, should interest run at the statutory rate which we have proposed or (if different) should it continue to run at the rate applicable after decree?
		(b)	Where a statute currently provides for interest to run without specifying the rate, should interest run at the statutory rate which we have proposed or (if different) should it run at the rate applicable after decree?
		(c)	Are there any statutes which currently provide for interest to run at a rate other than the post-decree rate which should be amended to provide for interest to run at the statutory rate which we have proposed or alternatively (if different) at the rate applicable after decree?
1.62	Thus far we have considered only statutory provisions which regulate entitlement to interest in private law relationships.  Most of the existing 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.  It is worth noting that the existing statutory provisions contain a very wide variety of specified rates for interest to run.  Sometimes compounding is specified and sometimes it is not.  We appreciate that there will be factors peculiar to individual circumstances which may make it appropriate for interest to run at different rates on different sums of money.  Nevertheless, we take the opportunity to invite views on the following question:
40.	Are there any other rates of interest specified in statutory provisions which ought to be brought into line with the statutory rate which we are proposing in this Discussion Paper for contractual and non-contractual debts and damages?