Stirring up interest

 Why we need a fix

A builder carries out work on an extension to the house of one of his regular customers. When the job is finished he submits his bill for £25,000. Although there is no complaint about the work which he has carried out, the house owner does not pay. Time goes by and, despite several reminders, the bill remains unpaid. Eventually, the builder has no alternative but to sue for payment. He has been deprived of the use of the money which he is owed, but his entitlement to interest begins only after the action for payment has been raised.

Or take an example nearer to home. A solicitor acts for a client in a messy divorce which takes almost two years to complete. The solicitor submits regular accounts for work carried out but nothing is paid. She has a longstanding relationship with the client, for whom she has regularly done conveyancing and other work over the years and is reluctant to jeopardise that relationship by suing for payment. Finally, there is no alternative but, once again, interest does not run until court proceedings have begun.

Wrongful withholding

Why can interest on contractual debt only be demanded from “the date of citation”? Because, according to Scots case law, it is only when a judicial demand has been made that the money can be said to be “wrongfully withheld”, creating an entitlement to demand interest. This unsatisfactory situation, which arises out of the reliance which the courts have placed upon certain dicta – mainly obiter – in two 19th century cases, Carmichael v Caledonian Railway Co (1870) 8M (HL) 119 and Blair’s Trs v Payne (1884) 12R 104, is peculiar to Scots law. Fossilisation of the judicial demand rule was completed in Dean Warwick Ltd v Borthwick 1983 SLT 533, when the court observed: “There is here a rule of law, a rule that interest runs from citation, and one which does not admit of modification by the exercise of judicial discretion.”

Subsequently, Lord Hamilton, delivering the opinion of an Extra Division in Elliott v Combustion Engineering Ltd 1997 SC 126 at 133, observed: “It may be a matter of concern that in modern commercial contexts the law does not in general allow for interest to run on debts from a date earlier than judicial demand. However, reform of the law on interest on debt is a matter for the legislature, as was reform of the law on interest on damages.”

This suggestion was taken up in a reference by the Scottish Ministers to the Scottish Law Commission in November 2003, inviting the Commission to make recommendations as to possible reform of the law relating to interest on claims for payment of money from contractual and other obligations. The Commission’s Report on Interest on Debt and Damages (Scot Law Com no 203), including a draft bill, in response to this reference has now been published, and is available on the Commission’s website at www.scotlawcom.gov.uk/downloads/rep203.pdf .

Patchwork of rights

In 1998 the position regarding business-to-business debt was altered by the Late Payment of Commercial Debts (Interest) Act, which in implementation of the UK’s obligations under an EU directive created an implied contractual entitlement to interest where both parties to a contract are acting in the course of a business. Our investigations indicated that this Act is not as widely utilised as one might expect, possibly because the entitlement which it creates is to interest at a punitive rate. It would not, in any event, apply to either of the examples at the beginning of this article.

The present law contains other anomalies. Interest on damages, as opposed to debt, is governed by statute and (borrowing the English approach) runs at the court’s discretion from a date not earlier than the time “when the right of action arose”. This might in practice be earlier or later than the date of citation. Other types of non-contractual debt, such as claims for repetition, salvage, aliment and money held subject to an obligation to account, have differing rules not all of which have been clearly enunciated by case law. Perhaps this is because interest tends to be dealt with briefly as a footnote to the court’s decision on the main point in dispute. The rate of interest due on unpaid debt and on damages tends, in absence of a clear alternative, to follow the judicial rate for interest post-decree (currently 8%).

The recommended right

The Commission recommends the replacement of this incoherent patchwork of rules by a statutory entitlement to interest which runs regardless of whether a court action is raised. In formulating our recommendations we adopted three guiding principles:

•     interest should run on pecuniary claims during the same period regardless of whether the claim is for contractual debt, non-contractual debt or damages;
•     interest should provide the creditor with realistic compensation for loss of the use of money, but should not punish the debtor for late payment;
•     interest should compensate the creditor for loss of the use of money throughout the period during which the loss has been sustained.

The wide scope of the proposed statutory entitlement is apparent from the first subsection of our draft bill: “A person entitled to payment of a sum of money is entitled to interest on that sum in accordance with the provisions of this Act.”

The usual starting date for interest to run would be the date on which the principal sum falls due. In many cases that date can be left to be determined by the general law. The draft bill does, however, specify the starting date for interest to run in relation to certain types of contractual debt. In the case of payment for supply of goods and services, interest would run from the date 30 days after whichever is the later of the date when the supplier’s obligation is performed and the date on which the debtor has notice of the amount demanded (whether or not that amount is disputed). This is the rule which would apply to the examples with which this article began. Special provisions would apply to sums due under a contract of insurance, and under a contract of employment. Interest on loans would run (as under the current law) from the date when the loan is made.

Parties to a contract would be free to agree that interest would run on a different basis from the statutory entitlement or, indeed, to agree that interest should not run at all. Entitlement to claim interest under the 1998 Act instead of under our proposals is preserved. Other statutory entitlements to interest would not be disturbed. There would be a limited judicial discretion to decide that, by reason of the conduct of the creditor, it would be in the interests of justice that interest should be remitted in whole or in part.

During the consultation period which preceded publication of our report, concern was expressed by some respondents that the creation of a statutory entitlement to interest on debts such as utility bills and domestic rent could exacerbate the difficulties of financially vulnerable members of the community. We shared these concerns but could see no basis in principle to exclude such debts altogether from the scope of the proposed legislation. Instead, our bill includes a ministerial power to exempt specified categories of debt from statutory interest if, as a matter of social policy, they consider it desirable to do so.

Interest on damages

The current law in relation to interest on damages rests on a wide-ranging discretion of the court to award interest at any rate and for any period since the date when the right of action arose: Interest on Damages (Scotland) Act 1958, s 1, as amended by the Interest on Damages (Scotland) Act 1971, s 1. In the case of damages for personal injury this discretion becomes an obligation to award interest unless there are reasons special to the case not to do so. Out of these rather opaque statutory provisions, which were received unenthusiastically when passed, certain rules of thumb have emerged as to when interest should run, and at what rate. In particular, established practice is to award interest at half the judicial rate on a sum such as solatium which accrues over a period of time. Our recommendations would replace the existing legislation with a more directly stated entitlement which, we believe, accords with both principle and current practice. Statutory interest would run on each head of loss from the day when that loss is sustained. Where a loss is sustained over a period of time, the “half rate” rule could continue to operate. The current rule in relation to the effect of a tender is also preserved and clarified.

At present, a successful litigant rarely has a right to interest on outlays (such as professional fees) incurred during the litigation; we recommend the creation of a general right to interest running from the time when such outlays are paid.

Compensatory rate

A critical feature of our recommendations is that statutory interest should run at a rate which compensates the creditor for late payment without unduly penalising the debtor. We recommend replacement of the “judicial rate”, which changes infrequently and is usually out of step with commercial rates, by a rate of simple interest which is set by reference to a bank base rate and which fluctuates with the base rate. A rate around 1.5% above the Bank of England official dealing rate would achieve the requisite balance. Speedy calculation of interest could be achieved by providing a calculator on an appropriate website which would be kept up to date whenever the base rate changed. (Since the beginning of the consultation period we have maintained a demonstration calculator on the Commission’s website.)

An incentive to pay?

We believe that the legislation which we propose would provide a simpler and fairer regime than the current one which has developed without a coherent underlying basis. It is hoped that the introduction of a statutory entitlement which exists independently of the raising of court proceedings, taken together with the linking of the rate of interest to the real cost of late payment, would encourage creditors to demand interest when it is due, leading perhaps, in turn, to a tendency for debts of all kinds to be settled more promptly.

    Colin Tyre QC is a member of the Scottish Law Commission

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SLC PAPERS ONLINE

All recent Scottish Law Commission publications can be viewed on the Commission’s website. The report on interest is at www.scotlawcom.gov.uk/downloads/rep203.pdf