Interest on damages: what rate?

On 20 February 2013, Lord Eassie delivered the Inner House’s decision in Farstad Supply AS v Enviroco Ltd [2013] CSIH 9, effectively underscoring the decision of the Lord Ordinary (Hodge): [2011] CSOH 153.

Farstad owned an oilrig supply vessel which was docked in Peterhead harbour. On 7 July 2002, a fire broke out in the vessel, apparently the fault of Enviroco – one presumes its workmen. It appears that Farstad paid for the remedial work itself and sued in early 2007 (prior to the quinquennium) in the sum of £2,514,761.38. The action settled extrajudicially on the eve of proof, in 2011, in the sum of £1,750,000. Controversy remained as to the interest rate.

Conventionally, Farstad had pled that interest should run “at such rate or rates as the court shall think fit”, and sought the legal rate of 8%. Enviroco contested this, pleading: “the pursuers are only entitled to the rate of interest which would put them into the same position in which they would have been if they had not suffered loss and damage”. It was said that if Farstad was granted interest at 8%, it would effectively be provided with a bonus.

Several things are common ground here. First, per the Interest on Damages (Scotland) Act 1958, the court will only ever award simple interest, never compound interest. On the face of it this places the pursuer at a disadvantage in that had he had the money to invest, he could have earned interest on a compound basis.

Secondly, although the legal rate has fluctuated from time to time, base rates have changed far more frequently; and generally speaking, the legal rate has lagged well behind the markets.

Thirdly, it appeared to be common ground that interest should run from the date of the event complained of – the fire – rather than from the commencement of the action.

Measure of compensation

Note that the legal rate is generally higher than base rate plus margin. To a degree, this compensates for the lack of compounding. This is a fairly broad brush approach, but has a number of benefits. The court will not analyse the pursuer’s loss of interest down to the last penny, which would require an inordinate amount of court time. Secondly, it avoids argument as to whether the pursuer should be compensated on the basis of interest that he could have earned, or for having had to borrow money (at a different rate). Thirdly, both sides know how the equation will be applied.

When the legal rate of 8% was applied, that was in excess of 2% over the rate known as base rate. Essentially, Enviroco contended that such was the discrepancy that if Farstad were awarded interest at the legal rate, they would receive a free bonus, and Enviroco would be penalised, contrary to the purpose of charging interest.

In the discussion part of his opinion, Lord Hodge noted a number of propositions. First, the winning pursuer was entitled to interest, to compensate for loss of use of the money, or other asset. Secondly, this compensation should be just that, not a penalty. Next, the court has a discretion; but equally there should not be a wide departure from normal practice, and it was not within the power of the Lord Ordinary to award interest on a “novel” basis, such as a rate linked to base rate (as in some English courts).

In the event, and exercising his discretion, Lord Hodge acknowledged that he, in line with general practice, needed to apply a broad brush. He awarded 8%, the legal rate, from 31 December 2002 (presumably when Farstad paid for remedial works and became out of pocket).

However, on 4 December 2008, base rates fell to 2%. In his Lordship’s view, the discrepancy between legal rate and bank rate became so wide at that point that it should be recognised. He awarded interest at 4% from 4 December 2008 down to the date of the interlocutor. Thereafter, the rate reverted to 8% – to encourage the defenders to settle quickly.

Discretion affirmed

Both sides reclaimed, Farstad contending that the full 8% should be charged over the entire period, following established practice, whilst for Enviroco the compensatory principle was stressed, and that Farstad had not demonstrated the loss claimed. The applicable rate should be an average.

Delivering the opinion of the court, Lord Eassie, along with Lords Mackay of Drumadoon and Marnoch, dismissed both appeal and cross-appeal. The Lord Ordinary was rightly concerned about the mismatch between the judicial and market rates from the time of the financial crisis in autumn 2008. Essentially, a successful pursuer awarded 8% would indeed be making a profit out of the situation, and a defender penalised. With that in mind, the Division underscored the Lord Ordinary’s decision and discretion.

The moral of all this? Unless there is a contract that establishes the rate of interest, or formula, the normal practice is for the court to apply the legal rate. However, the court has a discretion, and this case demonstrates that this will be applied if the discrepancy between commercial rates (lending or borrowing) and the legal rate becomes so marked as to give unfair advantage to the pursuer on the one hand, and penalise the defender on the other. The lesson appears to be to put something in your pleadings to indicate that the legal rate is going to be challenged: the fact that Enviroco did so appears to have figured to no small degree in Lord Hodge’s original assessment.