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You are here: BAILII >> Databases >> Scottish Law Commission >> Scottish Law Commission (Reports) >> Interest on Debt & Damages (Report) [2006] SLC 203(1) (1 September 2006) URL: http://www.bailii.org/scot/other/SLC/Report/2006/203(1).html Cite as: [2006] SLC 203(1)

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PART 1: Introduction

Terms of reference

1.1                In November 2003 we received the following reference^[1] from the Minister for Justice, Cathy Jamieson MSP:

"To examine the law of Scotland relating to interest on claims for payment of money arising from contractual and other obligations, including claims within the jurisdiction of tribunals and courts or submitted for decision to arbitration, adjudication or some other form of dispute resolution, and to make recommendations as to possible reform of the law."

1.2                The law of Scotland in relation to entitlement to interest on claims for payment of money has evolved over a period of many centuries. Although interest has now come to be regarded as an appropriate means of compensating a person for the loss of the use of money which he ought to have had, there has never been a comprehensive statutory scheme determining entitlement to interest. In recent years there has been legislation dealing specifically with interest on damages and on commercial debts. The result is a system which, subject to these exceptions, has become crystallised around rules laid down in the latter half of the 19^th century and reflecting even earlier social attitudes. It lacks principle and consistency. Interest may or may not run on a claim for payment depending upon whether it is categorised as a debt or as a claim for damages. In the case of debt arising under a contract which contains no express stipulation for interest, an entitlement to interest will not generally commence unless and until a court action for payment has been raised. If, however, the claim is categorised as a contractual claim for damages, interest may run, depending upon the exercise of the court's discretion, from any time from the date when the right of action arose. In Elliott v Combustion Engineering Ltd,^[2] Lord Hamilton, delivering the Opinion of the Extra Division, 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."

In this Report we recommend the creation of a general statutory entitlement to interest, to run from the time when a sum of money becomes due by one person to another, whether by way of debt or damages.

Consultation and research

1.3                Our Discussion Paper on Interest on Debt and Damages was published in January 2005. We invited comment on our proposal to introduce a statutory entitlement to interest on sums which have fallen due for payment which would apply regardless of the nature of the creditor's claim. We also sought views on the appropriate rate of interest and on the question whether the entitlement should be to simple or to compound interest. We are grateful to all those who responded to the Discussion Paper.^[3]
1.4                In preparing the Discussion Paper and this Report we have been assisted by an Advisory Group whose members are listed below.^[4] We held a meeting with a representative of the Forum of Scottish Claims Managers^[5] to discuss our proposals in relation to interest on sums due under contracts of insurance. We also discussed our proposals regarding interest on judicial expenses with the Auditor of the Court of Session.^[6] The contributions of all those who have provided us with the benefit of their advice are much appreciated.
1.5                Prior to publication of the Discussion Paper, we carried out a study of claims made in court in order to ascertain what kind of interest was usually claimed in practice. Our methods and an analysis of our results were set out in an appendix to the Discussion Paper. The results of this exercise were inconclusive. There was some evidence that interest under the Late Payment of Commercial Debts (Interest) Act 1998 was not always claimed by pursuers in circumstances where it appeared prima facie that a claim would be valid. In other cases, a variety of interest rates were claimed in summons and initial writs, which seemed to bear little relation to the nature of the claim. We suggested in the Discussion Paper that if any conclusion could be drawn from our research, it was perhaps that entitlement to interest is not always considered carefully by court practitioners at the time when the writ is drafted and lodged.

Guiding principles

1.6                The primary purpose of an award of interest is to acknowledge the fact that by being deprived of the use of money, a creditor has been unable to benefit from the use of the money or, alternatively, has incurred loss as a consequence of not having it to hand. Similar considerations apply to a sum claimed by way of damages: so long as the damages remain unpaid the claimant is deprived of that sum of money. If the claim is for losses incurred in the past, the claimant of damages is in a position analogous to that of the creditor of an unpaid contractual debt. The effect of an award of interest is to compensate the creditor by redressing the balance and, in theory, leaving both parties in the same position as if the debt had been paid when it fell due or, in the case of damages, as if reparation had been made as soon as the loss was sustained. Neither the claimant nor the debtor then benefits from delaying settlement or judicial determination of the dispute.
1.7           An award of interest can also be used to encourage early settlement of claims by penalising late payment. This occurs when the rate of interest awarded by the courts exceeds commercial rates so that the debtor ends up worse off by delaying payment than he would have been if he had paid immediately. An example of the use of interest for this purpose is the Late Payment of Commercial Debts (Interest) Act 1998^[7] under which the rate of interest is deliberately set well above bank minimum lending rates^[8] in order to penalise businesses who fail to pay their debts timeously. In recent years, the same effect has, in practice, occurred in Scotland in relation to awards of interest at the judicial rate^[9] which has from time to time exceeded commercial rates of interest by several percentage points. However, the terms of our reference do not merely cover situations in which the debtor is acting wrongfully in failing to make payment; they also cover situations in which the debtor may have good reason for not making immediate payment but where payment is subsequently agreed or found by a court to be due. There may have been a legitimate dispute as to whether any sum is due or, if so, how much. The defender in a court action may, for example, be justified in demanding further proof of the incurring of a loss before admitting the claim. In such circumstances, the pursuer still deserves to be compensated for loss of use of the money during the period of dispute but the debtor does not deserve to be penalised for refusing to make earlier payment.
1.8           There are therefore two approaches to interest which could be taken as a matter of principle. On the one hand, interest could be set at a punitive rate to encourage early payment subject to a court discretion to mitigate the penal element in appropriate cases by means such as reducing the rate or reducing the period during which interest runs. On the other hand, interest could be set at a compensatory rate subject to any specific exceptions in which it is regarded as proper to use interest as a "weapon" to penalise late payment. We favour the latter approach as being more appropriate to a comprehensive reform of the law of interest on debt and damages. In our view, the general rule should be that entitlement to interest should be neutral as between the parties so that neither benefits from delayed payment.
1.9           Nor, in our view, should it matter whether the claim takes the form of an action for payment of a debt or an action for damages. The common characteristic is that the claimant is being deprived of the use of money to which he is entitled. The form which his claim must take makes no practical difference to him. Whether the principal claim is for payment of a debt or payment of damages, the claim for interest could be regarded as a claim for damages for late implement of the principal obligation: it seems to us that there is no difference in principle which would warrant a different commencement date for the running of interest or a different rate of interest.
1.10           In the Discussion Paper we invited comment on our proposal to adopt the following principles as guidance for reform of the law of Scotland relating to interest on contractual and non-contractual debt and on damages:

•    So far as practicable, interest should run on pecuniary claims during the same period and at the same rate regardless of whether the claim takes the form of a claim for payment of a contractual debt, a non-contractual debt or damages.

•    The primary goal of an award of interest should be the realistic compensation, in commercial terms, of the creditor for loss of the use of money or property. Interest should not as a general rule be payable at a punitive rate.

•    An award of interest should compensate the creditor for loss of the use of money or property throughout the period during which that loss has subsisted.

Our consultees were agreed that these principles afforded a coherent basis for reform of the present law. In the draft Bill annexed to this Report we have endeavoured to give them statutory effect.

Summary of our main recommendations

1.11           Part 3 of the Report deals with debts of both contractual and non-contractual origin. We recommend the introduction of a statutory entitlement to interest. Such an entitlement exists already^[10] in relation to certain types of contract where both parties are acting in the course of a business, but our recommendations would apply to a wider range of contracts and in particular to contracts where at least one of the parties is not acting in the course of a business. In contrast to the 1998 Act, our recommendations would apply to all debts and not merely to debts arising from the supply of goods or services. We recommend a general rule that interest should start to run on the date when payment is due. In relation to contracts for the supply of goods and services we recommend the adoption of the same commencement dates for the running of interest as are used in the 1998 Act, namely the date for payment agreed by the parties or, failing such agreement, 30 days after the later of the day on which the supplier's obligation is performed and the day on which the purchaser has notice of the amount claimed by the supplier. In relation to loans, we recommend retention of the current presumption that interest runs from the date when the loan is made. As regards insurance claims we recommend that interest should begin to run 30 days after the date when a claim in respect of the occurrence of the event insured against is intimated to the insurer and vouched in accordance with the conditions of the contract, with special provision for cases where the insurer's obligation is to repair, reinstate or replace rather than to make a payment to the insured. Our recommendations would also apply to sales and leases of land, and to earnings from employment. There would, however, be a Ministerial power to exclude specified categories of debt from the scope of statutory interest.
1.12           The statutory entitlement which we recommend would not apply where the parties have made express provision in their contract in relation to entitlement to interest. In particular, it would remain open to the parties to agree that no interest would be payable on debts due by one party to the other. Nor would it apply to any circumstances in which provision for payment of interest is made by any other statutory provision. Thus, for example, interest on taxes and duties, and on compensation for compulsory purchase, which is already provided for by legislation, would be unaffected by our recommendations.
1.13           We recommend that the statutory scheme should also apply to non-contractual pecuniary claims such as claims based on unjustified enrichment, claims for legal rights, claims for salvage and claims for aliment.
1.14           In Part 4 of our Report we recommend a change in the existing statutory provisions which determine the commencement date for the running of interest on damages. At present the court has a discretion to award interest for any part of the period since the date when the right of action arose and a duty to award interest on damages or solatium for personal injury unless satisfied that there are reasons special to the case why no interest should be given. Under our recommendations, these discretionary powers would be replaced by an entitlement to interest on each head of loss (including solatium for personal injury) from the date when the loss in question was sustained.^[11] For some types of loss this is not intended to lead to any change from existing practice and we believe that it will clarify the law in relation to others.
1.15           In Part 5 we consider in relation to both interest on debt and interest on damages the extent, if any, to which a discretion should be given to the court to remit interest: in other words to decide that interest which would be payable in terms of our draft Bill need not be paid. Our recommendation is that the court should have a limited power, as regards both interest on debt and on damages, to decide that, by reason of the conduct of the person to whom interest would be payable, no interest, or a lesser amount of interest, should be paid.
1.16           Part 6 applies the principles of our recommendations to tenders, interim payments and judicial expenses.
1.17           Part 7 contains our recommendations in relation to the rate at which statutory interest should run. We believe that the rate selected should provide adequate compensation for the creditor but should not be punitive like the rate under the 1998 Act. We consider that a rate 1.5% above the Bank of England rate would give effect to this principle, being a rate at which large businesses can borrow and at which small businesses and consumers can also borrow by secured loan. We recommend that statutory interest should be simple and not compound interest, although our other recommendations would not be affected if it were decided to specify a compound rate.
1.18           Parts 8 and 9 apply our recommendations to disputes resolved by tribunals, arbiters and adjudicators.

Legislative competence

1.19           The recommendations made in this Report generally lie within the legislative competence of the Scottish Parliament. None would result in amendment to any of the enactments set out in Schedule 4 to the Scotland Act 1998 which cannot be modified by the Scottish Parliament. Certain consequential provisions in our draft Bill might be regarded as relating to reserved matters, such as the proposed amendments to the Bills of Exchange Act 1882, the Partnership Act 1890 and the Insolvency (Scotland) Rules 1986 and to the interest-awarding powers of employment tribunals. However, our view is that the purpose of these amendments is to apply our recommendations in relation to rate of interest consistently to these types of payment as to others.^[12] If a contrary view were to be taken, any implementing legislation would to that extent have to be enacted by the UK Parliament.
1.20           In our view our recommendations and the provisions of the draft Bill would not give rise to any breach either of the European Convention on Human Rights or of European Community law.

Note 1   Under the Law Commissions Act 1965, s 3(1)(e).    [Back]

Note 2   1997 SC 126 at 133.    [Back]

Note 3   A list of consultees who submitted a written response to the Discussion Paper is at Appendix C.     [Back]

Note 4   Mr John Downie, formerly Head of Press and Parliamentary Affairs, Federation of Small Businesses in Scotland; Dr Lucy O'Carroll, Economist, HBOS; Mr David Stevenson, Solicitor, Thompsons; Sheriff Principal James Taylor; Mr Michael Wood, Solicitor, Simpson & Marwick.     [Back]

Note 5   Mr Andrew Wilkinson.     [Back]

Note 6   Mr Neil Crichton.     [Back]

Note 7   See para 2.3.     [Back]

Note 8   The rate specified for the 1998 Act is 8 per cent per annum over the official dealing rate of the Bank of England (the official dealing rate being the rate at which the Bank is willing to enter into transactions for providing short term liquidity in the money markets): Late Payment of Commercial Debts (Rate of Interest) (Scotland) Order 2002 (SSI 2002/336), arts 3 and 4.     [Back]

Note 9   Rules of the Court of Session, rule 7.7 as amended; Sheriff Courts (Scotland) Extracts Act 1892, s 9 as amended.     [Back]

Note 10   Under the Late Payment of Commercial Debts (Interest) Act 1998.     [Back]

Note 11   See paras 4.3-4.6.     [Back]

Note 12   Cf Scotland Act 1998, s 29(4).     [Back]