WFU Law School
Law & Valuation
1.4 Legal applications

1.4.1 Pre-judgment Interest

Justice is not immediate. It may take months or (very often) years before an injured party receives an enforceable judgment. To compensate for the loss of the use of funds and the effects of inflation after the party suffers cognizable economic damages, courts sometimes award "pre-judgment interest."

At first glance, it may seem that prejudgment interest would be of minor importance—only a small percentage tacked on to the principal award. Indeed, for centuries many courts have approached the issue with this attitude. But, as the time between injury and judgment grows—as it often does in complex, high-stakes litigation—the potential impact of prejudgment interest grows also.

Despite the importance of prejudgment interest, there is no uniform method for determining it. In some jurisdictions, courts have wide discretion on whether and how to calculate the prejudgment interest and what factors to consider in determining the interest. In other jurisdictions, there are strict statutory or common law prescriptions on the application and calculation of prejudgment interest.

Example

King Tobacco Company has entered into negotiations with the State of New Columbia to compensate the state for its health-related costs related to tobacco use. The company says it will pay the State of New Columbia $200,000,000 for the payments incurred by the state over the last twenty year -- which have averaged $10 million per year for the last 20 years. (More>>)

 

Simple vs. compound. Some courts may apply only a basic calculation of “simple interest,” while other courts may apply some form of “compound interest.” The common-law rule is that prejudgment interest is not compounded. See Restatement (Second) of Contracts § 354 cmt. a (1981); Michael S. Knoll, A Primer on Prejudgment Interest, 75 Tex. L. Rev. 293 n. 76 (1996).

Many states have liberalized this rule by adopting statutes that set out with varying degrees of specificity the method and manner in which prejudgment interest may be calculated. Whether by case law, statute, or both, the guidelines imposed on a court’s decision to grant prejudgment interest can vary widely.

Choice of rate. When court have discretion to choose the pre-judgment interest rate, many choose an interest rate equal to the defendant's cost of funds.

Lost statutory rights. The methods for computing prejudgment interest may also inform how to value lost statutory rights. For example, when a corporate issuer fails to provide investors registration rights as required by contract, it might be argued that compensation for the lost rights should take into account the lost liquidity value. Using a method of "synthetic registration rights", Professor Barondes asserts the prevailing method of computing the rate of prejudgment interest (the defendant's cost of capital) can improperly shift value from corporate investors to corporate creditors. See Royce de R. Barondes, "Valuing 1933 Act Registration Rights" Working Paper (Dec. 2003).


Consider the approaches in different states on the question of simple or compound interest in awarding pre-judgment interest:

  • New York courts have fairly unfettered freedom to award prejudgment interest, providing that “interest and the rate and date from which it shall be computed shall be in the court's discretion.” N.Y.C.P.L.R. § 5001 (2002).
  • California courts have discretion whether to grant prejudgment interest. Cal. Civil Code § 3288 (2001).The California Supreme Court has recently ruled, however, that this discretion does not include the power to grant compound interest—only simple interest calculations are allowed. Hess v. Ford Motor Co., 27 Cal. 4th 516, 533, 41 P.3d 46, 58 (2002).
  • North Carolina courts must add interest to the principal amount of the award. N.C. Gen. Stat. § 24-5 (2001). The rate is that set by contract agreed upon by the parties or, absent that, the legal rate provided by statute (§ 24-4: 8% per annum, “and no more.” Courts have interpreted the statute as permitting courts to use a rate below the statutory rate.
  • Delaware does not permit compounding of prejudgment interest. Del. Code Ann. tit. 6, § 2301(a) (2001). Notably, however, Delaware courts may choose simple or compound interest in appraisal proceedings. Del. Code Ann. tit. 8, 262(i) (2001).
  • Federal courts are generally granted wide latitude in the award of prejudgment interest—including whether to apply simple or compound interest. See, e.g., Bio-Rad Lab., Inc. v. Nicolet Instrumental Corp., 807 F.2d 964, 969 (Fed. Cir. 1986).
Michael S. Knoll & Jeffrey Miguel Colon, "The Calculation of Prejudgment Interest" SSRN paper 732765 (May 31, 2005)

This Essay describes the proper method of calculating prejudgment interest based on sound financial principles. Using the paradigm that the claim plaintiff holds in litigation represents an involuntary loan from plaintiff to defendant and recognizing that in bankruptcy courts treat legal claims similarly to unsecured debt, we argue that prejudgment interest should be computed using the defendant's unsecured borrowing rate. Furthermore, we argue that courts should use a short-term, floating interest rate rather than a long-term rate in order to provide the proper incentive for the parties to settle. We criticize alternative bases for awarding prejudgment interest and address modifications to account for taxes, insurance, foreign currency conversion, asynchronous payments, and suits involving individual plaintiffs.

***

"Rejecting the Marie Antoinette Paradigm of Prejudgment Interest"

ROYCE DE ROHAN BARONDES, CORI Working Paper No. 2004-12

This paper examines principles for properly computing
prejudgment interest by examining the impact on different corporate constituencies. This paper concludes that prejudgment interest at a promisor's cost of funds can undercompensate promisees, by shifting value from the promisee's equityholders
to its creditors through a forced investment that decreases the risk of the promisee's portfolio of assets.

* * *

"Prejudgment Interest in International Arbitration" Free Download


JEFFREY M. COLON, Fordham University - School of Law
MICHAEL S. KNOLL, University of Pennsylvania Law School, University of Pennsylvania - Real Estate Department

Tribunals in international arbitration are regularly asked by claimants to award prejudgment interest. Unless foreclosed by an agreement between the parties, there is widespread agreement prejudgment interest should put the claimant in the same position as it would have been had it not been injured by the respondent. However, there is little consensus how to calculate prejudgment interest in order to accomplish that purpose.

In this Essay, we describe the proper method of calculating prejudgment interest based on sound financial principles. Using the paradigm that the respondent has forced the claimant to make an involuntary loan to the respondent, we argue that prejudgment interest should be computed using the respondent's borrowing rate. Furthermore, we argue that tribunals should use a series of short-term, floating interest rates rather than a single long-term rate at the commencement of the dispute in order to provide the parties with the proper incentive to settle their dispute. We also discuss how the calculations are different when the parties are individuals and closely held corporations as opposed to corporations and governments, and we address complications that arise when a tribunal calculates damages in one currency and makes a final award in another currency.

* * *

"Interest as Damages" Free Download

THIERRY SENECHAL, International Chamber of Commerce
Email: thierry.senechal@iccwbo.org
JOHN Y. GOTANDA, Villanova University School of Law
Email: gotanda@law.villanova.edu

In this article, we posit that when arbitral tribunals decide international disputes, they typically fail to fully compensate claimants for the loss of the use of their money. This failure occurs because they do not acknowledge that businesses typically invest in opportunities that pose a significantly greater risk than the risk reflected in such commonly used standards as U.S. T-bills and LIBOR rates. Claimants also must share the blame when they do not set out a well-constructed claim for interest as damages. However, even when claimants do so, tribunals often award damages at a statutory rate or at rate reflecting a nearly risk-free investment because they are unfamiliar with modern economic and financial principles. We propose changing this practice. We set out a legal framework for allowing an award of interest as damages and then furnish a model for claimants and tribunals to use. Under this model, interest accrues at a risk-free interest rate plus a market risk premium with the interest award to be compounded on a yearly basis. This model would bring awards in line with modern economic realities and more accurately compensate injured parties.

 

For further reading:

 

Example

Consider the case of In the Matter of: Oil Spill by the Amoco Cadiz, 954 F.2d 1279 (7th Cir. 1992). The suit was brought by the government of France, as well as private French citizens and businesses, against the Amoco Oil Company when one of Amoco’s supertankers, the Amoco Cadiz, ran aground in the North Sea and dumped millions of gallons of oil on the Brittany coast in 1978.

The litigation continued for thirteen years. When the case reached the Seventh Circuit in 1992, the court awarded the plaintiffs $65 million in damages and $148 million in prejudgment interest. The power of compounding interest and the sharp increase in inflation during the late 70’s and early 80’s, along with other factors considered by the court, combined to make the prejudgment interest more than double the principal damages award. (More>>)

1.4 Legal applications

©2003 Professor Alan R. Palmiter

This page was last updated on: April 15, 2008