Scottish court calls for "urgent" review of standard rates of interest on awards

The comments came at the end of an Inner House ruling in which judges were forced to apply interest "far in excess" of market rates to a sum due in a long-running dispute between Norwegian shipping company Farstad Supply AS and Enviroco Ltd. In his leading judgment, Lord Eassie said that he was unable to "retroactively depart from settled practice".

"It is plain that the mismatch between the judicial rate and interest rates prevailing in the financial world which has existed following the crisis of 2008 is a matter of concern," he said. "In the absence of a wider reaching reform of the law relating to the awarding of interest ... the responsibility for updating the current judicial rate, to meet that mismatch, falls to the Rules Council."

"It is for that council to consider - we would suggest urgently - the clear mismatch identified by the Lord Ordinary, which we ourselves would endorse, and which is widely recognised by all engaged in litigation before this court," he said.

Craig Connal QC, a litigation expert with Pinsent Masons, the law firm behind Out-Law.com, said that although the court was right to call for an urgent review of the standard rate, "arguably this does not go far enough".

"For commercial parties litigating in the Scottish courts interest can be the hidden peril - everyone is focussing on the main picture, not on far-off detail," he said. "If matters are resolved, well and good; but for those cases which do go the distance, explaining to a litigant that at a point of all-time low in interest rates they may have to pay 8% on any award is likely to be met be raised eyebrows at best."

"If there is a claim for interest from a date earlier than the start of the court case, when the party is clearly warned of the claim and potential rate of interest, then the rules ought to specifically allow for flexibility to reflect what has actually been lost. If the matter was made clear dispute might be minimised - music to the ears of business," he said.

Enviroco had already agreed to settle Farstad's damages claim, which was the result of a fire that broke out on Farstad's ship while it was berthed in Peterhead in 2002. The parties had agreed a principal sum of £1,750,000, but disagreed over the rate of interest to be applied to that amount. Farstad demanded interest at a rate of 8%, the rate which has been applied in decrees granted by the Scottish courts since 1993. Enviroco disagreed, arguing that this rate was so much higher than market rates that it would "provide [Farstad] with a bonus, rather than properly compensate them for their loss".

The 'judicial rate' of 8% per annum has applied since 1 April 1993. Over this period there have been dramatic reductions in the Bank of England base rate, which fell from 4.5% per annum at the start of the financial crisis in November 2008 to 0.5% per annum by the following March, according to the court. The rate has been held at 0.5% since 2009, resulting in "broadly reflective sharp reductions" in the interest rates available to depositors over the same period, according to the court.

The general purpose of damages is to put the injured party back into the position it would have been had the action not occurred. In England and Wales, courts usually award interest at one percentage point above the base rate from time to time prevailing over the relevant period. In his original decision, the Lord Ordinary said that the approach adopted in both jurisdictions was a "broad brush approximation" of the cost of borrowing on the open market. Taking account of the dramatic fall in the base rate in 2008, he awarded a rate of 8% from 31 December 2002 to 4 December 2008 and 4% over the period after this date.

On appeal, the Inner House upheld the Lord Ordinary's reasoning. There were "no circumstances special to this case which called for any modification of the general practice of the court" for the period leading up to December 2008, Lord Eassie said. It was "impossible to say" that the Lord Ordinary's decision to award interest at 4% after this date had breached the general compensatory principle, as argued by Enviroco, without detailed expert evidence, he said.

Lord Eassie said that the Rules Council of the Court of Session had been alerted to "concerns among insurers and others" about the disparity between the judicial rate and other rates of interest at its recent meetings. However, it had decided to make no change. The Scottish Government consulted on possible changes to interest on damages following the publication of a report by the Scottish Law Commission in 2006, but has not yet proceeded with any changes.

"In these circumstances we do not consider that it would be appropriate for this court to proceed to innovate retroactively by what would be, at least arguably, in large measure a judicial and retroactive legislative implementation of measures along the lines of recommendations from the Scottish Law Commission which government is as yet unwilling to adopt," he said.