The Court of Session in Edinburgh has recently considered whether the judicial rate of interest (8%) was appropriate in light of the prevailing market conditions and interest rates in recent years.  The court has discretion to award interest for any period between the date when a right of action arises and the date of the resulting decree, and can determine the applicable rate. 

Up until now, it has been the usual practice of the Scottish courts to award pre-decree interest on the sum due at the judicial rate of 8%.  However, for some time there has been discussion amongst insurers and others voicing a concern that such a rate provides excessive compensation.

In Farstad Supply AS v Enviroco Limited [2011] CSOH 153, the court was given an opportunity to consider the appropriate rate.  The parties settled a damages action stemming from a fire on board an oil rig supply vessel on the eve of a proof but left determination of the appropriate rate of interest to the court. 

The court pointed out that the reason behind the judicial rate was to provide certainty as well as a simple broad brush approximation of the loss to a pursuer.  However, Lord Hodge noted that the market rates on most forms of deposit and on many forms of borrowing have moved so far from the judicial rate that it is no longer an approximation of the loss which pursuers have suffered.  He therefore considered it open to him to “take into account the clear mismatch between the judicial rate and market rates in recent years” in coming to his determination. 

Lord Hodge took a broad approach to identifying a time when the mismatch between the rates became so pronounced that the judicial rate became significantly over-compensatory.  He noted that “it appears to me that there was a watershed in late 2008 and early 2009 when the base rate plummeted from 5 per cent in early October 2008 to 0.5 per cent in March 2009.”  He therefore applied the judicial rate from the date of the loss in 2002 to 4 December 2008.  Thereafter he considered that the applicable rate should be 4% (which readers will note is still significantly over the lowest base rate of 0.5%).

It should be noted that the reasoning of the court only applies to pre-decree interest.  The judicial rate of interest in relation to interest post-decree will likely remain untouched, despite being “mildly penal”, as a means of encouraging defenders to pay awards of damages promptly.

Pursuers and defenders should therefore be aware of the potential that the court may amend the judicial rate of interest to reflect market conditions, and plan accordingly.