Matt Enston, an Associate in our Dry Shipping Group, comments on the recent decision of the House of Lords in Sempra Metals Ltd v Inland Revenue Commissioners [2007] UKHL 34 (“Sempra”) which indicates that compound interest is in principle recoverable in restitution claims, and as damages for breach of contract and in tort.

The position pre-Sempra

The Sempra decision represents an important development in the law relating to the recovery of interest in restitution and damages claims.

With regard to restitution claims – that is, claims for the return of property or unjustified gains to the rightful owner/beneficiary – pre-Sempra, the position was essentially that the courts did not have power to award compound interest. Therefore, where (for example) a party mistakenly paid a sum of money to another party, whilst the first party was entitled to recover the principal sum, it was unable to recover the interest on that sum which the second party would or should have received. With regard to damages claims, claimants in the English Courts typically claimed interest on damages awarded to them, and the court has discretionary power to award simple (but not compound) interest under section 35A of the Supreme Court Act 1981.

Further, the judgment of the House of Lords in President of India v La Pintada Cia Navigacion SA [1985] AC 104 indicated that a claimant could recover interest as damages for the loss of use of money if that loss fell within the second limb of the Hadley v Baxendale rule: that is, a loss which may reasonably be supposed to have been in the parties’ contemplation at the time they entered the contract as the probable result of a breach. Oddly, however, the judgment in that case indicated that interest losses were not recoverable under the first limb of the Hadley v Baxendale rule (that is, on the basis that they were losses arising in the ordinary course of things as a result of the defendant’s breach).

The judgment in Sempra

The Sempra case concerned a claim in restitution by Sempra Metals Ltd against the Inland Revenue for the time value of money (in the form of corporation tax) which had been paid prematurely under mistake and/or pursuant to the Revenue’s unlawful demand.

The main issue before the House of Lords was essentially this: is a claimant entitled to recover compound interest in restitution?

In essence, it was held that Sempra Metals Ltd was entitled to recover compound interest, on the basis that its premature payments had (unjustly) given the Revenue the use of the money. The Lords determined that Sempra was entitled to recover the time value of the money, and in accordance with the normal principle in restitution claims – which is to be distinguished from the compensation principle applied to damages claims – the time value of money was to be assessed according to the cost to the defendant of borrowing the money on normal commercial terms. In that respect, although it may in the normal course be open to the government to borrow money on more favourable terms than are available publicly, the Lords held that the time value of the money was to be assessed objectively. Therefore, given that money is typically borrowed on terms that require payment of compound interest, that was the measure of the benefit enjoyed by the Revenue, for which it had to account to Sempra.

Damages claims

Whilst the principal issue before the House of Lords in Sempra concerned a claim in restitution, the judgment also indicates that compound interest should as a matter of principle be recoverable as damages in breach of contract and tort claims, subject to the usual rules of proof and remoteness.

In other words, claimants will no longer be restricted to claims for interest on damages (under the Supreme Court Act), nor will they necessarily be required to frame their claim for interest losses as a claim under the second limb of Hadley v Baxendale. Instead, they may claim compound interest as damages, providing the losses are not too remote. This aspect of the judgment was obiter dicta, but it is likely to be followed by other courts.

The House of Lords was however keen to stress two points. First, that claims for interest would have to be specifically pleaded and proved – a general claim for “damages” would not suffice, and the court would not presume interest losses – and second, that the Sempra judgment should not be taken as meaning that compound interest will always be recoverable as damages: any claim for interest must be pleaded and proved as a separate item of loss.

Practical consequences

The precise nature of the court’s power to award compound interest will no doubt be explored and further clarified by the courts. However, at first blush, it seems that the practical effects of the judgment in Sempra are that:

1. a claimant may now claim in restitution compound interest on money which it paid by mistake; and

2. a claimant may also claim compound interest as damages, providing (a) it can prove its loss, and (b) the interest loss either (i) arose in the ordinary course, as a result of the defendant’s breach, or (ii) can reasonably be determined to have been in the parties’ contemplation at the time the contract was entered into as the probable result of the breach.

Finally, given that the right to recover compound interest as damages is a common law and/or equitable remedy, the relief should be available in arbitration, as well as in High Court litigation. The Arbitration Act 1996 does of course already provide arbitrators with discretion to award compound interest on damages.