House of Lords ruling expands availability of compound interest

The House of Lords has held that compound interest is recoverable in a claim for restitution of money paid under a mistake of law and, although strictly obiter, indicated that it would be recoverable in principle in any claim in tort or for breach of contract, including debt claims: Sempra Metals Ltd (formerly Metallgesellschaft Ltd) v Inland Revenue Commissioners and another [2007] UKHL 34. In a ruling in July, their Lordships held unanimously that a claimant in restitution was, in principle, entitled to recover compound interest on the sums by which the defendant had been unjustly enriched. An award of simple interest would not be consistent with principle or reality. This is an important decision which significantly expands the circumstances in which compound interest is likely to be available to a claimant.

Background

The claimants had paid corporation tax prematurely under the English corporation tax regime which was subsequently held to be in contravention of European Community law.  (This was established by the European Court of Justice decision in the Metallgesellschaft / Hoechst joined cases relating to “group income elections” for advance corporation tax).  The claimants claimed in restitution to recover the “time value” of the money which had been paid prematurely under a mistake of law.  (The claimants could have claimed damages for the Inland Revenue’s breach of statutory duty based on the unlawful demand for payment of tax, but chose to pursue their alternative remedy in restitution for limitation reasons).

House of Lords decision

The House of Lords (Lords Hope, Nicholls, Scott, Walker and Mance) held unanimously that a claimant in restitution was, in principle, entitled to recover compound interest on the sums by which the defendant had been unjustly enriched.  An award of simple interest (for which the Inland Revenue argued) would not be consistent with principle or reality.  Lord Nicholls said “We live in a world where interest payments for the use of money are calculated on a compound basis.  Money is not available commercially on simple interest terms. … If the law is to achieve a fair and just outcome when assessing financial loss it must recognise and give effect to this reality”.

The majority (Lords Hope, Nicholls and Walker) held that the rate of interest did not depend on proof of what the defendant actually did with the money.  The defendant was presumed to have derived benefit from the opportunity to “turn the money to account” during the period of enrichment.  It was open to the defendant to demonstrate that it did not actually receive such benefit.  However the Inland Revenue’s case was not that it did not use the money at all, but that it was impossible to measure the interest earned (or saved) on the money.  On this basis, the assumption that the Inland Revenue had derived some benefit had not been displaced, and therefore a conventional rate of interest should be used (ie, the rate at which the government could borrow the relevant amounts in the market at the relevant times).

Although strictly obiter, their Lordships also expressed the clear opinion that it will always be open to a claimant to plead and prove his actual interest losses caused by the defendant’s breach, and that such losses will be recoverable, subject to the principles governing all claims for damages for breach of contract (such as remoteness and failure to mitigate).

Comment

This is an important decision which significantly expands the circumstances in which compound interest is likely to be available to a claimant.  Previously, compound interest was available only in claims based solely in equity (for example, recovery of sums misappropriated by a trustee) or where the claim for interest fell within the second limb of the Hadley v Baxendale test for remoteness, namely where the interest loss arose from special circumstances which were within the defendant’s knowledge at the time of the contract.  Following this judgment, it seems that compound interest can, in principle, be claimed not only in restitution, but also as damages in claims for non-payment of debts, as well as in other claims for breach of contract and in tort.

However, when claiming interest as damages the claimant must plead and prove his actual interest losses as a separate item of loss.  That loss may, for example, be the cost of borrowing money, or the loss of an opportunity to invest the promised money.  In either case there may be an element of compound interest.  Although this decision indicates that a claim for interest may fall within either limb of the Hadley v Baxendale test for remoteness, it may nevertheless be that in some cases a claim for interest is considered too remote.  Lord Mance commented that it is “still fair to assume that loss of interest is not within the parties’ contemplation under many everyday contracts”, for example, where a householder pays a builder or shop account late.

If the claim for interest is ancillary to a claim for debt or damages (in contrast to this case where the claim for interest was in fact the principal amount claimed) then, if a party chooses not to prove its interest losses or those losses are, for example, too remote, the court nevertheless has a discretion to award interest under section 35A of the Supreme Court Act 1981.  Lord Hope commented that in practice, especially where the period over which interest is sought is short or where the claimant does not have to borrow money to replace the debt, simple interest under section 35A “is likely to be the more convenient remedy”.

This decision represents a significant departure from the House of Lords decisions in Westdeutsche Landesbank Girozentrale v Islington London Borough Council [1996] AC 669, in which it was held that only simple interest was available on a restitutionary claim, and President of India v La Pintada Cia Navigacion SA [1985] AC 104, in which it was held that compound interest could only be recoverable for breach of contract if it fell within the second limb of Hadley v Baxendale.

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