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Oxford Law Citator

Part XI Remedies for Breach of Contract, 46 Interest

From: Global Sales and Contract Law

Ingeborg Schwenzer, Pascal Hachem, Christopher Kee

Content type:: Book content

Product:: International Commercial Law [ICML]

Published in print:: 26 January 2012

ISBN:: 9780199572984

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Subject(s):: Interest as damages — Compound interest — Calculation of interest — Payment of interest — Remedies for breach of contract

(p. 678) 46 Interest

A. General 46.01
1. I. The Concept of Interest 46.02
  1. 1. Basic Questions 46.02
  2. 2. The Territory of Interest 46.06
2. II. Interests Involved 46.12
3. III. Procedural v Substantive Approach 46.17
4. IV. Starting Points 46.21
B. Contractual Stipulations 46.32
1. I. Admissibility 46.33
  1. 1. General 46.33
  2. 2. Rate 46.34
  3. 3. Form Requirements 46.36
2. II. Limits 46.37
  1. 1. Rate 46.38
  2. 2. Compound Interest 46.42
C. Default Provisions 46.48
1. I. General 46.49
2. II. Dates at which Interest Arises 46.50
  1. 1. Payment Due 46.51
    1. (a) Relevant Dates 46.54
      - (i) Purchase Price 46.55
      - (ii) Damages 46.56
      - (iii) Unwinding of Contract 46.65
    2. (b) Relevance of Obligor’s Responsibility for Delay 46.67
  2. 2. Delivery of Goods 46.69
  3. 3. Delay 46.70
    1. (a) Notice 46.73
    2. (b) Fault 46.75
  4. 4. Initiating Proceedings 46.76
  5. 5. Date of Judgment or Award 46.77
3. III. Rate 46.79
  1. 1. Fixed Rate 46.80
    1. (a) Indiscriminate Single Rate 46.81
    2. (b) Different Rates 46.82
  2. 2. Variable Rate 46.85
  3. 3. Discretion of Adjudicator 46.95
  4. 4. CISG 46.100
    1. (a) Uniform Approaches 46.103
    2. (b) Application of Domestic Law 46.109
4. IV. Compound Interest 46.111
D. Interest and Damages 46.119
1. I. Interest as Damages 46.120
2. II. Damages in Addition to Interest 46.122

A. General

46.01 The obligation to pay interest is not the first concept that springs to mind when discussing sales transactions. Probably, this obligation is primarily associated with loan contracts, which are not addressed in this work.¹ However, that association is already quite close to the traditionally predominant set of circumstances in which interest is also relevant to sales contracts: late payment of the purchase price, which in its economic effects is a loan—involuntarily—given by the seller to the buyer. However, this is not the only constellation where interest may accrue in sale of goods transactions. To the contrary, other sums may be due, in particular damages awarded to one party or, in case of avoidance of the contract, the purchase price that is to be repaid from the seller to the buyer.²

(p. 679) I. The Concept of Interest

1. Basic Questions

46.02 Today the debate revolving around interest appears to be full of technicalities regarding the calculation of interest and economic considerations made in that context. However, it must not be forgotten that the concept of interest or, more precisely, its justification has been under scrutiny and dispute from philosophical, religious, and moral perspectives for more than 2,000 years. It may already be mentioned here that the interest-hostile position in those legal systems where the Islamic Shari’a is the main applicable law³ demonstrates that fundamental differences remain. A notable eruption of these differences occurred in the drafting process of the CISG where it was not possible to equip the Convention with an interest rate. Rather, after heavy debates that almost caused the failure of the entire drafting conference, the bare consensus was reached in Article 78 CISG that ‘If a party fails to pay the price or any other sum that is in arrears, the other party is entitled to interest on it … ’.⁴

46.03 Yet, not only Islam objects to the concept of interest. A general discomfort with and even hostility towards interest was at one or another time also displayed by Judaism and Christianity and some schools of thought within them maintain this position to this very day.⁵ Naturally, these religious concerns primarily arose from the field of loan contracts,⁶ where abuse is most likely to occur. However, these concerns became the general view on the concept of interest and thus warrant brief summary here.

46.04 The traditional objections voiced by all three religions to the obligation of interest primarily turn on the perception that interest worsens the situation of the obligor.⁷ The underlying rationale is that only economically disadvantaged parties need to borrow money and that this already dismal situation is aggravated by the obligation to pay interest.⁸ One of the driving motives of this argument appears to have been the solidarity among people adhering to the same belief required by all three religions.⁹ Thus in Islamic and Jewish legal teachings the majority view was to restrict the prohibition of interest in loan contracts to cases where both parties belonged to the same religion.¹⁰

46.05 Other arguments against the general concept of interest draw on the Greek philosopher Aristotle and essentially state that money does not bear fruit.¹¹ Hence, a party who lends money to another and collects interest basically makes a living from the work the recipient of the loan.¹²

(p. 680) 2. The Territory of Interest

46.06 Today it appears that the obligation to pay interest on a due sum is increasingly understood as part of the law of damages.¹³ A vivid example is Article 78 CISG which immediately follows the Convention’s provisions on the scope of the remedy of damages (Articles 74–7 CISG) and immediately precedes the Convention’s provisions on exemption (Articles 79, 80 CISG). Hence, although this provision is established in its own section entitled ‘Interest’, it is located in the Convention’s law of damages and thus was perceived by the drafters to be part of that area of the law.¹⁴ This is even more evident in the PICC, where the obligation to pay interest is established in Articles 7.4.9, 7.4.10 PICC, not in its own section but within Chapter 7, Section 4 entitled ‘Damages’.¹⁵ In the Netherlands Article 6.119(1) CC explicitly mentions interest as part of the definition of damages arising from delayed payment.

46.07 However, despite the fact that the concept of interest is increasingly understood as part of the law of damages, its primary objective is still subject to dispute. Two positions are advocated. First, interest seeks to compensate the obligee for the losses it incurred either due to not having been able to invest the outstanding sum profitably and possibly because the obligee was forced to take a loan to ensure liquidity until payment. Secondly, interest seeks to skim off benefits made by the obligor due to late payment—that is, to deprive the obligor of the profits it made by investing the due sum for longer than it should have.

46.08 From a theoretical point of view this debate is of interest insofar as traditionally the remedy of damages is perceived to be exclusively concerned with compensation and that any supra-compensatory notions must be kept out of the law of damages.¹⁶ This would militate for the view that compensation is also the primary function of interest. Were the disgorgement function to be assumed as the primary one, this would mean to establish an exception to the traditional understanding of the law of damages.

46.09 The practical effects of this debate are significant, in particular with regard to determining the applicable interest rate in international disputes.¹⁷ Giving primary regard to the function of compensation, the applicable interest rate would often be that at the place of the obligee. It would be assumed that this is also the place where it is deprived of the possibility to invest the outstanding sum profitably or where it must refinance its business. Giving primary regard to the function of disgorgement, the applicable interest rate would often be that at the place of the obligor. It would then be assumed that this is also the place where it profited from the sum still being in its accounts.

46.10 Naturally, this problem does not arise in domestic transactions, as the interest rate is identical at both places of business. However, as is discussed below,¹⁸ domestic legal systems vary greatly in their interest rates. Thus, in international transactions this question is highly relevant. Yet, there still appears to be no consensus. At the drafting conference of the CISG, the drafters could not agree on whether the rate at the obligee’s place of business or at the obligor’s place of (p. 681) business should be decisive.¹⁹ Additional objections based on religious views²⁰ from Islamic countries made it impossible to find any agreement as to the applicable interest rate.²¹

46.11 At the domestic level the debate on the function of the concept of interest has resurfaced in England in the context of the availability of compound interest.²² In particular, the question arose whether interest should be calculated on a borrowing rate or lending rate basis.²³

II. Interests Involved

46.12 The obligation to pay interest can be looked at from different perspectives. From the viewpoint of the parties, especially the obligee, the central issue is to prevent losses and to have profits accrue where they belong.²⁴ For example, the interest the obligee collects on the due sum represents the loss it has incurred as it was deprived of the possibility to use the money profitably.²⁵ Conversely, the interest collected strips the obligor of the profit it made by delaying payment.²⁶ The theoretical background of this viewpoint is provided by the axiom that capital does not stand still but is in constant motion and bears fruit;²⁷ in other words, that money always creates money.²⁸ This was the perception even in ancient Rome.²⁹

46.13 Taking a broader perspective, it must be noted that in recent times increasing attention is paid to the benefits of an obligation to pay interest for an economy in general. The absence of such an interest obligation, the possibility of future litigation proceedings alone, may not be sufficient to deter an obligor from breaching its contract;³⁰ this is especially so in those legal systems where each party bears its own legal costs.³¹ Similarly where litigation has been commenced, the prospect of interest can encourage defendants, in particular, to work towards a prompt resolution of the proceedings.³² On the other hand, obligees may feel the need to be extra cautious and use resources to protect themselves against detriments potentially following from late payment.³³ These behaviours obviously create undesirable inefficiencies.³⁴

46.14 Furthermore, it is clear that a delay in payment immediately affects the cash flow of the obligee. The missing liquidity may cause the obligee to be unable to satisfy monetary obligations towards its creditors. For example, the manufacturing seller awaiting payment of the purchase price encounters difficulties in paying salaries to its employees. It is obvious, especially for small and medium-sized companies, that late payments are potentially disastrous and can even lead to bankruptcy.³⁵

(p. 682) 46.15 It was this latter issue in particular that led the European Community to pass a specific directive in the year 2000 designed to protect companies from late payment.³⁶ Indeed, in revealing its motives for passing this directive the legislator expressly stated: ‘Late payment constitutes a breach of contract which has been made financially attractive to debtors in most Member States by low interest rates on late payments and/or slow procedures for redress. A decisive shift, including compensation of creditors for the costs incurred, is necessary to reverse this trend and to ensure that the consequences of late payments are such as to discourage late payment.’³⁷ It is undisputed that in the drafting process the issue of deterrence was of great significance.³⁸ All Member States have transposed this directive into their respective domestic laws.³⁹

46.16 As of 16 February 2011 the European Parliament and the Council of the European Union adopted a new directive, replacing that described in the preceding paragraph.⁴⁰ The motivation remained the same, yet, was felt even more strongly against the background of the financial crisis. The legislative bodies underline that late payment ‘affects … competitiveness and profitability when the creditor needs to obtain external financing because of late payment. The risk of such negative effects strongly increases in periods of economic downturn when access to financing is more difficult.’⁴¹ In outlining its purpose in Article 1, the directive now expressly states that combating late payment fosters the competitiveness of small and medium-sized companies in particular. The directive must be transposed into domestic law by the Member States of the European Union by 16 March 2013.⁴² The previously mentioned directive of the year 2000 will be repealed on that date.⁴³

III. Procedural v Substantive Approach

46.17 A remaining difference between civil law and common law jurisdictions is the perspective on the legal nature of interest-related questions.⁴⁴ In civil law legal systems all questions relating to the payment of interest are considered to be a matter of substantive law. This means that the general liability for interest, the period for which interest accrues as well as the applicable interest rate are part of substantive law.

46.18 The situation appears to be different in common law jurisdictions. A general distinction must be made between pre-judgment interest and post-judgment interest.⁴⁵ Pre-judgment interest is interest which forms part of an award.⁴⁶ In contrast post-judgment interest is interest on an award.⁴⁷ Yet, while this basic distinction is unanimously followed, common law jurisdictions (p. 683) are divided on whether both or only post-judgment interest is of procedural nature.⁴⁸ For example, as stated below,⁴⁹ liability for interest in the USA is a matter of state law. However, there is no uniformity among states on the substantive–procedural question.⁵⁰

46.19 It is sometimes stated for the USA⁵¹ that the substantive–procedural dichotomy follows the pre-judgment–post-judgment distinction, the former thus being substantive, the latter procedural in nature. About half of the individual USA states follow the classification of pre-judgment interest as substantive.⁵² Some courts have, however, refused this notion.⁵³ For English law it would seem that there is agreement only insofar as the general question whether a party is liable for interest at all is a matter of substantive law while the interest rate and the period of time for which interest has accrued may still be classified as questions of procedural law.⁵⁴

46.20 At the international level the civil law approach has prevailed as the CISG, the OHADA AUDCG, the PICC, PECL, and DCFR all contain provisions establishing the obligation to pay interest.⁵⁵ As far as the dichotomy of procedural and substantive law works,⁵⁶ these sets of rules, where applicable, are clearly instruments of substantive law.

IV. Starting Points

46.21 Under Roman law the starting point was that there was no general obligation to pay interest on sums payable to the other party.⁵⁷ Rather, the question whether the obligor had to pay interest ultimately depended on the action taken by the obligee. Where the obligee brought an action for a liquidated sum (certa pecunia) based on stipulatio or a last will, interest was not available to the obligee⁵⁸ unless agreed upon by stipulatio.⁵⁹ Only actions arising from contracts founded on good faith (bona fides), which included sales contracts, gave the obligee a right to interest in case of delay.⁶⁰ Thus, most importantly, interest was available to the seller under the actio venditi.⁶¹ However, the seller could not claim interest after it had received the purchase price, albeit with delay.⁶²

46.22 The interest rates applicable under Roman law increased from 4 per cent to 6 per cent in the first three centuries ad.⁶³ The interest rates primarily depended on the capital market; however, there were a number of legislative interferences to fix an upper limit to interest rates where the market failed.⁶⁴

(p. 684) 46.23 Typically following Roman law in this regard, the starting point for civil law legal systems is straightforward. Despite the influence of canon law which had objected to the concept of interest,⁶⁵ civil law legal systems typically envisage a general obligation to pay interest,⁶⁶ at least with regard to late payments.⁶⁷

46.24 As alluded to earlier,⁶⁸ however, it is not always the case that legal systems embrace the concept of establishing a general obligation to pay interest. Yet, it is not only legal systems where the Islamic Shari’a is the main applicable law⁶⁹ that the obligation to pay interest initially was met with scepticism. The development of interest in English common law and hence those systems following the English model require closer examination.

46.25 Indeed, in traditional common law,⁷⁰ the Roman law position regarding claims for ascertained amounts of money was prevalent.⁷¹ This meant first of all that there was no interest available on ascertained sums in actions for debt, unless intended by the contract or trade usage.⁷² This rule was subsequently interpreted to broadly cover all claims for money at common law⁷³ and thus that the general loss of use of money could not be recovered as damages in case of late payment.⁷⁴ Rather, interest was only available where the parties had included an express or implied term to that effect into their contract.⁷⁵ The situation was different where, due to late payment, the aggrieved party had to take a loan and pay interest.⁷⁶ These charges could then be recovered as special damages.⁷⁷ The result of this approach was that interest losses could only be (p. 685) recovered if contemplated by the parties as envisaged by the second limb of Hadley v Baxendale.⁷⁸ Yet, interest losses were thought not to be generally foreseeable losses in the context of a debt, and thus could not be recovered as general damages under the first limb of Hadley v Baxendale.⁷⁹ The underlying presumption was that interest losses were not generally in the contemplation of the parties.⁸⁰

46.26 However, in the early nineteenth century and then more significantly throughout the twentieth century the English legislature has at various points statutorily reformed the traditional common law position. In 1833 the Civil Procedure Act (Lord Tenterden’s Act) in its section 28 stated that interest was payable on debts or sums payable at a certain time or if there was a written demand for payment from the obligee to the obligor giving notice that interest will be claimed.⁸¹ However, the courts were granted broad discretion as they did not have to award interest in all cases but only ‘if they shall think fit’.⁸² Yet, the sum in question had to be certain which constituted a severe restriction of the obligation to pay interest.⁸³ The very narrow limits on claims for interest were subsequently criticized by the House of Lords.⁸⁴

46.27 In 1934 the Law Reform (Miscellaneous Provisions) Act enabled courts to award interests on sums ‘for the whole or any part of the period between the date when the cause of action arose and the date of judgment’.⁸⁵ This reform has found its way into nearly all common law jurisdictions which follow the English model.⁸⁶ However, a further 1982 reform in England and Wales, to the effect that courts could award interest also on sums that were paid after commencement of the proceedings but before the judgment,⁸⁷ appears to have only been adopted by Singapore⁸⁸ and Hong Kong.⁸⁹ Indeed, reform in Singapore goes further and permits interest on those sums which were paid late but before proceedings were commenced.

46.28 Since the broad discretion of the judges was retained through all legislative actions in the field of interest, the English law in the words of Lord Goff ‘had developed in a fragmentary and (p. 686) unsatisfactory way’.⁹⁰A significant change was brought about by the Late Payment for Commercial Debts (Interest) Act 1998 which established a general obligation to pay interest on late payments in commercial transactions.⁹¹ This Act was clearly the result of the growing dissatisfaction at the European level with the problems created by late payments.⁹² It upholds the traditional common law position insofar as it states that ‘It is an implied term in a contract … that any qualifying debt created by the contract carries simple interest … ’⁹³ Finally, the UK has also transposed the above-mentioned⁹⁴ EC Late Payment Directive. For these purposes the Late Payment for Commercial Debts (Interest) Act 1998 was amended to the effect that small businesses are now also able to claim statutory interest from other small businesses and that all businesses, including public sector organizations, are now able to claim interest from any other business, including small businesses or organizations.⁹⁵

46.29 In contrast, the USA does not seem to have witnessed similar struggles with the concept of interest.⁹⁶ As early as 1896 the United States Supreme Court stated that ‘[i]t is a dictate of natural justice and the law of every civilized country’ that the obligor of a payment ‘must pay the established rate of interest as damages for his non-performance’ in case of failure to meet the required time for payment.⁹⁷ The USA Supreme Court, however, also stated that ‘Hence it may correctly be said that such is the implied contract of the parties.’⁹⁸ Therefore, the position of the USA Supreme Court is built on the same premise as the traditional English position,⁹⁹ yet an implied agreement appears to always be assumed.¹⁰⁰ Today there is no federal law on interest in the USA. Rather, the matter is one of state law and states have created statutes establishing claims for interest in actions for breach of contract.¹⁰¹ In California and Louisiana the obligation to pay interest is contained in the respective civil codes.¹⁰²

46.30 The situation in Australia and Canada is similar to that in the USA. Interest on late payments is a matter for the individual Australian and Canadian states and territories. Today all of them have enacted statutes providing for the obligation to pay interest.¹⁰³ In Québec the issue did not raise particular difficulties. Being of civil law background the Québec Civil Code contains a provision establishing the general obligation to pay interest.¹⁰⁴

(p. 687) 46.31 At the international level the general obligation to pay interest is universally acknowledged. Both uniform law and projects contain provisions establishing such an obligation.¹⁰⁵ It has been suggested that in international commercial arbitration interest has gained such acceptance so as to amount to trade usage of international commerce.¹⁰⁶

B. Contractual Stipulations

46.32 Frequently parties will come to a contractual agreement on the obligation to pay interest on any due sum. This raises questions as to whether the freedom to do so is granted at all by legal systems and if so, within what boundaries. This not only relates to the general liability for interest but also to the question to what extent the parties can contractually fix the rate of interest and whether it is possible to agree on the application of compound interest.

I. Admissibility

1. General

46.33 Today contractual agreements on the obligation to pay interest are enforced in the vast majority of legal systems.¹⁰⁷ Even in some of those legal systems where for religious reasons there is no obligation to pay interest, an agreement between merchants in that regard is upheld where at least one of the parties does not belong to that religion.¹⁰⁸ Yet an agreement on interest between two parties belonging to the same religion may even nullify the entire contract.¹⁰⁹

2. Rate

46.34 The pivotal point for a contractual agreement regarding the obligation to pay interest naturally is the rate of interest. In this regard the general rule stated earlier,¹¹⁰ that the vast majority of legal systems enforce agreements on the obligation to pay interest, also applies here.¹¹¹ If it were otherwise that rule would be bereft of any meaning.

46.35 Nevertheless, many legal systems expressly state that it is first of all up to the parties to fix the applicable rate in the contract.¹¹² However, this freedom is not necessarily unlimited; areas where limits are imposed are addressed below.¹¹³

(p. 688) 3. Form Requirements

46.36 The question whether a contract must generally satisfy certain formal requirements has been discussed earlier in this work.¹¹⁴ In the present context it is of relevance whether specific agreements on the obligation to pay interest require a certain form. Occasionally legal systems require that agreements fixing an interest rate which exceeds the default interest rate must be made in writing.¹¹⁵ In other instances form is only required for the agreement of compound interest in civil transactions.¹¹⁶

II. Limits

46.37 While the general freedom of the parties to make provision for the obligation to pay interest, especially the rate, in their contract appears well acknowledged, it is self-understood that this freedom is not unrestricted. The keyword in this context is usury. This term is, however, not used uniformly. Originating in the Latin term usura (interest), today it is understood in the common law world as charging excessive interest on loans. In some civil law jurisdictions the meaning of the term usury appears to have been broadened so as to comprise all situations where performance and counter-performance are substantially disproportionate.¹¹⁷ This latter understanding moves the term usury closer to the general concept of unconscionability. In any event, although there may be no specific concept to prevent excessive interest rates established in contracts, any agreement must not violate the general framework of unconscionability, public policy, and similar concepts.¹¹⁸

1. Rate

46.38 With regard to clauses establishing an interest rate, a number of legal systems have expressly concretized the boundaries of freedom of contract. Typically, this is achieved by an upper limit to the interest rate. Some legal systems state that the interest rate agreed upon must not exceed the legal interest rate applicable at the time of the conclusion of the contract.¹¹⁹ Other legal systems fix the maximum amount by which the legal rate may be exceeded, for example 50 per cent.¹²⁰ Other legal systems provide that the contractual interest rate must not exceed that fixed by their respective central banks.¹²¹ Other legal systems provide fixed numbers for monthly¹²² or annual rates.¹²³ Especially in the Middle Eastern and Arab countries, fixed maximum rates are considered part of public policy.¹²⁴ In some legal systems the limits to the freedom of the parties to contractually fix an interest rate were established in court practice.¹²⁵

46.39 Legal systems display a significant degree of uniformity with regard to their reaction to situations where the parties go beyond the limits of their freedom to fix a contractual interest rate. Civil law legal systems, in particular, appear to agree that a reduction mechanism should apply. (p. 689) This can come in two different forms. First, where the contractually agreed interest rate exceeds the freedom granted to the parties, legal systems appear to agree that in these situations the default legal interest rate applies.¹²⁶

46.40 The second reduction mechanism, not only found in civil law legal systems but also in mixed jurisdictions and the Nordic systems, is established in the context of agreed sums payable upon breach of an obligation, traditionally known as penalty and liquidated damages clauses.¹²⁷ Here, the systems mentioned typically¹²⁸ allow for the reduction of excessive sums. Naturally, such sums may take a form of a contractual interest rate. For example, the contract may state that with each day of delay in payment, the purchase price shall be increased by a certain percentage. In these situations the clause in question may be moderated, if the agreed sum—here stipulated in the shape of interest—is disproportionate.¹²⁹

46.41 Common law jurisdictions do not operate with a reduction mechanism when it comes to agreed sums.¹³⁰ Rather, the clause is unenforceable.¹³¹ The exact legal consequences of the unenforceability are unclear. Traditional understanding has been that the clause is struck out of the contract¹³² while in recent times a reduction-like position was taken.¹³³

2. Compound Interest

46.42 Compound interest as opposed to simple interest means that the interest for a certain period of time is added to the principal sum and the new total amount is treated as the new principal sum on which interest is calculated for the next period of time.¹³⁴

46.43 As is discussed further below, the strong influence of canon law on the civil law legal systems in Europe led to widespread prohibitions of compound interest or at least severe restrictions.¹³⁵ These have also found their way to other parts of the world. Thus, today some civil law legal (p. 690) systems also prohibit the parties from providing for the availability of compound interest in their contract.¹³⁶

46.44 In some jurisdictions agreements on compound interest will only be considered, if they have not been made in advance.¹³⁷ Rather, a new agreement on compound interest is required. There is, however, no unanimity at what point such agreements are admissible. In the USA the Louisiana Civil Code expressly requires that interest has already accrued.¹³⁸ In Germany, while the law is silent on this matter, this is also the unanimously accepted view.¹³⁹ As regards the earliest point in time at which such agreements are possible the majority view in Germany appears to be that it is the point in time where the amount of simple interest is specified albeit not due.¹⁴⁰ In other jurisdictions agreements on compound interest are only allowed after a certain period of time in which simple interest has accrued spanning from three months¹⁴¹ to—in most of these instances—one year.¹⁴²

46.45 In contrast, some civil law legal systems¹⁴³—including Québec in Canada¹⁴⁴—but also the Nordic systems¹⁴⁵ allow for the parties to agree on compound interest without restrictions, although this is sometimes limited to commercial transactions.¹⁴⁶ In Mexico the Supreme Court has found compound interest to not be part of the default system but has not commented on the validity of contractual agreements to that effect.¹⁴⁷ The majority view in Mexico advocates the validity of such clauses.¹⁴⁸

46.46 In common law jurisdictions the question whether the parties can agree on compound interest so far has not created significant debate. Under traditional common law, interest had generally depended on a contractual agreement,¹⁴⁹ and indeed as noted earlier the USA Supreme Court based its decision on an ever present implied agreement of the parties on interest.¹⁵⁰ It is probably for that reason that it appears generally accepted that parties can also implicitly agree on compound interest.¹⁵¹

46.47 At the international level the freedom of the parties to agree on compound interest appears not to give rise to problems. As the CISG is entirely silent on the interest rate and Article 6 CISG gives broad liberty to the parties, the boundaries to that freedom are those established by (p. 691) domestic law.¹⁵² The PICC and the PECL do not address compound interest but only simple interest.¹⁵³ However, it has been suggested for the PICC that the parties nevertheless enjoy the freedom to agree on compound interest as far as allowed by the applicable domestic law.¹⁵⁴ As the DCFR even provides for compound interest by default,¹⁵⁵ it is undoubtedly possible for the parties to agree on it.¹⁵⁶ For international arbitral tribunals it has been suggested that they should always enforce agreements on compound interest unless such enforcement violates public policy.¹⁵⁷

C. Default Provisions

46.48 Failing any agreement by the parties on the obligation to pay interest, it is necessary to turn to the default rules established by legal systems. In this context the two central issues are the point in time from which interest accrues and the rate of interest.

I. General

46.49 Traditionally, interest is associated with loan contracts. It is therefore not surprising to find that a number of legal systems felt the need to expressly state that provisions establishing interest for late performance also apply to sales contracts,¹⁵⁸ or that a sale of goods Act does not prevent the recovery of interest established in other statutes.¹⁵⁹

II. Dates at which Interest Arises

46.50 The date at which interest arises presents more difficulties than might appear at first glance. One reason is that legal systems take different conceptual approaches to this question; that means they differ as to whether it is sufficient that the time of payment has arrived or whether additional requirements must be met to trigger interest. Another reason is that legal systems react differently to different monetary obligations—that is, whether the principal sum in question is the purchase price or damages. The distinction concerns certainty of the sum involved; while the amount of the purchase price will usually not be subject to dispute, the amount of the damages payable will often be disputed until the date of the judgment or award.¹⁶⁰

1. Payment Due

46.51 One approach to determining the date from which interest may be calculated is to rely on the date at which performance of the monetary obligation in question is due. The way to determine that date will then depend on the monetary obligation in question. This ‘payment due’ approach is shared by the majority of legal systems both at the domestic¹⁶¹ as well as at the (p. 692) international level.¹⁶² It should be noted that in common law jurisdictions for pre-judgment interest this date is often referred to as the date ‘when the cause of action arose’.¹⁶³ Frequently, courts enjoy broad discretion in choosing any point in time after the cause of action arose and before the rendering of the award.¹⁶⁴

46.52 In some legal systems, however, the date on which payment is due is only the relevant date for interest to arise where the parties have fixed the time for performance in the contract.¹⁶⁵ Otherwise the obligee needs to bring a judicial claim or notify the obligor by way of public notary so as to constitute delay.¹⁶⁶

46.53 In Europe the Member States of the European Union are obliged to enact legislation that provides for the payment of interest upon the payment becoming due¹⁶⁷ even though they may have traditionally operated with a notice requirement to constitute delay.¹⁶⁸

(a) Relevant Dates

46.54 Three groups of cases can be distinguished: (1) the (original) payment of the purchase price; (2) the payment of damages; and (3) the repayment of the purchase price where the contract must be unwound, for example because of avoidance following breach of contract.

(i) Purchase Price

46.55 In typical commercial transactions the parties will have determined the time for payment of the purchase price in their contract. Hence, where the date or period of time so determined arrives or passes, payment is due and thus interest accrues on that sum. Failing any agreement in this regard, legal systems typically establish default rules to determine the time for payment. These have been discussed earlier in this work.¹⁶⁹

(ii) Damages

46.56 The situation is less clear with regard to the payment of damages. A variety of factors are relevant to determining the point in time at which interest may accrue on damages.

46.57 At its simplest there are two points in time which must be considered. The first is the time of non-performance. At the domestic level this is typically favoured by common law jurisdictions, which generally provide a statutory discretion to the adjudicator to award interest from the (p. 693) time the cause of action arose; that is the time of non-performance.¹⁷⁰ In these jurisdictions it does not matter whether the case is one of non-conformity or non-delivery as damages would in either scenario be calculated on the basis of a market price.¹⁷¹

46.58 Civil law systems, on the other hand, rely on the date at which the loss is actually incurred. In cases of non-conformity there is no difference to the common law position as the inferior value of the goods is also calculated on the market price, and the loss incurred at the time of breach. However, with respect to non-delivery, there may be varying points in time depending on whether the obligee has conducted a cover transaction. Where it has conducted a cover transaction and its damages are calculated upon this very cover transaction, the loss is only incurred at the time that transaction takes place. If there has not been a cover transaction, and the obligee is allowed to calculate its damages on an abstract basis, there is again no difference to the common law systems.

46.59 At the international level interest on damages may be due from the time of non-performance. This is the position taken at the international level by the CISG and the uniform projects. However, under the CISG, it appears to be the prevailing opinion that where the aggrieved party undertakes a cover transaction and calculates its damages under Article 75 CISG, the loss is only incurred at the time the transaction takes place—and thus this is then also the time from which interest accrues.¹⁷² Where the aggrieved party intends to calculate its losses based on the market price under Article 76 CISG, the prevailing view relies on the time of the avoidance of the contract.¹⁷³

46.60 A further complicating factor, which may ultimately change the aforementioned rules, is that the quantum of damages is not known with certainty until the rendering of the judgment or award. The debate on whether interest is nevertheless payable before the final amount is determined by the adjudicator is typically headed by the keyword ‘liquidated sum’. In essence, the question is whether interest is only payable on sums which are certain—liquidated—or whether interest may also begin to accrue from a point in time at which the sum was not yet liquidated.

46.61 At the domestic level legal systems differ to some extent on this question. In some Civil law legal systems, especially those with a French background, it is required that the principal sum is liquidated.¹⁷⁴ In other civil law legal systems it does not generally matter that the sum in question is disputed.¹⁷⁵

46.62 The traditional common law position was that the principal sum bearing interest must be liquidated. Hence, interest on damages was not due before the decision or the award was rendered.¹⁷⁶ However, as noted above nowadays the relevant statutes typically envisage that the (p. 694) court may grant interest on damages for any period between the time when the cause of action arose and the judgment.¹⁷⁷

46.63 At the international level the domestic debate on the requirement of a liquidated sum has resurfaced also in the realm of the CISG. The Convention in Article 78 speaks of a ‘sum that is in arrears’.¹⁷⁸ Based on this wording some commentators have argued that a sum must be liquidated to be ‘in arrears’. They draw the conclusion that under the CISG interest is not payable on damages.¹⁷⁹ The clearly prevailing view, however, does not follow this argument.¹⁸⁰ One argument is that a requirement for a liquidated sum cannot be based on the wording of the CISG.¹⁸¹

46.64 Among the uniform projects the PICC expressly state that interest on damages accrues from the date of non-performance.¹⁸² This indicates that the sum does not have to be liquidated to bear interest. This approach is justified on the grounds that the date of non-performance most adequately reflects the point in time at which the obligee suffered losses and the time at which the obligor benefits from the sum it has to pay.¹⁸³

(iii) Unwinding of Contract

46.65 Where the seller has already received the purchase price but the contract comes to an end and must be unwound, the buyer is entitled to interest on this sum. In case of avoidance of the contract interest accrues from the time of the initial payment of the purchase price by the buyer. This is sometimes expressly stated by legal systems.¹⁸⁴ In other legal systems this result follows from the fact that the unwinding of the contract following avoidance of the contract requires the parties to also turn over the benefits they derived from what they have received.¹⁸⁵ On the part of the seller this is the interest created by the purchase price as of the date of its receipt.

46.66 It is, however, important to note that in many jurisdictions the avoidance of the contract has the same effects as the rescission of the contract—that is, that the unwinding of the contract is an extra-contractual relationship and thus falls within the law of restitution. Depending on the applicable regime this also has implications for the obligation to make restitution of fruits; in case of the purchase price interest.¹⁸⁶

(b) Relevance of Obligor’s Responsibility for Delay

46.67 There is controversy among those domestic systems that operate with the concept of fault as to whether the responsibility of the (p. 695) obligor to perform at the due date is of relevance for the obligation to pay interest. This issue primarily concerns the original payment of the purchase price. In some domestic legal systems liability for interest after payment was due is strict and thus it is irrelevant whether the obligor was responsible for the delay or not.¹⁸⁷ Other legal systems take the opposite approach.¹⁸⁸

46.68 At the international level, the clearly prevailing view under the CISG is that the obligor cannot rely on exemption by an impediment under Article 79 CISG.¹⁸⁹ Among the uniform projects this position is expressly taken by the PICC and the DCFR.¹⁹⁰ However, in Europe the Late Payment Directive 2000 and its 2011 recast both provide that the obligee is not entitled to interest where the obligor is not responsible for the delay.¹⁹¹

2. Delivery of Goods

46.69 In some East Asian civil law legal systems the obligation to pay interest immediately arises upon delivery of the goods as this is then also considered to be the time at which payment of the purchase price is due.¹⁹²

3. Delay

46.70 As indicated earlier,¹⁹³ in some legal systems it is not sufficient that payment of the outstanding sum is simply due in order to find that there has been delay. Hence, the obligation to pay interest does not arise before the requirements for delay in the present—technical—understanding are met.

46.71 The legal concept of delay is one of Roman law origin and is predominantly found in civil law legal systems. Today it is found in those legal systems that follow the cause-oriented approach to remedies for breach of contract.¹⁹⁴ The basic structures and relevant questions have already been laid out above in the more general context of remedies for breach of contract.¹⁹⁵ For present purposes it is only necessary to briefly summarize the requirements for delay to be constituted.

46.72 A functional equivalent of the concept of delay is found in some common law jurisdictions in the context of debt. There payment may already be due; however, the obligation to pay interest at the earliest arises when the obligee demands payment and gives notice that interest will be claimed.¹⁹⁶

(a) Notice

46.73 The concept of delay primarily requires that the obligee puts the obligor on notice, if no specific time for performance has been fixed in the contract. The underlying rationale is that before such time the obligor does not have to assume that the obligee is in need of performance. The consequence of this approach is that, prior to notice, compensation is not necessary and hence interest is not triggered.

(p. 696) 46.74 In most legal systems operating with the concept of delay, it is sufficient for the obligee to unambiguously demand performance.¹⁹⁷ However, in some legal systems notification is only possible by way of public notary. Others even require instituting legal proceedings.¹⁹⁸

(b) Fault

46.75 The dispute whether fault is a necessity for delay to be constituted is an old one and still not completely decided. There is even dispute as to whether Roman law required fault.¹⁹⁹ Today it appears that the majority of legal systems familiar with the traditional concept of delay do not require fault for delay to be constituted.²⁰⁰ A notable proponent for the fault-required position is Germany.²⁰¹ A differentiated approach is taken in Austria where objective (no fault) and subjective delay (fault) are distinguished.²⁰²

4. Initiating Proceedings

46.76 In some legal systems the obligation to pay interest only arises once the obligee brings a judicial claim before the adjudicators. In the Middle Eastern and Arab legal systems, however, the date from which interest accrues may be changed by contract or commercial usage.²⁰³

5. Date of Judgment or Award

46.77 In common law legal systems in particular, the date of the judgment or the date of the award are of relevance. The reason is that these legal systems traditionally distinguish pre-judgment and post-judgment interest. While the pre-judgment interest is intended to cover the period between the point in time when the action arose and the date of the judgment or the award, post-judgment interest refers to interest which accrues from the date of the decision onwards. This distinction has quite severe implications. First, post-judgment interest is unanimously considered to be a concept of procedural law and, secondly, the interest rates for post-judgment interest may differ from pre-judgment interest rates.

46.78 In international disputes, classification of post-judgment interest as a procedural concept may be pivotal in determining the applicable interest rate. Furthermore, there is some debate as to whether post-judgment interest as a separate concept is pre-empted by the CISG. Some commentators answer this question in the negative and state that it remains applicable notwithstanding the CISG.²⁰⁴ Opinions appear to be divided and the debate suffers from the attempt to solve the matter along the lines of the seemingly outdated dichotomy of substantive and procedural law. From the perspective of the CISG the only relevant question is whether post-judgment interest functionally addresses the same issues as Article 78 CISG.²⁰⁵ Post-judgment interest compensates for outstanding payment after the award and thus also attempts to compel the obligor to comply with the award. Article 78 CISG does not make the distinction between pre-judgment and post-judgment interest. Therefore from the viewpoint of the CISG it is simply a question of interest rate. Where a domestic system distinguishes pre-judgment and post-judgment interest and applies different rates for different time periods, Article 78 CISG does not prevent both rates from being applied to their designated time periods.²⁰⁶ Hence, for the purposes of the CISG interest is interest whether pre- or post-judgment.

(p. 697) III. Rate

46.79 As stated earlier, subject to the general boundaries of validity concepts such as gross disparity, unconscionability or usury, the fixing of the applicable interest rate is first up to the parties. Failing such an agreement the statutory interest rate applies. Legal systems display a considerable variety of solutions in this regard. For the Member States of the European Union a certain harmonizing effect has been reached by the Late Payment Directive.²⁰⁷

1. Fixed Rate

46.80 The traditional way—especially in civil law legal systems—to establish the rate of interest applicable to outstanding sums is to provide for one fixed rate applying to all sums. This had also been the approach of Roman law.²⁰⁸ However, legal systems following this approach differ as to whether there is one single interest rate indiscriminately applying to all contracts or whether different fixed rates apply to different contracts.

(a) Indiscriminate Single Rate

46.81 Fixing a single rate of interest that indiscriminately applies to all contracts is particularly popular in East Asian civil law legal systems. There, interest rates applicable to all contracts range from 5 to 7.5 per cent.²⁰⁹ However, the approach of employing one single interest rate is also used in the USA where the individual states provide for interest rates between 6 and 12 per cent.²¹⁰ Similarly, in Bolivia and Colombia a rate of 6 per cent applies indiscriminately.²¹¹ In Switzerland Article 104(1) CO also fixes the legal interest rate at 5 per cent but Article 104(3) CO gives discretion to adjudicators in commercial transactions to use bank rates, if they are higher.

(b) Different Rates

46.82 In other civil law legal systems it is also common to have interest rates fixed by law; however, these systems fix different rates for different contracts. This approach is predominantly taken by those Middle Eastern and Arab jurisdictions that acknowledge the concept of interest. In these systems the interest rate for civil transactions is typically fixed at 4 per cent.²¹² For commercial transactions the rate is typically between 5 and 9 per cent.²¹³

46.83 Among other legal systems a similar approach can be found partly in the Ibero-American region.²¹⁴ In Europe some legal systems establish fixed interest rates for civil contracts while operating with flexible interest rates when it comes to commercial contracts.²¹⁵

46.84 A specific approach is taken in Germany where a total of three interest rates exist. For commercial contracts a fixed interest rate of 5 per cent applies.²¹⁶ However, in case of delay this interest rate does not apply. Rather, § 288(1) CC establishes an interest rate of 5 per cent above (p. 698) the reference rate.²¹⁷ For contracts not involving a consumer § 288(2) CC provides for 8 per cent above the reference rate.²¹⁸

2. Variable Rate

46.85 The concept of using a variable interest rate currently appears to be the most popular one and is used by legal systems from all legal families. The ways in which this concept is applied, however, differ. Essentially, three approaches can be discerned. One uses an interest rate—for example a refinancing rate—which is fixed by a monetary institution, typically the central bank, or a governmental body and which at regular intervals is adapted to the economic circumstances. The second approach combines the concept of a fixed interest rate with a variable interest rate in that the fixed interest rate is added to a variable rate, such as a reference rate established by a monetary institution at certain intervals. The third approach uses an entirely flexible rate, for example by referring to the average bank short-term lending rate to prime borrowers prevailing for the currency of payment at the place for payment.²¹⁹

46.86 The first approach²²⁰ has a number of proponents especially in Eastern Europe and Central Asia.²²¹ Similarly, in India the applicable interest rate is fixed by the Reserve Bank of India.²²² In most of the Ibero-American legal systems it is also the reference rate fixed by the relevant institution that applies.²²³ Even in those Ibero-American legal systems that give primary regard to the discretion of the court,²²⁴ it is court practice to use such a reference rate.²²⁵ Occasionally this approach is also followed for commercial contracts in Middle Eastern and Arab countries.²²⁶

46.87 Many legal systems in Central Europe as well as the Baltic legal systems make use of the second way²²⁷—that is, they establish a fixed interest rate which is to be added to the interest rate fixed by a monetary institution or governmental body. The relevant institution is typically the central or monetary bank of the respective legal system. According to the Late Payment Directive 2000 in Member States of the European Union the European Central Bank is the relevant monetary institution²²⁸ insofar as these states also participate in the Euro. Otherwise, the respective central bank is relevant.²²⁹ In the UK the Late Payment of Commercial Debts (Interest) Act 1998 technically refers to the Secretary of State and to the Scottish Ministers.²³⁰ The Secretary of State determines a rate inter alia ‘so as to deter generally the late payment of (p. 699) qualifying debts’.²³¹ To conform with the Late Payment Directive the Secretary of State and Scottish Ministers link their rate to the official dealing rate of the bank of England plus at least 7 per cent. A similar approach is taken by the Netherlands.²³²

46.88 Those systems following this second approach differ to some extent and with regard to the type of situations where they apply this approach. Some systems use a fixed rate for civil contracts without adding it to a reference rate fixed by a monetary institution, but in contrast for commercial contracts add a fixed rate to a reference rate.²³³ Other systems use the mechanism of adding a fixed rate to a reference rate but apply different fixed rates to civil and commercial contracts.²³⁴ Finally, there are some legal systems which indiscriminately apply a fixed rate added to the respective reference rate.²³⁵

46.89 As for the exact rate, legal systems differ. In the European Union, the Late Payment Directive 2000 obliges Member States of the European Union to ensure that ‘the level of interest for late payment …, which the debtor is obliged to pay, shall be the sum of the interest rate applied by the European Central Bank to its most recent main refinancing operation carried out before the first calendar day of the half-year in question …, plus at least seven percentage points’.²³⁶ It should be noted that the Late Payment Directive is not intended to cover transactions involving consumers.²³⁷ Consequently, some systems have gone beyond the minimum requirements and established a higher fixed rate.²³⁸

46.90 The combination of a central bank rate plus a fixed rate is also found in common law jurisdictions. In Canada some territories rely on this mechanism to determine the pre-judgment and post-judgment interest rates respectively.²³⁹ However, the fixed rate to be added may differ between pre-judgment interest and post-judgment interest.²⁴⁰

46.91 It should be noted that under the first and second approach the variable interest rates fixed by the relevant monetary institution or governmental body may change in certain time intervals. It is impossible to list here all types of intervals used by legal systems and their precise computation. Where such interval is used, the most prominent approaches appear to be a six-month and a one-year period²⁴¹ for which the reference rate operates.

46.92 The third approach to variable interest rates described earlier²⁴² is to align the applicable interest rate as close to the commercial reality as possible. The proponents of this approach advocate the application of a floating commercial interest rate.²⁴³ Such a rate is perceived to reflect the (p. 700) compensatory needs more adequately than fixed statutory rates.²⁴⁴ In addition, it is argued that a floating commercial rate also has the advantage of accounting for currency devaluation.²⁴⁵ This latter aspect is naturally best used for compensatory purposes when applying the commercial interest rate at the place of payment.²⁴⁶

46.93 This third approach is most prominently followed by the uniform projects. These unanimously refer to the average bank short-term lending rate to prime borrowers prevailing for the currency of payment at the place for payment.²⁴⁷

46.94 For the PICC it has been suggested that this is the most appropriate solution as this is typically the rate at which the obligee will have to take a loan while awaiting payment.²⁴⁸ However, the PICC add that if such a rate does not exist, the relevant rate is the average bank short-term lending rate to prime borrowers in the state of the currency of payment.²⁴⁹ Failing such rate, the PICC provide that the ‘appropriate rate fixed by the law of the State of the currency of payment’ shall apply.²⁵⁰ This is interpreted to typically mean the legal interest rate.²⁵¹

3. Discretion of Adjudicator

46.95 Another approach taken by some legal systems shows more reluctance to actually establishing an interest rate. Rather, these legal systems entrust adjudicators with broad discretion to fix the interest in the case before them. This approach, for instance, can be found occasionally in Ibero-American legal systems. In Argentina it is primarily left for the judge to fix the applicable interest rate.²⁵² However, in Argentinean court practice that discretion is used in a way so as to make the reference rate fixed by the National Bank of Argentina applicable.

46.96 The model of giving adjudicators broad discretion in determining the interest rate applicable is also found in some common law jurisdictions. This is, for example, the situation in Singapore where the High Court and the Court of Appeal are of primary importance in this regard. However, it appears that for a time a least those c

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