AVOIDING WINDFALLS: THE BASIC ECONOMICS OF PREJUDGMENT INTEREST

Courts and tribunals are commonly faced with two challenges when determining an appropriate amount of damages to award to a claimant. The first challenge is simply determining the quantum of damages, often required to put the aggrieved party in the position it would have been at the time of the offence, absent the issue in dispute. Typically, this is an area of great focus and contention, involving testimony from company personnel and experts, demonstrative exhibits, and written submissions. The next challenge is translating a damages award for conduct that occurred in the past into present-day value as of the date of the award. This side of the damages exercise often receives relatively little attention, even though the careful and considered determination of damages can be substantially undermined if this second step is not done correctly.

The mechanism for translating past damages to present-day value is known as ‘prejudgment interest’. In simple terms, prejudgment interest is computed by applying an appropriate interest rate (or rates) to the amount of past damages. There is no question that the choice of the prejudgment interest rate makes a meaningful difference in the total award inclusive of prejudgment interest. Consider an example of a damages award of €10m for harm incurred 10 years ago. This amount is to be brought forward to the present. The two candidate prejudgment interest rates are annual rates of 4 percent (yielding €4.8m in interest) and 10 percent (yielding €15.9m in interest). (Note that interest amounts are computed using annual compounding. In the absence of some statutory or contractual directive to the contrary, it would not be appropriate to base prejudgment interest on simple interest.) In this example, like many actual arbitration awards, the amount of interest can approach or even become the largest component of the total damages award.

Jul-Sep 2013 issue

Charles River Associates (CRA)