In the interest of arbitration

SOMEONE once said, “I don't believe in principle but I do believe in interest.” We all know about interest. It's something we want on our hard-earned money when someone else has the use of it. Interest is supposed to be the compensation allowed by law or fixed by the parties for the use of borrowed money, but we also know that banks now pay very little of it on our principal.

When reviewing the published SMA awards, particularly the older ones, I found decisions in which arbitrators declined to award interest on damages. The reason appeared to be that, since the claimant did not specifically demand it, the panel did not award it. It is well possible that I too was one of those culprits. My reason had probably been that, since the party did not ask for it and I granted something in excess of the demand, it could be argued that I exceeded my arbitral powers, leaving the award open to a challenge in court, as it was in the Maria Sitinas.

Since interest is to be compensatory, and not punitive, it should be obvious and equitable that a claimant should be entitled to interest on an award whether asked for or not. There are a few awards which address different aspects of the entitlement to interest:

• The panel denied interest because of the extremely dilatory manner in which owners' claim was brought to arbitration;
• Owners who failed to pursue their claims diligently against charterers were denied more than six years of interest out of the nine years between the events and the award in owners' favour;
• A time charterer may not recover interest on the value of its bunkers retained aboard the vessel during offhire periods;
• Where owners delayed unreasonably in prosecuting their claim, the award of interest was limited to the period in which interest would have been earned if the claim had been prosecuted diligently;
• Interest was not awarded for a period when owners had delayed without justification in the prosecution of their claim;
• Because charterers had withheld the amount of their ultimate recovery, they suffered no damage from loss of use of their funds and the panel declined to award interest;
• Pre-award interest was not granted where charterers withheld hire for the full amount of their claim;
• Stealing cargo deprived owners of their remedy of interest on freight withheld by charterers as security for cargo shortage;
• Panel refused to award interest on sums at issue in demurrage claim where both parties contest actual amounts.

I remember an early case where the arbitrators decided to adjust the interest rate downwards because the claimant procrastinated in the pursuit of the arbitration in a rising interest market. The claimants asked for interest of ten per cent per annum. The panel made an award for interest, however, at a rate of eight per cent per annum, which was the prevailing rate when the arbitration began.

As a general rule, the SMA has used the prime rate (weighted and averaged for the period in question) as a benchmark. This is a way of addressing the interest issue in a clinical and consistent manner. The SMA has also used simple interest for the damage awards instead of compound interest. Bernstein's Handbook of Arbitration and Dispute Resolution Practice addresses the question of compound versus simple interest as follows:

The question whether to award simple or compound interest is one of discretion. In exercising the discretion, the arbitrator should bear firmly in mind the object of awarding interest. If the applicant can make out a case that compound interest is the only way he can be put in the position he would have been in if payment due him had been made on time, then he should have compound interest. Thus, for example, if the applicant has had to borrow money from a bank and pay compound interest, an award by the arbitrator of compound interest would be justified.

The matter of compound interest makes commercial sense, but I can see that it may create more problems than it will solve. How do arbitrators calculate interest – which is the base rate, should it be compounded daily, weekly or monthly? Without intending to be cynical, do arbitrators really want to spend more time on computing interest calculations which may take longer than deciding a case?

Some arbitrators have suggested and also applied the ‘prime rate plus' level as being more reflective of money cost. But how do you apply this concept in a consistent and equitable manner? Should the ultimate interest rate be prime plus 1 or 2 or 3? Who would be able to make the correct assessment? When banks evaluate potential borrowers, they look at assets, cashflow, anticipated earnings, past performance, and reputation, among other things, to determine the risk factors and establish an appropriate lending rate. Considering that this is a fairly complex process involving qualitative evaluations, I would question the arbitrators' ability (or justification for it) to determine the ‘plus' factor without having any underlying facts concerning the claimant's financial standing.

Most New York arbitration awards include a provision dealing with post-arbitration interest in a conditional fashion, using language such as;

If this award has not been paid within 30 days [or some other period], interest shall resume to accrue at the rate of ___ per cent p.a. on the principal amount from the date of this award until payment in full has been made or the award has been reduced to judgment, whichever first occurs.

The exceptions are unopposed arbitrations where most panels would direct that interest at ___ per cent shall run from the debt due date until payment has been received or the award has been reduced to judgment.

Why do arbitrators generally grant grace periods in normal arbitrations, but decline to do so in no-show actions? This practice, as well as the custom of allowing defendants a grace period from the date of an award, requires review. It has been argued that grace periods are necessary because parties must have a chance to review the submissions/claims. This is not unreasonable, but when you consider that a debt is due on a particular day, why should the claimant be denied the use of the money?

One blatant example would be the failure to pay time charter hire, which is normally due fifteen days in advance. To grant a grace period for the hire accounting would indeed reward the wrongdoer. In the days when cheques needed to be cut and mailed, or foreign currencies had to be purchased for the purpose of settling invoices or an award, it may have been appropriate to allow certain periods to accomplish this. However, in today's banking environment and the ease with which funds can be moved around (provided there is liquidity), there is no justification to allow a grace period of any duration.

In a recent case, a shipowner was awarded approximately $5.5 million in overdue freight. Since an interest rate of four per cent (the current prime) would not compensate the owner for the loss of funds or represent an inducement to charterers to pay this amount due, the panel decided to apply the statutory interest rate of nine per cent per annum as applied in New York State courts. The state courts award both pre-judgment and post-judgment interest by statute at this level.

The Federal Court in New York may follow the state statutory rate for pre-judgment interest or, in maritime cases, declare a rate in its discretion based on the submissions of the parties as to the actual rate over the pre-judgment period that would amount to restitutio in integrum for the recovering party. For the post-judgment interest, the Federal Court, by statute, looks to the published 52-week Treasury Bills rate.

In this context, I refer to a couple of court decisions dealing with interest;

• Compound pre-judgment is the norm in federal litigation [ Amoco Cadiz ];
• A claim which has been exaggerated will be reduced, but the claimant is nonetheless entitled to interest on the reduced portion [ Amoco Cadiz ];
• Interest calculated an average yield of six-month Treasury bills. [ Nepco v O.T. Sonja ];
• Interest should be awarded at the rate the wrongdoer would have paid to borrow the money or at the rate the victim could have earned for loaning the money, whichever is greater [ Gamma-10 v APL ]

The strangest request for interest I encountered was in a breach of contract case. The claim was for approximately $600,000 and the principal testified that his company should be entitled to interest at a rate of 46 per cent. When questioned about this extraordinary rate, he stated that, at the time of the breach, his company bought a stock in another company whose shares rose by 46 per cent. Therefore, he argued that, had they had the money due them (i.e., $600,000), they could have invested it and made this very substantial return. The panel, not unexpectedly, declined this rate.

Some might think there is justification in awarding the 46 per cent interest. But what about an adverse market reaction? If the shares had not gone up, but down, should claimants' entitlement to interest be reduced or totally negated at all? It is human nature to hope that everything will always work for the better, but this type of return is neither realistic nor foreseeable, and, therefore, inappropriate for an arbitration award.

Interest needs to be more reflective of commercial realities. Parties need to be made whole and not penalised by unrealistic rate levels. At the same time, the application should be standardised so that the results are not all over the map. With that thought in mind, it would be my suggestion that New York arbitrators adopt the court-applied rates.