In your interest?

Michael A van Gelder, member of the Society of Maritime Arbitrators Inc, New York, looks at how successful parties to arbitrations may be being short-changed on interest payments

IN GENERAL, most arbitration awards in New York contain provision for the prevailing party to receive compensation for its funds wrongfully withheld. That is only right and just. A panel's duty is to place the winner in the same position it would have enjoyed had there been no dispute. The challenge is determining how to do that in practice.

A corporation with a regular cashflow reduces the amount of borrowing needed to operate the business. Therefore, whenever a corporation, large or small, is deprived of the use of its funds, it usually needs to increase its bank borrowing. Banks charge interest on money loaned out, and require regular payments of that interest quarterly, monthly, or even weekly. If interest payments are not made when due, the bank then adds that amount to the principal and calculates interest on the total amount owed, thus compounding interest until a payment is received.

When a party is involved in arbitration, it is often to recover funds which have not been paid when due or which have been improperly withheld. During the time that these funds are not in the hands of the rightful owner, it is probable that the rightful owner's banker is carrying an equal amount of loans, all carrying interest as long as they are not repaid.

The next question that arises in dealing with a bank is the rate of interest that will be charged. Naturally, the bank looks at the creditworthiness of the customer before setting the interest rate, which will depend on the customer's past history in terms of current balances, regular timely repayment schedules and other matters that bankers consider relevant.

It is elementary logic that, the better the credit rating of the customer, the lower will be the interest rate assessed. Banks will always raise rates when money market conditions demand it, and will reduce them, generally more slowly, when market rates come down. Is there any good reason why arbitrators do not consider these conditions when calculating interest on sums awarded? New York arbitrators generally do this by keeping themselves aware of the market value of money by means of a table setting out the prime rates that the major New York banks charge their best customers. The words 'best customers' must be emphasised as this is totally relevant in understanding how vital it is for a small company to keep cashflow with the bank ongoing and regular.

When such a party becomes involved as a claimant in an arbitration, not only is it in an effort to correct a perceived wrong, but also - and more importantly - to retrieve a shortfall in its anticipated cashflow. During the entire time that the arbitration is going through its procedures - normally over many months and, occasionally, even years - this claimant is probably obliged to increase its borrowing from the bank. Surely, this claimant is then entitled to be fully compensated upon receipt of a favourable arbitration award.

In order to render a just award, panels should investigate, during the hearing period, or by asking separately for this information for a documents-only case, what the cost of money is to the two parties involved. Some parties may be reluctant to supply this private information for general use. However, making it clear that the information is 'for the panel's eyes only' may provide one way of overcoming this reluctance.

This raises the question of what evidence could be acceptable? There are several possibilities, including;

• a letter from the parties' banks stating the rate of interest being charged currently and during the period of dispute
• a print-out of quarterly bank statements for the relevant period
• a statement from each party as to the rate that each considers commensurate with its individual situation.

This latter option would leave the matter to the discretion of the panel, which may be preferable to many parties.

If it is clearly explained to the parties that the enquiry is solely for the purpose of awarding fair compensation, and that the information will be treated in the utmost confidence, parties may be more willing to supply the information. After all, would it not be in the interests of the party, particularly one whose interest cost is above average?

Currently in New York, this matter is being dealt with in a rather unscientific manner. Where counsel specifically request a rate of interest, on many occasions that will be granted, or even slightly reduced, without the panel having any idea whether the said rate is justified. In those cases where no specific rate of interest is requested, the panel will debate among themselves whether to apply the prime rate according to the tables in its possession, or whether to give a little - one per cent - more without having any real idea of why they may be doing so. That system may leave some parties short of a fair recovery, and therefore needs further study in order to achieve proper justice.

Whether interest is awarded at the prime rate or at some other level, the next question that needs deliberation is whether it should be calculated as simple interest or compounded. Few people nowadays lend funds at simple interest. The norm is to compound the interest over various periods. In many cases interest is calculated quarterly, but money market funds compute the interest on the daily balances, thus compounding interest daily.

Surprisingly, many arbitrators in New York have expressed great reluctance in awarding compound interest. There is a need to overcome this reluctance. There are ways of dealing with the matter. One option would be to adjust downward the rate below prime if that is judged reasonable by the panel. A second option would be to use the system outlined earlier to ascertain the facts. The bottom line is to ensure that we grant the prevailing party whatever is necessary to ensure that it will be no worse off than if there had been no arbitration. That will be completing the job entrusted to us as arbitrators.

It is an indication of the justice of so doing that arbitrators in London have recently adopted the practice of awarding compound interest. That does not mean that New York must follow blindly after London. However, more care should be taken when calculating interest awarded, in not only the rate, but also how to compensate the prevailing party for its loss of funds. In all fairness, interest should be compounded quarterly.