Lawrence W. Newman and David Zaslowsky ()
When awards are issued in an international arbitration—whether for breach of contract in commercial arbitration or expropriation in investment arbitration—an essential component is interest on the compensatory amount of the award. The interest component can, particularly when long periods of time have passed and/or generally prevailing interest rates are high, exceed the amount of compensation on the merits.1 We discuss here how awards of interest in international arbitration have been made and how commentators have urged that they be made.2
It is axiomatic that the purpose of an award of damages in arbitration or in court is to restore the claimant to the position that it would have been in had there been no wrongful conduct on the part of the respondent. To the extent that this righting of the balance is delayed, there is additional harm to the claimant that must be redressed. Thus, it is generally accepted that the award of interest is part of the award of compensatory damages to the claimant, to take into account the passage of time since the respondent’s wrongdoing took place. Therefore, claimants formulaically include in their prayers for relief requests that interest be awarded, sometimes adding the request that it be awarded through the time when payment of the award is made.
The arbitrators are left with the responsibility of determining to what extent they give recognition to this component. Institutional rules and national laws give arbitrators little or no guidance in awarding interest. Instead, they afford wide discretion to them.3 U.S. courts, when addressing awards of interest, limit their concerns to whether the awards violate public policy by imposing interest rates that are penal.4 Thus, arbitrators have a virtual tabula rasa in setting interest rates on their awards. It should come as no surprise, then, that, according to anecdotal and other evidence, arbitral awards are frequently the product of the application of a rough sense of what is fair together with negotiations among tribunal members to achieve unanimity in the award.
Awards of this kind have been criticized by one set of commentators as being part of:
…an incredible diversity of approaches taken by tribunals of varying levels of financial sophistication and also the unfortunate reality that…some tribunals are unfamiliar with such concepts and haven’t been helped by counsel. [The result has sometimes been that} awards have been rendered where the interest component [is] an unrealistic pittance, or a major windfall, or is given on the one hand and taken away on the other.5
These approaches are in contrast to the more painstaking process that ordinarily underlies the determination of compensatory damages. In analyzing how interest rates should be determined commentators have found certain components of interest determination to be less problematic than others. For example, whether there should be separate interest rates for different periods, such as before and after the award. Although some awards have been known to provide for a rate of interest to be applied until payment is made of the award, it is generally accepted, in the United States at least, that, once an award has been converted into a court judgment, interest thereafter must accrue at the statutory rate.
A distinction6 between pre-award interest and post-award interest has been made by parties arguing that prejudgment interest rates in state procedural codes, such as the 9 percent prejudgment interest rate under the CPLR,7 should be applied to the time period prior to the issuance of the award. Otherwise, there appears to be little support in the financial literature for the application of differing interest rates for the time periods before the award and thereafter before its conversion into a judgment. As a second example, the historic approach of awarding simple interest has seemingly given way to the frequent use of compound interest.
Perhaps the most important concern for arbitrators in crafting an award of interest is the rate of interest they should apply. One place for them to look for assistance is in the parties’ transaction, where they may have referred to an interest rate that the arbitrators might use as an indicator. Ordinarily, however, the parties have not left clues of this sort and the arbitrators must look to the world outside the case.
Claimant’s Lost Opportunity
The purpose of the damages award is to provide the claimant with a sum of money that puts it in as good a position as it would have been in but for the wrongful conduct of the respondent. Since the damages award has not been paid and may not be for some time in the future, interest must be added to the award to make up for the time until payment is made or a court judgment obtained. In the view of some commentators, the award, as a determined amount, albeit one that has not yet been realized by being turned into cash, should be treated as a fixed sum of money that should attract interest, as would any such liquidated fund, at a risk-free rate such as that of U.S. treasuries.
Other commentators say that it is not really a fixed sum but only an unsecured, liquidated claim against the respondent and therefore a debt owed by the respondent, which may or may not pay it promptly, if at all. Recognition, they say, should be given in the interest rate to this uncertainty. Therefore, the suggestion has been made that, in place of or in addition to, a risk-free rate there be introduced an additional component that reflects certain business realities such as the parties’ risks and opportunities.
But how are these risk or opportunity factors to be assessed? And from whose point of view—the claimant’s or the respondent’s? Many analyses focus on the financial situation of the claimant, since he or she is the one who experienced the loss and who is being compensated in the damages award. One such approach may be found in the Guidelines of the Chartered Institute of Arbitrators, which provide as follows:
The best approach is to attempt to assess the commercial rate of interest that someone in the position of the claimant would have had to pay to borrow the money which is to be awarded to him as a debt or damages.8
Some commentators go further and argue for the application of a rate of interest on the unpaid award that is based on the claimant’s cost of raising capital, assuming that, if the claimant had the money that arbitrators have awarded it from the time the claim arose, it would have had to obtain less money for its business. The argument is that a more conservative interest rate does not take into account the opportunity that the claimant was deprived of by the breach or taking and that the interest rate should be higher to compensate the claimant for having that opportunity replaced by what may well be a less valuable debt obligation of the respondent in the form of the damages award.9
This kind of analysis may require consideration by the arbitrators of such information as the claimant’s cost of capital or borrowing, and perhaps also the costs incurred by other businesses in the same industry or otherwise in a similar financial situation. Such information may also be gleaned from analyses that may well have been done by or for the arbitrators for their determination of the amount of compensatory damages—such as analyzing expected future cash flows of the enterprise. But this kind of analysis may not be easy and may well require the assistance of consultants.
Another—and analytically easier—way of looking at interest damages is from the point of view of the respondent, for whom the award of compensatory damages is, as mentioned, a debt owed by it to the claimant. The financial result of the award is that the respondent has obtained an involuntary loan from the claimant. Under this approach, the interest rate should be at least that which the respondent pays to borrow money.
Since the award could be paid at any time, it can be regarded as being akin to a demand loan and the applicable interest rate should be short-term. The riskier and more fragile the respondent’s enterprise, the greater the risk that it will not pay because of bankruptcy, and the higher the interest rates it will generally have to pay to obtain financing, the higher rate it should pay as part of the arbitration award.
Applicable rates of interest can be based on what the respondent, or similar businesses, pay on short-term commercial paper. In the absence of such information, the arbitrators may well have to obtain, from the parties or their financial consultants, other information concerning borrowing rates of the respondent and/or of enterprises of the same level of stability, or lack of it, as the respondent.
Whatever method the arbitrators use to determine the rate of interest, a reality test that they could apply to proposed rates is whether the rate may provide an incentive to either party to obtain an abusive advantage. Thus, it could be said that the rate should not be so low that the respondent will have little incentive to pay because the award constitutes cheap financing. On the other hand, the rate should not be so high that the claimant may be disinclined to pursue enforcement of its award vigorously—although this is a less likely scenario.
Just as the award of damages in arbitrations can be complex, so may the awarding of interest. To further the goal of making the process of international arbitration more predictable, it may well be desirable for further guidelines on the award of interest to be developed. Perhaps the International Institute for Conflict Prevention and Resolution (CPR), the International Bar Association or the Chartered Institute of Arbitrators (rethinking its current British-centered guidelines) could publish clear and workable guidelines that arbitrators may use to achieve this goal.
Lawrence W. Newman is of counsel and David Zaslowsky is a partner in the New York office of Baker & McKenzie. They are authors of “Litigating International Commercial Disputes” (West) and can be reached at lawrence.newman@­bakermckenzie.com and david.zaslowsky@­bakermckenzie.com.
1. See, for example, awards in the Iran-U.S. Claims Tribunal in the 1980s, when interest rates were high. The tribunal routinely awarded interest at the rate of 10 percent a year in cases that had taken many years to reach the award stage. In many of those cases, the interest component exceeded the amount of the liability.
2. Richard E. Walck, a partner in Global Financial Analytics, assisted in enabling the authors to obtain a clearer understanding of some of the financial concepts discussed herein. The authors, however, are responsible for the content of the article.
3. For example, Article 26.6 of the Rules of the London Court of International Arbitration afford wide discretion to the arbitrators, permitting them to award interest at rates they deem “appropriate.”
4. See, e.g., Brandeis Intsel Ltd. v. Calabrian Chem. Corp., 656 F.Supp. 160, 170 (S.D.N.Y. 1987).
5. Mark Beeley and Richard E Walck, “Approaches to the Award of Interest by Arbitration Tribunals,” (2014) The Journal of Damages in International Arbitration, 51, 56.
7. CPLR 5001(a), 5004.
8. Chartered Institute of Arbitrators Practice Guideline 13: Guidelines for Arbitrators on how to approach the making of awards on interest, section 4.2(2).
9. See Beeley and Walck, supra at 69.