Compound interest in international disputes

Law and Policy in International Business, Winter 2003 by Gotanda, John Yukio

One cannot imagine that a sophisticated businessman . . . would invest his companies' funds in instruments yielding simple rales of interest. Nor is it conceivable that . . . [his] lenders w[ould] provid[e] his companies with capital at simple rates of interest.1

I. INTRODUCTION

In today's economic world, compound interest, and not simple interest, is the norm in both third-party financing and investment vehicles. Yet, in disputes between transnational contracting parties, simple interest awards are the norm.

This odd disparity between awards of international tribunals and standard business norms can have striking consequences. In disputes between transnational contracting parties, awards of interest are often significant and, in some cases, may even exceed the principal owed.2 For example, in one recent arbitration, a panel awarded the claimant approximately $4 million for the property expropriated by the respondent and approximately $12 million in compound interest.3 With interest awards of this magnitude, an award based on simple interest would be far less than an award based on compound interest.

In international disputes, the traditional view is that a tribunal may award only simple interest.4 In fact, a federal district court in Washington, D.C. recently opined in a dispute between an American contractor and the Government of Iran that the prohibition on compound interest was so well settled that it could be considered a principle of customary international law.5 However, as the United States Court of Appeals for the District of Columbia Circuit pointed out, this statement was incorrect.6 Yet, the Court of Appeals declined to award the claimant compound interest for the loss of the use of its money.7 This arguably left the claimant without full compensation.

Perhaps misunderstandings over the availability of compound interest stem from the lack of comparative study of the issue.8 Indeed, some commentators have simply presumed that compound interest may not be paid, because it is generally prohibited in many legal systems.9 This has led one authority to argue that laws simply have not kept pace with modern financial practices and that tribunals should not apply them when awarding interest.10

In this Article, I examine the laws of various countries on the awarding of interest to learn whether there exists a prohibition on the awarding of compound interest. I found that many countries do indeed provide generally for the payment of only simple interest on damage awards. However, my study also reveals that many countries have made exceptions to this practice, and that these exceptions are significant and allow for the awarding of compound interest in a number of important circumstances. I conclude that, if utilized, these exceptions may enable tribunals to fully compensate parties for their loss of the use of money.

The Article is divided into five parts. Part I provides an overview of the payment of interest. Part II reviews the circumstances under which interest may be awarded pursuant to the laws of various countries in Europe, Oceania, Asia and North and South America. My study finds a divergent practice concerning awards of compound interest; some prohibit it, others allow it in certain circumstances, and a number of statutes are silent on the issue. Part III reviews the decisions of international tribunals on compound interest. I determine that these tribunals have traditionally awarded only simple interest, but that recently a few tribunals have granted compound interest. Part IV examines whether compound interest should be awarded in disputes between transnational parties. I conclude that today almost all financing and investment vehicles involve compound, as opposed to simple, interest. Thus, limiting interest awards in all cases to simple interest would result in the claimant not being made whole for its loss. In addition, it would confer a windfall on the respondent, who likely had the use of the claimant's money for less than the cost of borrowing it. Finally, Part V sets forth the circumstances under which awards of compound interest are appropriate. I argue that there are three situations where such an award is warranted: (1) when the parties have expressly agreed to the payment of compound interest; (2) when the respondent's failure to fulfill its obligations caused the claimant to incur financing costs in which it paid compound interest; and (3) when the claimant can prove that it would have earned compound interest in the normal course of business on the money owed if the claimant had been paid in a timely manner. Awarding compound interest in these circumstances would be consistent with the laws of many countries and would better achieve the goals of awarding interest than does the traditional practice of granting only simple interest.

II. OVERVIEW OF INTEREST

Interest is a sum paid or payable as compensation for the temporary withholding of money.11 It has been distinguished from usury, which was considered to be a form of unjust enrichment in that persons were receiving more than what they had lent.12 Unlike usury, interest has been "considered the compensation due to a creditor because of a loss which he had incurred through lending."13 Throughout history, the charging of interest has been regulated, restricted and prohibited: both Aristotle and Plato disapproved of interest;14 the Old Testament placed restrictions on the charging of interest (but it did not absolutely bar it);15 and, until 1830, the Roman Catholic Church placed various restrictions on, and often prohibited, the charging of interest.16 However, under Roman law, interest was well accepted as a sum "due from a debtor who delayed or defaulted in repayment of a loan. The measure of the [amount] due for the default or delay was . . . the difference between the creditor's current position and what it would have been if the loan had been timely and fully repaid."17