Interest Rates

I. Introduction

Interest “is a standard form of compensation for the loss of the use of money”.¹ Interest awarded should “address two of the most basic concepts in finance: the time value of money and the risk of the cash flows at issue.”²

Noteworthy, interest can have a significant impact on damages in arbitral awards.³

An award of interest is often categorized in interest that accrues from the date of valuation to the date of the award (pre-award interest), and from the date of the award to the date of actual payment (post-award-interest).⁴

II. Calculation of pre-award interest

A. Interest rates

Interest rates are sometimes specified either in the contract between the parties, in the applicable law or in a bilateral investment treaty. In these cases, the statutory or contractual rate, which could be a fixed interest rate, or a rate expressed relative to a benchmark rate, is to be applied.⁵

In case the interest rate is neither statutory nor established in the contract between the parties, economic principles can be employed to select an appropriate interest rate. Three rival theories exist:

Claimant is only “entitled to interest compensating it for the time value of money, but it is not also entitled to compensation for the risks it did not bear.”⁶ By “depriving the plaintiff of an asset […], the defendant also relieved it of the risks associated with investment in that asset.”⁷ Since there is no risk of default once the award is issued, Claimant should earn interest at a risk-free rate.⁸ Examples of interest rates that are considered (at least nearly) risk-free are yields on certain government bonds (issued for example by the US or Germany) or interbank rates, such as the USD Libor.⁹
As per the coerced loan theory, claimant was effectively coerced into providing respondent with a loan at the date of the original breach, and therefore deserves to earn interest on this forced loan at respondent’s unsecured borrowing rate.¹⁰
Since claimant had to raise capital to replace the funds lost as a result of a breach, interest should be awarded based on either claimant’s borrowing rate¹¹ or its cost of capital,¹² whereas the cost of capital reflects both claimants’ cost of debt and its required return on equity.¹³

In practice, pre-award interest is mostly awarded based on a market rate - Market rates such as a yield on government bonds or an interbank lending rate - plus, in some cases, a spread, or based on a fixed rate specified by the tribunal.

B. Simple v. Compound

In absence of a statutory rate or contractual regulations, tribunals need to determine whether interest accrues on a simple basis or on a compound basis.¹⁴ While both were equally common in arbitral awards pre-2000 and in the early 2000s, tribunals increasingly rely on compounding since around 2006, as it better “reflects the economic reality of investment”.¹⁵

C. Currency Issues

Interest rates must reflect the currency in which an investment is made to adequately consider the fundamental economic relationship between the value of a currency and the (nominal) interest rate offered on deposits in that currency.¹⁶

III. Calculation of post-award interest

Insofar as the principle of interest is to compensate Claimant for the time period between the date of valuation and the date of payment, there is no reason to differentiate between pre-award and post-award interest.¹⁷ In that spirit, tribunals in most cases “[...] did not comment upon or distinguish between pre-award and post-award interest.”¹⁸

10.

However, some tribunals “have subjected pre- and post-award interest to different rates”,¹⁹ arguing that the purpose of post-award and pre-award is different. I.e. “damages become due as at the date of the Award, and from this time, Respondent is essentially in default of payment.”²⁰ A higher post-award interest may also be justified to incentivize respondent to pay the award early.²¹