Full Compensation, Not Overcompensation: Rethinking Prejudgment Interest Offsets in Washington

• Publication year: 2007

SEATTLE UNIVERSITY LAW REVIEWVolume 30, No. 3SPRING 2007

COMMENTS

Full Compensation, Not Overcompensation: Rethinking Prejudgment Interest Offsets in Washington

Aric Jarrett(fn*)

I. Introduction

If justice were immediate, prejudgment interest would never be awarded.(fn1) Justice, however, is not necessarily immediate: some parties must endure years of litigation in order to obtain compensation for their damages.(fn2) Because "compensation is a fundamental principal of damages" in litigation,(fn3) varying types of interest may be awarded on such damage awards in order to fully compensate an injured party.(fn4) To be sure, a sum of money today is not a complete substitute for the same amount that should have been paid years ago.(fn5) One type of interest that courts may award is prejudgment interest-interest awarded on a legal judgment from the time the claim accrued until entry of that judgment.(fn6)

Although interest is not intended as a windfall,(fn7) interest does serve an integral purpose in judicial remedies.(fn8) In fact, many areas of the law award prejudgment interest as incident to a meritorious claim for damages.(fn9) Moreover, prejudgment interest awards may be especially large- in some cases even exceeding the value of the principal claim.(fn10) For example, the Seventh Circuit affirmed an award of more than $120,000,000 in prejudgment interest on a principal claim of $61,000,000.(fn11) More recently, the Supreme Court affirmed a decision awarding approximately $5,300,000 in prejudgment interest on a principal claim of approximately $1,670,000.(fn12) Accordingly, in any case, prejudgment interest may be a large, if not central, issue in litigation.(fn13)

Moreover, in many cases both the plaintiff and the defendant assert claims against each other, claims that may require awarding interest in order to fully compensate the respective claimant.(fn14) Some of the opposing claims arise from the same contract or same operative facts, while others arise from entirely separate, collateral matters. Based on various factors discussed below, the relationship between these claims determines which claims receive interest awards and how those awards are calculated vis-a-vis the opposing claims.(fn15) This Comment focuses on the situation where a liquidated claim is opposed by an unliquidated counterclaim. Although there are four different approaches to calculating prejudgment interest in this situation,(fn16) two are of central importance. First, some states apply the "interest on the entire claim" or "interest on the whole" rule.(fn17) Under that rule, prejudgment interest is calculated and awarded on the liquidated claim prior to deducting the opposing unliquidated counterclaim.(fn18) Washington currently follows this rule.(fn19)

Second, some states apply the "interest on the balance" rule.(fn20) Under that rule, interest is calculated and awarded only after deducting the opposing unliquidated counterclaim.(fn21) Accordingly, the liquidated claim is offset by the unliquidated claim prior to the calculation prejudgment interest, if any, on the liquidated claim under the interest on the balance rule.(fn22)

As noted above, Washington applies the interest on the entire claim rule in calculating prejudgment interest offsets.(fn23) Although Washington courts rarely permit the offset of an unliquidated counterclaim prior to the calculation of prejudgment interest on a liquidated claim, this Comment argues that Washington should adopt the interest on the balance rule when both claims arise out of the same transaction, contract, or operative facts. Indeed, this rule is articulated by numerous treatises(fn24) and followed in many states.(fn25)

Following this introduction, Part II explores the nature and purposes of prejudgment interest, focusing on the role that prejudgment interest plays in a claimant's remedy or damage award and exploring the historical distinction between liquidated and unliquidated claims. Part III builds on this historical distinction by examining two different approaches for calculating prejudgment interest where a meritorious liquidated claim is countered by a meritorious unliquidated counterclaim: (1) the Washington rule, also known as the interest on the entire claim or interest on the whole rule; and (2) the interest on the balance rule and its slight variation in California, which focuses on the distinction between a "payment" and a "discount". Based on those rules, Part IV argues that (1) Washington's continued reliance on Mall Tool Co. v. Far West Equip. Co.,(fn26) which applied the interest on the whole rule except in a very narrow situation,(fn27) leads to unjust results in many cases; and (2) the interest on the balance rule is the better reasoned approach. Finally, Part V concludes that Washington should replace the rule established in Mall Tool Co. with the interest on the balance rule for awarding and calculating prejudgment interest, thereby making interest on the whole the exception rather than the rule.

II. The Nature and Purposes of Prejudgment Interest Historically

A. The Historical Evolution of Interest

Interest is the sum of money paid or payable for the use or detention of money or property.(fn28) Prejudgment interest, then, is interest that is awarded as part of a judgment, but which is calculated to accrue prior to the entry of that judgment.(fn29) Although calculated on the total amount awarded in a judgment, prejudgment interest runs only for, and with respect to, some certain period prior to the entry of that judgment.(fn30) This timeframe distinguishes prejudgment interest from any other interest awarded on the judgment, which runs from and after the entry thereof.(fn31) In general, prejudgment interest may be awarded from the date of a breach of a contract,(fn32) commission of a tort,(fn33) or in some cases, the commencement of the lawsuit.(fn34)

Historically, societal prejudice and religious beliefs condemned the payment of interest as usury. As a result, interest was awarded to a meritorious claimant only in a limited number of circumstances and then only in the discretion of the jury.(fn35) Interest was "an abhorrence to the law, and a contract therefor was not only not enforceable, but criminal."(fn36) By the nineteenth century, however, American courts awarded interest, but only on liquidated claims.(fn37) At that time, "liquidated" meant that the amount of the claim was absolutely certain and payable at a specific date.(fn38)

B. Historical Rationales for Awarding Interest

Courts have justified prejudgment interest on at least three different theories: (1) punishment for the wrongful detention of money or property; (2) full compensation of the claimant; and (3) disgorgement of profits to prevent unjust enrichment.(fn39) In light of the various theories relied on over the course of jurisprudence, courts continue to debate whether interest should be awarded as a matter of right.(fn40) Regardless, courts continue to utilize multiple rationales for awarding interest.(fn41)

1. Punishment for the Wrongful Detention of Money or Property

The theory that interest was awarded as punishment arose out of the common law dislike of interest as usury.(fn42) With the increased importance of personal property and commerce, courts began to enforce contracts that awarded interest for non-payment.(fn43) The motivating rationale for allowing interest was a recognition that money was inherently valuable to the user and, consequently, it was a legitimate subject of compensation for the rightful owner.(fn44) "This concession [of the law] was followed by a recognition of the fact that a refusal to pay money legally due, like a refusal to perform any other legal duty to another, merited condemnation and punishment from the courts ... ."(fn45) As a result, interest was awarded to the rightful owner (for example, the meritorious creditor-claimant) in order to punish the debtor for the wrongful detention of money.(fn46)

2. Full Compensation of Claimants for Lost Value

Following the punishment theory for awarding interest, full compensation of a meritorious claimant became central to interest awards.(fn47 ) Under this theory, prejudgment interest compensates the claimant for the delay between the date of injury and the date of payment.(fn48) Prejudgment interest was used to provide an adjustment converting time-of-accident damages into time-of-judgment damages, thereby achieving the goals of full compensation.(fn49) As Chief Justice Cardozo explained in Prager v. New Jersey Fidelity.and Plate Glass Insurance Co. of Newark, (fn50) interest is held to be an incident to just compensation.(fn51) Interest, then, "is a concomitant very nearly automatic" for actions on contracts.(fn52) By the early nineteenth century, American courts awarded interest on tort claims as well as on contract theories of liability.(fn53)

Central to this theory of interest as compensatory is a recognition of the use value, or time value, of money(fn54)-recognition that both property and money have the potential to produce more value.(fn55) Courts have recognized the mercantile privilege of money in the marketplace, stating that the debtor "cannot be heard to say that it is fair and equitable that it should enjoy such a financial advantage for so long, and not pay a cent for it."(fn56) Further, because the...