Parties regularly demand prejudgment interest in their complaints, but too often the rules regarding the propriety and calculation of prejudgment interest are not fully understood, leading to faulty awards.
The objective of this article and self-study test is to review the basic rules governing prejudgment interest. Readers will learn about the different rationales for making awards, important limits to awards, and the mechanics of calculating prejudgment interest.
The earlier that parties resolve litigation, the less time the prevailing party will be deprived of the benefit in dispute. If an action drags on for years, the losing party can expect in many cases to pay its opponent prejudgment interest; otherwise, the judgment will not afford complete relief.
In practice, when parties agree to a sum due shortly after the dispute arises, no interest will normally be added to the settlement sum. Even if a lawsuit is filed but settled well before extensive discovery and pretrial motions, interest on the amount in dispute is likely to be minimal and may be further reduced as part of the overall negotiated settlement.
On the other hand, once both parties go through a contested court battle, any amount ultimately awarded will commonly include a substantial award of prejudgment interest that may even exceed the original principal portion of the judgment.
For typical loans, interest "is the compensation allowed by law or fixed by the parties for the use, or forbearance, or detention of money." Civil Code Section 1915. Prejudgment interest has an analogous purpose; it is considered a component of general damages, to compensate for the time that the plaintiff was denied use of the money or property in dispute. "The policy underlying authorization of an award of prejudgment interest is to compensate the injured party-to make that party whole for the accrual of wealth which could have been produced during the period of loss." Cassinos v Union Oil Co., 14 CA4th 1770 (1993).
In contract actions, awarding prejudgment interest essentially gives the plaintiff the benefit of the bargain denied by the defendant. See Lewis C. Nelson & Sons, Inc. v Clovis Unified Sch. Dist., 90 CA4th 64 (2001). In tort actions, prejudgment interest serves to make the plaintiff whole for the out-of-pocket losses suffered. See Lakin v Watkins Assoc. Indus., 6 C4th 644 (1993).
Because prejudgment interest is considered a part of the plaintiff's damages, it can be awarded even if not separately requested in the complaint. Sanders v City of Los Angeles, 3 C3d 252 (1970). "No specific request for interest need be included in the complaint; a prayer seeking such other and further relief as may be proper is sufficient for the court to invoke its power to award prejudgment interest." North Oakland Med. Clinic v Rogers, 65 CA4th 824 (1998). Of course, a request for prejudgment interest must be made to the trial court; it cannot be made for the first time on appeal. Peoples Fin. & Thrift Co. v Mike-Ron Corp., 236 CA2d 897 (1965).
By law, the ability to collect prejudgment interest in appropriate cases is an exception to the general rule that interest cannot be recovered against a state or municipality. Civil Code Section 3287(a); Santa Clara County Environmental Health Ass'n v County of Santa Clara, 173 CA3d 74 (1985).
To assure fairness to the losing side, prejudgment interest is generally available only if and starting when the damages become certain or capable of calculation. "Every person who is entitled to recover damages certain, or capable of being made certain by calculation, and the right to recover which is vested in him upon a particular day, is entitled also to recover interest thereon from that day, except during such time as the debtor is prevented by law, or by the act of the creditor from paying the debt." Civil Code Section 3287(a).
Damages are considered certain for purposes of prejudgment interest when the defendant would know, without a trial, how much is owed. Chesapeake Indus., Inc. v Togova Enters., Inc., 149 CA3d 901 (1983). The argument for this rule is that "it is unreasonable to expect a defendant to pay a debt before he or she becomes aware of it or is able to compute its amount." Lewis C. Nelson & Sons, Inc. v Clovis Unified Sch. Dist., 90 CA4th 64 (2001). If the defendant does not know or cannot readily compute the damages, the plaintiff must present a demand to start the running of interest. Levi-Zentner Co. v Southern Pac. Transp. Co., 74 CA3d 762 (1977) (interest started from submission of fire damage estimates by experts).
In contract actions, awarding prejudgment interest is mandatory on liquidated claims. Civil Code Section 3287(a). For previously unliquidated contract claims, prejudgment interest can be awarded "from a date prior to the entry of judgment as the court may, in its discretion, fix, but in no event earlier than the date the action was filed" Civil Code Section 3287(b). This discretion is explained as follows: "By allowing an award of prejudgment interest, but only for a limited time period and only if the trial court finds it reasonable in light of the factual circumstances of a particular case, [the Civil Code] seeks to balance the concern for fairness to the debtor against the concern for full compensation to the wronged party." Lewis C. Nelson & Sons, Inc. v Clovis Unified Sch. Dist.
In all other cases, particularly those involving oppression, fraud, or malice, prejudgment interest may be awarded in the discretion of the trier of fact (again, as long as the damages were certain or capable of calculation). Civil Code Section 3288; See Greater Westchester Homeowners Ass'n v City of Los Angeles, 26 C3d 86 (1979). This rule extends to actions for negligence. Bullis v Security Pac. Nat'l Bank, 21 C3d 801 (1978). Of course, prejudgment interest normally may not be awarded on noneconomic damages (such as pain and suffering) because these are plainly speculative and unliquidated before a verdict. Greater Westchester Homeowners Ass'n v City of Los Angeles.
Civil Code Section 3291, however, requires a partial award of prejudgment interest in personal injury cases, even on completely unliquidated claims, when the defendant rejects an offer to compromise under Code of Civil Procedure Section 998 and the plaintiff later obtains a more favorable judgment. The interest accrues at 10 percent annually on the amount the judgment exceeds the rejected offer from the date the offer was made; notably, such interest is not available in insurance bad faith actions because such actions seek damages for interference with a property right, not for personal injury. Gourley v State Farm Mut. Auto. Ins. Co., 53 C3d 121 (1991).
Prejudgment interest is not a substitute for exemplary damages and should not be used to punish the defendant. Vogelsang v Wolpert, 227 CA2d 102 (1964); Nordahl v Department of Real Estate, 48 CA3d 657 (1975). On the other hand, "it is also clear that prejudgment interest and exemplary damages are not mutually exclusive; both may properly be awarded in the same case." Vogelsang v Wolpert.
Once a court decides to award prejudgment interest, it must calculate the proper amount. The process starts by figuring a daily interest factor, and multiplying that factor by the number of days that have passed since the interest started to accrue. Most courts calculate the daily interest factor by multiplying the principal sum due by the applicable interest rate, and then dividing the product by the 365 days in a year. Some courts use the "bank industry" method and divide the product by 360 rather than 365. See Continental Airlines, Inc. v McDonnell Douglas Corp., 216 CA3d 388 (1989).
The appropriate interest rate varies with the type of case at hand. In contract cases, prejudgment interest runs at the annual rate of 10 percent unless the contract stipulates a different interest rate (whether lower or higher than 10 percent). Civil Code Section 3289. In all other cases and absent any statute to the contrary, prejudgment interest runs at the constitutional rate of 7 percent. Pacific-Southern Mortgage Trust Co. v Insurance Co. of N. Am., 166 CA3d 703 (1985); Cal. Const. Article XV, Section 1. For example, since there is no legislative act specifying the rate for a fraud claim, the constitutional rate of 7 percent applies. Continental Airlines, Inc. v McDonnell Douglas Corp.
In contract actions, the compounding of prejudgment interest, that is, adding interest on interest, is generally barred by the Usury Law unless the debtor signs an express agreement allowing for compound interest. Civil Code Section 1916-2. In all other cases, however, compounding may be allowed in the discretion of the trier of fact, such as when a plaintiff proves lost interest because of a defendant's breach of fiduciary duty. Michelson v Hamada, 29 CA4th 1566 (1994).
Once prejudgment interest is added to the judgment, the total judgment in turn bears postjudgment interest at the annual rate of 10 percent until satisfied. Code of Civil Procedure Section 685.010. The special prejudgment interest allowed in personal injury actions, when a judgment exceeds a prior rejected statutory offer to compromise, is not however added to the judgment and does not bear postjudgment interest. Civil Code Section 3291; Hess v Ford Motor Co., 27 C4th 516 (2002). Although in rare cases a court may compound prejudgment interest, there is no constitutional or statutory authority or equitable power for ordering that the judgment bear compound postjudgment interest. Westbrook v Fairchild, 7 CA4th 889 (1992).
The foregoing prejudgment rules may appear straightforward, but many common situations present thorny questions. For instance, a single late fee is considered a liquidated damage for late performance (Utility Consumers' Action Network, Inc. v AT&T Broadband of S. Cal., Inc., 135 CA4th 1023 (2006)) and probably should bear prejudgment interest along with the unpaid balance. Some late fees, though, are imposed monthly as a percentage of the unpaid balance; these contracts are considered credit sales, and although the late charges are not interest (and may exceed any usury limit), the rate is still used to establish the prejudgment interest rate on the unpaid balance, but the late fees do not themselves bear interest. See Southwest Concrete Prods. v. Gosh Constr. Corp., 51 C3d 701 (1990).
Similarly, in automobile and consumer credit sales, finance charges are not considered interest, but the rate establishes the rate used for prejudgment interest. See Kunert v Mission Fin. Servs. Corp., 110 CA4th 242 (2003). Unlike other credit sales, though, accrued finance charges are by law included in the balance on which prejudgment interest would be calculated. See Civil Code Sections 1806.3 and 2982(l). This does not apply to ordinary credit cards that are, in essence, bank loans and not credit sales.
Contractual arbitration awards bear prejudgment interest at 10 percent per annum from the date the award is issued (Civil Code Section 3289) but no case deals with awards that already contain preaward interest. Equitable subrogation claims by insurers, to recover payouts to their insureds from third parties, bear prejudgment interest from the date a demand was served on the defendant (Leatherby Ins. Co. v City of Tustin, 76 CA3d 678 (1977)), with the amount set by the court at 7 percent. No case explains what happens if the payout included compensation for personal injury. Common counts for the value of goods and services provided, being inherently unliquidated contract claims until judgment, should bear interest only in the court's discretion. Civil Code Section 3287(b).
Prejudgment interest is intended to provide complete relief while assuring fairness to the defendant. Keeping the foregoing rules in mind will help all judgments meet this goal.
Robert Harrison is a Commissioner of the Los Angeles County Superior Court.