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Excerpt from John O. Honnold, Uniform Law for International Sales under the 1980 United Nations Convention, 3rd ed. (1999), pages 465-471. Reproduced with permission of the publisher, Kluwer Law International, The Hague.

Article 78

Interest on Sums in Arrears

A. Legislative History
B. The Rate of Interest
C. Situations Calling for Interest
     -   Decisions on the Rate of Interest
          (1) The domestic law of one of the parties based on rules of "conflicts" (PIL)
          (2) Interest determined by the domestic law of the creditor
          (3) Interest based on international usage
          (4) The aggrieved party's cost of borrowing

§420 A. Legislative History

In recent decades economic forces, including inflation, have generated sharp increases in interest rates. Uncompensated delay in payment inflicts added loss on the aggrieved party while the party in breach gains from the use of the funds it should have paid. Adequate provision for interest not only compensates the aggrieved party for loss but also encourages voluntary performance.

The most extended delays occur during attempts to reach a settlement and as a result of ponderous judicial processes. Delays in collecting judgments are usually less serious; in any event, post-judgment interest is often provided as part of the forum’s general procedural system. We are here concerned with the more serious and intractable problem of pre-judgment interest.

Attempts to develop detailed rules in this area encountered sharp differences of view and reversals of position. The UNCITRAL Working Group’s Draft Convention (1976), building on Article 83 of ULIS (1964), provided that if the buyer delays in paying the price the seller is entitled to interest based on a two-factor formula—the higher, in seller’s country, of (a) the official discount rate plus 1% or (b) the rate for unsecured short-term credits. The full Commission tried unsuccessfully to develop a simpler formula; technical problems included the lack in some countries of an official discount rate or standard rates for short-term credits. In addition, some countries with mandatory rules limiting or prohibiting the charging of interest were opposed to dealing with the question. Faced with these difficulties the Commission deleted the draft article on interest.

The comments of governments and international organizations submitted to the Diplomatic Conference included proposals to reintroduce a provision dealing with interest. However, the Conference (like the Commission) found it difficult to agree on a formula to set the interest-rate. The Conference finally designated an ad hoc working group to seek a compromise; one of the group’s alternative proposals was approved by [page 465] the First Committee but failed in Plenary to receive the necessary two-thirds majority. A second working group then developed a draft establishing in general terms the right to receive interest on sums in arrears; this was approved (30 to 2, with 12 abstentions) and became Article 78 of the Convention.

Article 78

"If a party fails to pay the price or any other sum that is in arrears, the other party is entitled to interest on it, without prejudice to any claim for damages recoverable under article 74."

One reason for persisting in the effort that produced Article 78 was concern lest the lack of a provision on interest would lead to unintended divergences in the application of the Convention. In some legal systems compensation for lost interest is regarded as an aspect of damage-assessment; this led to concern lest laying down rules for damages (Arts. 74–77) without providing for interest might be understood as barring the recovery of interest. A similar concern resulted from the provision in Article 84(1), infra at §450, that a buyer who avoids the contract after paying for the goods may recover interest on the funds that the seller is bound to repay; providing for interest in this one setting might be construed to bar recovery of interest in all other situations.

Unintended intrusions on domestic rules could have been avoided by an express provision that the Convention does not affect any right under domestic law to recover interest. However, such a proposal was not accepted; reasons included the lack of uniformity resulting from the inadequacy or rejection of provision for interest in many countries and the lack of clarity and uniformity of rules of private international law as to which domestic law would be applicable.[1] In sum, Article 78 was designed to establish a general rule that would be free from the vagaries of domestic law.[2] [page 466]

§421 B. The Rate of Interest

As has just been noted, specific formulas for calculating interest were rejected in favor of a general rule that an aggrieved party "is entitled to interest" on "sums in arrears". The principle underlying this rule is like that of Article 74 which provides for the recovery of "damages...equal to the loss...suffered as a consequence of the breach". In many situations this general rule of Article 74 provides the sole guide for the measurement of damages. However, in some situations Article 74 is supplemented by Articles 75 and 76 which were designed to enhance definiteness in damage measurement. Consideration of these provisions in connection with the present question seems consistent with Article 7(2)’s invitation to settle unresolved questions "in conformity with the general principles" of the Convention (§§96-102, supra). Assume that an aggrieved party (A) has been wrongfully deprived of funds by the other party (X) and "in a reasonable manner" (Art. 75) replaces those funds by borrowing; Article 75 suggests that A’s loss may appropriately be measured by the cost of the "substitute transaction". In many enterprises, however, there is a constant in-and-out cash flow, supplemented where necessary by a general line of credit or by the diversion of capital; in these settings X’s failure to pay may not be matched by a substitute loan. Financial loss from X’s failure to pay is none the less real; in these cases the principle underlying Article 76 suggests that A’s loss may be measured by the "current price" of credit (cf. Art. 76(3)).[3] [page 467]

§ 422 C. Situations Calling for Interest

The provisions on interest in ULIS and in the draft Convention approved by the Working Group were confined to cases where the buyer delays paying the price. However, Article 78 of the Convention is cast in broader terms and extends to the failure of either party to pay any "sum that is in arrears".

The mandate of Article 7(1) to construe the Convention to promote "uniformity in its application" requires us to seek a principle governing the scope of Article 78 that can be considered as a basis for uniform application of the Convention. To this end let us look for situations that are clearly within, and outside, the purpose of Article 78.

Two specific situations are mentioned in the Convention:

(I) A buyer (X) delays paying the seller (A) for goods A has supplied (Art. 78);  (II) A seller (X) delays in refunding to the buyer (A) the price A paid for goods that were so defective as to justify avoidance of the contract (Art. 84(1)).

In both cases the party in breach (X) holds assets for which the aggrieved party (A) has not received the agreed return. In (I) the imbalance results from X’s holding goods for which X has not paid; in (II) the imbalance results from X’s receipt of funds X should return. In both a sum is "in arrears".

In contrast, assume that a seller (X) on June 1 delivered 100 units of goods to a buyer (A) at an agreed price of $1,000 which A agreed to pay on July 1. The goods were defective or, alternatively, consisted of only 800 units. A promptly resold the goods under Article 75 for $800 and paid this sum to X on July 1. Here X was guilty of breach of contract to the extent of $200 but this did not deprive A of funds to which A was entitled. In the language of Article 78 no sum was "in arrears"; no interest should be imposed.

"Liquidated" sums and international trade. Article 78 refers to any "sum" in "arrears". In some jurisdictions interest does not accrue until the amount in arrears has been "liquidated"—i.e. made certain; other jurisdictions grant interest even though the sum owed is in dispute.[4] [page 468]

Let us consider the effect of a strict "liquidated sum" requirement in the most common situation that falls explicitly within Article 78—the buyer’s failure "to pay the price". Deliveries in the large quantities common in international trade often are subject to a shortage in quantity or to a quality defect in a few units. These cases call for a price adjustment; the balance that the buyer must pay is not an agreed or ‘liquidated" sum. A strict application of a "liquidated sum" requirement would mean that a buyer could delay payment without interest until the precise adjustment is adjudicated; this would create a temptation for intransigence in negotiating an adjustment and dilatory tactics in litigation—a serious impairment of the policies underlying Article 78. On the other hand, it would be reasonable to conclude that no sum is "in arrears" when goods have caused damage that could off-set a substantial and undetermined portion of the price. Tribunals and arbitrators are accustomed and qualified to make judgments on such matters in framing a final judgment or award.

"Simple" or "compound interest. Sharp controversy has developed over whether an award of interest for delayed payment should be compounded at specified intervals (weekly, monthly or yearly) so that interest accumulates on unpaid interest.[5] Fortunately, this problem need not arise under the approach suggested above (§421) that the amount of interest should be based on the credit costs faced by the aggrieved party.

One may be tempted to regret the inclusion of a provision on interest that can generate so many questions. These questions, however, were not created by Article 78; questions of even larger dimension (e.g., does any interest accrue) are now latent in domestic law, and in international trade are compounded by problems of conflict of laws (P.I.L.).

One might hope to solve these problems by contract (Art. 6) and this may be possible for a detailed contract prepared for a specific transaction; it will require special skill to prepare a standard clause that will not create difficulties (like clauses on applicable law) in closing the contract.[6] [page 469]

Decisions on the rate of interest: More decisions have dealt with the rate of interest than with any other issue. The reason: Litigation on many issues concludes with a decision that one party owes the other a sum of money, with interest. The inability, described above, to agree on a formula for computing interest, inevitably led to a variety of approaches. The most that is feasible here is to provide examples of the principal formulae.

(1) The domestic law of one of the parties based on rules of "conflicts" (PIL). (A conflicts rule in many States points to the law of the party whose obligations are the most "characteristic" or unique—usually the law of the seller, whose obligations are more specialized—in contrast with the standard duty of the buyer to pay.) E.g.:

GER. OLG Rostock, 1 U 247/94, 27 July 1995. S (Denmark) sold flower-plants to B (Germany), who failed to pay. The court ordered B to pay S, with interest at the rate at the domestic law of the seller (Denmark). UNILEX D. 1995–18.1. In this case, the formula called for the domestic rate in the country of the party deprived of funds. On the other hand, if the buyer had prepaid and the seller had not delivered, the above formula would have required the seller to pay interest at the rate in seller’s country, although the buyer was the party deprived of funds. This result would be appropriate if the cost of money were the same in different countries, but this often is not the case. For many cases illustrating the above approach, see UNILEX C.3–78, 2.3.

(2) Interest determined by the domestic law of the creditor.

RUSS. FED. ARB: Int. Comm. Arb., Ch. of Comm., 1/93, 15 April 1994.  B paid in advance but S did not deliver the goods. S was required to repay B, with interest at the rate in B’s country, since B was the party wrongfully deprived of funds. UNILEX D.1994-8.2. Comparable cases, UNILEX C.3–78, 2.1.

(3) Interest based on international usage.

ARGENTINA. Juz. Nac. de Pr. I. Com.#10.56.179, 6 October 1994. Interest was based on "international trade usage" (CISG Art.9). UNILEX D.1994–24.2.

(4) The aggrieved party’s cost of borrowing.

(1) ARB. ICC. (Paris), 8128/1995 (1995). B (Swiss) contracted with S (Austrian) for chemical fertilizer. On partial failure of delivery by S, B [page 470] was awarded interest based on the average bank lending rate for prime borrowers in B’s country. The tribunal noted that this was based on the solution adopted by the UNIDROIT Principles of International Contracts. (The UNIDROIT Principles, Art. 7.4.9. (1994) state: "The rate of interest shall be the average bank short-term lending rate to prime borrowers prevailing for the currency of payment at the place for payment...". See: Principles, supra, Art. 4.507.) UNILEX D. 1995–34.  (2) GER. OLG Düsseldorf, 6 U 152/95, 11 July 1996. In a contract to buy hydraulic engines, B failed to pay. The court awarded interest "as damages" (See Arts. 74, 78) at the rate charged for bank loans. UNILEX D.1996-9.  (3) SWITZ. HG K Zürich, HG 940513, 10 July 1996. On non-payment of the price, S was awarded 9%, the cost of S’s bank loan. CLOUT 193  (4) BELG. Rechtbank v. Kh., Hassalt, A.R.,1970/95, 8 November 1995. UNILEX D.1995–28.1.2; idem., A.R. 2012/96, 09-10-1996. UNILEX D. 1996-9.1. Additional cases: UNILEX C.3–78, 2.1.2.

Comment: Schlechtriem, Com. (1998) 592–599, Bonell/Ligouri, ULR (1996-2) 370–373 (citing many decisions). Some later decisions, especially in arbitrations, seem to prefer alternative (4)—the aggrieved party’s cost of borrowing. (For additional signs of bias, readers may detect a resemblance between this approach and that of the present book inherited from the second edition, at Article 78, §421, invoking Article 74 on damages.) [page 471]

FOOTNOTES: Chapter on Article 78

1. Proposal: O.R. I38, Docy. Hist. 710. Discussion in First Committees: O.R. 388–392, O.R. 415–419, 429–430, Docy. Hist. 609–613, 636–640, 650–651 (included discussion of working group alternatives providing formulas for calculating interest, one of which was accepted). Compare the proposal for a reservation by Arab countries, O.R 418, Docy. Hist. 639. No such provision was made.

2. Nicholas, B-B Commentary 570, §2.1 agrees that, under Article 78, one is entitled to interest even if applicable domestic law makes no provision for interest but adds that domestic law applies if it provides "a relevant formula for calculating interest". The latter suggestion seems difficult to apply when domestic law, through obsolescence or hostility, provides relief that is derisory in relation to the loss of the aggrieved party; in these cases deference to domestic law also seems inconsistent with the policy underlying Article 78 and other articles of the Convention designed to provide compensation for loss resulting from breach of contract.

3. Articles 75 and 76 strictly apply only when the contract is avoided but they apply to losses that are similar to those where interest is due under Article 78. This is illustrated by Article 84 which provides that, when the contract is avoided, "If the seller is bound to refund the price, he must also pay interest on it...". The reason for this express provision for interest is that the buyer has suffered a loss (the use-value of the funds) which was not part of an agreed exchange. The same is true when a buyer fails to pay the price when it is due (Art. 78). Indeed, as we shall see at §422, infra, such an imbalance resulting from the lack of an agreed exchange provides grounds for interest on a "sum in arrears" (Art. 78). Consequently, the loss suffered by a buyer who rightfully avoids the contract and purchases substitute goods at a higher price (Art. 75) is comparable to the loss of a seller who fails to receive the price when it is due. In other words, in situations where interest is due, avoidance is irrelevant since the lost value of the funds is not part of an agreed exchange.

4. Restatement Second of Contracts (U.S.A.) §354. Interest as Damages, Paragraph(1), provides that interest is recoverable not only for failure to pay "a definite sum in money" but also for failure to "render a performance with fixed or ascertainable monetary value". See Comment C on Paragraph(1): interest is recoverable even though the amount of performance is in dispute and must be proved by evidence extrinsic to the contract. Paragraph (2) provides for allowance of interest in other cases "as justice provides...". Under Comment d, this recovery may extend to interest on consequential loss. For the flexible approach in sales cases in the U.K. since legislation in 1934 see Benjamin, Sales §1246–1248.

5. Contrast the (English) Law Commission, Working Paper No. 80 (1981), discussed in Bowles & Whelan, 45 Mod. L. Rev. 434 (1982) with Law Reform Commission of British Columbia, Working Paper No. 49, discussed in Bowles & Whelan, 64 Can. Bar Rev. 142 (1986). See also Bowles & Whelan, 1 Int. Rev. L. & Ec. III (1981).

6. A seller with strong bargaining power might propose: "The buyer shall pay interest at—% per annum on delay in paying for the goods. In no other situation will either party be liable for interest." Questions that remain might include the reaction of buyers and, under domestic law, challenges to validity. See Art. 4(a), supra.

Pace Law School Institute of International Commercial Law - Last updated March 1, 2005
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