Prejudgment interest is a form of compensation that seeks to convert financial harm suffered by a party in the past to a present value as of the date a judgment is issued (if interest is an allowable remedy) or a settlement agreement is reached (if interest is part of the agreement). Prejudgment interest, along with damages analysis, aims to achieve the overarching objective of making the harmed party “whole” as measured by the financial impacts associated with the claimed bad acts of the other party.
Prejudgment interest can serve several important functions as it relates to the resolution of a dispute:
Compensation for the time value of money: The awarding of prejudgment interest recognizes that the injured party has been deprived of the use of funds during the period leading up to the judgment or settlement. It can be used to compensate for the potential earnings or investment income that could have been generated had the funds not been lost or withheld.
Encouraging prompt resolution: Prejudgment interest can incentivize parties to settle disputes or bring suits to trial in a shorter time frame vis-à-vis engaging in prolonged litigation. The tolling of prejudgment interest works to increase the potential financial exposure incurred by the responsible party.
Fairness and equity: Prejudgment interest promotes economic fairness by compensating the injured party for the financial harm suffered while awaiting resolution. It aims to ensure that the injured party is not further disadvantaged by the delay in obtaining a judgment or settlement.
While the application of prejudgment interest can be thought of as a means to convert past damages to a present value that makes the harmed party whole, in practice its determination may only approximate achievement of these goals by emphasizing policy objectives or computational simplicity. As such, damages experts should, absent compelling economic theory or an instruction from counsel, remain agnostic regarding any perceived shortcomings or ill-effects of a prejudgment interest inquiry and focus on adhering to the guidance applicable to the facts and circumstances of the engagement.
Sources of applicable guidance will likely be dictated by the adjudicative setting in which a dispute is being heard. It may be governed by law or statute, by case precedent, or by the observed practice of the presiding judge. The damages expert should consult with counsel on the applicable “local rules” for determining prejudgment interest. We discuss the most commonly considered factors below.
Date of loss or harm: The starting point for calculating prejudgment interest is typically the date when a loss or harm occurred (such as, for example, the wrongful termination of a contract that leads to a 100% cessation of economic activity). Depending on the nature of the harm (such as uncompensated overtime shifts by a worker), multiple dates of harm may exist. In such cases, each date/measure of harm would be subject to a separate prejudgment interest calculation. However, the expert needs to be careful to ensure that each stream of prejudgment interest is applicable to a mutually exclusive measure of financial impact.
Interest rate: The interest rate applied to calculate prejudgment interest can vary depending on federal or state statutes, contractual agreements, or court orders. It may be defined as a single fixed rate, or it may vary over time (for example, if based on interest rates or investment yields published by agencies of the U.S. government). In cases where no outside guidance is identified, it may be measured by the rate of return earned by the harmed party on investments of excess funds during the damages period (referred to by economists as “opportunity costs”).
Compounding frequency: Prejudgment interest is typically calculated on a “simple” basis. That is, the interest rate is applied to a principal amount that does not change throughout the interest period (i.e., the loss incurred on the date of harm). However, if allowed by statute, contract, or the commercial practice at issue in a dispute, interest can be calculated on a “compound” basis with a certain frequency (such as annually, semi-annually, or monthly). When interest is compounded, the principal amount and the interest accumulated on the principal amount up to the date of the last interest calculation is subject to the current interest rate calculation. Prejudgment interest calculated on a compound basis will result in a larger total than if calculated on a simple basis. As such, it is critical for the expert to confirm that compound interest is allowable in the specific setting.
Admissibility and evidentiary requirements: Typically, the awarding of prejudgment interest is at the discretion of the judge or arbitrator. The judge’s decision may depend on factors outside of the sphere of influence of the expert (such as whether the defendant’s acts were found to be intentional). It may also depend on the strength of the evidence supporting the measure of past harm. With the latter possibility in mind, the expert should assemble an appropriate amount of supporting documentation – such as invoices, financial records, or testimony – to provide a basis for the judge to conclude that an award of prejudgment interest is appropriate. This may entail a more substantive level of support than would reasonably be required to justify the measure of past harm itself.
About the Authors
David Ottenbreit is a Director with Chess Consulting LLC. For over 25 years, Mr. Ottenbreit has analyzed business operations and financial conditions, determined appropriate damage theories, as well as addressed claims for lost sales and profits, increased costs, reasonable royalties, diminution of shareholder and business entity value, unjust enrichment, and lost wages and compensation. He also has performed investigations of fraud allegations, including employee embezzlement and government contractor false claims allegations. Mr. Ottenbreit has been retained as an expert in damages analysis in federal and state courts and arbitration. Mr. Ottenbreit earned a Master of Science degree in economics from Baylor University. He also holds professional certifications in business valuation (Certified Valuation Analyst) and fraud examination (Certified Fraud Examiner).
Rodney Bosco is a Director with Chess Consulting. Over the past 40 years, he has conducted economic impact assessments and their underlying causes pursuant to disputes, investigations, business valuations, and regulatory proposals. Measures of economic impact have included profits, cash flow, enterprise and shareholder value, personal and household earnings, royalties, out-of-pocket costs, over- and under-payments, and risk-adjusted present value conversions. Mr. Bosco – whose work has been used to proffer expert testimony in federal and state courts, in arbitrations and before a subcommittee of the U.S. Congress – holds professional certifications in financial forensics, business valuation, and fraud examination.