A person who loans money or otherwise gives credit is always entitled to receive interest, absent an agreement with the debtor that no interest will be payable. Entitlement to prejudgment interest is established by Civil Code §3287. Subdivision (a) of the statute provides, "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...." This covers situations in which the a debt is capable of being liquidated (and not merely estimated) as of a certain date. If suit is brought on an unliquidated contract claim, Civil Code §3287(b)gives the court discretion to allow interest covering a limited period of time: "Every person who is entitled under any judgment to receive damages based upon a cause of action in contract where the claim was unliquidated, may also recover interest thereon 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."
This statute specifies the circumstances in which a creditor has the right to recover interest. One must look elsewhere to find the rate that will apply. Perhaps no other question is the source of so much daily confusion in debt collection cases in the courts of California. The reason for the misunderstanding is that there are two answers to the question. One interest rate applies before breach of the obligation to pay. A higher rate applies after breach.
The California Constitution, Article 15, §1, provides that if the parties have not contracted in writing for some other lawful rate, "The rate of interest upon the loan or forbearance of any money, goods, or things in action, or on accounts after demand, shall be 7 percent per annum...." For example, if a friend loans me money, and I sign a promissory note, but the note does not state what rate of interest will apply, the rate will be seven percent per year during the term of the loan. (The California Constitution recognizes that a different interest rate will apply, if agreed upon in writing, and if that rate is not illegal because it violates the usury laws.)
Civil Code § 3289 specifies a higher rate of interest applicable only after a breach of the contract. Subdivision (a) of the statute first clarifies, "Any legal rate of interest stipulated by a contract remains chargeable after a breach thereof...." In other cases, Civil Code § 3289(b) specifies, "If a contract entered into after January 1, 1986, does not stipulate a legal rate of interest, the obligation shall bear interest at a rate of 10 percent per annum after a breach."
To continue with the example in which a friend has loaned me money, if the agreed term of the loan was six months, the seven percent annual interest rate specified in the Constitution will accrue during that six month term. However, if I fail to repay the loan at the end of the six months, that will be a breach of the contract. From that point forward, the loan will bear interest at ten percent per year until paid.
When one brings suit on a contract debt, for which the parties did not agree upon an interest rate, one should keep in mind the distinction between the pre-breach and post-breach rates of interest. It will be necessary to determine when the breach occurred. In some cases, the interest that should be included in a judgment will be calculated at seven percent per year for a part of the time in question, and thereafter at the higher rate of ten percent per year.
Author: Christopher P. Valle-Riestra