Cefaclor Interest is devoted to assessing the proper rate of return for compound interest damages. While the determination was ultimately a matter of fact, it raises issues that will arise in any similar determination. I also suggest that an overarching lesson from the decision is that whatever particular approach is used, the determination of the rate of return as a matter of fact is likely to be a burdensome undertaking. As a matter of policy is might be desirable to amend the relevant statutory provisions to permit a successful party to claim compound interest at a modest rate as a matter of law, without the need for a fact intensive inquiry as to what exactly it would have done with the money.
As discussed here and here, the common law traditionally prohibited recovery of interest on a damages award. While that prohibition was reversed by statutory provisions permitting the award of pre-judgment interest, those statutes generally did not allow for compound interest. In Bank of America 2002 SCC 43 the SCC recognized that simple interest is not fully compensatory, and consequently, the SCC held that even if compound interest was not available under the relevant statute, it was available under the common law of contract as compensation, so long as it was claimed as such and proven.
In Cefaclor Damages FC, the damages portion of a bifurcated trial, Zinn J had awarded lost profits of just over $31m (the Lost Profits), with compound interest on the Lost Profits as damages: [4]. On appeal, in Cefaclor Damages the FCA confirmed that compound interest is indeed available in the patent context when interest is claimed as a head of damages: see here. However, Zinn J had held that the loss could be presumed, and the FCA reversed on this point alone, saying “a loss of interest must be proved in the same way as any other form of loss or damage” [158]. The FCA therefore remitted the matter to Zinn J for reconsideration of this point alone [164].
When compound interest is claimed as damages, the loss is the value of the lost opportunity to use the funds that the plaintiff would otherwise have had — in this case, the Lost Profits. The question in Cefaclor Interest therefore, was whether Lilly had proven a lost opportunity to use the Lost Profits, and how prove the applicable rate of interest: [18].
Zinn J’s broad answer to this was simple: compound interest as damages are to be proven the same way as any other damages. Compound interest compensates the patentee for the lost opportunity to use the money it would have had but for the infringement. The question then is what it would have done with that money. This a matter of constructing the same hypothetical “but for” world that is at the core of the damages assessment: [22], [52], [54]. This means the applicable approach is same ‘could have / would have’ test set out in Venlafaxine 2016 FCA 161 that applies to constructing the but for world more generally [43].
There was some debate as to whether the “but for” world has to be established on the balance of probabilities, as Apotex argued [46], or according to degrees of probability, as argued by Lilly, relying on Athey [1996] 3 SCR 458 [41]. I have suggested that there is an argument to be made on the SCC authorities that the “but for” world should be assessed in terms of relative likelihood: see here and here. But even if that is so, that approach would be applicable to all aspects of the “but for” world—there is no justification for treating compound interest differently. As Zinn J noted, the use of balance of probabilities in constructing the “but for” world has been endorsed by the FCA: [45]-[46]. If this approach is to be changed, it would have to be done by the FCA, after full consideration of the relevant SCC jurisprudence. Zinn J therefore agreed with Apotex and used the balance of probabilities approach.
Using this general framework, Zinn J’s approach to compound interest turned largely on the combination of two points. The first is that “the best evidence of what would occur in the but-for-world is what happened in the real-world” [69]. (See similarly [24], [57] [60]). The second point is that the total Lost Profits, which were spread over five years, amounted to a very small part — only about 1% — of Lilly’s world-wide annual profit [30], and so on average would have been something like 0.2% of Lilly’s profits for the year. The combination is important because:
[66] When considering whether the past financial decisions and performance can be used
as a mirror of hypothetical financial decisions and performance based on a larger sum, it
is relevant to consider the relative size of the sums being examined. If the additional sum
is small when compared with the historical sum, then common-sense informs that there is
no reason to think that the small amount would be treated differently. On the other hand,
if the additional sum is close to or exceeds the historical sum, then common-sense
informs that it is more likely it would have been treated differently.
Consequently, in deciding what Lilly would hypothetically have done with the Lost Profits, Zinn J focused on what Lilly actually did with the money it made at the time in the real world, on the view that Lilly could and would have done something very similar with the (relatively) small amount of extra money represented by the Lost Profits:
[57] Where that proposed use of the slightly larger pool of profits parallels the use Lilly
made in the real-world, there must be a heavy burden on Apotex to show that there was
something making it impossible for Lilly to do so again.
He found the evidence of the experts largely unhelpful, because they considered the use that would have been made of the Lost Profits “as if it is a sum separate and apart from the other Lilly profits” [53]. So, Apotex’s expert “examined the Lilly’s financial records and concluded: ‘Lilly had no additional investment opportunities available to it that exceeded the return on short-term cash deposits....’” [54, original emphasis].
Zinn J instead accepted evidence that Lilly would have taken the Lost Profits into its general revenue pool, and found that “it is most probable that had the Lost Profits been received when it should have, it would be spread among those same uses” [56]. Consequently, he found that the rate of return on the Lost Profits would be the average rate or return for Lilly Canada [72].
I’m not sure if I agree with Zinn J’s approach. In theory, at least, any business has a range of opportunities, and it will invest first in those with the highest expected rate of return, say 25%, then the next tier at 20%, and so on until the last investments it makes have a relatively low rate of return, such as putting the money in a bank deposit at something like 3%. The average rate of return is higher than the rate of return on the last investments. The experts considered the damages as an additional investment that would be invested in the most profitable remaining opportunities, which are subject to a lower rate of return than the average rate of return on Lilly’s investments.
As noted, Zinn J’s criticism of that approach is that Lilly would have simply added the Lost Profits to the pool and spread it among the actual uses, thereby generating the same rate of return. The difficulty is that the same principle of diminishing marginal returns applies as well to any specific investment. So, when investing $1m in an opportunity that is expected to return 20% on that $1m, it does not follow that another dollar invested in that same opportunity would also return 20%. On the contrary, if an additional dollar would have returned 20%, then, even without the Lost Profits available, Lilly would presumably have taken $1 that it actually invested in a worse opportunity, such as putting it in a bank account at 3%, and invested it in the better opportunity, where it would get 20%. So, even when a particular opportunity has an overall rate of return of 20%, the last dollar invested in that opportunity should, in theory, earn only the same rate of return as a dollar invested in the worst investments that were actually made. This implies that whether one considers the Lost Profits have been invested additionally as a distinct amount, or spread among existing investments, the rate of return should be the same.
With that said, Zinn J had the benefit of hearing all the evidence in this case. His holding is in any event a matter of fact, and it does not necessarily imply that the same approach will be taken in future cases with different evidence.
Apart from that, an express limitation to Zinn J’s approach is that it only applies if the quantum of damages is small relative to the plaintiff’s overall profits, or, more precisely, the amount which the plaintiff actually did invest in the past. When the damages would amount to a significant fraction of the past investments, Zinn J’s analysis would support analysing them as an additional specific investment.
There is an important overarching question as to whether this fact specific inquiry is the best way to assess compound interest. The argument in favour is that it more accurately reflects the actual loss to the injured party. (The patentee in this case, but the generic in a s 8 NOC claim). The argument against is that however it is approached, determining the appropriate rate will be a burdensome inquiry, that raises entirely new financial issues, such as the rate of return on other investments, Lilly’s other corporate opportunities, Lilly business model etc, many of which would otherwise not need to be addressed.
As a matter of policy, perhaps it would be best to reserve this very fact intensive inquiry for cases where the amount of interest at stake is sufficiently large to warrant the cost. Of course, the plaintiff is never required to claim compound interest as damages, and can always fall back on statutory simple interest under the applicable statutory provision (such as Federal Courts Act s 36). But that means the plaintiff will have to choose between an expensive inquiry as to the compounding rate, or foregoing compound interest entirely, and accept the fact that it will be undercompensated.
I suggest it might be preferable to amend the Act to allow the plaintiff to claim compound interest at a modest statutory rate which would be low enough as to rarely or never result in overcompensation. This would have two advantages. First, it would offer some measure of compensation for lost compounding even in cases in which the plaintiff choose not to pursue it. Also, it might save litigation costs as plaintiffs might be more likely to forgo the burdensome process of proving opportunity costs if the alternative were modest statutory compounding rather than simple interest.
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