Be Careful When Entering a Contract that Could be Litigated in Federal Court

Under California law interest on judgments secured in state court runs at the rate of 10% per annum. (Cal. Code of Civ. Proc. Section 685.010(a).) But what is the rate of interest when a judgment is secured in a diversity action in a federal court located in California? Ordinarily, interest on a federal judgment is based on the “weekly average 1-year constant maturity Treasury yield, as published by the Board of Governors of the Federal Reserve System, for the calendar week preceding the date of the judgment,” 28 U.S.C. § 1961(a), a rate which these days is considerably lower than 10%. In fact at the time this article is published it is approximately 0.14%.

This can make a huge difference. For example, assume a party agrees to sell goods to another and the contract amount is $2,000,000. The buyer does not pay and the seller brings suit to recover the amount. The seller prevails at trial and obtains a judgment for $2,000,000. The buyer appeals the judgment and the case makes its way through the appellate process for 2 years until the buyer exhausts all appeals. If California’s post judgment rate is applied, then the seller would be entitled to collect an additional $400,000 of post judgment interest (2 years at 10% of $2,000,000). On the other hand, if the federal rate is applied, the seller would only be entitled to $5,600 of post judgment interest (2 years at 0.14% of $2,000,000).

n Northrop Corp. v. Triad Intern. Marketing, S.A. (1988) 842 F.2d 1154, the plaintiff brought a diversity suit to confirm an arbitration award that arose from a contract that was governed by California state law. In determining the proper rate of post-judgment interest to be applied, the 9th Circuit made clear that even in diversity cases arising from state law claims, the post judgment interest rate is set by federal law not by state law. Id. at 1155.

The Northrop court and federal courts from around the country have uniformly held:

First, diversity actions state law governs the award of prejudgment interest.

Second, in diversity actions the federal rate applies to post-judgment interest.

Third, parties by contract can agree in “clear, unambiguous and unequivocal language” that a different rate of post-judgment interest will apply to federal judgments.

Fourth, the standard choice-of-law provision of a contract will not alter the federal rate of post-judgment interest because it does not contain “clear, unambiguous and unequivocal language” expressing an intent that a rate other than the federal rate will apply post-judgment. The parties must be more precise.

Therefore, if a party intends to enter into a contract which could potentially be removed to federal court (e.g. the other party to the contract is not a resident of California and the amount in controversy could exceed $75,000), it should be mindful if it wants to ensure the ability to collect post judgment interest at the more generous California rate of 10% and include “clear, unambiguous and unequivocal language” in the contract stating such.

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