New York Approves Law Legalizing Compound Interest
New York State Bar Journal, p. 26, October 2009
5 Pages Posted: 12 May 2016
Date Written: October 1, 1990
Compound interest is the accruing of interest upon unpaid interest and is sometimes referred to as "interest on interest." In 1814 the Court of Appeals, the highest court in the State of New York in, State of Connecticut v. Jackson, 1 Johns Ch. R. 13 (1814), adopted the British rule prohibiting enforcement of a promise to pay compound. In establishing this prohibition on compound interest the court found that:
"Interest on interest, promptly and incessantly accruing, would, as a general rule, become harsh and oppressive. Debt would accumulate with a rapidity beyond all ordinary calculation and endurance. Common business cannot sustain such overwhelming accumulation."
In 1814, this principle was an appropriate one; the society was agrarian and there was very limited ability to calculate compound interest over any substantial period of time. In a case named Young v. Hill, Judge Church (in dissent) expressed the traditional abhorrence of having interest compound with the following words:
"These principles are founded upon a wise public policy for the protection of the weak and ignorant debtor against extortion and oppression by the grasping creditor who, by an apparent indulgence is enabled to delude his victim into certain ruin."
Over the next 175 years, various exceptions and the many creative attempts to find ways around the rule made it very difficult to determine which financial arrangements violated the New York rule and which did not. Many New York law firms found that they could not give opinions on the enforceability of compound interest provisions.
The author, who at the time was Director of Corporate Law for New York City, wrote the following in a memo to Frederick A. 0. Schwarz, the Corporation Counsel of the City of the City of New York :
"The rule [against enforcement of compound interest] is an anachronism: New York is one of a very few states that has such a rule. It is therefore recommended that legislation be proposed that either fully eliminates the rule or retains it only in a limited fashion, such as in consumer loans."
Led by the author, with the aid of other members of the City Bar, The City of New York and the City Bar Association were brought in to become official co-sponsors of the proposed new law. The Bill was then also endorsed by the Committee on Banking of the State Bar Association, and by other groups.
This is the story of why and how the legislation was written, the changes that were made and how to understand the law.
Keywords: compound interest, interest on interest, simple interest
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