September 2011

Ontario's Rules of Civil Procedure and the Discount Rate

In the past two years, contradictory rulings have been issued by the Ontario Superior Court of Justice relating to the proper interpretation of Rule 53.09 of the Ontario Rules of Civil Procedure, which concerns the discount rate to be used in quantifying the present value of future pecuniary losses. The financial impact of these rulings is potentially quite large; indeed, it is unusually significant at the present time, given the historically low short-term rate of 0.50% currently being applied for 2011 trials. A review of the history behind the development of Rule 53.09 is therefore particularly timely.

The Current Debate

Rule 53.09 of the Ontario Rules of Civil Procedure states that "the discount rate to be used in determining the amount of an award in respect of future pecuniary damages, to the extent that it reflects the difference between estimated investment and price inflation rates, is:

• For the 15-year period that follows the start of the trial, the average of the value for the last Wednesday in each month of the real rate of interest on long-term Government of Canada real return bonds (Series V121808, formerly Series B113911), as published in the Bank of Canada Weekly Financial Statistics for the 12 months ending on August 31 in the year before the year in which the trial begins, less 1 per cent and rounded to the nearest ¼ per cent; and
• For any later period covered by the award, 2.5 per cent per year."

There have been two different interpretations put forth with respect to how Rule 53.09(b) is to be implemented.

There have been two different interpretations put forth with respect to how the last part of the rule is to be implemented. The position that has been consistently advanced by our firm is that the discount rate to be applied to all lost cash flows beyond the 15th year is 2.5 per cent per year. In Greenhalgh v. Douro-Dummer (Township), 2009 CanLII 71014 (ONSC), Lauwers J. accepted this interpretation of the Rule

Conversely, the position often advanced by other experts has been that cash flows beyond the 15th year are discounted by the short-term rate for the first 15 years and by 2.5 per cent for all subsequent periods. This blended approach to the discount rate tends to produce a significantly higher present value calculation in the current interest environment. In Slaght v. Phillips and Wicaartz, 2010 ONSC 6464 (CanLII), Turnbull J. accepted this "blended" approach.

The financial significance of such a divergence of interpretation can be illustrated through an example. Consider a young professional who is catastrophically injured in an accident and is 26 years old at the date of trial. Based on projected annual income of $100,000, the "blended" approach would calculate a future income loss of $3.03M, while our approach would result in a future loss of $2.62M, a difference of $410,000, or 17%. Clearly, this is a financially impactful issue.

Given the current state of the judicial debate over this significant issue, a review of the historical background and economic theory underlying the Rule is of assistance.

The History

Ontario's search for a universally applicable discount rate began in 1980 with the "Report to the Committee of the Supreme Court of Ontario on Fixing Capitalization Rates in Damage Actions". The Committee was charged with determining a real risk-free rate to be applied in computing future pecuniary losses.

The Committee's conclusion was based on a simple insight. It reasoned that, while real risk-free yields on government bonds in Canada historically had experienced significant fluctuations, over the long-term they had tended to converge to an average between 2%-3%. It was on that basis that a discount rate of 2.5% was adopted in the Rules of Civil Procedure.

The 1980s witnessed high levels of real returns on government bonds not seen since the Great Depression. As a result, in the 10 years following the introduction of Rule 53.09 there were several attempts by experts to deviate from the prescribed rate of 2.5% on the grounds that it was not reflective of the then-current reality. In 1990 a committee was convened to determine if Rule 53.09 should be updated; it recommended that a rate of 4.25% be used until December 31, 1999, with a rate of 3% to be used thereafter. This proposal was not accepted.

1998 Report - Two-Tiered Rate

The current two-tiered incarnation of Rule 53.09, cited above, is based on recommendations from the 1998 "Report to the Subcommittee of the Civil Rules Committee on the Discount Rate and Other Matters". The formula adopted was not a repudiation of 2.5% as the expected long-term average rate, appropriate for use in long-term future loss calculations. Rather, the purpose was to provide a flexible formula that accounted for both the historical long-term average rate of 2.5% and the inevitable short-term deviations from this average which rendered this long-term average inappropriate for computing short-term future losses.

The Current Debate - Revisited

The implication of this background to Rule 53.09 is reasonably clear. Over a long period of time, the overall effective discount rate should tend to converge to the long-term average of approximately 2.5%. For example, an award for future loss of income involving a child ought to result in an average discount rate of approximately 2.5% per year, consistent with past historical experience. While over the short-term a different rate may prevail, eventually rates will reverse themselves, such that the overall average rate should be 2.5%. Under our interpretation, this is indeed what occurs; over a period of 50 years Rule 53.09 will equate to a uniform discount rate of 2.16% per year, even with the low discount rate of 0.50% used for the first 15 years for 2011 trial dates. This is well within the range of 2% to 3% suggested by the original 1980 committee report.

On the other hand, under the blended approach, the overall discount rate over a 50 year loss period equates to an average discount rate of 1.39% for 2011 trial dates. This appears to be inconsistent with the rationale behind the Rule and the economic theory that the long term rate will approach 2.5%.

Conclusion

Within Canada, the other provinces with a statutorily defined discount rate (British Columbia, Saskatchewan, Manitoba, New Brunswick and Nova Scotia) have prescribed single-tier rates, all of which are within a range of 2.5% to 3.5%; in Canadian jurisdictions where there is no mandatory discount rate, a rate of 2.5% to 3% has also often been used. A real rate of return of 2.5% has also been prescribed in the United Kingdom.

Ontario's two-tiered discount rate is no exception; it too recognizes that over the long-term, the real risk-free rate of return will be approximately 2.5%. In light of the recent judicial debate over the proper interpretation of Rule 53.09, perhaps it is time that the Rule's wording be revisited to more clearly reflect the intentions of the original committee.