Tackling scourge of late payments

There are two types of customer who can damage a business: those that can’t pay and those that won’t pay. Late payment has consistently been stated as businesses’ number one problem and for no one is this a greater problem than the small business person. A recent survey by NOP1 found that Britain has the third worst record in Europe for late payment, that more than half of all invoices are paid late and that 53% of payments are delayed deliberately. Of most concern, 62% of businesses polled said that late payment had caused them serious cash flow problems and threatened the survival of their business. 

The European Commission has identified late payment as one of the major barriers to growth in small and medium sized enterprises (“SME’s”) and, accordingly, issued a Recommendation2 encouraging member states to take both legal and practical measures to combat the problem of late payment.

Against that background, the Government adopted the view that a statutory right to claim interest would encourage purchasers to pay on time and reduce the problem. Further, if late payment persists, suppliers would be able to claim interest to compensate for not being able to make use of the money owed to them and to cover the cost of increased borrowings resulting from late payment. “The cost will no longer be borne by the supplier but by the person who can control it – the purchaser.”3

The Late Payment of Commercial Debts (Interest) Bill was introduced to provide the statutory right to interest. The subsequent Act4 received Royal Assent on 11th June 1998 (at 7.50pm) and came into force on 1st November 1998.

Statutory right

The purpose of the Act is to provide suppliers with a statutory right to interest on late payments. The rate of interest has been prescribed at 8% over the Bank of England’s official dealing rate (more commonly known as “base rate”).5

The Act operates by implying a term into contracts to which it applies stating that any qualifying debt carries interest at the prescribed rate.6 The Act only applies to contracts for the supply of goods and/or services where both purchaser and supplier are acting in the course of a business.7 It expressly does not apply to consumer credit agreements, contracts operating by mortgage, pledge, charge or security nor to any other contracts to be specified by the Secretary of State.8

A “qualifying debt” is simply one where an obligation to make payment of the contract price arises under a contract to which the Act applies.9

It is to be noted that the interest to be applied is calculated as simple interest and that the right to the interest is assignable along with the debt.10

Implementation

The Act is to be implemented in three stages, the first of which, from 1st November, is already active. Before discussing the stages of implementation, it is necessary to define certain terms used in those:11

A “small business” is defined as one which has 50 or fewer full-time employees or part-time equivalents.

A “large business” is one with more than 50 full-time employees or part-time equivalents.

A “United Kingdom Public Authority” (“UKPA”) is defined at length in the Commencement Order but, in general, means any emanation of the State.

The three stages of implementation are to be:

Small business suppliers are given the right to claim interest at the statutory rate against large business and UKPAs. This is in force.12

The Government has stated that after two years of operating phase one, it will extend the right to claim interest to all small business against all other businesses and UKPAs.

After a further two years, the statutory right to claim interest will be further, and fully, extended. At that juncture, all businesses and UKPAs will have the right to claim interest against all other businesses and UKPAs. A supplier is free to decide whether or not to claim interest: the statutory right is not compulsory.

Time

The right to claim interest arises when a payment is late. A payment is late when it is not made by the “relevant day”.13 The relevant day is the date agreed for payment or, in the event that no such date has been agreed, the last day of the period of 30 days beginning with the later of (a) the day of the supply/performance; or (b) the date of notice to the purchaser of the amount of ht debt: in practice, the invoice date.

Different rules exist where the contract requires advance payment(s). These are dealt with in section 11 of the Act. There are several ways in which advance payments can be required. The principle is that the Act does not give a right to claim interest unless and until at least some of the goods have been delivered or part of the service performed. In essence, the section 11 provisions allow for the right to claim interest 30 days after delivery/performance.

Once the payment is late, interest runs at the prescribed rate from the day after the relevant day until the principal sum is extinguished by payment.14 Unless a payment is accepted by the supplier on other terms, any payment received goes first to pay/reduce the accrued interest.

A claim for interest is made by the supplier informing the purchaser, once the payment is late, that he/she is claiming interest. Notification can be in any fashion but it would be sensible to put the claim in writing. The supplier need not do anything further although it would be prudent for the supplier to specify:

• How much is owed 
• How much of that is interest
• The daily rate of interest
• That the sums are owed for
• To whom payment should be made and where
• How payment should be made (i.e. cash, cheque, etc)

A claim for interest need not be made straight away. A supplier, in Scotland, has five years in which to make the claim. If a purchaser will not pay the interest, or will not agree the amount, the remedy is to raise court proceedings.

The Act provides that in certain circumstances interest may be remitted in whole or in part.15 Remission can be applied if, by reason of any conduct on the part of the supplier, the interests of justice require it. Interest can be removed entirely or reduced to run at a lesser rate. It is thought that this will primarily be used by the court in circumstances, for example, where the supplier did not give the purchaser enough information about how much was owed, where to make payment etc.

Contracting out

Many organisations, including small businesses, already make their own arrangements for remedies for late payments. For example, it is common to find business standard terms and conditions providing for interest to run on late payments. In recognition of that, the Act provides that where arrangements have already been made, the statutory right to interest will not apply.16

 To prevent purchasers abusing their right to agree arrangements with a supplier, any contractual remedy must be a “substantial remedy”17; if it is not, it is void.

A remedy for late payment is ‘substantial’ if it is:

Sufficient to compensate the supplier for the cost of late payment or to deter late payment; and:

It is fair and reasonable to allow the remedy to oust or vary the statutory interest that would otherwise apply.

In determining whether a remedy satisfies the “fair and reasonable” test, regard is to be had to:

• The benefits of commercial certainty;
• The relative strength of bargaining power between the parties;
• Whether the term was imposed by one party to the detriment of the other;
• Whether the supplier received an inducement for agreeing to the term.18

Conclusion

The Act undoubtedly provides a tool with which the organisations can seek to combat the menace of late payment. The effectiveness of the Act in relation to fairly small amounts remains to be seen. The economic viability or lack of that, of enforcing the right to interest may deter small businesses at least from using the right to interest to any great extent. Further, recent research has shown that only 2% of SME’s across the UK believe that the Act will benefit their business. Whilst there is no real way of forcing payment from those who can’t pay, 44% of the survey sample believed that it is necessary for the Government to provide other ways to force payment from those who won’t pay.

Copies of the Act and Statutory instruments referred to can be found at: www.hmso.gov.uk/

Bryan M. Darroch is an associate with MacRoberts

1. NOP Research Group survey 12th April 1998 – for text and results, see: http://www.nopres.co.uk/archive/business/b01.htm 
   
2. May 1995 – COM/95/0228
   
3. Mrs Barbara Roche – Minister for Small Firms, Trade and Industry 14th May 1998
   
4. Late Payment of Commercial Debts (Interest) Act 1998 Chapter 20 (“the Act”)
   
5. Late Payment of Commercial Debts (Rate of Interest) (No. 2) Order 1998 (SI No. 2765) – the rate of interest was originally prescribed at the same rate by the No.1 Order (SI No. 2480) but that Order was improperly laid, was defective and thus ineffective, rendering the No. 2 Order necessary. SI No. 2765 came into effect on 13th November 1998 – some contracts could be affected by the time lapse and resultant lacuna between the Act coming into force and a proper interest order being made. For more details see http://www.pkf.com/uk/insolvncy/news/19981116.html
   
6. s 1(1)
   
7. s 2(1)
   
8. s 2(5)
   
9. s 1(1)
   
10. s 13
    
11. Definitions are contained in Regulation 2 of the Late Payment of Commercial Debts (Interest) Act 1998 (SI No. 2479) (“the Commencement Order”). The Schedules to that Order contain the provisions for calculating who is or is not an employee and the part-time equivalents to full-time employees
    
12. Regulation 3 of the Commencement Order
    
13. s 4
    
14. s 4(2)
    
15. s 5
    
16. s 8(2)
    
17. “Substantial remedy” defined in s 9
    
18. s 9(3)