Employers imposing unfairly low interest on late payment could pay a penalty

Half a percent above base rate does not a substantial remedy make. The case of Yuanda vs WW Gear [2010] EWHC 720 TCC is possibly the most important decision that has emerged from the Technology and Construction Court so far this year. The validity of “Tolent” clauses has been brought into question ahead of the implementation of the Construction Act 2009, and many column inches have been occupied by the impact the case will have on adjudication provisions.

However, the case was also a landmark decision on what constitutes a “substantial remedy” in accordance with sections 8 and 9 of the Late Payment of Commercial Debts (Interest) Act 1998.

Yuanda was one of more than 30 trade contractors engaged by Gear for the construction of a luxury hotel. The contract was based on the JCT Trade Contract standard form, which was amended to be heavily weighted in Gear’s favour. In particular, the contract had been amended so that the interest on late payment was a mere 0.5% over base rate as opposed to 5% over base rate. Yuanda disputed this provision, saying that it was not a “substantial remedy” within the meaning of the act.

The judge’s reasoning was that the low rate of interest was effectively imposed on Yuanda, as it had failed to spot, and therefore negotiate, the relevant provision

The court held that, taking into account all relevant circumstances, 0.5% over base rate was not a substantial remedy and should be replaced with the statutory rate of 8% over base rate.

The judge’s reasoning was that the low rate of interest was effectively imposed on Yuanda, as it had failed to spot, and therefore negotiate, the relevant provision. It would not be fair or reasonable to allow Gear to take advantage of this fact.

It appears that Gear shot itself in the foot by imposing such a low interest rate: the judge pointed out that the imposition of the high statutory interest rate on Gear acts as a penalty for failing to provide a fair remedy for late payment to suppliers. This implies that contractual rates lower than the statutory rate may still be considered a substantial remedy, particularly if the rate was negotiated between the parties.

The judge also ruled that 5% over base rate, as stated in the JCT standard form, should be considered a substantial remedy because “this was thought by those responsible for drafting the contract to be a fair rate of interest for late payment in the context of the construction industry”.

Impact of the judgment on the industry

So, what are the implications for the rest of the construction industry?

  • Any contractual interest rates set at 0.5% above base rate will no longer be considered a substantial remedy.
  • If the contractual interest rate is not considered a substantial remedy, the risk is that the courts will impose the statutory interest rate of 8% above base rather than the JCT standard form interest rate of 5% above base
  • When imposing an interest rate lower than the statutory rate or the JCT standard form rate, it is now crucial to ensure the supplier is aware of the interest rate, as this will mean that the courts will be more reluctant to intervene.
  • In the current climate, some might say it is a harsh punishment to impose such high interest rates, but it is a good incentive for the parties to include a substantial remedy in the contract in the first place.