The late payments act: an idle threat?

November 1998 saw the introduction of the Late payment of commercial debts (interest) act 1998 (the Act) and a new statutory right to claim interest on late payments.

Initially, this new statutory right was only available to those businesses which employed 50 or fewer employees claiming against large businesses and public bodies. The statutory right was widened in November 2000 to cover small businesses claiming against other small businesses and has, since 7 August 2002, been extended to cover virtually all businesses claiming against any other business or public body.

The Act applies to all contracts for the supply of goods or services where both supplier and buyer are acting in the course of business. The rate of interest is set above the official Bank of England dealing rate which is published daily. In an attempt to simplify the calculation of interest on late payments, for the purposes of the Act, the rate of interest is set twice a year as follows:

• In respect of interest which starts to run between 1 July and 31 December in any year the statutory rate of interest is 8% above the official dealing rate in force on 30 June.
  
• In respect of interest which starts to run between 1 January and 30 June in any year the statutory rate of interest is 8% above the official dealing rate in force on 31 December.

Interest will run from the day after the date on which the buyer and supplier have agreed in their contract that the payment of the debt must be made. If no date has been agreed, the Act provides that interest will start to run 30 days after either the performance of the obligation giving rise to the debt or the date from which the buyer has notice of the debt, whichever is the latest.

The Act is intended to compliment the payment provisions of the Housing Grants Construction and Regeneration Act 1996 which requires that construction contracts contain the means by which payment dates can be identified. If there is no clear payment mechanism the Scheme for Construction Contracts will impose payment terms and prescribe the relevant due date and final dates for payment. Whether using the payment provisions under the Scheme for Construction Contracts or standard form contracts it should be possible to identify the date from which interest on late payments will start to run.

Although the ability to claim interest under the Act is implied into all commercial contracts the parties are free to exclude or vary the right to claim interest but they may only do so if there is an alternative 'substantial remedy' for late payment. Otherwise any provision varying or excluding the right to claim interest on late payments will be void and unenforceable. Such an alternative remedy must adequately compensate the supplier and deter late payment. It must also be fair and reasonable to rely on the alternative contractual remedy if the statutory of rights to interest is to be excluded or varied. The Act creates a presumption that any alternative remedy is 'substantial' unless the claimant can show otherwise.

Consequently, in determining whether or not there is an alternative substantial remedy the court may take into account the course of business between the parties or evidence of market custom and practice. It must be questionable whether any business would be prepared to pursue a claim on the basis that an alternative remedy was not 'substantial' given that the difference between the statutory rate of interest and the alternative contractual rate is likely to be relatively insignificant in monetary terms.

Standard forms of construction and engineering contracts, such as JCT and ICE, contain an express provision for interest on late payment at 5% above the official dealing rate. Although this is less than the statutory rate it may yet prove to be compliant with the Act on the basis that there is an alternative substantial remedy in the right to suspend work for non-payment as introduced by the Housing Grants Construction and Regeneration Act. In addition, the fact that 5% above the official dealing rate is recognised in a number of standard forms of construction contract may be evidence that this is an acceptable practice in the construction industry. In any event, what self respecting contractor or consultant is about to pursue a client simply over the 3% difference in the standard form and statutory interest rates?

In addition to the statutory right of interest it was recognised by Parliament that where unpaid sums were relatively small, it may not be worthwhile pursuing interest on such amount given the costs that the supplier might incur pursuing the claim through the courts. Consequently, under the Act, a supplier may be entitled to an additional fixed sum on top of any interest depending upon the amount of unpaid debt, as illustrated in table 1.

  The purpose of the Act was to give effect to a European directive which sought to provide a deterrent to late payments which, throughout Europe, was a major threat to the financial stability of many businesses, particularly smaller businesses who lacked the strength of bargaining power of larger organisations. The seemingly penal rate of interest is deliberately high because it should not be a cheap option for debtors to simply withhold payment. Time will tell whether or not suppliers will seek to enforce this new found statutory right. To do so may jeopardise the commercial relationship between a supplier and a buyer and irrevocably damage any future dealings between the parties. To this extent, the Act may have introduced nothing more than an idle threat. It is, nevertheless, a significant attempt by Parliament to lend assistance to businesses who might otherwise struggle to survive with large amounts of unpaid accounts. Whether or not the Act is actually used may not be quite as important as the threat of its use, which may help businesses recover money owed to them.