In a tough economic climate, disruption to cash-flow can have catastrophic results. Often, SMEs (inevitably further down the supply chain) enter into financial difficulty arising from pressure to agree to unfavourable payment terms. SMEs may now find comfort that a recent EU Directive has introduced maximum payment periods of 30 days (for commercial contracts with public authorities) or 60 days (for business to business contracts).
Parties wishing to agree lengthier payment terms in business to business contracts may do so, provided that this arrangement is not ‘grossly unfair’ to the supplier. In the event payment terms are deemed grossly unfair, such terms will be unenforceable and the original terms shall be replaced with the statutory provisions outlined below.
The Late Payments of Commercial Debts (Interest) Act (the “Act”) came into force in 1998, which was subsequently amended to include the ability for suppliers to claim compensation on overdue accounts from debtors in the form of a ‘one-off’ fixed sum in addition to statutory interest, such fixed sums being:
- £40 for debts less than £1,000;
- £70 for debts of £1,000 or more but less than £10,000; or
- £100 for debts of £10,000 or more.
However during 2008, EU-wide research confirmed that SMEs were still experiencing difficulties with late payments, particularly at the hands of public authorities. The EU therefore adopted a new Directive in 2011 to attempt to resolve late payment issues.
The changes implemented
The Late Payment of Commercial Debts Regulations 2013 (the “Regulations”) implemented the new EU Directive and took effect on 16 March 2013. The Regulations apply to commercial contracts entered into from 16 March 2013 onwards (i.e. the Regulations shall not apply to any contracts made prior to this date). The Regulations have updated the Act to include:
- Default payment periods – 30 days for public authorities and 60 days for business to business contracts which shall run from the latest of:
- the date the invoice is received;
- the date the goods/services are received; or
- where the goods/services have been accepted as provided in the contract (provided this does not result in payment terms extending beyond 90 days in total when incorporating a 30 day inspection period, in which case interest shall run from the 90th day following the date of the supplier delivering the goods/completing services under the contract).
Interest of 8% above base rate shall also become payable on any overdue payments.
- Maximum testing/inspection period – there shall be a default maximum period for the purchaser to test/inspect the goods or accept the services of 30 days. However, where the parties have expressly agreed to lengthier periods, this is permissible as long as the period of time is not ‘grossly unfair’ to the supplier. Effectively a 30 day acceptance period extends payment terms in business to business contracts to 90 days (e.g. 30 days to inspect the goods, and a further 60 days to submit payment for the goods).
- Definition of ‘gross unfairness’ – this is defined as ‘terms which deviate from good commercial practice’ and ‘are contrary to good faith and fair dealing’. The purchaser is also required to have an objective reason to deviate from the default terms.
- Recovery of compensation – in addition to statutory interest on overdue sums, the supplier is able to charge its ‘reasonable costs’ in recovering the debt (i.e. if the fixed sum does not adequately cover the costs of recovery of the debt, the supplier is permitted to recover the costs over and above this amount, however such costs must be reasonable).
Other remedies for late payment
The parties can exclude the supplier’s right to interest under the Act, provided the contract provides a ‘substantial remedy’ for late payment of debts. There is no clear definition of a ‘substantial remedy’ however s9(1) of the Act states that a remedy will not be substantial where:
- it is insufficient to compensate the supplier for late payment or deter late payment; or
- it would not be fair or reasonable to let it vary the right to statutory interest.
Aspects such as the rate provided, length of any credit period, bargaining powers of the parties and the industry standard (if any) would also be taken into consideration in the event of any dispute.
In circumstances where the parties wish to contract out of the Act, we would recommend that:
- wording is inserted into the contract which provides that the parties agree that the payment dates and interest rates provide a substantial remedy; and
- copies of any correspondence evidencing each party’s agreement to the terms is retained.
A supplier may also wish to insert a sub-clause which states that in the event the contractual right to interest is unenforceable for any reason, the statutory right to interest shall survive.
If there is a genuine dispute as to the whole of the invoice value and whether it is due, then the supplier is not entitled to reclaim recovery costs and interest under the Act until the dispute has been resolved. The courts have the discretion to protect the purchaser by limiting interest to a certain period or reducing the rate of interest payable. However, a court is less likely to apply such discretion where the purchaser has not provided notice of the dispute to the supplier as soon as reasonably possible, and in particular where a purchaser has refused to submit payment without any explanation at all.
In order to alleviate confusion as to when sums become due and payable, both suppliers and purchasers are advised to be unequivocally clear when quoting payment terms (e.g. “the Purchaser shall pay the Supplier within 30 days of the end of the month in which the Purchaser has received the invoice”). In addition, suppliers should ensure there is an express clause which lays out the procedure to be followed by the purchaser in the event an invoice is disputed (i.e. how to notify the supplier and the mechanism to be used for resolving the dispute).
Purchasers should take note of the Regulations when negotiating contractual terms with suppliers. In some circumstances it may be justifiable to extend payment periods beyond those provided for in the Regulations, however in the event of a dispute, purchasers must be able to demonstrate that the payment terms are not ‘grossly unfair’ or risk a) such terms being declared unenforceable, and b) face additional claims for compensation, recovery costs and interest.
Suppliers should ensure that they are aware of the default periods under the Regulations, consider its future contractual terms with purchasers and, where changes are applied, ensure accounts employees update internal credit control procedures where appropriate. Where suppliers are under pressure to agree to unfavourable payment or inspection/acceptance terms, suppliers are advised to notify the purchaser of its obligation to comply with the Regulations and seek further legal advice if required.