The recent announcement of the UK Government's Payment and Cash Flow Review has once again put the spotlight on late payment clauses and other payment practices. Larger businesses in particular may be criticised for failure to comply with legal requirements or "best practices" in relation to their purchasing activity. Meanwhile, faced with challenging economic conditions, suppliers should be looking to maximise the protection available to them against late customer payments.
Late payment clauses: time for a review?
Overview
Key points for buyers
The key risk for buyers, especially larger businesses, is that evidence provided to the Review may highlight failures to comply with the existing law or best practices. Buyers may therefore wish to consider the following:
- Compliance: Do your late payment provisions comply with the existing law and current best practices? In particular, is the interest rate on late payments sufficient and do you insist on credit periods of over 60 days? See section 2.
- Disclosure: Are you caught by the disclosure regime described in section 3? If so, do you publish all the required information (there are criminal penalties for failure to comply) and is there a risk of being "named and shamed" as a 'late payer' based on that information?
- Smaller Businesses: Do you purchase from a significant number of smaller businesses? If so, note the plans to strengthen the powers of the Small Business Commissioner ("SBC") described in section 4 and consider whether you may be at risk of complaints being made either to the SBC or in the form of evidence to the Review.
Key points for suppliers
Suppliers may wish to consider the following:
- Remedies: Are your existing contractual remedies for late payment more generous than they need to be, given the law in this area? See section 2.
- Subcontracting: If you subcontract to other suppliers, particularly smaller businesses, do any of the points made above in relation to buyers apply to you?
- Public sector tenders: Do you regularly tender for central government contracts worth over £5 million per year? If so, are your payment practices (in relation to your own suppliers) putting you at risk of exclusion from bidding? See section 3
Late payment: what does the current law say and what will the Review cover?
The current legal framework
There are three main areas in which the current law seeks to intervene with a view to discouraging late payment:
- Statutory remedy for late payment: the law gives all businesses a reasonably generous statutory remedy for late payment of debts (including a right to claim interest on late payments of Bank of England base rate plus 8%). However, the statutory remedy can be "ousted" by including express provisions on late payment – and in practice, many, if not most, commercial contracts seek to do this (although this is not to say that they will always be successful in achieving that objective). See section 2
- Disclosure regime: larger businesses are required to report on their payment practices and performance, including average payment times. This enhanced level of transparency is intended to create an "embarrassment factor" and give suppliers more information on the payment practices of potential customers. In addition, any supplier bidding for central government contracts in excess of £5 million per year must provide similar information as part of the bid process, and could be excluded from tendering if, for example, it has failed to pay 95% of all supply chain invoices within 60 days. See section 3
- Small Business Commissioner: small businesses which have not been paid on time can complain to the Small Business Commissioner (SBC). However, the SBC has no real teeth and is largely restricted to "naming and shaming" late payers (as for example, in the case of Holland & Barrett in 2019). The SBC also oversees the voluntary Prompt Payment Code (again though, the sanction for failure to comply is confined to "naming and shaming"). See section 4
What will the Review cover?
A 'Payment and Cash Flow' Review was announced in December 2022 which will assess the success of the measures outlined above. Some idea of the magnitude of the issues around late payment is conveyed by the Government's estimate that UK businesses are owed over £23 billion based on outstanding invoices. In particular, this Review should confirm whether:
- the SBC will be granted stronger powers (as detailed in section 4); and
- the disclosure regime and government procurement aspect of the current measures should be continued and/or strengthened (see section 3).
The Review will also look at whether the statutory remedy could be improved (see section 2), together with a variety of ways in which businesses (particularly SMEs) could be supported in managing their cashflow, using technology, finance and improving awareness. Its conclusions are expected to be published in 2023 (probably towards the end of the year).
The statutory remedy for late payment
The Late Payment of Commercial Debts (Interest) Act 1998 gives suppliers a statutory right to recover:
- interest of 8% above the Bank of England base rate on overdue payments from the customer; and
- debt recovery costs of a 'fixed sum' (either £40, £70 or £100 depending on the size of the overdue debt). Where these fixed sums do not cover the reasonable costs of recovering the debt, additional amounts may also be claimed.
If the payment provisions in the relevant agreement are silent as to the payment date, statutory interest accrues after a 30-day period – so in effect, payment terms of 30 days are implied. However, as explained below, it is possible to exclude this statutory remedy. In practice, many contracts seek to do so, typically applying a significantly lower rate of interest on late payments and also in some cases a longer credit period e.g. 60, 90 or 120 days.
Excluding the statutory right
The statutory right can be ousted by the inclusion of express wording in an agreement which provides for "some other substantial remedy" for late payment. There is limited guidance on what constitutes a "substantial remedy"; however, in practice, the courts have found that an interest rate of 5% above the base rate was sufficient and have accepted that a case could also be made for 3-4% above base.
As regards credit periods, if the statutory interest-rate remedy has been excluded, parties are free to agree payment terms longer than 30 days (provided the buyer is not in the public sector). However, if the specified credit period is found to be "grossly unfair", then a court will substitute a default period of 60 days. Whilst there is, once again, limited guidance on what constitutes gross unfairness, it will generally be preferable not to go beyond 60 days without a reasonable commercial justification for doing so.
Does it work?
The effectiveness of the statutory remedy depends partly on the willingness of businesses to make use of it – which they may sometimes be reluctant to do. For example, one survey from 2015 suggested that about half of all businesses do not exercise their rights to claim late payment interest on overdue invoices for fear of losing future business.
However, the success of the legislation should probably also be viewed in terms of whether it has encouraged buyers to improve their payment terms, both as regards rates of late payment interest and credit periods. Here, the relative complexity of the legislation and the freedom allowed to businesses to agree their own payment terms may have undermined its impact. For example, had the legislation stated that payment periods longer than 60 days could only be justified in exceptional circumstances, this might have had a more significant impact in persuading businesses using longer credit periods (e.g. 90 or 120 days) to reduce them.
The Payment and Cashflow Review is expected to look again at the effectiveness of the legislation and may make recommendations as to how it could be improved e.g. possibly by imposing more constraints on the freedom for businesses to agree their own late payment remedies.
Suppliers: are you giving away more than you should?
Suppliers may wish to consider whether they could make better use of the legislation as a negotiating tool to secure better payment terms. For example, faced with an interest rate on late payments of 1-2% interest above a base rate, a supplier could point out that this may not be regarded as a "substantial remedy" and should be substituted for a higher rate. Similarly, where customers are proposing payment terms of say, 90 days, suppliers can point out that the legislation appears to have been drafted on the basis that 60 days is a more reasonable credit period for most purposes – and ask customers to justify why they require longer than this. That said, in practice, much will depend on the parties' relative bargaining power and in some cases suppliers may prefer to focus their efforts on other aspects of the agreement where they wish to secure concessions from the buyer. Finally, suppliers should note that if a late payment remedy is out of all proportion to the loss they are likely to suffer, it may be regarded as an unenforceable penalty – although as noted above, the more usual problem is that the express contractual provisions are less generous than the statutory remedy.
Watch out for LIBOR
Although many late payment clauses refer to the base rate of a commercial bank or the Bank of England, some refer to LIBOR – which is being wound down and will not be available at all beyond 2024. For more detail and guidance on what to replace it with, see this briefing.
Late payment: disclosure obligations
The Payment Practices and Performance Regulations
The Payment Practices and Performance Regulations 2017 ("PPPRs") require large companies and LLPs to report twice a year on their payment practices and policies in relation to certain contracts. Such disclosures include reporting on the business' standard payment terms, their process of resolving payment disputes and statistics on average payment times. There are criminal penalties for failure to comply. So far, there do not appear to have not been any prosecutions, although it is clear that the Government monitors compliance and has on occasions threatened enforcement action. A brief reminder of their scope is set out below but for more detail on the PPPRs, see this briefing.
Who is caught by the PPPRs?
The PPPRs apply to all 'large' UK companies and LLPs (including private companies and public companies, whether listed or unlisted). The definition of 'large' is the same as under the Companies Act 2006, i.e. entities satisfying two of the following criteria on their last two balance sheet dates:
- turnover of more than £36m;
- balance sheet total of more than £18m; and
- more than 250 employees.
Which contracts are caught by the PPPRs?
The disclosure obligation relates to any contract between two or more businesses for goods, services or intangible assets (including IP). Other kinds of contracts (e.g. business to consumer contracts) are excluded, as are contracts for financial services. Contracts must have a "significant connection" with the UK to fall within the regime (English law governed contracts will always be caught).
Do the PPPRs work?
Part of the aim of the PPPRs is to allow suppliers to understand customer performance and identify which customers they want to contract with (or to seek additional protections such as payment guarantees from late payers), thus helping them to mitigate the risk of late payment and the subsequent negative impact of their cash flow. However, it is not clear to what extent this happens in practice and the UK Government's own statutory review of the Regulations suggests they have not been particularly effective in this respect. The Government has also noted an 'embarrassment factor', whereby companies may be driven to improve their payment practices for fear of being "named and shamed" if they are identified as being late payers; however, whilst there is some evidence of improvement in suppliers being paid within agreed timeframes, it only relates to about 4% of invoices.
Impact of the Review
The Payment and Cash Flow Review will look at whether the PPPRs should be continued and/or enhanced in some way (a decision to discontinue seems unlikely, as the statutory review suggested broad support for the disclosure regime). Businesses should note that the Review is very likely to look at data provided under the PPPRs; it may also commission further research into late payment practices and/or issue a call for further evidence of such practices.
Suppliers to the public sector
Any organisation that bids for a central government contract in excess of £5m per annum will normally be required to provide information about their supply chain management and payment tracking systems. In particular, bidders are normally expected to demonstrate that they have paid 95% of invoices within 60 days. For more detail, please see the UK Government's Procurement Policy Note. The guidance indicates that bidders which do not meet the prompt payment criteria should generally be excluded from the relevant tender process.
Late payment: role of the Small Business Commissioner
The Small Business Commissioner (SBC) was introduced in 2016 to support small businesses in dealing with late payment and other unfavourable payment practices. To qualify as a 'small business', a business must have fewer than 50 staff (there is no turnover threshold or other criteria).
The SBC can investigate complaints – although it has no powers to impose sanctions on businesses which refuse to cooperate, beyond "naming and shaming" them in its reports (as was the case with Holland & Barrett in 2019). It also provides general advice and administers the Prompt Payment Code, a voluntary scheme under which signatories agree to meet targets such as paying 95% of all invoices within 60 days and paying 95% of small business invoices within 30 days. The sanctions are limited to "naming and shaming" and suspension or removal from the Code scheme.
Proposals to strengthen the SBC's powers
The SBC currently lacks "teeth" in situations where businesses fail to cooperate with its complaints process. In October 2020 the government launched a consultation on whether the SBC should be able to:
- impose fines on businesses which fail to comply;
- compel disclosure of information in connection with the investigation of the complaint;
- issue binding monetary awards following investigation; and
- investigate suspected poor payment practices on its own initiative.
For more detail, see this briefing. The consultation ended on 24 December 2020 and a decision on whether to proceed with the above changes is expected as part of the ongoing Payment and Cash Flow Review. At the same time, a Statutory Review of the SBC is taking place, which is also expected to feed into the Review.
More information on pricing and payment issues
This is the third in a series of briefings about pricing and payment issues in commercial contracts. The first two briefings were:
You can sign up to be notified of more content here.
How we can help
We have considerable experience of advising on pricing issues in commercial contracts across a wide range of sectors. We are also one of very few firms to be consistently ranked as one of the top tier advisers in the UK in this area.
