UK: Interest on Late Payments: New Development

The Late Payment Act (or to give it its full title the Late Payment of Commercial Debts (Interest) Act 1998) came into force in November 1998. The Act introduced a statutory right to interest on debts which remain outstanding beyond final dates for payment. Prior to the Act interest on late payments could only be recovered (i) if a contract provided for this; (ii) from the date court proceedings were commenced to recover the debt itself; or (iii) in other very limited circumstances.

The Act applies to debts of any size incurred under contracts for the supply of goods and/or services where the supplier and the purchaser are each acting in the course of a business. Contracts for the hire of goods also fall within the ambit of the Act. A diverse range of contracts entered into across the spectrum of industry and commerce – construction, manufacturing, engineering, information technology, professional services – are therefore affected by the Act.

The rate of interest currently provided by the Act is 8% above the Bank of England base rate current at the time a debt falls due. The right to statutory interest is implied by the Act into qualifying contracts, but can be displaced if the parties to a contract agree a remedy for late payment alternative to that proposed by the Act. Any such agreed term must be a "substantial remedy" for the late payment of a debt. One example of such a remedy is the right to interest on late payments at 5% above the Bank of England base rate set out in the JCT suite of building contracts.

The Act has been introduced in phases. Debts which have fallen overdue prior to 7 August 2002 only attract statutory interest if they are owed to "small businesses". The Act defines a small business as one with less than 50 employees. Small businesses can rely on the Act (in the absence of express contractual provision for interest) to recover interest on debts falling due prior to 7 August 2002.

On 7 August 2002, however, the position will change and the final phase of the Act will come into effect.

It has always been anticipated that businesses of any size would eventually be able to rely on the Act to recover interest. The original government timetable indicated that this would be the case from November 2002 onwards. The government has, however, accelerated the phasing-in process (and introduced other enhancements to the Act) to meet the requirements of European Directive 2000/35/EG. The result of this is the Late Payment of Commercial Debts Regulations 2002.

The key features of the Regulations are:

1. From 7 August 2002 businesses of any size will be able to rely upon the Act to claim interest on payments which (i) have not been made by the due date for payment (as defined by the terms of the contract in question or the implied terms of the Act); and (ii) which arise under contracts entered into after 7 August 2002.
2. The party entitled to seek interest will also be entitled to claim prescribed "compensation" from the debtor. The compensation allowable will depend on the size of the debt. For debts of £10,000 or more the payee will be entitled to claim £100.
3. The method of calculating the interest due on a given debt has been simplified. Six month interest rate "reference periods" have been created. If a debt falls due within a given 6 month period the relevant rate of interest will be the Bank of England interest rate applicable at the beginning of that period.
4. A "representative body" may challenge any purchaser's standard terms of contract which purport to vary the statutory right to interest, but which are not thought to provide a "substantial remedy" for late payment. Any organisation established to represent smaller or medium sized enterprises, a particular sector industry or geographical constituency would be entitled to challenge such standard terms.

As the Act allows a contract to provide a remedy for late payment other than that which the Act provides, it will be advisable for businesses to review their standard terms of contract to check whether a remedy for late payment is in fact provided. If it is not, one should be introduced as in its absence the terms of the Act will apply. If a party purchasing goods and/or services is able to impose its own standard conditions of contract it may be in that party's interests to specify a lower rate of interest or a different credit period to that specified in the Act (the "default" credit period specified by the Act is 30 days). A proactive approach to a remedy to late payment will often be preferable to simply remaining silent on the question of late payments and allowing the Act to apply.

Care should be taken, however, that the remedy for late payment provided is a "substantial" one. The question of what is substantial will turn on the circumstances of the parties to the contract and the type of contract. A court may take into account factors such as whether there was equality of bargaining power between the parties at the time the contract was formed and whether standard terms have been unilaterally imposed. If a rate of interest applicable to a late payment is significantly lower than the usual rate of borrowing for a payee, or a credit period is significantly different from custom and practice in a given industry sector, it may be that such provisions could be struck at by a challenge in court.

The extent of reliance on the Act will probably grow in line with the increased number of debts to which it will now apply. Reliance on the Act has to date perhaps been somewhat limited, possibly as a result of an understandable reluctance amongst small businesses to irritate customers by using it to recover interest. Larger businesses – especially when larger debts are involved - may not be so reticent.

Readers should also be aware that liquidators may review past payments to insolvent companies and seek to recover interest on debts which were paid late. Claims under a series of contracts could be made for interest alone. The eventual payment of a debt does not remove the right to statutory interest which accrued before payment – generally speaking interest could be claimed up to 5 years after a claim for this arose.

Clearly, in an ideal world payments should be made timeously. But for those businesses who believe they may on occasion find themselves paying debts late the message is simple – contract conditions should be reviewed and the potential impact of the extended scope of the Late Payments Act recognised and dealt with.