UK: The Late Payment Of Commercial Debts (Interest) Act 1998 - A Short Guide

Last Updated: 17 November 1998

1. Introduction

Economists estimate that at any one time in Britain, £50 billion worth of debts have not been paid within the agreed credit limit. In order to improve the payment culture, The Late Payment of Commercial Debts (Interest) Act 1998 ("the Act") received Royal Assent on 11th June 1998 and a part of it comes into force on 1st November 1998. The Act gives businesses a statutory right to claim interest on overdue commercial debts. Before the Act it had only been possible to claim interest on unpaid debts if there was a contractual provision or if proceedings were issued (section 35A, Supreme Court Act 1981 and section 49 (3)(6) Arbitration Act 1996). From the 1st November, any small business can claim statutory interest against a large business or public sector body.

2.Implementation of the Act: Transitional Provisions

The legislation will be phased over a period of four years:

(i) for the first two years, 1st November 1998 - 31st October 2000, small businesses will be able to claim interest from large businesses and the public sector on debts incurred under contracts agreed after that date;

(ii) the right to claim interest will be extended, from 1st November 2000 to 31st October 2002 so that small businesses will also be able to claim interest from other small businesses for debts incurred under contracts agreed after that date;

(iii) from 1st November 2002, all businesses and the public sector will be able to claim interest from all businesses and the public sector on debts incurred on contracts agreed after that date.

Thus, small businesses will have four year's use of the rights available under the Act before large and medium sized businesses are able to claim a reciprocal right. Note that these transitional provisions do not appear on the face of the Act.

3. Who can claim statutory interest?

From the commencement of the Act, any small business can claim statutory interest against a large business or public sector body. A small business is one with fifty or fewer employees on average over the previous financial year prior to the year the contract was made. The legal status of the business (i.e. whether it is a sole proprietor, partnership, limited liability company etc.) is irrelevant.

An employee is anyone who works for a business for payment. This includes temporary staff, partners, owners or directors who work in the business.

Casual staff who are not required by contract to turn up for work are not employees. Both full-time and part-time employees are counted although part-time staff are counted as a proportion of a full-time employee.

A business that belongs to a group of businesses is only considered small if the group as a whole fulfils the criteria of a small business, i.e. the group has fifty or fewer employees. A group exists where one business has direct or indirect control of another or where two or more businesses are directly or indirectly controlled by the same third person or business.

Again being a transitional arrangement, these definitions do not appear on the face of the Act.

4. What is a commercial debt?

The Act applies to a "qualifying" debt under a contract for the supply of goods or services where the purchaser and supplier are each acting in the course of a business (section 2). If the debt is created by an obligation to pay the whole or any part of the contract sum, it is a qualifying debt (section 3). The size of the debt is irrelevant - no minimum level has been set below which a claim for interest cannot be made.

5. Whom can a claim be made against?

A small business can claim interest against any large business or public sector organisation. A large business is any business which falls outside the definition of a small business, i.e. any business with more than fifty employees. The public sector body is any government department, local or public authority. A purchaser who falsely claims to be small to avoid paying interest or a supplier who falsely claims to be small to obtain interest for which it is not entitled might be guilty of fraud. If the matter comes to court and the size of a business or supply of business is in dispute, then it will be for the supplier to prove it is small and, thus, entitled to interest.

Conversely, a purchaser will have to prove that it is small to avoid a claim for interest. Employee records, such as payslips, PAYE and National Insurance returns would be useful evidence in proving size.

6. When is payment late?

A payment is late when it is received after the expiry of the contractually agreed credit period. Where no credit period is defined, the Act sets a default period of 30 days (section 4(5)). The 30 day default period starts running from the later of two actions:

(i) the delivery of the goods or the performance of the service by the supplier; or

(ii) the day on which the purchaser has notice of the amount of the debt.

7. What is the rate of interest?

Section 6 provides that this is to be set by the Secretary of State in consultation with the Treasury. It has been confirmed by the DTI that the rate of interest has been set at base rate plus 8%, (ie currently 14.75%). Note that the interest owed on a late payment is simple and not compound. It is calculated like this:

debt x interest rate x the number of days late/365

Interest stops running on a debt once the principal has been paid. If the purchaser owes principal and interest any part payment of the debt will go to reduce the amount of interest first unless payment is accepted on any other terms.

Section 5 provides for the remission of statutory interest in the "interests of justice" because of the conduct of the supplier.

8. Time limits

The Limitation Act 1980 applies. The supplier has six years in which to make a claim. Receivers or liquidators of a business may pursue its purchasers for interest on a later payment going back over a period.

9. Interaction with contract terms

The legislation gives precedence to contractually agreed provisions. However, there are provisions set out in Part II, sections 7-10, to prevent the parties to a contract from contracting out of the legislation by setting very low rates of interest on late payments or by extending credit terms excessively or by any other terms which result in no "substantial remedy" for late payment. The provisions apply a test of "reasonableness" to such terms. In determining whether the reasonableness test is satisfied, section 9(3) sets out a number of relevant factors such as the benefits of commercial certainty, the relative bargaining positions of the parties, whether the term was imposed on a party (by standard term), and whether there was an inducement to agree to the term. In the guide prepared by the DTI, ("The Late Payment of Commercial Debts (Interest) Act 1998, A User's Guide") examples of contractual terms that courts might declare void because they result in no "substantial remedy" for late payment are set out. They include:

(i) a credit period that is significantly different from custom and practice in that industry;

(ii) a credit period that is significantly different from other supply contracts operated by the purchaser.

(iii) an interest rate on late payment, significantly lower than the statutory rate.

The DTI has stressed that the list is not exhaustive and the courts will take a case by case approach.

10. Separation and assignment of interest

Section 13 allows the interest to be pursued separately from the principal debt and permits assignment of the interest to third parties such as factors.

11. Are UK importers liable to claim for interest from overseas' suppliers?

If the contract is governed by English law an overseas' supplier may claim interest under the Act from a UK importer. Similarly, the UK supplier may claim interest under the Act from an overseas purchaser.

12. How will European law affect the right in future?

The European Commission plans to adopt a directive, combating late payment in commercial transactions, following protests from various European business organisations that there are different rules in different countries and that some nations have better payment records than others. Measures put forward by the Commission would aim to give creditors a right to fair compensation when a debt is paid late.

There would be a statutory right to interest equal to the European Central Bank "REPO" or credit rate, plus 8%, unless the contract specified otherwise. This is in line with the new provisions in the U.K. However, the EU rules would allow full compensation from the late payer for any damage caused to the business. This goes much further than the UK laws. Suppliers here are not entitled to any compensation for administrative costs in chasing late payments. The directive was approved by the European parliament in Strasbourg on 17th September. It is now being considered by the European Council's working group.

This note is intended to provide general information about some recent and anticipated developments which may be of interest. It is not intended to be comprehensive nor to provide any specific legal advice and should not be acted or relied upon as doing so. Professional advice appropriate to the specific situation should always be obtained.

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