In November 1998 the Late Payment of Commercial Debts (Interest) Act 1998 was welcomed by many as another blow to the widely perceived late payment culture of the Construction Industry. The Act introduced a statutory right to interest in the event of late payment of debts due to businesses with less than fifty employees (defined by the Act as small businesses) by businesses with over fifty employees, or public authorities. In November 2000 the Act was extended to debts due to small businesses by businesses of any size, and public authorities. But has the Act really made a difference?

Recap of the Essentials of the Act

  1. The Act applies to debts of any size incurred under contracts for the supply of goods and services where the "purchaser" and "supplier" are acting in the course of a business. Typical construction contracts, professional appointments and contracts for the supply of materials are therefore covered by the Act. Debts assigned to factoring agencies are also held to be qualifying debts under the Act.
  2. Qualifying contracts must provide a "substantial remedy" for the late payment of debts. While parties can agree what this remedy should be, it must satisfy the "fair and reasonable" test set out in the Act before the statutory provisions can be displaced. Factors such as the relative bargaining positions of the parties will be taken into account in evaluating whether a term can be regarded as "a substantial remedy". Attempts to circumvent the Act by agreeing exceptionally low rates of interest to apply to late payments or protracted credit periods could be challenged.
  3. If a substantial remedy for the late payment of debts is not provided in a qualifying contract, the Act will apply and interest will run on late payments at the statutory rate from the "relevant day" defined by the Act.
  4. The statutory rate of interest is 8% above the Bank of England Base Rate which prevails on the date the debt becomes overdue.

The Impact Of The Act So Far

A recent survey carried out for found that only 15% of the small businesses surveyed had used the Act to claim interest on debts. This finding is perhaps not surprising. The understandable reality is that many small businesses will often choose to ignore an entitlement to interest provided by the Act for the sake of commercial harmony with their customers.

The present level of awareness among small businesses as to rights afforded by the Act and when it can be used is questionable. Many businesses simply may not be aware of their rights under the Act and when these can be enforced. A basic knowledge of the Act could be potent – for example, reference to the Act and the statutory rate of interest in standard terms of contract or invoices may be enough to discourage the late payments of debt. The best starting point for further information on the Act is still the DTI's user guide.

It would be wrong to assume that the Act has not had some impact. The introduction in 1998 of interest based remedies for late payment to many standard forms of contract unquestionably granted one of Sir Michael Latham's wishes, but was also at least partly driven by the imminent arrival of a statutory right to interest. The JCT Standard Forms of Building Contract, for example, provide for interest to be paid at the rate of 5% above the Bank of England Base Rate in the event of late payment. Such provisions are now commonly relied upon, not least in claims made via adjudications.

Some Unanswered Questions

The question as to whether interest provisions in some standard forms truly displace the statutory rights to interest – whether they are "substantial remedies" for the late payment of debts – remains one of the unanswered issues arising from the Act (at least by the courts). For example, does the interest rate of 2% above Base Rate set out in ICE 7th satisfy this test when the Act specifies a rate of 8% above the Bank of England Base Rate? Would the answer to this depend on the financial position of the creditor, and would it differ from case to case? Would the Act's interest rate be regarded as penal? There has, so far at least, been no reported authority on these questions. This may change if more parties come to rely upon the Act in making a claim for interest.

A Sleeping Giant?

Virtually all contracts in the construction supply chain will eventually be subject to the Act. Consequently, if standard form contracts incorporating interest provisions are not put in place, the Act may have a role to play. Bespoke conditions of sub-contract used by some main contractors do not provide a right to interest on late payments. If a sub-contractor has over 50 employees it cannot currently rely on the Act to claim interest. If, however, such conditions are incorporated into contracts entered into after (at the latest) November 2002, the Act will provide a right to interest on late payments.

As the number of contracts affected by the Act increases, so too will the size of debts and the amount of interest payable, as well as the number of businesses entitled to statutory interest. Larger enterprises may be less wary than small businesses of irritating those they have contracted with, and hence the number of businesses using the Act could rise rapidly.

If a relationship does break down and the party seeking payment wishes to maximise a claim, interest accrued between final and actual dates of payment during the course of a contract may be "swept up" in one global claim. Such an approach may come as a nasty surprise for habitual late payers at the end of a contract. The sensible course of action for those likely to be on the receiving end of such claims will be to formulate their own "substantial remedies" for late payment with interest, perhaps, at a lower rate than the statutory rate.

Liquidators may also review a company's dealings over a period of time with the aim of collecting outstanding, but unclaimed, interest on debts which have persistently been paid late.

The European Dimension

European Parliament Directive 2000/35/EC requires member states to introduce a right to claim interest in the event of late payment. The Act provides this right but not, currently, for all businesses. As the Directive is due to be implemented before 8 August 2002 the final planned extension of the Act (by 1 November 2002) may be brought forward.

The Act complies with most of the Directive's requirements but does not provide a right for a creditor to claim "reasonable compensation" from a debtor for "all relevant recovery costs" incurred as a result of late payment. The Directive insists on this. An amendment to the Act or secondary legislation may be needed to ensure harmony with the Directive – a fixed scale for costs based on the size or age of the debts is among the options being considered to bring about compliance. Such a change may make the pursuit of interest and late payments more attractive to creditors.

Further details on the Directive are available from the Small Business Services Website. A commentary on the act is available in Debts and Interest in the Construction Industry: a Guide to the Late Payment of Commercial Debts (Interest) Act 1998 [Johnston; Thomas Telford 1999].

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.