In the UK, large businesses which delay making payments to a smaller supplier which need the money on time to meet their expenditure can put the latter at huge disadvantage. Debt recovery for these smaller companies is therefore of huge significance.
To ensure companies adopt fairer payment and credit check practices, the UK government enacted the Late Payment of Commercial Debts (Interest) Act 1998 LPCD(I)A 1998. It was further amended by the Late Payment of Commercial Debts Regulations 2002 which allowed all businesses, including public sector organisations, to claim interest from any other business or organisation, including small businesses.
The Act applies to all commercial contracts created on or after 7 August 2002. It allows UK business to charge interest on late payments and debt recovery costs for clients and customers that have exceeded the payment terms agreed by the parties.
Businesses can charge eight per cent above the Bank of England base rate set on a twice-yearly basis and also debt recovery compensation of up to £100 on each overdue order.
The fact that companies can charge this amount in excess of the standard rate means the charges that can be levied are more likely to exceed the benefit a company sees in withholding payment. The Act therefore incentivises businesses to pay up on time.
Can the parties agree to not be bound by the rules under the Act?
Both parties to a commercial contract can agree not to use the provisions contained within the Act. However, this is only where the contract provides a substantial remedy for late payment.
Section 9 of the Act defines a substantial remedy as:
- if either the remedy is apt both to deter late payment and to compensate the creditor;
- even if it is not apt it is fair and reasonable to allow reliance on it, taking account of the needs of commercial certainty and the relative bargaining position of each of the parties.
Unfair Contract Terms Act 1977
All terms inserted into a contract to try and get around LPCD(I)A 1998 will be subject to the test of reasonableness established by the Unfair Contract Terms Act 1977.
Are there any commercial contracts that the Act does not apply to?
LPCD(I)A 1998 only applies to debts. Therefore it does not apply to:
- liquidated damages clauses;
- insurance indemnity policies.
Where a court has jurisdiction to award interest under other legislation (such as the Supreme Court Act 1981), LPCD(I)A 1998 will not apply.
Contracts which have no connection to the UK, only in relation to the choice of English law to govern them, will also not be subject to LPCD(I)A 1998.
What happens if a company simply refuses or fails to pay?
Despite the interest payments which can be threatened on a party under LPCD(I)A 1998, the increasing amount of money owed under a commercial contract payment may still never be paid.
If an invoice from a company remains unpaid the company has the following options:
- act of goodwill;
- statutory demand;
Act of goodwill
Where a business owes another company large sums of money and that business forms a large part of the revenue source, there will sometimes be seen an ‘act of goodwill’, whereby a longer payment time will be provided in exchange for a guarantee of future orders or
The option of a statutory demand will only be available if the amount owed is greater than £750 and where the debts are not in dispute.
Following a statutory demand the company has 21 days to pay the commercial debt with the threat of winding up prompting the payment.
If the company fails to pay the debt after 21 days a winding up petition can be presented to the company with a liquidator appointed to liquidate the company.
There is no guarantee the debt will be paid in full as the company owed the money will be ranked as an unsecured creditor during the insolvency proceedings. This means when the company is wound up, secured creditors will take priority over unsecured creditors.
LPCD(I)A 1998 enables a company to apply for legal proceedings with the interest continuing on a daily basis throughout the litigation process.
The advantage of litigation over insolvency proceedings is there will no other parties involved in the proceedings meaning no one else will be able to claim a stake in the money. However, if the company goes insolvent during the court proceedings the insolvency proceedings take precedence.