The Late Payment of Commercial Debts (Interest) Act 1998 came into force on 1 November 1998. How will it be implemented? What will its ramifications be? Should contracting parties amend their standard conditions to take the Act into account?
This article considers the implementation of the Act, looks at the potential ramifications of implementation, and assesses whether or not contracting parties should amend the standard conditions upon which they contract.
The Act came into force on 1 November 1998. It introduced a right to be paid interest on unpaid debts arising in many business transactions. The Act applies to contracts for the sale of goods/supply of services where both parties are acting in the scope of their business, however, its implementation will be phased, and at this stage the right to statutory interest is confined to small businesses only. Therefore, only debts owed by a large business purchaser or a public authority to a small business supplier attract statutory interest. Debts owed by a large business to another large business are not affected, and neither are those owed by small businesses to anyone. However, in November 2000 the right will probably be extended so small businesses can claim from each other and by November 2002 it is likely that all businesses will be able to claim against each other and against public bodies.
Four separate Orders have been introduced as follows:
• The Late Payment of Commercial Debts (Rate of Interest) (No.2) Order 1998 - this Order revokes and replaces the original Rate of Interest Order. This was due to a defect in the first Order, in that the consent of the Treasury had not been obtained.
• The Order sets out the rate of Statutory Interest which can be claimed. The applicable rate is a simple rate of 8% above the Official Dealing Rate of the Bank of England, more familiarly known as the 'base rate'. The official dealing rate presently stands at 5¼%. Therefore debts that are presently outstanding to which the Act applies are currently accruing interest at 13¼% in aggregate.
• The Late Payment of Commercial Debts (Interest) Act 1998 (Commencement No.1) Order 1998 - this Order brings the Act into force for the purposes of the first phase and addresses the phased introduction of the Act. The respective definitions of a "small business" a "public sector body" and a "1arge business" are dealt with in Schedules I-III of the Order.
• The Late Payment of Commercial Debts (Interest) Act 1998 (Transitional Provisions) Regulations 1998 - this instrument addresses the evidential burden relating to the size of a business i.e. whether it is a "small business" or a "1arge business".
• The Late Payment of Commercial Debts (Interest) (Legal Aid Exceptions) Order 1998 - this order provides for certain contracts made by the Legal Aid Board to be excepted from application. The contracts concerned are those where the charges and fees are not negotiated but rather are determined in accordance with the relevant regulations under the Legal Aid Act, 1988. Payments made under such contracts by the Legal Aid Board will therefore not carry statutory interest under the Act.
The Act works by providing that the contract giving rise to the debt has an implied term giving the right to interest. Interest entitlement is therefore a term of the contract. Interest runs from the date the parties agree payment is due or, if no date is agreed, from the later of the date of performance of the obligations to which payment relates or the date the debt is notified to the paying party. There are special rules for advance payment.
The provisions of the Act cannot be contracted out of except by providing an alternative 'substantial remedy' for late payment under the contract. It is not precisely clear what will qualify as a 'substantial remedy', although S.9(1) of the Act states that a remedy will be deemed to be substantial if:
• it is sufficient to compensate the supplier for the cost of late payment or for deterring late payment; and
• it would not be fair and reasonable in the circumstances for the statutory right to interest to oust or vary the contractual remedy.
The Minister of State for the Department of Trade and Industry, Lord Clinton-Davies sought to explain the reason for setting the interest rate at 8% above base on the basis that the DTI had been advised by the Bank of England that this is the rate at which the weakest businesses may obtain agreed overdrafts or term loans. If this is the case, for the parties to agree a contractual rate of interest beneath the 8% figure may lead to such contractual remedies being held to be insufficient "for the purposes of compensating the supplier for late payment..." under Section 9 (1) (a) of the Act and treated as void.
It remains to be seen whether the courts will consider the level at which the supplier has actually been able to obtain bank finance as a telling factor in determining whether or not the contractual interest rate of less than 8% above base is or is not a substantial remedy. However the scope for argument is certainly there. Not unsurprisingly the Minister responsible for the Bill's passage through the Commons and Standing Committee would not be drawn on what would constitute a 'substantial remedy'.
The Order which deals with the phased implementation of the Act, initially providing a right to statutory interest to small businesses only, defines a small business as a business that had 50 or less full time employees for the period 1 April to 31 March immediately preceding the date that the contract in respect of which statutory interest is claimed was formed. The schedule to the Order which defines the meaning of the ,small business' is a fairly lengthy and arduous section. There are complicated arrangements for defining which employees are taken into account in totalling up the 50. Parttime employees are treated as fractions of full-time employees and employees of associated businesses are taken into account (an associated business is one controlled by the same individual or a business which controls, or is controlled by, the business claiming payment). Meal breaks and rest periods are all fed into the equation, and where the numbers fluctuate there are ways of working out the average over the relevant period.
However well it is drafted the definition will unfortunately lead to anomalies in practice. Businesses continually expand and contract and there is every prospect, especially since the definition looks to the year prior to the date the contract was entered into, (which could be a number of years prior to the commencement of a period of statutory interest for which the small business is claiming) that the supplier who is seeking to claim statutory interest is either as big if not bigger than the business the supplier is seeking to claim statutory interest against. This however is the inevitable consequence of legislating ostensibly to protect particular sectors of commerce and industry.
The legislature oversaw these problems when debating the application of the Unfair Contract Terms Act 1977 between two enterprises contracting in a business relationship and therefore chose not to go down the road of partial or phased implementation. The Housing Grants Construction and Regeneration Act 1996 on one view could be seen as moving towards particular sectors of the construction industry but its provisions apply equally to all contracts that fall within that particular Act's definition. This Act takes the protection of specific sectors of commerce and industry still further.
It remains to be seen whether claiming parties, especially small businesses keen to obtain future work from their present customers, will actually enforce claims for interest or challenge any lesser contractual rate as not constituting a 'substantial remedy'. To enforce the right to interest a creditor has to take some form of legal proceedings and it is thought that few sub -contractors, for example, will want to jeopardise their working relationship with main contractors by insisting on payment of statutory interest. In the majority of cases any entitlement to interest, even at the full statutory rate, will not be for such a significant sum that would make it cost effective to have recourse to the courts or arbitration purely to enforce a right under the Act or challenge a lower rate set in the contract.
Finally, it is also worth considering just how extensively the Act will apply in the construction industry. As stated previously, the definition of ,small business' regards as one business all employees working for an associated employer such as a parent or sister company. It is quite likely therefore that a vast number of subcontractors will actually be too large to fall within the definition and therefore avail itself of the right to statutory interest. A more likely application of the Act will be the next layer down, namely the sub-subcontract/sub-sub-supplier level. It is not therefore inconceivable that subcontractors who have in the past been guilty of late payment will feel the commercial implications of the Act more than their main contractor counterparts.
In the final analysis this is a matter for the contracting parties themselves. However there appears to be a limited scope within which a contracting party can amend its standard terms and conditions,'by the introduction of an express right to interest in consequence of late payment. As mentioned above any reduction in the rate set out in the Order of 8% above base will run the risk of not constituting a substantial remedy. Similar risks will apply to any attempt to extend substantially the date when interest would otherwise run. However the consequences of a contractual right to interest which seeks to displace the statutory right of interest being held to be void for not constituting a substantial remedy are simply that the supplier will become entitled to statutory interest (most likely higher interest for a greater period of time) as if the express contractual position had not been included in the first place. To have reached this stage, however, the ',small business" pursuing the claim for statutory interest will have had to litigated the entire matter before the Court at the trial. It see Im; therefore that the only penalty for removing the supplier's right to statutory interest by a remedy held not to be substantial will be to return to the application of statutory interest.
One of the contract drafting bodies which has introduced amendments thus far that touch upon the subject matter of the Act is the JCT. Clause 30.8.5 of the JCT Standard Form (1998 Edition), for example, provides for simple interest at 5% above base. Whether or not it is actually a substantial remedy may not matter certainly for the next 4 years until such time as the Act extends to large businesses which is projected to take place in the year 2002. It may however have more significance in relation to similar amendments to be found in the JCT family of subcontracts.
Over the next 4 years it may be the preferred option of contracting parties not to include any express provision entitling interest on late payment at all since unless it is obvious that they are contracting with a "small business" they will be providing an express entitlement to interest for late payment to their supplier in circumstances where the supplier in question would not otherwise have such a right. The author understands that Employers are quite often deleting the contractual right of interest in the main contracts and further their requirement for the main contractor to include a similar provision in its subcontracts. Are we to see an additional enquiry being raised in the tender documents for the tenderer to state the number it employs working for its organisation for the year 1 April to 31 March prior to the invitation to tender?
In the final analysis deciding whether to amend is down to the contracting party. There is no obvious right or wrong answer. Shrewd contracting parties however would be well advised to consider the material provisions of the Act, assess their effects on their business, and consider whether or not they should amend the contract provisions upon which they regularly contract, if they have not already done so.
Michael Hopkins is a partner at Masons Solicitors, Manchester office specialising in construction and engineerine law.