Difficult trading conditions bring an increased risk of customers paying late. So, what rights do businesses have to claim interest on late payments?
Bases of charging interest
There are various grounds on which you can recover interest on late payments. The right can arise under contract or under statute (including the Late Payment of Commercial Debts (Interest) Act 1998 (Late Payment Act), or the court may exercise an inherent discretionary power to award interest the Senior Courts Act 1981 and County Courts Act 1984 (Courts Acts).
This note focuses on contractual interest, due under an express contractual term or under the statutory implied term under the Late Payment Act.
Express contractual obligation
A contract can include an express obligation on a party to pay interest on overdue sums. The clause should set out the period over which interest is chargeable (which can run past the date of any related judgment), what payments attract interest, the applicable rate and whether interest is simple or compound. An express right to interest will usually override the court’s statutory power to assess and award interest under the Courts Acts and if it provides a “substantial remedy” (as to which see below), it will also override any implied term as to interest under the Late Payment Act.
Generally, the court will not interfere with the bargain the parties have reached on interest, unless it is unfair (as it can be in some consumer contracts) or is an unfair credit relationship, or the rules about penalties apply, or the payee has a discretion to set the rate and acts unreasonably or dishonestly or in bad faith in doing so.
What about an implied term?
A term requiring a party to pay interest will not be implied into a contract except under the Late Payment Act. The Late Payment Act implies a right to receive simple interest into commercial contracts between businesses for the supply of goods and/or services. Consumer contracts are not covered. Nor are employment contracts, contracts for property or share sales, intellectual property licences and certain finance agreements such as consumer credit agreements or mortgages.
Further, the Act only applies to a “qualifying debt”, meaning an obligation to pay the whole or part of the contract price. VAT may be part of the price, depending on how the payment clause (if there is one) is drafted, but other sums which may be due either way under the contract will not be caught.
As with an express contractual right to interest, entitlement to interest under the Act does not depend on a court judgment. The Act also gives the payee a right to recover a small fixed sum, up to £100 depending on the value of the debt, together with the reasonable costs (less the fixed sum) of recovering the underlying debt. The underlying EU Directive suggests reasonable costs might include legal costs or debt collection agency costs and internal costs. The courts normally take a strict approach to the recovery of such admin costs and, therefore, companies should always be mindful of such an approach.
Interest period and rates under the Late Payment Act
For contracts made after 14 May 2013, interest under the Act runs from the day after the principal sum is due, if a due date has been agreed, and if no date has been agreed, from the date 30 days after the later of delivery, invoice and (if applicable) acceptance. (Slightly different provisions apply to earlier contracts.)
Interest accrues until the underlying debt is paid or otherwise satisfied or discharged in some way or, if earlier, the date of any judgment for payment in favour of the payee. From that point statutory interest on the judgment debt may be available.
Where the Act applies, the rate is set twice a year, at 8% over the then current Bank of England base rate.
Importantly though, where there is an express term granting the payee a right to interest, that express term will displace the implied term under the Late Payment Act (LPA), including the right to recover the reasonable costs of recovery, but only where the express term provides a “substantial remedy” to the supplier for late payment: if it does not then it will be void and the regime under the LPA will apply.
A remedy will not be “substantial” where it does not sufficiently compensate the payee/supplier for the late payment or deter late payment and it would not be fair or reasonable to let it override the payee’s entitlement under the LPA, determined by reference to all relevant circumstances. Fairness and reasonableness will be assessed by reference to factors such as commercial certainty, relative bargaining position, how the term was introduced and whether the payor received any inducement to agree it. A lengthy delay to the start date for interest to run is another factor which might affect whether an express clause provides a substantial remedy.
In one case, an express clause providing for a very low rate of interest, at 0.5% over base rate, was found to not give a substantial remedy, given industry practice and lack of awareness of the rate on the part of the payee. However, express contractual rates of around 4% to 5% over base will usually be a substantial remedy, even though those rates are lower than the rate applicable under the Act (8% over base rate). Rates at 4% or 5% over base have been accepted as a substantial remedy even when the base rate was higher than it is now.
Bear in mind too that even where the clause does provide a substantial remedy, under the Act the court can still reduce the amount of interest, the interest rate or interest period where the “interests of justice” require that, which most obviously applies where the payee’s conduct means a reduction is appropriate.
Should you include an express contractual right to interest?
A supplier (a payee) confident the LPA will apply may resist an express provision for interest, assuming of course it is less generous to the supplier than the entitlement under the LPA. Equally, a supplier may push for an express interest clause more generous to the supplier than the entitlement under the Act: for example, the interest rate under the Act is generous but not all payments under a contract will attract interest under the Act and the Act only gives simple interest whereas a supplier may want compound interest. An express provision will also provide protection in contacts not covered by the Act, although in the absence of an express provision, the courts’ powers to award interest under the Courts Act or under the courts’ general discretion will help a supplier.
A supplier may also take the view that an express clause is far less generous to the supplier than the Act and may not be a “substantial remedy” so may fail and leave the supplier with, in that case, better rights under the Act. Although relying on that argument will often be risky.
Alternatively, a supplier may prefer the certainty of an express specified rate in the contract for goods and services and take the view that losing the right to recover costs under the LPA is acceptable. A successful claim may give a return on legal costs, assuming there are proceedings at all and they allow cost recovery: not all do, as it is dependent on the amount.
A customer (the payor) will ideally seek an express provision less generous to the supplier than the supplier’s entitlement under the LPA, as long as it still provides the supplier with a “substantial remedy”. Such a provision will displace the Act and the court’s power to award interest under the Courts Act. While the interest rate will clearly be relevant in assessing the “substantial remedy”, other factors can also be relevant, such as the interest period, bargaining position and negotiation. The customer may also want to expressly provide for interest on sums the supplier may have to pay to it, something the Late Payment Act does not provide for, covering as it does interest on payments to the supplier by the customer only.
Regardless of whether the Late Payment Act applies, usual contractual principles and rules of interpretation will still apply to any express interest clause included in the contract.
Let Muckle Collect
We now have a portal for businesses, Muckle Collect, which helps streamline your invoice recovery and helps get your cashflow back on track. For details about how Muckle Collect can help your business, please contact us.
More generally, if you need help drafting or negotiating interest clauses in your contracts or help recovering debts or interest on late payments please get in touch with Robin Adams at [email protected] or your usual Muckle LLP contact.
Guidance only: seek legal advice before taking action based on this note.