Late Payment under Construction Contracts – what new remedies are available to payees?

The Late Payment of Commercial Debts Regulations 2013 (the “Regulations”) came into force on 16 March 2013. They apply to all commercial contracts, including construction contracts, entered into after this date. The Regulations amend the Late Payment of Commercial Debts (Interest) Act 1998 (the “Act”) by introducing new remedies for late payment.

Remedies for Late Payment For Contracts Entered Into Before 16 March 2013

The Act implies into contracts a statutory rate of interest on late payments of 8% above the Bank of England base rate. The Act also allows payees to recover a fixed sum as compensation for late payment of a debt. The fixed sums are £40 (for debts up to £999.99), £70 (for debts £1,000-£9,999.99) or £100 (for debts over £10,000).

However, it is crucial to appreciate that the statutory interest rate and the right to claim fixed compensation can be excluded from contracts if the parties agree an alternative “substantial remedy” for late payment. The Act does not define what a “substantial remedy” is, but rather vaguely states that a remedy will be substantial unless it is unfair or unreasonable to allow that remedy to replace the remedies available under the Act. Typically, a “substantial remedy” will be a contractual interest rate, with interest rates between 2% and 5% usually classed as a “substantial remedy”. Most contracts which contain an interest rate at this level (particularly standard forms such as the JCT contracts) will therefore not be subject to the Act. The Act only tends to apply in cases where the parties have failed to include a contractual rate of interest, such as in letters of intent or contracts which are badly drafted.

Remedies for Late Payment For Contracts Entered Into After 16 March 2013

The Regulations implement EU Directive 2011/7/EU, which attempts to combat late payments in commercial transactions across the EU by increasing suppliers’ rights.

The Regulations introduce two new rights for payees which exist in addition to the rights already available under the Act:

1. A right for payees to claim the “reasonable costs” incurred in recovering the debt.

2. A right to claim statutory interest after 60 days.

These additional rights only apply to contracts entered into after 16 March 2013.

Recovery of Reasonable Costs

The right to claim the “reasonable costs” of recovering a debt only arises when:

1. the Act applies i.e. when there is no alternative “substantial remedy” for late payment in the contract; AND

2. the fixed sum of £40, £70 or £100 (depending on the value of the debt) does not cover the payee’s reasonable costs of recovering the debt.

It is not clear from the Regulations what is meant by “reasonable costs”, and this has led some to question whether the costs of adjudication or legal proceedings can be recovered as “reasonable costs”. However, although the courts have yet to clarify the issue, it is unlikely the Regulations will be interpreted in this way.

The legal costs of adjudication are irrecoverable and the Housing Grants, Construction and Regeneration Act 1996 (as amended) prohibits contracting parties from including any term in their contracts which provides for one party to the pay the other’s legal costs incurred in adjudication. It would therefore be contradictory if the Regulations allowed the recovery of legal costs in adjudication proceedings.

As far as legal proceedings are concerned, if the Regulations permitted the automatic recovery of legal costs, this could undermine both the detailed procedural rules and the courts’ general discretion in relation to the award of costs.

It therefore seems that the “reasonable costs” which payees can recover under the Regulations will be limited to costs incurred prior to formal debt recovery proceedings, such as the administrative costs of sending letters and possibly the cost of preliminary legal assistance such as solicitors’ letters.

Payees should, however, note that it is unlikely the paying party will voluntarily pay their “reasonable costs”, at least not without considerable scrutiny of the costs incurred. In some cases, it may be necessary to consider legal action in order to recover costs, which is unlikely to be appropriate unless significant costs have been incurred. Payees should therefore ensure they keep detailed records of the costs they incur in recovering debts.

Right to Claim Statutory Interest After 60 Days

Under the Regulations, statutory interest will begin to accrue 60 days (or 30 days where the paying party is a public authority) after whichever is the latest of:

  • the day the payee performs the obligations to which payment relates;
  • the day the payee submits a claim for payment; or
  • the day the payer verifies or accepts goods or services provided (where the contract includes a verification or acceptance procedure).

The effect of the Regulations is therefore to impose a limit on how long a payment period can be before statutory interest begins to accrue. On a strict reading of the Regulations, it appears that if the contract has a payment period of longer than 60 days, the payment period will still stand but the payee has a right to claim interest after the 60 day period has expired, even if that is before the agreed contractual payment date.

However, the guidance on the Regulations issued by the government explains things differently. The guidance states “businesses must pay their invoices within 60 days”, but the Regulations, on a strict interpretation, do not say this. The Regulations say that statutory interest will start to accrue after 60 days. Businesses therefore do not have to pay invoices within 60 days if they do not wish to do so, but they may face a claim for statutory interest after the 60 day period applicable under the Regulations has expired.

In theory, it could therefore be costly to have payment periods of longer than 60 days. However, payers may not need to worry unduly about reducing their payment periods to 60 days or less because there are two important exceptions to the rule.

First, the 60 day rule appears, on a strict interpretation of the drafting of the Regulations and the Act, only to apply in cases where statutory interest applies i.e. not in cases where there is a contractual “substantial remedy” for late payment. Arguably, this means where there is a substantial contractual interest rate, the 60 day rule will not apply. However, given the wide range of remedies for late payment now available under the Act and the Regulations, it may be that payees can now argue that an interest rate alone does not constitute a “substantial remedy” and that contracts must provide more generous remedies in order to exclude the Act and the Regulations.

Secondly, the Regulations say that the 60 day rule does not apply in cases where the contracting parties have “expressly agreed” a payment period longer than 60 days and that period is not “grossly unfair”. The Regulations state that, in determining whether something is “grossly unfair”, all the circumstances should be considered. Specifically, anything that is a “gross deviation from good commercial practice and contrary to good faith and fair dealing” may be grossly unfair. It is not clear what is meant by “expressly agreed” or whether standard terms and conditions can give rise to an “express” agreement.

What Should Payers Do To Protect Their Position?

Any payer whose contracts do not provide the payee with a “substantial remedy” for late payment must be aware that they can be required to pay interest at 8% above the base rate, in addition to a fixed sum of compensation and other “reasonable costs”. Furthermore, if the contractual payment period is more than 60 days, the Regulations allow the payee to claim statutory interest from the 60 day point, unless the payer can establish that the payment period is not “grossly unfair”.

It is therefore essential for payers to ensure their contracts contain a “substantial remedy” for late payment of a debt. At the very least, this means including a reasonable contractual rate of interest. Payers who do have a payment period of longer than 60 days may also wish to consider how to justify it, in case they find themselves on the receiving end of a “grossly unfair” allegation.

Terms & Conditions Health Check

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This article contains information of general interest about current legal issues, but does not provide legal advice. It is prepared for the general information of our clients and other interested parties. This article should not be relied upon in any specific situation without appropriate legal advice. If you require legal advice on any of the issues raised in this article, please contact one of our specialist construction lawyers.