Practical Law

This month’s Ask the team considers what statutory rights, if any, a supplier (be that a professional consultant, a building contractor, sub-contractor or materials supplier) may have to improve their cashflow, if they agreed a long payment cycle that they now regret.

Can I escape from agreed extended payment terms?

A professional consultant has entered into a professional appointment with extended payment terms. The consultant has agreed to carry out design work for a proposed project, submitting monthly accounts. Given the early stage of the project, it’s agreed that the final date for payment will be six months after each account falls due.

As the project progresses, the consultant finds its weakened cashflow increasingly difficult to manage. It hopes it may be able to argue its way to a shorter payment cycle, which the client is reluctant to accede to. This raises two questions:

• Are long payment cycles permitted?
• Could the consultant use the Construction Act 1996 or any other statutes to help it in its predicament?

Freedom of contract

One of the fundamental principles of contract law in England and Wales is freedom of contract. That is, the courts will respect and enforce the terms agreed by the parties. However, over the years that principle has been tempered (some might say eroded) by legislation. That tempering effect is perhaps particularly firmly felt where one of the parties is a consumer, but it is also present in business-to-business transactions. Here, we focus on the legislation affecting business-to-business contracts, in a construction-specific context.

The Construction Act 1996

One of the policy principles underpinning Part II the Housing Grants, Construction and Regeneration Act 1996 (Construction Act 1996) (and its 2011 amendments) was to improve payment practice and cashflow in the construction sector. Section 110 of the Act requires each construction contract to provide an adequate mechanism for payment.

While it is tempting to suggest that extended payment terms alone would render the payment mechanism inadequate, the consultant is unlikely to succeed if that is its only argument. Section 110(1) expressly records that:

“[t]he parties are free to agree how long the period is to be between the date on which a sum becomes due and a final date for payment”.

If the payment delay was a sham, simply designed to get around the Construction Act 1996, that might be another thing. However, that would be a very high hurdle for the consultant to try to jump.

The Late Payment Act 1998

Contracts entered into in the course of business are subject to the Late Payment of Commercial Debts (Interest) Act 1998 (Late Payment Act 1998). If a contract does not provide for a “substantial remedy” for late payment, the Act adds implied terms requiring the purchaser (here, the consultant’s client) to pay statutory interest on overdue sums.

Understandably, much of the debate about whether a contract provides for a substantial remedy has focused on whether a contractual rate of interest, fixed lower than the statutory rate of interest, meets that criteria. For example, we know that the contractual rate of 5% over base rate set out in the JCT suite of contracts can provide a substantial remedy, even though the statutory rate is 8% over base rate (see Yuanda (UK) Co Ltd v WW Gear Construction Ltd and Walter Lilly & Company Ltd v Giles Patrick Cyril Mackay).

However, if the parties have agreed extended payment terms, with interest for late payment not running until after the extended final date for payment, could the consultant argue that its appointment fails to provide for a substantial remedy?

To do so, the consultant would have to show (for example) that it would not be “fair or reasonable” to allow the delayed contractual interest payment to oust the right to statutory interest (section 9(1)(b), Late Payment Act 1998). However, it may struggle to do this, because section 4(3) of the Act expressly allows the parties to agree what the “relevant day” is, when interest starts to accrue:

“Where the supplier and the purchaser agree a date for payment of the debt (that is, the date on which the debt is to be created by the contract), that is the relevant day…”

If we accept that the debt is created on the final date for payment (not the due date), while the consultant could (in effect) throw itself at the mercy of the court, the court would take some persuading that the consultant should be relieved of the consequences of simply entering into a bad bargain with long payment terms.

Changes to the Late Payment Act 1998: March 2013

We publish this post in changing times. If the contract in question is dated on or after 16 March 2013, amendments to the Late Payment Act 1998 will have come into force. It’s important to remember that the Act still works the same way: if the parties don’t agree a substantial remedy for late payment, then the Act incorporates implied terms into the contract. If the parties do provide for a substantial remedy, there is nothing for the Act to do (section 8(2)). If the Act bites, additional implied terms now include a tougher regime on setting the date when interest will start to accrue.

Following the amendments, the consultant could seek to bolster its argument on fairness, citing the Act’s new implied term that delaying a supplier’s right to interest for more than 60 days from performing its obligations will be ineffective, if the supplier can show that such a delay would be “grossly unfair” to it. (Note that the Act still includes special implied terms for advance payments, but now also refers to different implied terms for payment after an acceptance procedure.)

Whether it is grossly unfair depends on the court, guided by section 4(7A), which refers to (for example):

“a gross deviation from good commercial practice… contrary to good faith and fair dealing”.

Here we must add a significant word of warning. On one analysis, the consultant would be using a secondary line of argument (about whether it was grossly unfair to delay its right to statutory interest) to try and win its primary argument (about whether the contract provided a substantial remedy). In other words, the client could argue that the consultant’s approach puts the cart before the horse: it should not be permitted to raise the “grossly unfair” argument, unless it has already shown that the contract does not provide a substantial remedy.

However, the mischief the consultant would be trying to address in its argument would be a client agreeing a substantial rate of interest, but then still not providing for a substantial remedy for late payment by excessively delaying the start of the period for which that interest could be claimed.

Freedom v fairness?

From the consultant’s side of the fence, if six months was a fair payment period in the particular circumstances of its deal with the client, what about nine months, a year, or two years? Would it always be a case of the consultant being hoisted by its own petard, or would (at some point) the courts come to its rescue?

From the client’s side, surely it’s up to the consultant to determine whether or not it is prepared to contract on the payment terms offered?

Whichever side of the fence you sit on, it seems that the further the parties want to go from a 30 or 60-day payment cycle, the more careful they should be about recording their reasons (in a form they would be prepared to disclose). If a contract includes a long payment cycle, but pays a premium to allow for the slower cashflow, again those calculations should be recorded in a way that demonstrates they are part of a “fair” payment cycle, or at least one that is not “grossly unfair”.

Those sorts of records could help demonstrate both that the parties are not trying to circumvent the Construction Act 1996’s payment rules and that they have provided for a substantial remedy for late payment. Particularly with those records in place, a supplier may struggle to overturn agreed payment terms.