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Adjudication costs and the Late Payment of Commercial Debts (Interest) Act 1998 (Part 2)

In my last blog, I looked at the potential conflict between section 108A of the Construction Act 1996 and section 5A(2A) of the Late Payment Act 1998, and concluded that the recent case of Lulu v Mulalley hasn’t provided us with a definitive answer to the question of whether a conflict exists.

This week I’m going to consider how the Late of Payment Act 1998 can be ousted, and what might constitute a “substantial remedy”.

Ousting the Late Payment Act 1998

One of the reasons I decided to write about this topic was because I’d recently heard Rachel Gwilliam of Blake Morgan present her excellent paper on this subject to the Society of Construction Law in London. Rachel’s paper looks at the various ways in which a party’s rights under the Late Payment 1998 can be ousted, so that they cannot claim their “reasonable costs” of recovering a debt under section 5A(2A). For example:

  • Rachel notes that a “qualifying debt” under the Late Payment Act 1998 is a debt created by an obligation to pay the “whole or any part of the contract price”. There is a relatively unhelpful definition of “contract price” in the Act, which simply refers to the price in the contract (see section 16(1)), so it begs the question of what is included in the “contract price”? Well it certainly wouldn’t include damages, whether they are liquidated or unliquidated. But what about loss and expense claimed under the terms of a contract? This is treated as part of the adjusted contract sum under JCT contracts, but is that sufficient to form part of the “contract price”?
  • An entitlement to costs will not arise until statutory interest begins to run, and it is open to the parties to exclude the right of statutory interest by agreeing an alternative “substantial contractual remedy for late payment of a debt”.

A further method by which statutory interest can be avoided is under section 5, which provides that, by reason of any conduct of the payee, in the interests of justice statutory interest should be remitted in whole or in part.

So, even if there is no conflict between section 108A of the Construction Act 1996 and section 5A(2A) of the Late Payment Act 1998, it may still be possible to oust the right of a party to recover their “reasonable costs” of recovering a debt.

What constitutes a “substantial remedy”?

The starting point for establishing what constitutes a “substantial remedy” must be the definition in section 9:

“(1) A remedy for the late payment of the debt shall be regarded as a substantial remedy unless—
(a) the remedy is insufficient either for the purpose of compensating the supplier for late payment or for deterring late payment; and
(b) it would not be fair or reasonable to allow the remedy to be relied on to oust or (as the case may be) to vary the right to statutory interest that would otherwise apply in relation to the debt.”

A many of you will know, in Yuanda (UK) Co Ltd v WW Gear Construction Ltd, Edwards-Stuart J found that an interest rate of 5% over the base rate was a substantial remedy. He also said that:

“It may even be that a case could be made for saying that 3-4% would provide a substantial remedy for late payment, particularly if the rate had been specifically discussed and agreed between the parties (I have already noted that in this project one trade contractor negotiated a rate of 2% over base).”

Akenhead J also found that 5% was a substantial remedy in Walter Lilly & Company Ltd v Mackay.

However, Rachel points out something of (potentially) critical importance. Pursuant to section 8(4) of the Late Payment Act 1998, Rachel considers that it is the overall remedy, and not just the rate of interest provided in the contract, that must afford the payee a substantial remedy:

“The ‘overall remedy’ means ‘any combination of a contractual right to interest, a varied right to statutory interest or a contractual remedy other than interest’. Section 10(2) of the Late Payment Act confirms that ‘a reference (however worded) to contract terms which vary the right to statutory interest is a reference to terms altering in any way the effect of Part 1 in relation to the debt’. The right to payment of the fixed sum as compensation for late payment under section 5A and the right to the ‘sum equivalent to the difference between the fixed sum’ and the supplier’s reasonable costs under section 5A(2A) both arise under Part 1 of the Late Payment Act and form part of ‘the overall remedy’.”

Rachel notes that both Yuanda and Walter Lilly were decided prior to the introduction of section 5A(2A), and she questions whether a contractual provision providing for a lesser rate than the statutory interest rate and excluding a right to the “reasonable costs” of recovering a debt would still constitute a “substantial remedy”.

However, I have also heard counter arguments to this. In particular, the definition of “overall remedy” quoted above does not refer to the statutory right to “reasonable costs” under section 5A, but rather it only refers to a “contractual remedy other than interest”. As such, it is not permissible to take the provisions of section 5A into account when considering the overall remedy.

How do you deal with the implications of section 5A(2A) in your contract?

First and foremost, I think that parties need to provide for interest in their contracts. Judging by what was said in Yuanda, I would go for 5% above base rate as a minimum. It would be foolhardy not to include any provision for interest. In those circumstances, unless the provisions of the Late Payment Act 1998 have been ousted, the payer is certain to be hit by the full force of the Late Payment Act 1998. That means that not only will the payer be looking at an interest rate of 8% above base, but will also be contending with the “reasonable costs” of recovering the debt.

But what if you’ve entered into a JCT contract that provides for interest at 5% above the base rate of the Bank of England, but there is no provision for the reasonable costs of recovering a debt? Will relying on Yuanda and Walter Lilly be insufficient as Rachel warns?

Well, given current borrowing rates, 5% above base rate may well provide a sufficient remedy for compensating the payee for the late payment of a debt for the purposes of section 9(1)(a). It is also important to remember that section 9(3) sets out the following matters that are to be taken into account when deciding whether section 9(1)(b) (it would not be fair and reasonable for the contractual remedy to oust the statutory remedy) applies:

“(a) the benefits of commercial certainty;
(b) the strength of the bargaining positions of the parties relative to each other;
(c) whether the term was imposed by one party to the detriment of the other (whether by the use of standard terms or otherwise); and
(d) whether the supplier received an inducement to agree to the term.”

If the parties had roughly equal bargaining positions and had agreed to use a JCT contract, would it not be fair and reasonable to allow the contractual remedy to oust the statutory remedy? Perhaps the payer could offer an inducement instead of including a provision for the reasonable costs of recovering a debt, for example increasing the rate of interest? The parties may also wish to expressly record that the interest provisions constitute a substantial remedy for the purposes of the Late Payment Act 1998.

In summary

I appreciate that I have raised a significant number of questions in these two blogs, many of which remain unanswered, the most important being:

  • Is there a conflict between section 108A of the Construction Act 1996 and section 5A(2A) of the Late Payment Act 1998 and, if so, which takes primacy?
  • Will a contract have to provide for the “reasonable costs” of recovering a debt, as well as interest, in order to constitute a “substantial remedy” under the Late Payment Act 1998?

There is also the issue of Brexit. In particular, as explained in my last blog, section 5A(2A) derives from the EU Late Payment Directive 2011 (2011/7/EU). Perhaps Brexit will provide an opportunity to clarify the potential conflict between section 108A of the Construction Act 1996 and section 5A(2A) of the Late Payment Act 1998?

However, unfortunately I don’t have a crystal ball…

MCMS Ltd Jonathan Cope

One thought on “Adjudication costs and the Late Payment of Commercial Debts (Interest) Act 1998 (Part 2)

  1. I have claimed costs out of adjudication many times and it’s been refused only once.

    The answer, in my view, sits within the Regulations themselves.

    Paying parties need to start having conversations about interest rates; what rate is being applied and why.

    This goes to circumvent the main reasons costs are being awarded in adjudication (imposition of the rate).

    It doesn’t alter the position of whether a particular interest rate does create a ‘substantial remedy’, which is arguably a matter of fact. But it chips away at the reasons relied upon by payees for why their costs can be claimed in the first place.

    Let’s also not forget that the base rate plays a part in the over all interest rate too. So the lower that is, the higher the chance of being awarded costs.

    The only reason I can see that supports the paying parties’ sense of injustice at costs being awarded is that there is no ‘flip’ side to the award (i.e. if the adjudication is lost, the paying party doesn’t get its costs).

    But then, let’s not forget that the reason the regulations were introduced in the first place – to protect the payee.

    There is still a huge problem in this industry of failure to pay based on, frankly, unfair payment practices. I am looking at a contract now, drafted by a household name, which includes a Tolent clause.

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