Interest on Late Payments – an Extra Consideration for Contracts involving Public Bodies

When recently advising a recent local authority client on a dispute involving payment to its contractor, the question of what rate(s) of interest should be applied to the payment (now agreed) came up.

In this particular matter, the rate of interest included in the contract was lower than the statutory rate in the Late Payment of Commercial Debts (Interest) Act 1998 (the "Act"), and was also defined by reference to a banking rate which was ambiguous. The discussion served as a useful reminder of a particular point which public bodies should consider when negotiating the interest provisions in their contracts.

The Act implies a term in to business-to-business contracts, giving at least 8% a year interest on the price of goods or services, plus a fixed sum and reasonable costs of recovering the debt.  Can parties agree that the right to payment of interest at the rate stated in the Act be excluded from a contract?

The answer is yes as long as the contract provides an alternative "substantial contractual remedy" for late payment. Therefore, a party can include a lower rate than that stated in the Act, but should be aware that this will likely to be subject to challenge in the event of a dispute that it is not "a substantial contractual remedy." What constitutes a substantial contractual remedy is a question that has been considered many times by the courts, and is beyond the scope of this article; a determination will depend on the facts on each case.

According to the Act, the rules relating to contracting out of statutory interest rate apply equally to public bodies as to private entities. The Act applies to contracts where the purchaser and the supplier are each acting in the course of a "business", and business is expressly confirmed to include the activities of "a local or public authority."

However, an unresolved issue caused by the way the original European directive (the Late Payments Directive 2011 (2011/7/EU)) (the "Directive") was implemented by the Act means that public bodies need to proceed with caution when deciding whether they can in fact contract out of statutory interest rate as the Act seems to permit.

This is because the Directive gives suppliers an absolute right to statutory interest against public bodies but, as above, this was not implemented by the Act. If the European Commission considers that the UK has failed to implement the Directive, it may bring infringement proceedings against the UK in the European Court of Justice. The important consideration for public bodies is that in the meantime, a directive may have direct effect against the state that failed to enact it. In other words, the Directive applies as if English law.

Government guidance follows the line of the Directive, regardless of the position under the Act. A user guide[1] contains guidance for businesses involved in commercial transactions with a public authority (published by the Department of Business of Skills shortly after the Act was amended in 2013. The Act has not been amended since this time. This guidance confirms that "the late payment interest rate will be a minimum of 8 percentage points above the Bank of England’s reference rate" which "cannot be negotiated" and "the contract cannot exclude interest for late payment or compensation for recovery of costs if paid late."

What will happen as a result of Brexit and how this current discrepancy will be addressed remains to be seen. However for now, the advice to public bodies is that the interest terms included in contracts it should reflect the terms available under the Act, as not only does a public body have to argue that the lower rate is a substantial contractual remedy, there is the added risk of a challenge based on the fact that the Directive should be directly applied.

[1]               https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/360834/bis-14-1116-a-users-guide-to-the-recast-late-payment-directive.pdf