LEGAL - Better now than later

Outstanding payments can prove to be crippling to small firms but the law has handed them a weapon.

Heralded by the small firms minister as a 'weapon in the hands of the law has handed them a weapon. small businesses', the Late Payment of Commercial Debts (Interest) Act 1998 came into force on 1 November last year. Initially, small businesses are given a statutory right to claim interest at eight per cent above base rate if a large business or public sector organisation pays its bills late. In time, all businesses will have this right and be subject to this rate of interest.

According to one survey, less than 20 per cent of UK companies pay on time and the largest companies are the worst offenders. But does this legislation bite? The act has already been overshadowed by Rentokil's much-publicised offer to its suppliers of one per cent more than Midland Bank's base rate for bills unpaid after 65 days. Its words were: 'We are only prepared to do business with you on these terms.' This means the impact on the small businesses the act was designed to help is at best minimal, with the long-term effect of placing large businesses in an even more powerful position.

The act is being phased in three stages, with discretion for amendment.

The second phase will come into effect on 1 November 2000, when small businesses will be able to claim interest from all businesses and the public sector on debts incurred under contracts agreed after 1 November 2000. From 1 November 2002, all businesses and the public sector will be able to claim interest from all businesses and the public sector on debts incurred under contracts agreed after 1 November 2002. A small business is defined as having on average 50 employees or less prior to the year the contract was made.

When is payment late?

Where the parties have agreed a credit period, payment is late if it is made after the last day of the credit period. If no period has been agreed, the act sets a default of 30 days after which interest can run.

It is possible to override the act in two ways. First, there is no obligation on suppliers to claim statutory interest. Indeed, increased administration costs and, more importantly, potential loss of customers are potent arguments for the small business supplier not to enforce the act. Research suggests that less than a quarter of owner managers intend to claim statutory interest, calling into question the act's practical ability to help small businesses.

Second, as the Rentokil offer demonstrates, the act does not apply irrespective of the terms in the contract, nor does it replace existing custom and practice.

Purchasers and suppliers can stipulate a remedy for late payment in the contract. But the remedy must be 'substantial' for the act not to apply.

If it is not substantial, in the event of a dispute ending up in court, the remedy will be struck down by the court. Instead, the act will apply to the contract, so the supplier will be able to claim statutory interest on the debt.

Where parties have conducted business on the basis of usual industry practice, this practice will probably still apply. But again, if the remedy for late payment is not substantial, the terms of the act will apply.

A remedy for late payment is substantial as long as it is sufficient to compensate the supplier for the cost of late payment or for deterring late payment. It must also be fair and reasonable in all circumstances to allow the remedy to replace or vary the statutory right to interest provided in the act.

In a dispute, it is up to the supplier to show a remedy is not substantial.

The courts then determine whether, in all circumstances, the remedy meets the criteria. An interest rate set below base rate is highly unlikely to satisfy the criteria.

The question still arises as to whether Rentokil is flouting the spirit of the act. Its approach may be criticised but it will be followed by other powerful businesses, undermining the legislation.

Still, suppliers and purchasers should not ignore the impact the act could have on their businesses. For a supplier in a strong bargaining position, there is the possibility of imposing high interest rates of up to eight per cent above base, without such provisions being considered penal. Negotiations regarding credit periods and rates of interest can be conducted on a different premise, with purchasers perhaps offering other benefits to suppliers to obtain a credit period or interest rate which is otherwise clearly below the substantial test.

Businesses should not forget that on 1 November 2002, when statutory interest becomes law for all businesses, the largest will have the weight to make eight per cent standard when dealing with all their purchasers, plus the power to override the act and impose conditions similar to the Rentokil offers when dealing with all their suppliers.

Stephen Sidkin is a partner and Meena Guram a trainee solicitor in the commercial department of City law firm Fox Williams.