The Late Payment of Commercial Debts Act - what constitutes "substantial"

28 April 2010

Many contracts contain provisions which allow the supplier of goods or services to charge interest if they are not paid in time - a right which in the current economic climate might be getting more attention than usual. Under the Late Payment of Commercial Debts Act 1998, a supplier to another business is entitled to charge interest on late payments at a rate of 8% per annum above base rate. This term is implied into contracts for the supply of goods and services between businesses. Any attempt to exclude the provision is void unless the contract includes an alternative substantial remedy for late payment of a debt.

It is not unusual to see a wide range of interest rates in contracts, from 0.5% to 8% and above, simple interest and compound interest, depending on the circumstances of the parties involved. But, if you include an alternative interest rate in the contract and exclude the statutory rate, how do you know if it is substantial enough? When will the courts override this expression of the intentions of the parties and revert to the statutory rate?

A recent case provides some guidance on these issues. In Yuanda (UK) Co Ltd v WW Gear Construction Ltd [2010] EWHC 720 (TCC), the Technology and Construction Court had to consider whether a construction contract contained a substantial remedy, when the rate of interest for late payment was set at 0.5% above base. In the circumstances, it was decided that it did not. Therefore, the provision was void and the statutory interest rate applied. But why?

The interest provision was an amendment to the standard Joint Contracts Tribunal (JCT) contract, which specified an interest rate of 5%. It was either not spotted, or simply not negotiated, by the parties.

The Act sets out certain considerations that must be taken into account in determining if an alternative remedy is substantial enough and the court considered those factors in this case: the parties were of relatively equal bargaining power, and the supplier was not offered any inducement to accept this lower rate of interest. It was not raised in the pre-contractual negotiations and the court interpreted this as an imposition of the term on the supplier by the customer, to the supplier's detriment. There were no special circumstances to suggest that such a low interest rate was appropriate.

Having taken all this into consideration, the rate could not be considered a substantial remedy.

Could any interest rate under 8% have been substantial? Yes. The court said that 5% (as contemplated by the unamended JCT contract), despite being 3% below the statutory rate, would have been, and also suggested that there is no reason why a lower rate of 3 or 4% couldn't be acceptable if it had been understood and agreed by the parties.

The key message from this case is that for those wishing to insert an interest rate which is considerably below the statutory rate, or indeed the industry norm, it is vital that this rate is drawn to the attention of the supplier prior to signature of the contract, to provide the opportunity for negotiation. The courts are well aware of the difficulties businesses can encounter due to the significant changes in base rate during the lifetime of this legislation (base rate was around 7% when it was first brought in), and, it seems, will be sympathetic to businesses caught out by this unexpected change in circumstances.

Look out for our guide to late payment provisions in the coming days.


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