|Late Payment of Commercial Debts|
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Who are we and why are we qualified to explain late payment charges?
We are Andrews & Arnold Ltd. We have a wide a range of customers that buy anything from one off small items at £20 to equipment and installations running in the £10,000s. We are an ISP and bill thousands of people every month. We have been charging late payment penalties (interest initially) since 1997 and have years of practical experience in dealing with a wide range of customers and ways of charging late payment penalties. We are not lawyers or credit control advisers and offer the advice on this site as is based on our practical experience.
A few assumptions
We recently had a long debate about these web page on a mailing list and were surprised to find some people seem to live in a different world. So this is just to clarify some assumptions. To explain the world we live in (and thankfully the world the courts live in too).
Firstly, we are assuming people understand the basic ideas of contracts. A contract is a legally enforceable agreement - usually with one side agreeing to pay money and the other side agreeing to provide goods and services. There are people in the world that do not treat contracts as that important, and consider things like actually paying by the agreed date as not really necessary. There are people that are of the view that nobody reads contract terms and paying when you consider reasonable or convenient is fine, regardless of the contract. We have the view that a contract should be clear and agreed and adhered to. If you think contracts don't matter much you'll probably not find this page easy to understand.
Secondly we have this quaint idea of paying what is due. If we owe money we pay it. If we are owed money we expect it to be paid. It seems some people have a much more relaxed view on this and think that, for example, we should not actually collect late payment penalties that are due. They automatically assume the threat of penalties is just an idle threat and nobody actually pays them. As a limited company we have to act in the best interests of the shareholders, and that is almost always ensuring we collect any money that is due whatever it is for. There are exceptions where good will is more valuable for ongoing business, but they are exceptional.
Finally, we think that it is important for anyone running a business to be aware of the laws that affect them. There is an assumption that everyone knows the law, but this is especially important for businesses. There are people that assume that because they have never heard of some law that it does not apply to them.
What are late payment penalties?
When someone buys goods or services a contract is formed. A contract is just an agreement between the two parties. This contract will normally involve a supplier selling goods or services in exchange for money. The contract may be formal and in writing and signed, or implied, or according to published terms which are implicitly agreed. One aspect of the terms is when and how to make the payment. The seller may give the buyer time to pay (credit terms). If the buyer does not make the payment within these terms then they are late. Paying late is breaking the contract. Late payment penalties are simply a pre-agreed penalty that is due if the terms are broken by paying late.
We are talking about commercial contracts here - business to business. It is especially important for any business to read the contract and only agree to it if they are happy they can meet that agreement. Not meeting the contract terms is breaking the contract and can usually involve more than just late payment penalties. Some contracts can be terminated completely because of a small breach, and some may mean services stop suddenly. So all businesses should read the contract carefully.
Why have penalty clauses at all?
Contract law means that if you break a contract with someone then you are liable to pay them penalties which are their costs for your breach. Paying late is a breach of contract. A penalty clause means that there is a pre-agree penalty. Without such a clause the penalty is ultimately up to a court to decide - it does not mean there is no penalty. Having a pre-agreed amount simplifies matters so everyone knows where they stand in the case of a late payment.
There has been a little debate over the word penalty in this context. We are using it to mean something to pay as a result of doing something wrong. In this case for breaking the contract terms by paying late. There is a general principle that such payments are not there to profit the other party, just reimburse them for the consequences of what you did wrong.
What sort of penalties are there?
There are two obvious sorts of penalty that one might agree in a contract - a fixed cost and interest. They have pros and cons.
For a small debt only a little late, interest may be pence, and so no deterrent and not worth collecting. However, for a large debt or a debt that is long overdue, interest helps encourage payment sooner rather than later and helps compensate for lost interest on the money that should have been paid.
For a small debt a fixed penalty can be a serious discouragement. However, for a large debt, a fixed penalty may be a drop in the ocean and no deterrent at all. If you only have a fixed penalty, then as soon as someone is late there is no incentive to pay now rather than leave it even longer.
The best approach is to have both a fixed sum and interest. This acts as a deterrent and provides compensation whether the debt is small or large.
However, penalties are not meant to be a deterrent normally, they are just to cover the costs of the breach of contract. In some cases there may be quite low costs in practice even if those costs were collected. So contract law does not really encourage paying on time much on its own.
How can you make penalties part of a contract?
If you have a formal contract then it is a simple matter to include penalty clauses that spell out what has to be paid if the contract is breached by paying late. The penalties have to be a realistic pre-estimate of likely costs for the breach. If the contract terms could be argued - e.g. standard terms on a web site which the buyer can say they did not read in detail, etc, then having explicit terms like this can be harder to enforce. There is also the issue of whether the penalty charges in the contract are reasonable and valid.
The other approach, which we recommend by far, is using statutory penalty clauses. All commercial contracts have penalty clauses by law, and the statutory levels provide a fixed fee and interest. This only works on commercial contracts, but there is no issue as to whether the details of the contract were agreed or whether the levels of penalty are reasonable.
The whole idea of statutory penalty clauses is to get people to pay on time. It is meant as a deterrent against paying late and to compensate for it as well.
It is possible to have worse penalties than the statutory provisions if you want. A contract which has alternative substantial penalties can exclude the statutory penalties. It is hard to see how a contract with penalties that are less than the statutory levels could be considered substantial, so the statutory levels are effectively the minimum.
It is important for commercial customers to realize that they cannot escape penalty clauses. The law has been worded carefully to avoid this. If this was not the case, and there was any way for a supplier to exclude penalties, then it would be a standard condition of all purchase orders anyone ever sends and the late payment act would be useless.
To invoice or not to invoice?
The official advice for charging penalties is that you should send a demand letter to the customer detailing the penalty charges. However, our experience is that customers will normally ignore any demand letters, threats, notes on statements, or indeed anything that is not an invoice. Our advice is to issue an invoice for the penalty charges. There are some points to be aware of:-
What are the statutory penalties?
Late Payment of Commercial Debts Regulations 2002 (SI 2002 No 1674)
Why a law?
Normal contract law allowed penalties anyway, but they were harder to define and enforce. Making late payment penalties a specific amount defined by law and in all commercial contracts means it is simple to apply, and small suppliers can avoid being bullied by larger customers into charging no, or nominal penalties. There are clauses in the law outlawing customers insisting on unreasonably long terms as well.
The reasoning is that the main reason for business failures is cash flow problems due to late payment. Statutory penalties encourage paying on time and help improve cash flow.
Because it is the law there is no need to state penalties in the contract or tell people penalties apply. However, we make a point of making it very clear to our customers.
One reason for not telling customers is that the penalties may be pursued up to 6 years later (as can any debt) and so you could choose not to mention them to customers, especially if you have customers that always pay late. Then, when they stop being customers any more, you could send a large bill for all of the £40 fees for all of the late paid invoices over the previous 6 years. This is not exactly nice, but from what we can tell is completely legal and they would not really have any defence. We choose to tell customers when they have a debt to us.
Whilst we normally raise late payment invoices immediately we have pursued them later and we have been asked by a judge why a late payment penalty was not pursued at the time. There are of course many valid answers such as "We felt pursuing this debt was not at the time in the best interests of on-going customer relations, knowing that the Limitations Act allowed us 6 years to do so should we wish."
We also have a one page information sheet we provide to customers when they pay late, explaining the penalties.
One concern is that charging penalties could lose good will. It is worth bearing in mind:-
Is paying late a risk?
This is another area that has much debate. We feel it would be foolish for any business to pay invoices late on a regular basis as doing so is running up a debt for late payment penalties even if the supplier is not yet aware. Some people feel that most suppliers do not actually pursue the debts so it is not a big risk, or that good will is more important and so they will not pursue them. However, one important aspect to consider is the number of businesses going bust. It would be irresponsible for any liquidator or receiver to ignore the potentially huge asset that 6 years of uncollected late payment penalties represents, especially when they are so easy to prove. If one of your suppliers goes bust the liquidator could ask for £40 for each invoice paid late in the last 6 years, and you would not really have any defence against that in court. So, its a risk, in our opinion, even without considering that the supplier may change management or just wise up to what they are owed one day.
See our tips on enforcing penalties.
See our list of excuses and how to resolve them!