Late Payment Penalties in the UK

Late Payment of Commercial Debts

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.

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.

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.

Why have penalties?

If you make an agreement and then break your promise it is only fair that the other party is compensated - that is a basic principle of contract law. Having penalties serves two main roles:-

Discouraging breach of contract
Covering costs of the other party

One thing penalties are not there to do is give the other party a profit. You could not make the late payment penalty a million pounds unless that was a realistic pre-estimate of costs because of paying late (somewhat unlikely).

What sort of penalties are there?

There are two main sorts of penalty - 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.

How can you make penalties part of a contract?

If you have a formal signed 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.

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:-

You can invoice the fixed charge immediately that the debt is overdue.
You can only really invoice the interest element once the invoice is paid, but you could raise periodic interest invoices if you wanted to.
There is no VAT on interest and penalty charges.
Not paying a penalty invoice on time does not give rise to a statutory penalty charge for that invoice (statutory penalties being applicable to debts for goods and services).
You may need to allocate payments carefully as customers may forget to pay the penalty invoice and pay later invoices.

What are the statutory penalties?

A fixed charge of £40, £70 or £100 depending on the size of the debt (under £1,000, under £10,000, and higher).
Interest at 8% over base rate (a level set each 6 months for simplicity).

Which law?

Late Payment of Commercial Debts (Interest) Act 1998

Interest at 8% over base rate
1st Nov 1998 for small suppliers to large customers
1st Nov 2000 for small suppliers to small customers

Late Payment of Commercial Debts Regulations 2002 (SI 2002 No 1674)

Additional fixed penalty charge £40, £70 or £100 as well as the 8% over base rate of interest
7th Aug 2002 applicable to all commercial contracts

Note that these apply to contracts formed after the dates specified.

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.

Telling customers

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 (well, back to Aug 2002). 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.

We also have a one page information sheet we provide to customers when they pay late, explaining the penalties.

Good will

One concern is that charging penalties could lose good will. It is worth bearing in mind:-

Penalties only apply to customers that have broken their contract and not paid on time anyway.
Once a penalty invoice is charged, we normally credit it for the first offence as a good will gesture. This usually restores good will whilst making payment on time important to the customer.
Penalties are part of every commercial contract, even if other suppliers are not pursuing them yet. Anyone paying suppliers late is taking a gamble.
It is possible to lose customers because of late payment penalties, but our experience is that this is more than made up by reduced bad debt, better cash flow, and penalties collected.
It may simply be worth being selective about who you want as customers and one good criterion is on-time payment.

Enforcing penalties

See our tips on enforcing penalties.

Excuses!

See our list of excuses and how to resolve them!

Late Payment of Commercial Debts

Home Tips Excuses Stories Disclaimer	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. 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. 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. Why have penalties? If you make an agreement and then break your promise it is only fair that the other party is compensated - that is a basic principle of contract law. Having penalties serves two main roles:- Discouraging breach of contract Covering costs of the other party One thing penalties are not there to do is give the other party a profit. You could not make the late payment penalty a million pounds unless that was a realistic pre-estimate of costs because of paying late (somewhat unlikely). What sort of penalties are there? There are two main sorts of penalty - 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. How can you make penalties part of a contract? If you have a formal signed 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. 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:- You can invoice the fixed charge immediately that the debt is overdue. You can only really invoice the interest element once the invoice is paid, but you could raise periodic interest invoices if you wanted to. There is no VAT on interest and penalty charges. Not paying a penalty invoice on time does not give rise to a statutory penalty charge for that invoice (statutory penalties being applicable to debts for goods and services). You may need to allocate payments carefully as customers may forget to pay the penalty invoice and pay later invoices. What are the statutory penalties? A fixed charge of £40, £70 or £100 depending on the size of the debt (under £1,000, under £10,000, and higher). Interest at 8% over base rate (a level set each 6 months for simplicity). Which law? Late Payment of Commercial Debts (Interest) Act 1998 Interest at 8% over base rate 1st Nov 1998 for small suppliers to large customers 1st Nov 2000 for small suppliers to small customers Late Payment of Commercial Debts Regulations 2002 (SI 2002 No 1674) Additional fixed penalty charge £40, £70 or £100 as well as the 8% over base rate of interest 7th Aug 2002 applicable to all commercial contracts Note that these apply to contracts formed after the dates specified. 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. Telling customers 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 (well, back to Aug 2002). 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. We also have a one page information sheet we provide to customers when they pay late, explaining the penalties. Good will One concern is that charging penalties could lose good will. It is worth bearing in mind:- Penalties only apply to customers that have broken their contract and not paid on time anyway. Once a penalty invoice is charged, we normally credit it for the first offence as a good will gesture. This usually restores good will whilst making payment on time important to the customer. Penalties are part of every commercial contract, even if other suppliers are not pursuing them yet. Anyone paying suppliers late is taking a gamble. It is possible to lose customers because of late payment penalties, but our experience is that this is more than made up by reduced bad debt, better cash flow, and penalties collected. It may simply be worth being selective about who you want as customers and one good criterion is on-time payment. Enforcing penalties See our tips on enforcing penalties. Excuses! See our list of excuses and how to resolve them!