Ousting the Late Payment Act: what exactly is a “substantial remedy”?

United Kingdom

Two recent TCC decisions have considered the scope for parties to oust the provisions of the Late Payment of Commercial Debts (Interest) Act 1998 (the “Late Payment Act”). In one case, the application of a penal rate of interest to undisputed debts was sufficient, even though no contractual interest rate was stipulated for disputed debts. In the other case, the court considered, and struck down, a contractual interest rate of 2% above the Bank of England base rate. These two decisions provide considerable clarity as to the requirements for ousting the Late Payment Act and parties may wish to refresh their approach to contractual rights of interest in light of them.

The Late Payment of Commercial Debts (Interest) Act 1998 

The Late Payment Act provides a statutory mechanism for the recovery of interest on late payments in commercial contracts for the supply of goods or services. This statutory entitlement arises when a payment is not made by the requisite date, allowing the creditor to claim interest at a statutory rate above the Bank of England base rate (often referred to simply as “base”). This rate is set by the Secretary of State – currently, it is 8% above the Bank of England base rate of 5%.

The Late Payment Act affords creditors, under contracts to which it applies, a default remedy for the late payment of “qualifying debts”; that is, a debt created by virtue of an obligation to pay the whole or any part of the contract price. This applies to interim payments under construction contracts as well as advance payments.

Any contract terms which purport to exclude or vary the right to statutory interest in relation to a qualifying debt are void, unless the contract provides a “substantial remedy” for late payment of the debt. Under section 9(1) of the Late Payment Act a contractual right to interest will be regarded as a substantial remedy unless:

  1. the remedy is insufficient to compensate the supplier for late payment or for deterring late payment; and
  2. it is not fair or reasonable to allow the contractual remedy to be relied on to oust or vary the statutory interest that would otherwise apply.

In determining what is fair and reasonable, the Late Payment Act provides that regard is to be given to all relevant circumstances at the time the contractual terms were agreed – this includes: the benefits of commercial certainty; the relative bargaining strengths of the parties; whether the term was imposed by one party to the detriment of the other (including by the use of standard terms); and whether the supplier received an inducement to agree to the terms.

Two recent cases decided in August and September this year have clarified the boundaries of what constitutes a “substantial remedy” under the Late Payment Act.

Disputed vs undisputed debts

In Tata Consultancy Services Ltd v Disclosure and Barring Service, an outsourcing and software development contract provided that interest on “undisputed” invoices (or parts thereof) was to be paid in accordance with the Late Payment Act. Disputed amounts were to be subject to a dispute resolution process, but no interest rate was stipulated for the late payment of such amounts.

In the court’s judgment, these provisions meant that a debt did not arise for disputed amounts until the dispute resolution procedure had been completed. As a result, where amounts had been properly disputed under the contract, and until that dispute had been resolved, there was no “qualifying debt” under the Late Payment Act in respect of those amounts.

The court nevertheless went on to consider whether the Late Payment Act would have applied had debts in relation to disputed amounts (which were subsequently upheld) arisen at the same time as undisputed amounts. In this regard, the court recognised an important distinction between awarding interest on a sum that is disputed (whether as to liability or amount) and awarding interest on a debt in respect of which there is no room for reasonable dispute. In Banham Marshalls Services Unlimited v Lincolnshire County Council, Eady J observed that “it is … necessary to have in mind that the mischief to which the statute appears to be primarily directed is that of casual or feckless non-payment.” Similarly, in Yuanda (UK) Co Ltd v WW Gear Construction Ltd, the TCC noted that:

“there is a difference in principle between awarding interest on a sum that was disputed, usually both as to liability and as to amount, and awarding interest on a debt in respect of which there might often be no room for reasonable dispute".

The key question was whether the overall remedy was a “substantial remedy” notwithstanding the lack of interest available in situations where the debt is properly disputed i.e. does it satisfy both limbs of section 9(1) of the Late Payment Act.

In relation to section 9(1)(a), the court considered that removing the right to statutory interest when the debt is genuinely disputed takes away the remedy by way of interest to compensate for payment which – if the dispute is resolved against the non-payor – will be “late”. The first part of section 9(1)(a) therefore applied. Despite this, the court found that the absence of a right to interest on disputed debts was nonetheless fair and reasonable, meaning that section 9(1)(b) did not apply and that, overall, the contract provided a substantial remedy for late payment.

A key aspect of the court’s reasoning as to the fair and reasonable requirement was that the contract, through the application of the penal rate under the Late Payment Act to undisputed debts, still provided a deterrent against the late payment of debts. The Late Payment Act was never intended to deter genuine disputes in relation to debts and the contract was therefore consistent with the purpose of the Act. In the court’s view:  “This is a weighty factor when considering whether an agreement between parties to reflect this distinction within a contractual regime for the late payment of debts is fair or reasonable, and it militates in favour of the overall remedy remaining a fair and reasonable one.”

Other factors which supported the fairness and reasonableness of the contract provisions were:

  • The payee being able to claim pursuant to section 35A of the Senior Courts Act 1981.
  • The desire to give weight to the parties’ contractual bargain. This was a sophisticated contract and the parties had expressly agreed how disputed and undisputed payments should be treated.
  • The relative equal bargaining power of the parties.

What contractual rates are sufficient?

The rate provided in the JCT 2024 suite of standard forms is 5% over base. The TCC considered this JCT rate in Yuanda and concluded that there was “no reason why 5% over base should not be regarded as a substantial remedy within the meaning of the Act, even though it is 3% less than the statutory rate.” The court acknowledged that a case might be able to be made for 3-4% above base, particularly, if the rate was specifically negotiated between the parties. In that case, the court struck down a contractual rate of interest of 0.5% above base, concluding that this was not a substantial remedy.

In a later case, The Kennel Club Ltd v Micro-ID Ltd, the court upheld a contractual interest rate of 3% above base. In so doing, it relied on the TCC’s comments in Yuanda

In a decision published last month (A&V Building Solution Ltd v J & B Hopkins Ltd), the TCC has now found that a rate of 2% above base in a sub-contract did not constitute a substantial remedy. The court was persuaded by the fact that:

  • the main contractor’s bargaining power was greater, by a very substantial margin, than the sub-contractor’s;
  • the contract rate was part of the main contractor’s standard terms, which were likely issued on a "take it or leave it" basis;
  • the contractual provision worked in only one direction, if the main contractor failed to pay, meaning there was no limit on what interest rate the main contractor could seek to recover; and
  • the base rate for the purpose of the clause was to be fixed at the date of non-payment, meaning that the rate remained fixed even if interest rates rose during the period of non-payment, as they were likely to do when the sub-contract was agreed.

The court reached this decision despite the interest provision expressly stating that:

“[The sub-contractor] acknowledges that such rate is a substantial remedy for late payment (as defined in the Late Payment of Commercial Debts (Interest Act) 1998).”

The court considered this to be mere “competent drafting” on the part of the main contractor’s lawyers, rather than an accurate reflection of both parties' consideration of the pros and cons of the interest rate agreed on.

Conclusions and implications

The Tata and A&V Building cases provide valuable insights into the application of the Late Payment Act and the sufficiency of contractual interest rates. With the Bank of England base rate being at a relative high, the impact of a claim under the Act can be substantial. This is illustrated by Tata where the amount claimed under the Late Payment Act was more than £2 million greater than an alternative claim under section 35A of the Senior Courts Act calculated at 2% over base.

The court’s reasoning in Tata potentially provides a simple way for commercial parties to limit the effect of the Late Payment Act by providing for a penal rate of interest on undisputed claims only. It is worth noting that Tata had argued that such a conclusion would “drive a coach and horses” through the Late Payment Act by permitting any party to avoid the application of statutory interest by simply notifying a dispute. The court was not persuaded by this argument, noting that the dispute would have to be (at least) bona fide and that the courts were readily able to discern between a sum that is genuinely disputed and a debt in respect of which there was no room for reasonable dispute.

The court’s finding that disputed amounts did not give rise to a debt until the dispute had been resolved in accordance with the contract raises a number of broader issues. For example, it may affect the point at which the debt can be set-off or assigned and from when interest under the Senior Courts Act can be claimed. The finding also appears to be at tension with the usual rule for Limitation Act purposes that rights to payment accrue upon completion of the work and are not postponed by contract terms dealing with the mechanics of payment or the provision of payment notices. For a recent Law-Now of ours on that topic, please click here.

The decision in A&V Building suggests that a rate of around 2-3% above base is becoming the tipping point for what constitutes a "substantial remedy" under the Late Payment Act (putting aside any distinction between disputed and undisputed sums). Rates below this threshold are likely to be struck down, especially if they are part of standard terms and are not genuinely negotiated.

The brushing aside of the acknowledgement wording in A&V Building is also of interest, as such provisions are frequently included where interest rates are at the low end of the range. It remains to be seen, however, whether more sophisticated wording might be effective; for example, an explicit acknowledgement that the parties have discussed and properly considered the fairness of the chosen rate.

More generally, the significant guidance provided by these two cases suggests that parties should reconsider their approach to interest provisions in commercial contracts, both to avoid falling foul of the Late Payment Act, but also to consider opportunities to more effectively tailor the position to suit their interests.

References:

Banham Marshalls Services Unlimited v Lincolnshire County Council [2007] EWHC 402 (QB)

Yuanda (UK) Co Ltd v WW Gear Construction Ltd [2010] EWHC 720 (TCC)

The Kennel Club Ltd v Micro-ID Ltd [2019] EWHC 1639

Tata Consultancy Services Ltd v Disclosure and Barring Service [2024] EWHC 2025 (TCC)

A & V Building Solution Ltd v J & B Hopkins Ltd [2024] EWHC 2295 (TCC)