Out-Law Analysis | 06 Nov 2015 | 9:49 am | 9 min. read
As long payment terms increasingly become viewed as unjustifiable and unreasonable – and the issue increasingly moves into the corporate social responsibility space – businesses should take this opportunity to review their existing practices to ensure that they can stand up to legal scrutiny, and to scrutiny from suppliers, trade bodies and the public.
Tesco's revised payment terms and practices
Tesco recently announced new payment terms for its suppliers, including additional concessions for small and medium-sized businesses. The announcement hit the headlines, but was unsurprising given the recent pace of change in this area.
Small suppliers who deliver up to £100,000 of product a year will now be paid within 14 days, while medium sized suppliers, categorised as those supplying up to £10 million in product value, will be paid five days earlier than larger companies in their category.
Suppliers of fruit, vegetables and meat will all be paid in a maximum of 28 days under the new system, while chilled and frozen goods will wait for 35 days. Alcoholic drinks and clothing suppliers will be paid in 60 days, for large suppliers, 55 for medium and 14 for small companies. Clothing and general merchandise from overseas will remain on 90 day terms.
For most categories the new payment terms will see all suppliers paid faster and, as a result, it might be expected that they will in turn pass this on to their own suppliers. The changes may have repercussions across the whole industry and prompt Tesco's competitors and larger suppliers to follow suit.
If other businesses at the top of the supply chain follow Tesco's lead and publicly announce revised payment terms and practices, this will make any disparity in payment terms throughout the supply chain obvious. This could lead to challenges and adverse publicity for those that do not flow these revised payment terms down to their own supplier base, particularly small and medium sized enterprises (SMEs).
Payment practice reporting requirements
From next April, large UK businesses will be required to publicly report on their payment practices. This new policy has been designed to highlight poor treatment of companies in the supply chain, and of SMEs in particular.
This legislation is still being drafted, although the government has made a series of announcements indicating what some of the requirements might be.
Based on these announcements, large businesses will be expected to report on the following every six months:
It is envisaged that requiring large businesses to publish this information in a central location will give suppliers more information about what to expect before entering into contracts – while making it easier for consumers to see which companies have the most 'ethical' payment policies.
Large businesses should ensure that their systems are able to collect and report on the above, bearing in mind that they may be subject to change once the final legislation has been published. They may also wish to review and revise their current payment term and practices in order to reduce any adverse reputational impact of having to publicly report on them.
Late payment laws in the UK
Commercial payment terms in the UK are governed by the Late Payment of Commercial Debts (Interest) Act (the Act) and the EU's Late Payment Directive (the Directive), which was implemented into English law in 2013 through regulations which amended the Act.
The Act does not impose maximum time periods within which invoices raised under commercial contracts must be settled. However, it does introduce specific payment periods by giving suppliers the right to charge interest in the event that a customer fails to pay on time, and also gives them the right to claim reimbursement for reasonable costs that have been incurred in recovering any amounts that are overdue.
The following payment periods apply where a business purchases goods or services:
If the contract is silent on the time for payment, or where the payment term is not valid (for example because it is "grossly unfair"), interest will start to run on outstanding payments from 30 days after the latest of the events listed above. Interest will be charged at the statutory rate, which is currently a fixed rate of 8% over the Bank of England's Base Rate.
The meaning of the term "grossly unfair"
The concept of "gross unfairness" was introduced by the Directive and is new to English law. As yet, the term has not been interpreted by the English courts and there is very little guidance on how a customer might show that its payment terms are not grossly unfair.
However, the Act does provide that all the circumstances of the case should be considered when deciding whether payment terms are grossly unfair. This includes in particular:
The UK government's Department for Business, Innovation and Skills (BIS) consulted on whether to clarify the definition of the term “grossly unfair” in statute earlier this year. However, In October, it ruled out doing so in favour of leaving the term to be defined by the courts.
This appears to be a missed opportunity by BIS to clarify the law for suppliers and their customers alike. Indeed it could take years to develop detailed case law as to what the term “grossly unfair” means – assuming, of course, that businesses are even willing to take their customers to court in respect of their payment terms and practices in the first place.
In the meantime small and large businesses, acting as both customers and suppliers, will continue to face uncertainty as to whether the payment terms and practices that they are using, or are being asked to accept, are grossly unfair or not.
The Prompt Payment Code
The government-backed Prompt Payment Code (the Code) was set up in 2008 as a voluntary industry-led initiative promoting good payment practices. It is administered and overseen by the Chartered Institute of Credit Management (CICM). Code signatories, which include a number of FTSE100 businesses, commit themselves to:
In March 2015, the Code was strengthened to promote 30-day payment terms as standard with an absolute maximum term of 60 days allowed for those that wished to sign up or remain a signatory to the Code. A new Code Compliance Board, made up of business representatives, was appointed at the same time to investigate challenges made against Code signatories and to rigorously enforce the removal of those found to have breached its standards.
Although the Code remains voluntary, these initiatives and the link between the Code and the new payment practice reporting requirements should strengthen its role. A more robust Code will also give businesses a powerful tool with which to distinguish themselves from their competitors once the new reporting requirements come into force. However, businesses that sign up to the Code should ensure that they can comply with the required standards and be aware that suppliers may be more willing to challenge a signatory's payment practices. A publicly announced removal from the Code could have an adverse affect on a business' reputation and defeat the object of signing up to the Code in the first place.
More representation for SMEs
What many of the government's recent initiatives have in common is an increased emphasis on the way in which suppliers that are also SMEs are treated by their larger customers. The government is also encouraging the growth of new avenues through which SMEs can pursue complaints about the payment terms and practices of their customers.
Although it has dropped plans to more closely define the term “grossly unfair” for the time being, the government is consulting on how to implement powers contained in the Directive that allow representative and trade bodies to challenge grossly unfair terms and practices The consultation proposes that representative and trade bodies would be able to “self-nominate” themselves as being willing to challenge "grossly unfair" payment terms and practices in the courts on behalf of their members.
The government has also announced its intention to establish a Small Business Commissioner (the Commissioner), who would be able to help small businesses resolve payment disputes with their larger customers without having to go to court. The new commissioner will also be able to consider whether an act or omission relating to payment was “fair and reasonable” in the particular circumstances of the case.
The intention behind the Commissioner is to act as a strong disincentive to unfavourable payment practices and work with larger businesses to help them improve their practices. The Commissioner will also build the confidence and capabilities of small businesses to assert themselves in contractual disputes and access information and advice so that they become able to negotiate more effectively.
The success of these initiatives is likely to be dependent on SMEs referring late payment issues and disputes to representative bodies or the Commissioner in the first place. As is the case with their existing rights, this is something they may be unwilling to do for fear of jeopardising their business relationships. However, SMEs should be aware of the increased rights and protections they are soon to have as regards the payment terms and practices they are being asked to accept. Conversely, large businesses should be mindful to SMEs or their representatives being more likely to challenge payment terms and practices they deem to be "grossly unfair" or otherwise unacceptable.
It will be interesting to see whether these measures bring about a culture change in respect of payment terms and practices: with customers less willing to impose unfair payment terms and practices on their supply chain; and suppliers more willing to challenge them.
What you should do now
Large businesses should prepare for the above changes to the regulatory frameworks applicable to payment terms and practices, particularly in light of the new reporting requirements due to come into force next year.
Payment terms appear to be moving into to the heart of corporate social responsibility, and there are bodies that will be able to make public announcements – or denouncements – about your company’s payment terms and practices. We may also see increased challenges from customers, in particular SMEs, who deem particular payment terms or practices to be "grossly unfair" or otherwise unacceptable.
With this in mind, as a minimum, you may wish to consider the following actions:
Ben Gardner is a commercial law expert at Pinsent Masons, the law firm behind Out-Law.com.