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This blog from our business debt recovery solicitors aims to provide information on when interest can be charged on unpaid debts.
The Late Payment of Commercial Debts (Interest) Act 1998
This legislation adds an implied term in business-to-business contracts for the supply of goods and services, giving at least 8% a year interest on the price, plus a fixed sum and reasonable costs of recovering the debt.
No interest can arise under this legislation unless there is a contract between the parties. The contract need not be in writing but could be a contract made by speech or conduct.
Each party must be acting in the course of a business in making the contract for it to fall within the Act.
The Act applies where goods and/or services are supplied. Both “goods” and “sale of goods” are widely defined in the Sale of Goods Act 1979. Unfortunately, there is no comparable statutory definition of services. Notwithstanding this, the Late Payment Act applies to most kinds of supply of services and goods.
Contract exclusion
Some contracts are expressly excluded from the Act, such as employment contracts and security contracts (including mortgages and other charges). In addition, if no money exchanges hands for the goods or services provided, the contract also falls outside the scope of the Act.
The term implied by the Act is for simple interest to be paid at a fixed rate. The rate is set twice a year by adding 8% to the Bank of England’s official base rate.
The start date for interest to be paid depends on the relevant payment date. The end date for interest to be paid is usually when the principal debt is paid.
In addition to interest, the Act allows the creditor to be paid a fixed sum. The amount is fixed according to the size of the overdue debt:
- For debts below £1,000: a fixed sum of £40;
- For debts of at least £1,000 but less than £10,000: a fixed sum of £70; and
- For debts of more than £10,000: a fixed sum of £100.
Also, for contracts made on or after 16 March 2013, if a fixed sum is payable, the creditor is also entitled to be paid the reasonable costs of recovering the debt, less the fixed sum.
Reasonable costs might include debt collection agency fees and solicitor’s fees but not administrative or internal costs, which are covered by the fixed sum.
Express interest clauses
As an alternative to relying on the Late Payment Act, an express interest clause can be included in the contract for the supply of goods and/or services.
An express interest clause provides a contractual sanction for non-payment of a sum of money. Often, in the absence of an interest clause, there is no right to interest on a late payment. In other cases, especially in the supply of goods and services, the statutory right under the Late Payment Act may give 8% a year or more on a late payment, which may seem too high. An express interest clause may improve on or restrict the creditor’s rights under the general law.
In general, no term is implied for payment of interest, even on a loan. With few exceptions (such as the Late Payment Act referred to above), the common law provides no remedy for late payment of money.
When drafting an express interest clause, it is important to get the drafting right. For example, it must be obvious who must pay and who will receive the interest. The applicable interest rate must also be set carefully. If the interest rate is set too high, the Courts may view it as a penalty and not award interest in the sum provided for in the contract.
In general commercial transactions, it is common to specify an interest rate of 3% or 4% above a major bank’s base rate or the Bank of England’s base rate. Finally, it is important to think about whether simple or compound interest will apply.
The Court’s discretion on awarding interest
The Court has a wide discretion to award simple interest at such rate as it thinks fit on all or any part of the debt or damages in respect of which judgment is given. Although discretionary, interest awards are usually made as a matter of course to the successful party.
The Court can only award simple interest and not compound interest unless the relevant contract provides for compound interest to be paid.
When deciding what interest to award, the Court can still consider whether any payments were made by the debtor before judgment was given.
The basic principle is that interest will be awarded from the date the cause of action accrued, i.e. the date payment of the debt became due. However, the Court can depart from this basic principle if, for example:
- It would be unjust to make the debtor pay interest from the date payment of the debt became due; and/or
- The claimant’s conduct was unreasonable, for example, by unreasonably delaying the pursuit of the claim.
In terms of the interest rate the Court will apply, the basis of the interest award is to compensate the creditor, not punish the debtor. It has been held by the Courts that the proper question in commercial cases is to ask at what rate the creditor could have borrowed the sum rather than what return the creditor could have expected if it had invested the monies.
The Court will also often take into account the base rate of a major bank or the Bank of England when deciding what interest rate to apply.