A burden or a benefit?

Believe it or not, when it comes to late payments, small contractors (those with 50 employees or less) are protected by the law. Large firms cannot charge interest on debts incurred by small firms. Small firms can charge interest on debts incurred by other small firms, but the law protects them from the big boys.

However, that all changes on 1 November when a revised law comes into play, theoretically generating a level playing field where everybody can screw everybody else regardless of their size.

The Late Payments of Commercial Debts Act 1998 was introduced to protect against unscrupulous late-paying companies and allows the supplier of goods or services to claim interest (at base rate plus a further 8% per annum) on overdue debts.

The first phase of the Act allowed businesses employing less than 50 staff to claim interest from large businesses and public sector organisations on debts incurred on contracts agreed after 1 November 1998.

The second phase, which ran from October last year, allowed small businesses to claim interest from other small businesses as well as large companies and public sector organisations.

The third phase starts on 1 November and allows all businesses to claim interest on overdue debts incurred on contracts agreed after that date from any other company or public sector body.

Michael Key, commercial litigation expert at Manchester law firm Glaisyers, said: "It is likely that there will be a significant increase in parties looking to claim interest on overdue debts following the third phase of this Act.

"Small businesses have been protected so far under this law, so the fact that any company can make a claim means that everyone needs to take notice.

"Given the impending deadline, it would be sensible for credit control departments to be aware of their ability to claim statutory interest on overdue debts," Key said. He said that this legal right can be enforced even on a fixed-price contract and applies to verbal agreements and deals done without an agreed formal contract. If a due date for payment is not agreed, interest can be charged from 30 days after the service was completed, or the date of the invoice, whichever is later.

Any standard form contracts that do not provide sufficient compensation to the creditor for late payment will be overruled by the Act. "In simple terms, the right to recover interest exists, whether or not the parties enforce it is a matter for them," Key said.

It is possible to draw up a contract that opts out of the Act's provision, but only if a "substantial remedy" (an alternative) for late payment is offered in its place. Given that any such remedy would necessarily have to be of a similar level to the Act's provision, Key thinks it unlikely that many clients will try to take the opt-out route. "In practical terms this [alternative] may be difficult to demonstrate."

Key concluded: "The provision could be a tactical weapon in a contractor's armoury." However, he admitted: "There's always the possibility that someone can get the rough end of the deal."

Peter Brooker, a director at business and financial information firm Experian, agreed with Key's final assessment. "The law will have unforeseen consequences and will have a disproportionate effect on smaller businesses. I don't think a lot of large companies will have an objection to charging interest on smaller companies."

While small contractors are loathe, given commercial reality, to charge interest on sums owed to them by larger contractors or clients on whom they depend for future work, they may find themselves being squeezed by their own supply chain.

As the building supplies market continues to consolidate and small contractors take an interest in slimming down their supply chains, those contractors will find themselves dealing with fewer suppliers.

The nightmare scenario is a supplier deciding to enforce its right to charge interest on an overdue payment from a small contractor. Ultimately that contractor will have to pay, but will be unable to pass the surcharge up its supply chain, and its tiny margin will be cut even further.

On the positive side, the law is intended to act as a deterrent to unnecessary and overlong legal proceedings as every day that passes means another day's interest. It may even lead to fewer proceedings getting underway.

Even so, Key's statement that he expects more parties to claim interest would suggest yet more legal proceedings. In an already notoriously litigious industry, do firms need yet another reason to call in the lawyers?

While broadly welcoming the legislation, Tony Maynard, chief executive of the National Federation of Builders, noted: "The clear necessity of this legislation highlights just how much further the industry has to go before the principles set out in Rethinking Construction - which are founded on trust, respect and a true co-operation between client and contractor - are being successfully and widely implemented on construction projects.

"The number of firms that choose to invoke this legislation will be a barometer of how adversarial this industry is."