In two recent cases, the Technology and Construction Court (TCC) has clarified how parties can disapply the statutory right to interest on late payments under the Late Payment of Commercial Debts (Interest) Act 1998 (“1998 Act”).
In the first case, the court held that applying interest to “undisputed” debts – but not to “disputed” debts – was sufficient to oust the 1998 Act. In the second case, the court held that an interest rate of 2% above the Bank of England base rate was insufficient to oust the 1998 Act.
The Late Payment of Commercial Debts (Interest) Act 1998
The 1998 Act is central to both cases discussed below. It provides a statutory right to claim interest on late payments in commercial contracts.
This remedy applies to late payment of “qualifying debts”. These are debts connected to obligations to pay the contract price, including interim payments under construction contracts. The rate of interest under the 1998 Act is currently set at 8% above the Bank of England base rate of 5% (13% total).
Contract provisions that attempt to exclude the statutory right to claim interest under the 1998 Act are void unless the contract includes a “substantial remedy” for late payment. Per s 9(1) of the 1998 Act, a contractual right to interest is considered a substantial remedy unless:
(a) the remedy is insufficient to compensate the supplier or to deter late payment; and
(b) it would not be fair or reasonable to provide the remedy as an alternative or variation to the statutory right to claim interest.
S 9(2) of the 1998 Act ensures that all relevant circumstances must be considered to determine whether the contractual remedy is “substantial”. S 9(3) lists factors that help determine whether the remedy is fair or reasonable, including:
- the benefits of commercial certainty;
- the strength of the parties’ relative bargaining positions; and
- whether the term was imposed by one party to the detriment of the other.
Tata Consultancy Services Limited v Disclosure and Barring Service
This recent case considered whether contractual provisions that applied interest to undisputed debts, but not to disputed debts, could oust the 1998 Act’s default statutory interest. The contract provided a dispute resolution procedure for disputed payments but ensured that the 1998 Act provisions only applied to undisputed payments.
The court held that no obligation to pay a disputed sum could arise until the dispute surrounding it was resolved, so disputed debts would not count as qualifying debts for the purposes of the 1998 Act. The court still helpfully explained that a remedy which seeks to distinguish between sums that are disputed and those that are undisputed is nevertheless a substantial remedy under the 1998 Act.
Importantly, the court considered that the distinction between disputed and undisputed debts mirrored the policy of the 1998 Act and differences in principle discussed in earlier case law. The court cited Banham Marshalls Services Unlimited v Lincolnshire County Council, in which it was observed that “the mischief to which the statute appears to be primarily directed is that of casual or feckless non-payment”. In other words, the statutory interest under the 1998 Act was intended to penalise late payment without good reason. The Act’s provisions were not intended to deter legitimate disputes over liability for debt or the amount to be paid.
In light of this, the court found that the lack of interest on disputed debts was fair and reasonable. This meant that s 9(1)(b) of the 1998 Act was not triggered, so the contractual right to interest remained a substantial remedy. Further factors that supported this conclusion included the parties’ relatively equal bargaining position and their highly specific and detailed contract.
A & V Building Solution Limited v J & B Hopkins Limited
In this case, it was held that a contract clause providing an interest rate on late payments of 2% above base rate did not constitute a substantial remedy that could oust the 1998 Act.
This was despite the clause stating the parties acknowledged “that such rate is a substantial remedy for late payment” under the 1998 Act. The court noted that this was merely "competent drafting" on the part of the main contractor's lawyers rather than a "reflection of both parties' consideration of the pros and cons".
Outlining the “fairness and reasonableness” factors listed in s 9(3) of the 1998 Act, the court considered that:
- there was significant inequality in the bargaining power between the parties;
- the interest rate of 2% above base rate was part of the main contractor's standard terms, so the subcontractor likely had no choice but to accept this if it wished to do business;
- the provision on interest only applied where the main contractor failed to pay, meaning there was no limit on the interest rate to be paid if the subcontractor failed to pay; and
- the rate of interest under the contract was to remain fixed even if interest rates rose during the period of non-payment (as the relevant base rate was “fixed” at the point of non-payment, as opposed to when payment was actually made) – this was "massively weighted" in favour of the main contractor given the current rising interest rates.
So, the contractual remedy was not fair or reasonable and thus not deemed a substantial remedy under the 1998 Act.
Key takeaways
The Tata Consultancy Services case provides the following lessons:
- parties to a contract can oust the 1998 Act by providing that no interest is to be paid on disputed debts;
- the 1998 Act was intended to penalise parties who have no good reason for late payment, but not to deter legitimate payment disputes; and
- factors like an equal bargaining position and sophisticated contract can point to alternative interest provisions being fair and reasonable.
Lessons from the A & V Building decision include:
- a low interest rate on late payments (such as 2% above base rate or lower) is unlikely to provide a substantial remedy, particularly if it only applies to one of the parties;
- express acknowledgement within a contract that its interest provisions are a substantial remedy is not enough to reflect true negotiation on this point; and
- inequality of bargaining power between parties and the presence of interest provisions in standard terms point towards those provisions not being fairly negotiated.
This article was co-written by Trainee Valentin Pyataev.