The Government plans to introduce the EU’s Late Payment Directive this year. Jayne Hussey, partner at international law firm Pincent Masons, explains what the new regulation means for businesses.
The new Late Payments Directive was approved by the European Commission on 15 March 2011. The Directive establishes specific deadlines for the payment of invoices and a right to compensation in the event of late payment of debts. All member states of the EU must amend their current legislation or introduce new legislation to implement the Directive into domestic law by 16 March 2013.
In the United Kingdom, Business Minister Ed Davey has announced that the UK Government wishes to fast-track, ahead of its March 2013 deadline, the implementation to “address some of the concerns expressed by small businesses over payment terms and late payment”.
Although the Government is yet to announce its final timetable for implementation, it is expected to be transposed into UK law during the first half of 2012.
MAIN PROVISIONS OF THE DIRECTIVE
The maximum time periods for payment of an invoice differ slightly depending on whether the creditor is a business or a public authority.
For business-to-business transactions, the purchaser must make payment within 30 days of the date of receipt of a request for payment or, if later, receipt of the goods or services. This may be extended up to 60 days if expressly agreed between the parties and it is not “grossly unfair” to the creditor.
Caution should be exercised when considering payment terms that extend beyond 60 days as such terms could be labelled “grossly unfair” by the courts and effectively banned or give rise to a claim for damages. There is currently little guidance on what will be considered to be “grossly unfair” although this is likely to include any terms inconsistent with good commercial practice or that are contrary to good faith and fair dealing.
For public authority-to-business transactions, the public authority must make payment within 30 days of the date of receipt of a request for payment or, if later, receipt of the goods or services. The payment period may be extended up to 60 days only if the extension can be objectively justified in the light of the transaction. These requirements differ slightly where a public authority is carrying out economic activities of an industrial or commercial nature by offering goods or services on the market or providing healthcare.
Creditors will also be able to charge interest, compensation and claim ‘other reasonable costs’ where customers fail to pay invoices on time.
BENEFITS OF THE DIRECTIVE
It is hoped that the Directive will improve timely payments and so ease the cash flow burden on small and medium sized businesses.
As well as promoting the timely settlement of invoices, it is anticipated that it may also bring about cost savings for both suppliers and customers. Indeed, the European Commission believes that, once introduced by all EU member states, the new rules could mean an extra £150 billion being made available to businesses across Europe.
IMPACT ON ORDERING PROCESSES
It has been calculated that, in 2010, the average payment period for businesses in the European Union was 54 days. In fact, across the EU customers are able to order large quantities of goods and “sit on them” for in excess of 90 days without having to pay for them.
The Directive itself implements much more stringent deadlines for the payment of invoices which can only exceed 60 days in very limited circumstances. As a result, customers may start making smaller, more frequent orders so that they do not have to pay for goods that they will not use in the near future. Adopting a leaner ordering process may help customers, in the face of shorter payment periods, to manage their cash flow more effectively.
On the other hand, suppliers should be aware that smaller orders may be submitted by customers on a more frequent basis in order to seek to counteract the effect of the Directive.
Both suppliers and customers will need to ensure they have sophisticated systems in place that are able to cope with what may become a more fragmented ordering landscape.
IMPROVED CASH FLOW
A more efficient approach to ordering goods will ensure, from a customer perspective, that cash is not tied up in stock which is not being used. From the supplier’s perspective, more timely payments may also assist on the cash flow front.
Customers will need to ensure that their invoice processing and payment systems are able to accommodate shorter payment periods.
SOPHISTICATED PAYMENT SYSTEMS
The Directive entitles creditors to charge interest at 8% over the base reference rate on overdue payments. The current UK legislation aimed at curbing late payments and the right to statutory interest is rarely relied upon in normal trading situations. This is because, amongst other things, from a creditor’s point of view the cost of collecting the interest is disproportionately high.
To remedy this, under the Directive creditors will also be entitled to compensation of €40 for late payment and they may also be able to claim ‘other reasonable costs’ (for example, recovery costs). It is hoped that the availability of such remedies will encourage suppliers to pursue the full amounts that they are entitled to and encourage customers to settle invoices on time so as to avoid any additional charges.
Both suppliers and customers will need to ensure that they have effective systems in place to monitor the payment and non-payment of invoices. Customers should strive to be efficient payers and avoid the unwanted charges that suppliers are entitled to receive under the Directive. Similarly, timely receipt of payment will be crucial to suppliers who, in turn, will be subject to shorter payment deadlines.
WILL IT WORK?
In 2009 a report by the European Commission found that there was just under €2 trillion of late payments in the European economy, of which half was owed to small or medium sized businesses.
There is still uncertainty as to whether small and medium sized suppliers will enforce the provisions of the new directive for the same reasons they accept such long payment terms in the first place – fear of damaging their commercial relationship with the customer.
Until greater emphasis is attributed to initiatives such as the Prompt Payment Code and the need for the payment terms of larger organisations to be more transparent, any new payment regulations will do little to increase the bargaining power of small and medium sized businesses in this area.
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