“Is there enough interest?” Substantial remedies and contracting out of statutory interest rates under the Late Payment of Commercial Debts (Interest) Act

Introduction

Two 2024 Technology and Construction Court (“TCC”) decisions have brought ‘substantial remedies’ under the Late Payment of Commercial Debts (Interest) Act 1998 (the “Late Payment Act”) back into the spotlight for the construction industry.

In the first case, the question as to what extent parties can contract-out of the statutory interest rate under the Late Payment Act was considered in order to determine whether provisions of an alternative remedy in a contract were sufficient where the contract did not stipulate a specific interest rate for disputed debts.

The second case concerned whether an agreed contractual interest rate of 2% above the Bank of England’s base rate for late payment could be considered a ‘substantial remedy’, given the circumstances at the time the contract was drafted.

The court accepted that the position in the first case was sufficient, while finding that 2% interest above the base rate in the second case did not constitute a substantial remedy.

Late Payment of Commercial Debts (Interest) Act 1998

The Late Payment Act currently allows for a statutory rate of interest of 8% above the Bank of England’s base rate to be implied in a contract for the supply of goods and services where the ‘purchaser and the supplier are each acting in the course of business’. The applicable rate is set by the Secretary of State.

It is not possible to exclude the right to statutory interest in relation to disputed and undisputed debt under the Late Payment Act unless parties expressly agree to vary the rate under section 8(3) which provides a mechanism by which contracting parties can ‘vary the right to statutory interest in relation to the debt’ so long as the ‘statutory interest as varied or the overall remedy for late payment of the debt ‘is a substantial remedy’. In practice, we frequently see employer clients seeking to negotiate a lower percentage rate than 8% above the base rate from a commercial and risk management perspective.

The Late Payment Act provides some guidance as to the nature of substantial remedies, albeit the terms are arguably somewhat vague. Under section 9(1) of the Late Payment Act a contractual interest rate will be regarded as a substantial remedy unless it is insufficient for the purpose of compensating the supplier for late payment or for deterring late payment, and it must be fair and reasonable to allow the remedy to be relied upon to oust or vary the right to statutory interest that would otherwise apply.

In establishing the parameters of what would be considered ‘reasonable’ by the courts in such circumstances, the following four areas[1] will be taken into account, these are briefly:

(1) the benefits of commercial certainty;

(2) the strength of the relative bargaining power of the parties;

(3) whether the term was imposed by one party (i.e. under standard contract terms or otherwise) to the detriment of the other; and

(4) whether the supplier received an inducement to agree to the term.

How low can you go?

The question of what constitutes a substantial remedy has entertained many a court room, and perhaps unsurprisingly, given the varying contractual realities and circumstances which are part and parcel of the commercial world, the courts have hitherto interpreted the boundaries of ‘substantial remedy’ quite widely. Where possible however, the courts will typically seek to give effect to the contractual and commercial terms agreed by parties, particularly where two businesses have entered into the contract.

In Longulf Trading (UK) Ltd v. Niyazi Onen Gida Sanayi AS [2019], the court considered and held that 15% per annum, a figure considerably higher than the statutory rate of 8%, was enforceable. Similarly, in Biosol Renewables UK Ltd v. Lovering [2021], an interest rate of 1.5% per month was considered and held to be a ‘substantial remedy’.  Although the judgment did not specify the annual equivalent of the monthly rate, this would have been significantly higher than 8% above base rate. Further, the court concluded that the rate of 1.5% per month was “clearly not disproportionate to, or extravagant or unconscionable”.

Authority on the question of what exactly constitutes a substantial remedy to date has been the decision in Yuanda v. WW Gear Construction Ltd [2010], where the courts emphasised the importance of the four areas to be considered when establishing reasonableness outlined in the previous section. In their decision the courts held that, absent special considerations, the rate of 0.5% was clearly not a ‘substantial remedy’ and would be unenforceable.  This figure sits on the other end of the spectrum of applicable percentages that have been agreed by parties in respect of late payment.

Yuanda is of further interest in that the judgment considered whether a remedy which is found not to be substantial should then be replaced with the statutory interest rate of 8% (on balance, arguably a much better position for the contractor or consultant, but a risk strategy to try to rely upon at a later date in practice). This deliberation is especially pertinent in circumstances where the contracting parties had originally deviated from the often-used JCT standard Interest Rate of 5% per annum above the official rate of the Bank of England current at the date that a payment due under the contract becomes overdue.

In answer, Mr Justice Edwards-Stuart stated that, “I can see no reason why 5% over base should not be regarded as a substantial remedy within the meaning of the Act, even though it is 3% less than the statutory rate.” Indeed, the judgment goes on to say “[i]t may even be that a case could be made for saying that 3-4% would provide a substantial remedy for late payment, particularly if the rate had been specifically discussed and agreed between the parties…”. The reasoning in this decision has been applied in subsequent case law, however, it could also potentially be used by parties when assessing what an appropriate figure would be considering the nature and duration of the applicable contract and associated risk profile.

Recent TCC decisions:

More recently, in Tata Consultancy Services Ltd v. Disclosure and Barring Service [2024], the court considered Section 9(1) of the Late Payment  Act where a contract, while expressly requiring payment for undisputed invoices with interest, failed to stipulate an interest rate for the late payment of disputed amounts. The court held that until disputed amounts between the parties had been resolved under the applicable dispute resolution process in the contract, there was no qualifying debt to trigger the Late Payment Act.

Mr Justice Constable’s judgment considered the relative bargaining powers of the parties to be important and found them to be equal, with no suggestion of any inducement having been received. The court further considered the parties’ contractual bargain in determining that the absence of a right to interest on disputed debts was, given the circumstances, fair and reasonable in that the Late Payment Act was not intended to deter genuine disputes in relation to debts. Importantly, the relevant clause, as varied, still provided the requisite ‘moral and public policy’ objective, that is: a “deterrent by way of the application of penal interest to those who choose not to pay their outstanding debts”. The Court of Appeal is scheduled to hear an appeal regarding this decision in March 2025.

A further recent decision in A&V Building Solution Ltd v. J & B Hopkins Ltd [2024] found, however, that a rate of 2% above the base rate did not constitute a substantial remedy despite the sub-contract agreed stating otherwise. It is important to note that in that case the TCC found a disparity in bargaining power between the respective parties by a “very substantial margin”. Mr Roger Ter Haar KC at paragraph 73, sitting as a Deputy High Court Judge, outlined various factors which informed his judgment:

• The standard terms of the contract had, in practical terms, been given or presented in a “take it or leave it” scenario.
• The overall bargaining power of the main contractor was significantly greater than that of the sub-contractor.
• “[t]he contractual provision worked only in one direction…” where the clause applied if the sub-contractor failed to pay, the main contractor had no limit on what interest rate it could seek to recover.
• The base rate in relation to the clause was fixed as at the date of default (at 2%), which Mr Ter Haar determined weighed heavily in favour of the non-paying party, especially in a period of rising interest rates, and was effectively a “one-way bet” in favour of the main contractor.

Notably, the TCC reached this conclusion notwithstanding the statement in the interest provision that the sub-contractor acknowledged this to be a substantial remedy under the Late Payment Act.

Commentary

The 2024 decisions in Tata Consultancy and A&V Building Solutions has undoubtedly garnered interest in the field of commercial and construction contract negotiations. Both decisions come after a turbulent few years of fluctuating and particularly high Bank of England interest rates brought on, in part, by the aftermath of COVID, and parties will be more wary when discussing ‘substantial remedies’ if departing from the statutory rate of interest. The interest rate provision may act as some form of leverage when seeking outstanding sums, especially when the construction market faces challenges.

Unsurprisingly to those in the construction world, the new standard JCT Design and Build Contract (2024 edition) released in April 2024 has maintained its standard “Interest Rate” of 5% per annum above the official rate of the Bank of England current at the date that a payment becomes overdue. While the judgment in Tata Consultancy has potentially been viewed by some as permitting “any party to avoid the application of statutory interest by disputing an invoice and drive a coach and horses” through the Late Payment Act, the four pillars of what will be considered ‘reasonable’ by the courts have been found repeatedly to inform and define the judgment in these cases.

The guidance from these cases indicates a willingness by the courts to uphold contractual terms when they meet the reasonableness requirements outlined above. This may be the case especially where contracts uphold the underlying purpose of the statutory rate of interest when choosing to oust or vary the Late Payment Act, namely to ensure sufficient compensation or a realistic deterrent against late payments.

These rulings also underscore the necessity of negotiating and drafting contract terms related to the interest for late payment and consideration of the Late Payment Act, emphasising that merely labelling a remedy as ‘substantial’ does not inherently make it so. It is therefore recommended that parties no longer refer to such clauses as ‘boilerplate’ or purely commercial decisions and take steps to actively check and confirm that the contract drafting reflects their discussions and agreed intentions. If, for example, interest provisions for late payment are offered on a ‘take it or leave it’ basis or do not provide a rate of interest, this could be recorded in correspondence.

The decisions also highlight the importance of considering the contractual and commercial terms as a whole prior to entering into contracts. This may include other protections such as tying the applicable interest rate to an underlying agreed base rate (be that the Bank of England or otherwise, i.e. to provide some protection in the event of fluctuating rates), indexation, and variations, particularly under longer-term contracts.

Should you have any questions on the findings of the recent case law authorities or how they may impact the negotiation or implementation of your construction contracts, please contact Nathan Modell or your usual Beale & Co lawyer.

[1] Section 9(3) of the Late Payment of Commercial Debts (Interest) Act 1998.