When negotiating the interest which will apply to late payment of debts under a commercial agreement, the payer often seeks the lowest possible rate.
A recent High Court decision[1], however, illustrates that a contract term which provides for an interest rate which does not provide a substantial remedy for late payment could be found to be void. As a consequence, the statutory late payment interest rate (8% above Bank of England base rate) could be applied to the unpaid amount.
Understanding the statutory interest rate
The statutory interest rate for late payments is governed by the Late Payment of Commercial Debts (Interest) Act 1998 (the Act). Under the Act, any qualifying debt created by a contract to which the Act applies carries interest at the statutory rate. The Act generally applies to commercial contracts for the supply of goods or services. Qualifying debts are obligations under the contract to pay the whole or any part of the contract price. They do not include claims for damages for, say, loss of profit.
It is possible to disapply the Act by including a contract term which specifies a different interest rate than the statutory rate. If this amounts to a “substantial remedy” for late payment of the debt, the statutory rates does not apply. However, if the term does not provide a substantial contractual remedy for late payment, the contract term will be void.
What is a substantial remedy?
A remedy for late payment will be regarded as a substantial remedy unless:
- the remedy is insufficient either for the purpose of compensating the supplier for late payment or for deterring late payment; and
- it would not be fair or reasonable to allow the remedy to be relied on to oust or (as the case may be) to vary the right to statutory interest that would otherwise apply in relation to the debt.
In determining whether a remedy is not a substantial remedy, regard shall be had to all the relevant circumstances at the time the terms in question are agreed.
In determining whether it would not be fair or reasonable to allow the remedy to be relied on, regard shall be had to the following matters:
- the benefits of commercial certainty;
- the strength of the bargaining positions of the parties relative to each other;
- whether the term was imposed by one party to the detriment of the other (whether by the use of standard terms or otherwise); and
- whether the supplier received an inducement to agree to the term.
Case ofA & V Building Solution Limited v J & B Hopkins
In summary, the case related to non-payment of sums under a sub-contact (amongst other matters in dispute).
The contract specifically provided for interest at 2% over the Bank of England base rate for late payments due from the contractor to the sub-contractor. The term fixed the Bank of England base rate at the date of default and included an express acknowledgement that the contractual rate was a substantial remedy for late payment (as defined in the Act).
Notwithstanding the express terms of the contract, the Court found that the contractual rate was not a substantial remedy for late payment and applied the statutory rate to late payment of the contract price.
Court rationale
In particular, the Court determined that:
- the contractor’s bargaining power was greater than the sub-contractor by a “very substantial margin”
- the contractual term was part of the contractor’s standard terms – the Court did not determine that they were “imposed” on the sub-contractor but commented that in practical terms the sub-contractor was faced with “take it or leave it” terms
- the acknowledgement in the contractual term that the contractual rate was a “substantial remedy” for the purpose of the Act was described as “competent drafting” on the part of the contractor’s lawyers rather than a reflection of both parties’ consideration of the pros and cons of including a contractual rate of interest
- the contractual provision only worked in one direction. If the subcontractor failed to pay, there was no limit on what interest rate the contractor could seek to recover
- the contractual rate remained fixed even if interest rates during the period of non-payment which, in a period of increasing interest rates, was massively weighted in favour of the contractor and against the sub-contractor. As interest rates had been low when the clause was agreed, it was effectively a “one-way bet” in the contractor’s favour
Key takeaways
- avoid overly-low rates: whilst a contractual rate of 3% above base rate has been upheld in a previous case, rates at or below 2% above base rate run the risk of being voided, especially if not negotiated
- substantial remedy matters: a contractual rate must compensate for late payment and deter delayed payment. Courts will look beyond acknowledgements to assess whether the terms are genuinely fair and reasonable
- one-sided terms can backfire: ensure interest rate clauses are balanced and apply fairly to both parties
By ensuring interest terms are balanced, fair and genuinely negotiated, businesses can reduce the risk of unenforceable clauses and maintain commercial certainty.
[1] A & V Building Solution Limited v J & B Hopkins Limited [2024] EWHC 2295
