17th January 2018
In recent years, a growing number of SMEs have suffered as a result of a late payment culture among larger businesses. The Small Business Commissioner has been appointed with a view to driving a new culture change in payment practices to ensure small businesses are treated fairly.
Some commercial contracts contain payment terms which mean that it is almost impossible for sub-contractors to take action if they are not paid until it is too late. The exception is a “construction contract” as defined under the Housing Grants, Construction and Regeneration Act 1996 (which is likely to include a significant part of Carillion’s sub-contracting in its construction business). This article does not cover such construction contracts, where payment provisions may be imported by statute if not expressly compliant , or where “pay when paid” clauses cannot operate, except in the very specific circumstance of insolvency .
At their simplest, payment provisions state that debts will be settled within a certain number of days. There may be negotiations over that payment period, although very often the payer will take the attitude that its payment terms are not up for negotiation. This, however, can sometimes be just the tip of the iceberg.
In theory, failure to pay on time gives the sub-contractor a variety of rights – commonly a right to interest on the overdue sum and, potentially, a right to end the contract. In practice, however, it is rarely that simple.
It is now fairly common to see in commercial contracts terms which require the sub-contractor to take various steps before they can, ultimately, end the contract for non-payment. Typically, the sub-contractor has to give written notice that the payment is late and then wait a further period of time before taking any further steps.
For example, if the original payment period is 60 days and the sub-contractor is required to wait a further 60 days after giving notice that payment has not been made, the payment period becomes 120 days. The difficulty for the sub-contractor is compounded if the main contractor requires, say, six months’ worth of payments to be outstanding before the sub-contractor can end the contract. Meanwhile the sub-contractor has to continue delivering the services or supplying the goods.
In commercial contracts this can mean that the sub-contractor is on the back foot from the start and can basically be held to ransom. If the main contractor is not willing to negotiate its contract terms, the sub-contractor is faced with a stark choice: don’t take the job, or accept the work in the knowledge that it could potentially cause them major cash flow problems in the future: the very issue for which Carillion are being criticised.
Regrettably there is no easy answer. There will doubtless be calls for new and revised legislation and codes of practice around payment, but those will take time.
Every organisation entering into a contract to supply goods or services would be wise to check both the payment provisions of the contract and the rights (if any) the contract gives them if payment is not made on time. Those rights may, in practice, be very limited. .
Forewarned is forearmed. And it does at least mean that the commercial risk can be assessed before signing on the dotted line.