Most businesses know the frustration of waiting to be paid. For some, it's an inconvenience. For others, it can have a serious impact on cash flow, investment plans and growth.
The problem is far from new. For decades, small and medium-sized businesses have carried the cost of waiting - sometimes for months - for invoices to be settled by larger customers. In the construction sector, the long-standing practice of withholding retention payments has added another layer of financial pressure.
Now, the UK Government says it intends to tackle the issue through what it describes as the most ambitious package of late payment reforms in more than 25 years, following the publication of its consultation outcome paper, Late payment consultation: time to pay up.
Whether you operate in construction, professional services, manufacturing or retail, these proposals are well worth paying attention to.
The reforms will be particularly significant for North-east businesses operating in construction, energy supply chains and professional services, where long payment cycles can create significant working capital pressures.
A win for small businesses: tougher enforcement
One of the most significant proposals is an expansion of the powers of the Small Business Commissioner.
At present, the Commissioner's role is largely limited to providing guidance and applying reputational pressure. Under the proposed reforms, however, the Commissioner would gain the power to investigate persistent late payers, impose financial penalties linked to unpaid statutory interest, and adjudicate disputes between businesses.
That would represent a significant change in approach. It's one thing to name and shame poor payment practices; it's quite another to introduce meaningful financial consequences for businesses that repeatedly pay suppliers late.
For smaller businesses that have found themselves at the mercy of larger customers' payment practices, the prospect of an enforcement body with real powers could be a welcome development.
A hard limit on payment terms
In its response to the Late payment consultation: time to pay up, published on GOV.UK, the UK Government has proposed a legal cap of 60 days on payment terms where large firms are paying smaller ones, with a further reduction to 45 days anticipated in future legislation. Currently, businesses can agree longer terms provided they are not considered "grossly unfair" - a test that has proven difficult to apply in practice. That flexibility will go.
For large businesses, this is now a compliance issue as much as a commercial one. Boards and audit committees will be required to publish and report on payment practices, meaning that slow payment becomes a matter of public record at the highest level of a company's governance.
For smaller businesses, a guaranteed 60-day maximum - properly enforced - would represent a material improvement on current practice in many supply chains.
One key detail still to be clarified is exactly how the legislation will define a 'large' business and a 'smaller' supplier.
In construction, there could be unintended consequences. Main contractors may be required to pay subcontractors within 60 days while still waiting longer to be paid themselves. That could create cash flow pressures and force businesses to rethink how contracts are structured
Statutory interest: no more opting out
Alongside the payment term cap, the Government has confirmed it intends to close a significant gap in the existing rules on late payment interest.
At present, businesses are entitled to statutory interest on overdue invoices, currently set at 8 per cent above the Bank of England base rate. However, that right can be displaced if the contract itself contains a "substantial remedy" for late payment.
Under the new proposals, statutory interest would apply regardless of what the contract says. If payment is late, interest runs - full stop.
Alongside this, the government also plans stronger board and audit committee accountability, with additional reporting obligations for large businesses on payment practices and performance. That moves the issue further into the compliance space, rather than leaving it as a matter of private contract negotiation.
A bigger shift for construction: the end of retention
For those working in construction - as developers, contractors or sub-contractors - the most far-reaching change is the proposed ban on retention.
Retention is the practice of holding back a percentage of contract payments (typically 3 to 5 per cent) as security against defects. It has been used in the construction industry for well over a century, and reformers have been pushing for change for years. Now, the Government has confirmed its intention to legislate to ban it, subject to further consultation on the practical detail.
Removing retention will require those at the top of the supply chain to find alternative ways of managing the risk that contractors fail to return and remedy defects. The most common alternatives - performance bonds and parent company guarantees - are well established but come with their own challenges.
Bonds can be expensive and are not always accessible to smaller businesses. Not every company has a parent, and not every parent has the financial strength to stand behind a guarantee.
The Government has committed to working with the financial services sector to help develop the surety market, but affordability is likely to remain a real issue in the short term. The question of where that risk ultimately lands - and who pays for it - will be one of the defining practical questions of the next stage of reform.
What should your business be doing now?
Legislation has not yet been introduced. The aforementioned UK Government paper states that legislation will be brought forward as soon as parliamentary time allows, with further consultation expected beforehand. But the direction of travel is clear, and the time to prepare is before the law changes, not after.
Some practical starting points:
- Review your standard payment terms - If your contracts currently include terms that displace statutory interest or allow payment periods beyond 60 days, those provisions will need revisiting.
- Check your reporting obligations - Large businesses should be reviewing their payment reporting processes now, ahead of increased board-level accountability requirements.
- If you are in construction, start thinking about security - Whether you are an employer seeking to replace retention or a contractor being asked to provide a bond, understanding how these instruments work (and what you are agreeing to) is increasingly important.
- Engage your supply chain early - Changes of this scale will affect the whole chain, not just the parties at either end. Early conversations about how risk and payment terms will be restructured are likely to be less costly than disputes later.
The Government's ambition is clear. The detail is still to come, but for businesses of all sizes - and particularly for those in the construction sector - these reforms represent a genuine opportunity to reset payment culture on fairer terms.
Prepare your business for the late payment reforms
The proposed reforms could affect your payment terms, contracts, reporting duties and approach to managing risk across your supply chain. Taking advice before the legislation comes into force can help your business identify any changes needed and avoid costly disputes later.
Jennifer Young is an Aberdeen-based Partner in the construction team at Thorntons Law LLP. She advises businesses on construction contracts, payment disputes, retention and alternative forms of security. To discuss how the proposed reforms could affect your business, contact Jennifer at jyoung@thorntons-law.co.uk