As businesses face continued uncertainty, many are asking: Will our customers still be in a position to pay? And what will happen if they don’t?

Businesses may consider tactics to encourage customers to pay quicker or have consequences for late or non payment. Those solutions are often included within the contract. They may involve having a good retention of title clause, in order to keep ownership of the goods until payment has been made in full. There may be a reduced price to reward prompt payment. Or interest may be chargeable on payments not made by their due date.

A recent case has ruled on what a reasonable rate of interest for late payment would be.

What many people do not realize is that there is legislation which automatically imposes interest on late payments in business-to-business contracts. That legislation is called the Late Payment of Commercial Debts (Interest) Act 1998. The rate set is 8 percent above Bank of England base rate.

In the recent case, the parties entered into a construction contract, which was based on the industry-standard JCT contract but with some terms varied. One variation related to interest on late payments. Instead of interest being applied at 5 percent above base rate as in the standard JCT terms, it was varied to just 0.5 percent above base rate.

The rate in the 1998 Act can only be replaced if it is a ‘substantial remedy’. A ‘substantial remedy’ means something sufficient to compensate the supplier or to deter late payment. It is not a ‘substantial remedy’ if it would not be fair or reasonable. In determining what is fair and reasonable, regard is had to commercial certainty, strength of bargaining positions, whether the term is imposed by one party to the other’s detriment, and whether the supplier receives an inducement to agree to it.

In this particular case, the High Court ruled that 0.5 percent over base rate could not amount to a substantial remedy in the absence of other special circumstances. The clause was therefore void and replaced by the higher statutory rate.

However, just because a replacement rate is significantly less than the statutory rate, does not automatically make it void. The court said that a genuinely negotiated replacement rate should not be set aside lightly. The 5 percent rate in the JCT contract indicated that that rate was right for those construction contracts, even though it was 3 percent less than the statutory rate. It may be possible to have an even lower rate than 5 percent above base rate, but 0.5 percent above base rate clearly went too far here, said the court.

This decision highlights the point that suppliers may be better off without stipulating an interest rate in the contract. If they ask for, say, 3 percent above base rate, they may be short-changing themselves.

Meanwhile, customers should not assume that an agreed lower rate than the statutory rate will apply, because that could get struck out and replaced with the higher statutory rate.

In general, a rate of just under the statutory rate is more likely to be valid than one closer to zero. For the grey areas in between, much would depend on what a particular judge thinks is fair and reasonable on the facts of the particular case, including whether there was a negotiated inducement for the lower rate and the risks being assumed by the parties. For example, a bad payer may attract a higher rate because of the increased risk, but it may be reasonable for a good debtor to demand a lower rate.

One thing is certain: the issue should be considered carefully.