Just as the UK gears up to host COP26, the press is reporting the collapse of energy firms with gas prices going through the roof. Some consumers who signed up to low, fixed-term tariffs have seen their providers collapse and their account automatically transferred by Ofgem to other providers, usually on less favourable terms. Businesses are also seeing price hikes, although perhaps any Finance Director who hedged their company’s fuel supply costs will be hoping for a decent Christmas bonus.
Market-wide price shocks happen from time to time, of course. If the 2008 credit crunch taught us anything, it’s that any company might face a sudden and crippling liquidity crisis. And if the recent panic-buying of petrol teaches us anything, it’s that crises can be triggered by anticipation of a structural constraint well before that constraint would otherwise start to bite.
Big businesses will often leverage reports of market challenges either to squeeze suppliers for better payment terms during negotiations or to demand tolerance of late payments long after the contracts have been signed. But in a multi layered financial world where even hedged positions can be hedged, such positioning should betaken with a pinch of salt. Take the most recent survey of the FT350 and how quickly they settle invoices by the Good Business Pays campaign (https://goodbusinesspays.com/ftse/). The headline news, that big corporates are taking an average 90 days to clear their bills, will probably surprise no-one. But what’s interesting is the variability within every sector.
Pick pretty much any area of the economy and you’ll see good and bad payers. Not only that, you’ll see that the worse payer a company is, the more likely it is to breach its agreed payment terms: aerospace (BAE Systems PLC - 27 days/3%, Meggitt PLC- 132 days, 85%); banks (Barclays - 10 days/11%, Sainsbury’s - 56 days/4%); green tech/recycling (Renewables Infrastructure Group - 12 days, 3%, DS Smith - 72days, 23%); travel/hospitality (Intercontinental Hotels – 6 days/0%, TUI – 101days/63%).
So, neither the sector nor a company’s track record is any guarantee that invoices will be paid on-time or at all. This is likely true across the economy and not just for the FTSE350 and there are many financial tools a supplier can use freely to manage liquidity risks, such as invoice financing. But what may be more of a quirk in dealing with FTSE350 companies and their equivalent, is how limited the contract tools tend to be. There are few larger companies that readily agree to significant deposits, letters of credit, or retention of title (where that would even work) or to give guarantees when they contract through subsidiaries. Generally, it is simply a matter of negotiating credit terms and the contract interest rate that (in theory at least) applies to late payments.
In the UK, a supplier has the legal right, under the Late Payment of Commercial Debts(Interest) Act 1998, to claim interest and reasonable debt recovery costs if its customer is late paying an invoice. The applicable interest rate for B2Btransactions is a whopping 8% above the Bank of England base rate. Moreover, the permissible credit term is also regulated and must usually be within 30 days for public authorities or 60 days for B2B transactions.
The catch is that businesses are free to agree a different interest rate and, if it’s “fair” to both businesses, they can agree longer than 60 days credit term. There are few cases of businesses agreeing more than 8% above BoE base rate and it’s almost unheard of for payment terms over 60 days to be ruled unfair. In practice, larger buyers typically insist on contract interest rates of around 2-4%and will justify any credit term longer than 60 days on the basis of the technical or other operational benefits of the contract. Moreover, even where30-60 days credit terms are typical, the customer will often make it clear than any attempt to charge even the contract interest rates will likely see are duction in future orders, meaning the agreed credit terms are of administrative assistance only, as the Good Business Pays survey showed.
The 1998Act has had marginal effect on addressing late payments. One attempt to improve the situation is being led by Lord Mendelsohn who recently introduced a Private Members Bill to the House of Lords. The bill would legislate a 30-day limit for all invoice payments, enforced by the Small Business Commissioner, which would have the power to impose large fines on repeat offenders and ban what are deemed “predatory” payment practices such as prompt payment discounts and charges for onboarding and staying on supplier lists.
It’s clearly the view of Lord Mendelsohn that late payments are themselves a structural constraint within the UK which is so dependent on SMEs and that past legislation has only made things worse. “This Bill,” he said, “will tackle the issue once and for all with a package of measures that is operable, impactful and measurable.”
How likely a Private Members Bill from a Labour peer is to succeed under the current Government remains to be seen. In the meantime, new ideas on how to use contract terms to regulate late payment are coming on-stream, such as in the new toolkit launched on 1 October 2021 by The Chancery Lane Project (TCLP), a pro bono collaboration of lawyers which is developing new standard contract terms to help transition business operations to a greener, more sustainable basis.
In a new formulation proposed by TCLP, failure to make payment on time would trigger an obligation on the customer to make a payment (calculated on the same basis as late payment interest) to a carbon off-set provider or to another named beneficiary, such as a reputable not-for profit supporting environmental improvement in the UK. In a world where larger companies are now publicly committing to a net zero transition, the reputational harm of failing to make such additional “green” payments may prove a better incentive to settling supplier invoices on time in the first place.
The say that climate change is making elephants’ ears grow bigger to help them regulate their body temperature*, it may be that addressing climate change may make businesses clear bills quicker, creating a virtuous circle of improving liquidity just when we need it.
* https://doi.org/10.1016/j.tree.2021.07.006 (7/9/21)