Why construction firms should review their payment terms following the rise in interest rates

Following the rise in interest rates how should construction firms protect themselves? Head of Commercial Disputes Abi Lutey at Coodes Solicitors gives her verdict.

The Bank of England has raised interest rates for the first time in more than ten years. The first increase since July 2007 has seen the official bank rate being lifted from 0.25% to 0.5%. According to Bank of England governor Mark Carney, interest rates are likely to rise twice more over the next three years.

Because of the rising cost of materials and labour, the new interest rates could have a major impact on construction firms. Put simply, the increase in interest rates will mean an increase in the cost of construction projects. This could create cash flow problems, so it is more important than ever for contractors at every level to protect themselves as much as possible by reviewing their payment terms.

Cash flow is King in construction

There is a well-known saying in the construction industry that “cash is king”. Unfortunately, late payment is still an issue in the sector and many building companies go into administration because of cash flow problems.

‘Pay when paid’ clauses, which used to allow a contractor to pay a subcontractor after receiving their own payment from a client, were outlawed in 1996. However, this practice still exists, causing cash flow problems for building firms. You should seek legal advice if you are subject to such behaviour.

Reviewing your payment terms

Construction contracts usually have a ‘due date’, setting out when the payment is due, and a ‘final date for payment’ which, as the name implies, is the date by which payment has to be made. If, payment is not made by the final date for payment it is overdue. In light of rising interest rates, do you need to reconsider how long you leave between the due date and final date for payment? Would a shorter gap ease some of the burden on your business? You could also consider bringing forward your due date.

It is also worth checking that your payment terms reflect how you invoice. For example, do you invoice weekly while your terms say you invoice monthly? Having consistency across your terms and what you actually do in practice will leave you less vulnerable to late payments and cash flow problems.

Can you charge interest on late payments?

Under the Late Payments and Commercial Debt Regulations 2013, a business is entitled to charge interest at 8% plus base rate on any late payments. In addition, there is a fixed “damages” sum dependent upon the value of the debt. You are able to set a lower level of interest in your terms and conditions. Many firms avoid charging interest because it can damage client relationships. However, you have up to six years from the date of the breach to be able to claim the interest. But beware, if you delay in bringing the claim the court might not award you the full amount for the full period. Legal advice should be sought, whether the claim is immediate or delayed, as it can be difficult to enforce without going through a lawyer.

Fluctuations

A building contract can contain a mechanism under which the contract sum increases due to fluctuation events. These events can be increased cost in labour, materials, transportation, currency, taxation and so on. Fixed lump sum contracts generally, by their nature do not permit the contract sum to change due to fluctuations.

A contractor usually accepts a fluctuations risk where the contract period is a matter of months rather than years, although in practice this also depends on prevailing market conditions. It is certainly worth checking if your contract permits price fluctuations and to include such provisions in future contracts.

What if my business does not get paid for work we have done?

If you believe you have not been paid by a client, the first thing to do is to check the terms of your contract to make sure payment is definitely due and owing. If the debt is due and owing, you should consider serving a Default Notice. This is a formal notice demanding payment. The notice usually allows seven to 14 days to correct the breach, depending on the terms of the contract. The Default Notice informs the other party of the breach and gives them an opportunity to correct the breach. This can often lead to repayment quicker than legal proceedings and preserves the contract for the benefit of the parties. Any future breach on similar terms may allow you to terminate the contract.

Most Default Notices need to contain certain information and/or be served in a particular way. You should obtain legal advice before serving one as the effects on the parties can be serious, especially if one is served incorrectly.

Serious or persistent breaches of the contract may allow termination. This is a very serious step to take and you should always obtain legal advice before doing so as otherwise you may be sued for wrongful termination; even if you are owed money by the debtor.

Most building contracts specify that alternative dispute resolution (ADR) will be used to deal with any disputes, including debts. ADR includes mediation and other ways of resolving disputes without going through an expensive court case. A lawyer will be able to guide you through this process and explain the advantages and risks.

Rising interest rates will have consequences for any business. This is a timely opportunity to check your payment clauses in your terms of business and ensure your invoices state interest is payable on late payments. And, if you don’t have any terms of business, now is a good time to rectify that.

For more information or advice contact the Corporate and Commercial Team at Coodes Solicitors. For advice on settling a Dispute, please contact Abi Lutey in the Commercial Disputes Team on 01872 246200 or abi.lutey@coodes.co.uk