The payment for services provided is a fundamental tenet of any contractual agreement, so the first question we’d ask, is ‘why?’. Why would a client organisation be looking to delay payment under a contract?
If you are considering withholding payment under a contract, in part or in full, it is most likely to be due to one of the following three potential reasons:
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- Cashflow problems
It happens, unforeseen circumstances necessitate a shift in priorities, coffers run uncomfortably low, and temporarily the funds are not available to make all the payments as and when they are supposed to be made.
If this is your reasoning for a delay in payment under a contract then often the best course of action is to sit down with your supplier and have an honest and frank conversation. Remember, your goal should be to move beyond this point with your commercial trust and their level of commitment intact.
It is also worth considering the domino effect of non-payment. Many small suppliers (and some larger ones), especially in today’s economy, are operating on increasingly challenging financial ground. Your payment delay may be the straw that breaks the camel’s back and, should this cause your supplier to go under, the costs and disruption that results, until you are able to find an adequate substitute, could well make the cashflow challenges you were looking to mitigate seem relatively insignificant. Adequate consideration and thorough due diligence will go some way to preventing this eventuality.
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- Dispute or contractual breach
If your supplier is failing to meet agreed milestones, is delivering to a sub-standard or is not performing at all, it would doubtless feel appropriate to withhold some or all of your payments to them. But this can be a bit of a blunt instrument to implement in the first instance of poor performance.
Your first course of action, however, should be to check your contract to see what rights you have and, just as importantly, what rights your supplier has under these circumstances. If you withhold payment, your supplier may have the right to withhold its services to you, ramping up the stakes. Know your contract to know your next move.
If you have tried to operate a collaborative escalation process in line with your contract but your supplier’s performance remains significantly off-beam, then this may provide all the evidence you need to support withholding payment. If you then decide to move forward with this, you would need to issue a contractually compliant withholding-notice; this needs to explain why you have taken this course of action and the amount of money you are delaying the payment of.
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- On-going (persistent) contractual performance issues
Rather than being reactionary, delaying payment under contract can also be used at a more strategic level to guide a persistently difficult supplier to performing to the levels, quality and schedule they agreed to.
Where you have a supplier with ‘form’ for poor performance and/or delivery and nothing else seems to have worked to guide them back on track and realign their behaviours and actions to your expectations of them, withholding payment may be an option of last resort.
An example of where this may be necessary is for sub-standard performance on a PFI contract. Withholding some of the monthly unitary charge, proportionate to the severity of the failure to deliver, may provide the push needed to unclog a supplier’s workload logjam. However, it is worth remembering that this will not always go unchallenged.
Contractual limitations of delayed payment under contract
The reason we stress that your best first step is to review your contract is that what it says in these circumstances can be pivotal. Suppliers will often look to include clauses that limit a client’s ability to hold back payments, even in circumstances where they (the suppliers) are failing to hit milestones or performance targets. This can leave you with the infinitely less effective (at motivating your supplier back into action) option of taking them to court after the fact.
Should your supplier insist on a clause within the agreement that limits your right to withhold payment, to protect yourself from having to continue to pay for a service you are clearly not receiving (to contractually agreed standards), it would be appropriate to insist that in the event of ‘continued’ (or persistent) poor performance, you could hold back appropriate proportions of payments until particular targets have been achieved. For more on this take a look at our article 13 Outsourcing contract clauses to avoid. (NB. This article relates to outsourcing, but the principles apply to any major/complex project.)
Ramifications of a delayed payment under contract
A delayed payment under contract may cause challenges for your supplier, therefore you should note that, in some circumstances, it may even entitle them to terminate the agreement they have with you.
This means it is a mechanism which should not be used lightly. There are numerous ramifications of delayed payment, some directly impacting parties, others take a slightly more ‘round the houses’ route to impacting the project.
Some examples are:
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- Interest charges
The Late Payment of Commercial Debts (Interest) Act 1998 provides your supplier with the right, even if this is not specifically included within your written contract with them, to charge you interest on the amount you did not pay.
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- Supply chain trickle down
We’ve already touched on the subject of the damage that payment delays can have on your supplier, but what about all of the others in their supply chain? Your supplier may now not be able to (or simply refuse to) pay their subcontractors and their suppliers on time. Some may be small SMEs and could potentially fail as a result. Some may simply decide not to deal with your prime supplier anymore or put up their prices due to the increased perceived risk of doing so. This too can, therefore, come back around to impact you in the future.
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- Commercial trust
It’s hard won and easily lost but an incredibly valuable perception to manage. The greater the commercial trust between you and your supplier, and its supply chain the more likely they are to warn you of issues that could impact your project/relationship, to be open with you, committed to innovate and understand the true risks and rewards of working with you (something often reflected in a supplier’s costs). A knock-on effect of lost commercial trust due to delayed payments will be their lack of eagerness to go the extra mile for you or even work with you again in the future.
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- Viral bad press
Social media gives everyone with a keyboard access to a world of opportunity to express their dissatisfaction with you. If you cause your supplier discomfort, distress, or even disrespect due to a delayed payment (or payments), they have the freedom to out you across their chosen platform. At BPG we regularly report on how the news media reports on projects in peril, and when your reputation has been muddied it can have a very real and financial impact on future projects.
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- Credit score impact
For a variety of reasons, an increasing number of suppliers now insist on credit scoring a client both before agreeing to work with them and during the course of being a client. CCJs, resulting from a supplier taking you to the small claims court for withheld payments will impact on your score. Once again, this makes working with you seem riskier and results in suppliers increasing their fees to compensate (if they will work with you at all). It can also have an impact on the challenge of accessing funding, something most organisations will inevitably need to do from time to time.
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- Erosion of your supplier’s ‘expert’ responsibilities
Your fallback of last resort in any major project relationship, should things go awry, is legal action. In this situation, your case may rely on your supplier’s ‘expert’ responsibilities to you. However, through action or inaction, when things are going wrong, you could inadvertently erode this legal recourse. Too much action could be seen as you taking on the mantle of ‘expert’, too little action and you could be seen as accepting the level of service received. It’s a difficult balance to get right.
Conclusion
While withholding or delaying a payment under contract may be necessary or unavoidable in some situations, it’s important to recognise that due to the potential ramifications of such a move, that this should not be undertaken lightly (or without all of the justification and evidence to support your decision).
Often there will be significant push-back from your supplier, so on top of understanding your legal position, it is also worthwhile appreciating the full implications of this action on the supply of their services to you. And when known, these should be factored into your calculations when considering the best way forward.
Should you need any help determining the correct path for you to take, the wider implications of doing so and the options in front of you, feel free to get in touch – advice@bestpracticegroup.com or call 0845 345 0130.
