Towards the end of last year, the European Commission published a revision of the Late Payments Directive that is now being proposed as a regulation, which would result in a more harmonised application across the EU.

The proposal, which is a key component of the SME Relief Package, has stirred controversy due to the stringent requirement of enforcing a mandatory maximum payment term of 30 days in business-to-business (B2B) and government-to-business (G2B) transactions.

While late payments are a problem and one should strive to achieve an on-time payment culture, it is important to firstly differentiate between late payments and longer payment terms; secondly, it is important to understand how the EU could intervene in a free-market economy through the imposition of mandatory fixed payment term limits on businesses conducting commercial transactions. This constrains the liberty of private companies negotiating their own payment terms.

In terms of addressing late payments, a distinction should be made between government-procured goods and services, and B2B transactions. In the case of the former, the proposed requirement in the Regulation to limit payment terms up to 30 days is a commendable initiative, as governments and public authorities are normally less constrained with liquidity issues compared to private companies.

Therefore, governments should lead by example and effect payments in the shortest time possible. On the other hand, in the case of B2B transactions, while swift payments naturally help businesses run more smoothly throughout supply chains, there are diverse business realities that vary by sector, size, lifecycle, and the international economic climate, among others, that need to be taken into consideration. In the case of the private sector, the issue of late payments cannot be resolved through this new requirement, which is considered as a one-size-fits-all measure.

On the other hand, long payment terms are an accepted practice and essential in certain economic sectors, for example where companies operate with low margins or when cash flow depends on the selling of supplied goods. In such cases, longer payment terms can provide companies, particularly SMEs, more time to make sales and pay their suppliers over time, especially if they do not have the resources to buy stock upfront.

Although the possibility of requesting financing from credit institutions exists, this may not be an option for all companies depending on their different circumstances, and during times of increasing interest rates this adds the pressure on profit margins significantly.

There are also cases of other forms of flexibility that exist in some value chains, such as with upstream suppliers agreeing to longer payment terms, particularly with businesses with whom they have a long-standing, trust-based business relationship. SMEs also benefit from this type of flexibility.

The above is not meant in any way to dilute the issue of late payments, which exists, and is of great concern for many companies. Abuse should be addressed, particularly if companies use their size as leverage to coerce SMEs into extending payment terms. To this effect, there should be more efficient redress instruments for companies, including strong alternative dispute resolution mechanisms.

One should also look at improving discipline in commercial transactions, and in fact the proposal for a Late Payments Regulation puts forward several solutions to this effect. For instance, that the procedure of verification or acceptance of goods or services should not exceed 30 days from the date of the reception of the goods or services is a good step towards the behavioural change for a culture of prompt payments.

Another important form of discipline is the application of 8% interest rate on late payments and a fixed €50 administrative fee towards recovery costs. Businesses ought to have a right to negotiate payment terms according to their needs, but once agreed, the terms should be respected. The application of an interest rate and administrative fee serve as a deterrent for companies from abusing their position and especially from attempting to use late payment as a form of cheap financing.

On this point, however, while the proposal forbids creditors from waiving their right to obtain interest and recovery cost, there could be challenges for this to be applied or enforced in practice, particularly for SMEs. For this reason, competent authorities should be provided with sufficient resources enabling them to investigate and apply sanctions where it results that abuse is taking place.

To conclude, an on-time payment culture is essential both for individual companies and the economy in general. One should strive towards creating the right economic conditions where businesses thrive and are able to make payments when they are due. At the same time, longer payments terms also have an economic purpose, and where this does not result in abuse, it is imperative to preserve room for contractual flexibility to accommodate specific circumstances.

This was also a key request by the European Parliament, where it called for the ensuring of a balanced approach that preserves the freedom of contracts when addressing payment delays, in its resolution on the state of the SME Union published in July last year.

As the regulation is now being negotiated in the EU Council and the European Parliament, one hopes the right balance is found between improving payment discipline, respect for the ‘freedom of contract’ and allowing flexible solutions that businesses may need in specific circumstances.