Avoiding Late Payment in Construction – A Fair Payment Practices Guide

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Background

Payment issues in the construction industry have been well known for some time. With cash flow being critical to the success of construction projects and the solvency of the wider supply chain, late payments or long payment periods create acute points of contention between clients and suppliers.

Overall, late payments are considered detrimental because they disrupt financial stability, incur additional costs, hinder growth potential, strain relationships, and can have a lasting impact on creditworthiness. It is important for businesses and contracting authorities alike to prioritise timely payments and to use methods to mitigate occurrences of late payment to maintain a healthy financial environment and sustain positive business relationships within the construction industry.

Major contractors often fail to pay on time, as the following statistics demonstrate:

  • a survey of small, medium, and enterprise-sized businesses found 87% of businesses reported that their invoices are paid after the due date[1],
  • three in five (58%) SMEs are currently waiting on money which is tied up in unpaid invoices,[2]
  • 1 in 5 insolvencies are attributed to late payments[3],
  • large companies tend to take 30% more time than small companies to pay invoices[4],
  • 82% of overdue invoices are monies owed to subcontractors by tier-1 main contractors[5], and
  • construction businesses across the UK are owed over £30 million in unpaid invoices[6].

The Government’s vision for construction in 2025 is, among other things, that late payment no longer characterises the construction industry. In its ‘Construction 2025 Industrial Strategy’ [7] the Government discussed the importance of ‘equitable financial arrangements and certainty of payment’ as crucial factors to the success of the construction industry.

In this article, we consider a variety of methods and options available to public sector contracting authorities and the wider construction industry to avoid issues of late payment in construction contracts.

Project Bank Accounts

Project Bank Accounts (PBAs) were first used in 1999 and have grown in popularity across the public sector. The latest Construction Playbook[8] states that PBAs should be used on Government construction contracts “unless there are compelling reasons not to”. PBAs hold monies in trust, held in the names of the trustee(s) (usually the lead contractor and named subcontractors, or, for dual PBAs, the lead contractor, named subcontractors, and the client), channelling payments to the supply chain on time and helping to alleviate late payment issues.

When a PBA is set up, the funds will be sent to a dedicated separate account, segregated from the main contractors’ other funds, ensuring funds are protected for the supply chain of that project and not diverted elsewhere or delayed.

Payments are made ‘directly and simultaneously’[9] to all parties, helping to promote transparency, certainty of payment and ensure funds are promptly disbursed to subcontractors and suppliers, meaning the supply chain doesn’t have to wait for payments to be processed.

PBAs also protect against insolvency within the construction supply chain, not only ensuring payments are still made to members of the chain but they also reduce cash flow issues.

Whilst PBAs can have wide ranging benefits for projects that have complex supply chains, they are not always suitable. An often-stated disadvantage of PBAs is that they can be costly, in terms of time and money, to set up and they do not guarantee that payment disputes will be eradicated from a project.

Fair payment terms

Contracting authorities should also consider including fair payment terms in contracts to help deter late payments by setting clear expectations, defining consequences for overdue payments, and providing a framework for addressing payment-related issues. Fair payment terms can set out transparent and auditable payment periods, establish payment milestones, set out incentives for early payment or penalties for late payment, and clearly outline the requirements for invoicing.

Fair payment terms may include the following:

  • A clearly defined payment schedule: Upfront, upon completion of specific milestones, or at regular intervals.
  • Invoice requirements: Clear guidelines on how invoices should be submitted, including details that need to be included on the invoice.
  • Specify periods within which invoices must be paid.
  • Detail late payment penalty terms and set out consequences if a payment is not made on time (e.g. late fees or interest charges).
  • Specify the acceptable payment method(s).
  • Ensure that timely payment is made by the client to the main contractor to facilitate efficient flow of monies to the supply chain.

Payment KPIs

Authorities should consider including KPIs to track ‘on time’ payments, measuring the number of invoices paid to suppliers on time. KPIs can be established relating to payment timeliness, such as the average number of days taken to process invoices, or the percentage of invoices paid within the agreed-upon period.

Monitoring payment through KPIs can highlight any delays in payments and enable proactive measures to address these issues promptly. Where KPIs have deductions or incentive payments associated with them, they will also help to incentivise contractors to follow stipulated payment requirements.

Fair payment charter

Another method regularly used on large-scale construction projects is the creation of a “fair payment charter”. By signing up to a fair payment charter, construction companies, industry stakeholders, and other signatories publicly affirm their commitment to uphold fair payment practices. The commitment sets a clear expectation that payments will be made promptly and fairly within agreed terms. Joining a charter is on a voluntary basis and the success of a charter in helping to alleviate late payments will depend on the level of buy-in from the supply chain as a whole.

Amongst other things, charters include guidelines promoting best practices, acceptable payment terms, recommended payment schedules, mechanisms for addressing payment disputes, standard payment terms and efficient invoicing procedures.

Standardised invoicing procedures

Standardised invoicing procedures at each tier of the payment chain can help streamline payment processes, ensuring that invoices are prepared and submitted in a consistent format, containing all the necessary information such as project details, work performed, payment terms, and relevant contacts. This consistency reduces the likelihood of errors and delays in processing invoices.

Establishing monitoring and reporting mechanisms to track the progress of invoices, identify bottlenecks or delays in the payment process, and to generate reports on payment performance, can help stakeholders address issues proactively and continuously improve their invoicing procedures.

PPN 10/23

Although not a mechanism for reducing late payment, it is worth mentioning PPN 10/23, which comes into effect on 1 April 2024 and emphasises the importance of prompt payment to suppliers and subcontractors within the public procurement process. PPN 10/23 aims to ensure that contracting authorities help to create a fair, transparent, and efficient payment environment that benefits both buyers and suppliers in the construction industry.

PPN 10/23 provides draft wording to be included in selection questionnaires to assess the timeliness of suppliers’ payment of their own supply chains. The PPN sets out guidelines and expectations for prompt payment practices within the public procurement sector, including suppliers having in place systems to enable prompt and effective payment and procedures for resolving invoice disputes.

Procurement Act 2023

Authorities should be aware that prompt payment is given a substantive role under the Procurement Act 2023 (the “Act”) which is expected to come into force in October 2024. Under the Act, implied payment terms will apply to most public contracts, meaning that contracting authorities will be required to pay undisputed invoices within 30 days of (i) receipt of an invoice, or (ii) the relevant payment becoming due. Implied payment terms will also be extended to subcontracts that contribute to the performance of a public contract, thereby applying such terms to the whole supply chain.

In addition, contracting authorities will be required to publish a “Payment Compliance Notice” when they make a payment under a public contract to show how payment processes are being managed. This aims to bring public sector payment reporting in line with the requirements of the private sector.

This article is for general awareness only and does not constitute legal or professional advice. The law may have changed since this page was first published. If you would like further advice and assistance in relation to any issue raised in this article, please contact us by telephone or email enquiries@sharpepritchard.co.uk

[1] The 2022 Late Payment Report by Chaser and BACS Payment Services research.

[2] Research conducted by Opinium of 500 small business owners / MDs / CEOs in companies of 0-249 employees with a turnover of less than £6.5 million from 22nd to 29th September 2021.

[3] Late and Unpaid Invoices – UK Statistics (source: Trade body R3)

[4] Late and Unpaid Invoices – UK Statistics

[5] Unfair Payment Issues in Construction – Coventry University

[6] Unfair Payment Issues in Construction – Coventry University

[7] Industrial Strategy: Government and industry in partnership – Construction 2025 (HM Government).

[8] The Construction Playbook – Government Guidance on sourcing and contracting public works projects and programmes (HM Government).

[9] The Construction Playbook – Government Guidance on sourcing and contracting public works projects and programmes (HM Government).

Posted in Allan Owen, Clarice Harper Smith, Construction, Latest news and blog, Procurement.