European Commission Proposes the Regulation on Combating Late Payment in Commercial Transactions

European Commission (“Commission”) is taking action to combat the problem of late payments in commercial transactions in Europe.  To address this problem, the Commission proposed a new Regulation on combating late payments, which revises the existing Directive from 2011. 

The revision of the Late Payment Directive has been included in the Commission 2023 work program under the objective ‘A Europe fit for the Digital Age’. The revision addresses the shortcomings, with the ultimate aim of improving the payment discipline of all concerned actors (public authorities, large companies, and SMEs) and protecting companies from the negative effects of payment delays in commercial transactions. 

1. Why is the Commission proposing new rules to combat late payments in commercial transactions?

Late payments have a major impact on SMEs (small and medium-sized enterprises). One of the root causes of late payments is asymmetries in bargaining power between a large or more powerful client (debtor) and a smaller supplier (creditor), this often results in suppliers having to accept unfair payment terms and conditions.

The Commission aims to bring fairness in commercial transactions, increase the resilience of SMEs and supply chains, foster more widespread use of digitalization and improve the financial literacy of entrepreneurs with the revision.

2. How are businesses and SMEs affected by late payments?

In the European Union, on average, one out of two invoices in commercial transactions are paid late, especially in times of crisis and economic turmoil. SMEs, who rely on regular and predictable streams of cash to operate, are more vulnerable to the risk of being paid late and to its damaging effects.

In general, late payments reduce businesses' competitiveness, increasing financing costs and causing companies to forego attractive business or investment opportunities, for example investing in the green and digital transitions. 

A one-day reduction in payment delays would increase EU companies' aggregated cash flow by 0.9% and could save them €158 million in financing costs.

3. Why has the Commission decided to revise the current Late Payment Directive?

Several studies and assessments carried out by the Commission since 2015, as well as the 2019 Resolution of the European Parliament and the 2021 Opinion of the Fit for Future Platform, have established that the current EU legal framework on combatting late payments in commercial transactions is not adequate to tackle the problem. 

These analyses have identified several main shortcomings in the existing Directive; especially the lack of preventive measures and effective enforcement as well as redress mechanisms easily accessible to SMEs.

In addition, the analyses point out that the proper application of the Directive has been hindered by certain unclear concepts and the lack of a maximum payment term in Business-to-Business transactions (B2B). To address these shortcomings, the Commission has decided to revise these rules and has presented a new proposal for a Regulation on late Payments.

4. What are the key novelties of the Late Payment Regulation proposal compared to the existing Late Payment Directive? 

The Commission has proposed to replace the current Directive with a Regulation. Contrary to a Directive, a Regulation is directly applicable and lays down the same provisions across the EU, thus benefitting especially those businesses that rely on cross-border trade in the EU.

The proposal introduces stricter and more streamlined measures to prevent late payment practices in the form of maximum payment terms; ensures that the payment of accrued interest and compensation fees is rendered automatic; as well as laying down new enforcement and redress measures to protect creditors against bad payers.

5. How does the new Regulation change the legal payment limit terms?

Currently, the existing Directive lays down a payment term of 30 days in B2B transactions. However, this can be extended to 60 days or more “if not grossly unfair to the creditor”. In practice, the absence of an effective maximum payment term and the ambiguity in the definition of “grossly unfair” in the Directive has led to a situation whereby payment terms of 120 days or more are often imposed on smaller creditors.

The new proposal for a Regulation now streamlines the current provisions and introduces a single maximum payment term of 30 days for all commercial transactions, including B2B and transactions between public authorities and businesses. This term will be the same across the EU. The freedom of contract is preserved since parties can negotiate any payment term as long as it does not exceed 30 days. The proposal does not affect shorter payment terms laid down in national legislation, to ensure legal certainty. 

Contrary to the current Late Payment Directive, the proposal also eliminates the ambiguous concept of “grossly unfair” contractual provisions, replacing it with a list of well-identified unfair payment terms and practices.

The new Regulation also proposes, for the first time, a limit for verification procedures to ascertain goods and services. These are only allowed if necessary due to the special nature of the contract and shall not exceed 30 days.

6. What are the new rules on payments of interest and compensation fees by debtors?

New rules propose to make the payment of interest automatic and compulsory until payment of the debt. Under the new proposal, the creditor cannot waive its right to claim interest for late payment. A contractual provision or practice to the contrary would be unfair, and therefore null and void of any legal effect. The creditor is therefore relieved from the burden of claiming the payment of interest, which becomes an automatic obligation of the debtors when they pay late. 

7. How does the new Regulation improve enforcement of the rules?

Under the new proposal, Member States are to set up enforcement authorities to monitor and ensure the application of the rules. These authorities shall have the power to receive complaints, initiate investigations, and issue sanctions that are effective, proportionate, and dissuasive against late payers. In addition, Member States should promote the voluntary use of Alternative Dispute Resolution (ADR) to preserve the contractual relation between debtor and creditor, and provide a quick resolution to the payment dispute between the parties, while ensuring the proper implementation of the rules.

8. How is this proposal expected to benefit businesses and SMEs in particular?

Paying on time is the fastest, simplest, and most effective form of financing SMEs. This proposal aims at ensuring that liquidity goes into the real economy and directly into the hands of businesses and SMEs. On average, reducing late payments yields an increase in aggregate cash flow of roughly 0.9% for each day of reduction of payment duration.

This proposal lays down a stronger framework that streamlines the rules across the EU, eliminates ambiguity, empowers SMEs to claim their rights when paid late, and creates enforcement and redress mechanisms to ensure that the rules are respected. 

By being paid on time, companies will save each year at least five man-days currently lost to chasing debtors, equal to 340.2 million man-hours, or almost €9 billion for the entire EU economy. Setting up ADR mechanisms would allow companies to save at least €27 million in avoided court cases per year, while preserving business relations with their clients. 

9. Does the proposal create a new administrative burden for SMEs and public authorities? 

The proposal does not impose any new reporting requirements, neither on business nor on public authorities. Most costs affecting all businesses are one-off costs. These include updating standard invoices to reflect new payment terms and adjusted compensation fees, estimated at €243 million across the EU. 

The costs associated with the public authorities are limited and proportionate. Public authorities would face some costs to designate and run the enforcement and mediation bodies, but these costs would be satisfactorily compensated by the overall benefits of improving payment discipline. For example, the expected overall reduction in late payments means fewer bankruptcies and associated costs (including unpaid taxes and social contributions) to the public purse.

10. What is the impact of the proposal on international competitiveness?

It has been estimated that 10% of invoices issued in commercial transactions around the world were not paid on time, costing the global economy $1 trillion every year. Many EU partner countries, such as Canada, the US, Türkiye[1]^,[2], Japan, New Zealand, Australia, and the UK already imposed legislation on late payments. Therefore, the risk that in international transactions companies would circumvent EU legislation by systematically referring to non-EU regulations is limited.

11. How will the implementation of the rules and progress be monitored?

The Regulation obliges the Commission to report on the implementation of the Regulation within four years of its entry into force. This will complement own initiative annual reports and data collected in some Member States on the payment performance of their public authorities.

Eventually, once adopted by the European Parliament and the Council, the new rules will become applicable one year after the entry into force of the Regulation, to allow the relevant actors to take the necessary steps to comply with the new rules. Note that commercial transactions carried out after the date of application of the Regulation shall be subject to the provisions of the Regulation, including when the underlying contract was concluded before that date.

You can read the full text of the proposal here and the Q&A published by the Commission here.

Kind regards,

Zumbul Attorneys-at-Law

info@zumbul.av.tr