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The European Union’s latest regulation on late payments presents a balancing act reminiscent of tightrope walking.

It demands precision and careful consideration, much like the steps of a tightrope walker, to ensure small and medium-sized enterprises (SMEs) — the backbone of the European economy — are not adversely affected.

With over 18 billion invoices issued annually within the EU, (that’s over 500 invoices issued per second,) the impact of late payments is significant, and responsible for one in four business insolvencies.

The new regulation seeks to address this by enforcing stricter payment terms, a move akin to navigating a narrow path suspended high above a complex landscape of diverse business needs and practices.

The narrative of late payments is not new, but the European Union’s unexpected move in September 2023 to tackle this issue certainly is.

What is the current Late Payments Directive (LPD)?

The Late Payments Directive (LPD), was initially introduced in 2000 (formally known as Directive 2000/35/EC on combating late payment in commercial transactions).

It was later revised and replaced by Directive 2011/7/EU, which sought to strengthen the measures against late payments.

Key components of the 2011 directive were a step by the EU to combat the culture of late payments in commercial transactions.

It aimed to ensure that payments for goods and services were made within 60 days unless expressly agreed otherwise and provided such terms were not grossly unfair. 

Despite its good intentions, the directive’s impact was less than stellar. 

SMEs across Europe continued to struggle with late payments, adversely affecting their cash flow and, in some cases, leading to insolvency.

Fast forward to the present day, and the European Commission has decided it’s time for a change.

The Commission’s new proposal, part of its SME relief package, seeks to replace the old directive with a more stringent regulation.

This shift from a directive, which required transposition into national law, to a regulation, which applies directly, marks a significant escalation in the EU’s approach to the issue.

Directive to regulation: 4 key changes in the Late Payments Regulation

The new regulation, COM(2023) 533, proposes a non-derogable 30-day maximum payment term for business-to-business transactions, a stark reduction from the previous 60-day limit.

Moreover, the regulation introduces mandatory interest on late payments and a flat-fee compensation for recovery costs, adding a layer of deterrence against late payers. 

The Commission’s data suggests that these measures could save European businesses up to €2.5 billion annually in financial costs.

  1. Streamlined payment terms:

The regulation introduces a uniform 30-day payment term (from 60 days) for all commercial transactions, applicable to both business-to-business and business-to-public authority dealings, aiming to standardise and expedite payment processes across the board.

  1. Elimination of extended payment terms:

The new framework does away with the option for parties to negotiate extended payment terms, even in cases where such extensions wouldn’t be deemed ‘grossly unfair’ to the creditor. 

  1. Mandatory late payment interest:

Under the new rules, debtors are automatically liable for interest on late payments, as well as prohibiting the ability to waive this interest. This interest accrues at a rate of 8% above the base rate, reinforcing the regulation’s stance against delayed payments.

  1. Enhanced enforcement and redress mechanisms:

The regulation mandates that member states designate specific authorities to oversee and enforce compliance, who are required to ensure fair and objective treatment of both private enterprises and public authorities.

However, as promising as these changes sound, one might wonder if they are too good to be true or perhaps do not address all the issues. 

The regulation’s strict terms, while beneficial on paper, raise questions about their practicality and the potential unintended consequences for the European business landscape. 

Will this new regulation truly be the panacea for late payments, or are there complexities and challenges that have been overlooked?

Unintended consequences

The European Union’s proposal to enforce a 30-day payment term for business transactions has sparked a multifaceted debate, highlighting a range of concerns and implications across different sectors.

Trade and supply chain finance under scrutiny

Industry experts such as Sullivan point out the potential challenges that the regulation poses to supply chain finance, a critical tool for managing working capital for both sellers and buyers. 

The regulation could disrupt the flexibility businesses currently have in arranging commercial transactions, including the provision of commercial credit.

Geoffrey Wynne, partner, Sullivan told TFG, “Supply chain finance is aimed at bridging the gap between extended payment terms that buyers may want and early payment terms that sellers may want.

It assumes (and perhaps confuses) late payment which could perhaps be penalised with extended payment terms, which are often quite reasonable depending on the parties’ commercial requirements and what is being bought and sold.

A more focused approach seems clearly necessary rather than this ‘one size fits all’ attempt to regulate the world of commercial sale and purchase transactions.

He adds, “This could adversely affect the supply chain finance industry, which has benefits for both suppliers and buyers. It really needs a total rethink, but I have no doubt the ingenuity of the marketplace will have to find ways to solve the problem otherwise.”

The directive would have equal application to trade sectors with shorter and longer working capital cycles.

Whereas the directive probably well serves the situation where perishable goods are traded, this is not the case for sectors such as the fabrication and trade of furniture.

Richard Wulff, Executive Director, ICISA told TFG, “One size (30 days payment terms) cannot fit all, there must be a possibility to differentiate on the basis of sectoral and country practices and needs.”

Some firms such as Mayer Brown raise concerns about the lack of clarity in the proposed regulation. 

The current draft, resembling a directive more than a regulation, leaves several key aspects undefined, such as the precise definition of “commercial transactions” and the scope of its application. 

This vagueness could lead to increased litigation and uncertainty in its enforcement.

Charles Thain, partner, Mayer Brown told TFG, “From a legal perspective, the proposed regulation has not been properly considered and is underbaked. 

For example, it is unclear whether the regulation applies to persons in EU member states or contracts governed by the laws of an EU member state (we assume the latter), the mandatory late payment interest appears to be calculated from the date of the relevant invoice or receipt of goods/services (whichever is later) rather than from the end of the 30-day payment term and so a one-day late payment would trigger a 31-day late payment interest (which we assume is not correct), and there has been no consideration as to how the regulation applies to assignees.”

The directive largely ignores the difference between longer payment terms (for instance 60 days) and late payments. Many support the need for contractual freedom in determining payment terms.

Peter Mulroy, (outgoing) Secretary General, FCI told TFG, “There is a reason for goods and services to have varied payment terms, stemming from the nature and duration of their product development cycle, plus the fact that certain product categories have a longer shelf life than others, hence the regulation would eliminate the ability of these parties to match terms with the realities in business practices.”

Wulff said, “The directive equally applies to the situation where the SME is the buyer of goods (i.e. the creditor). 

Supplier-finance is an important part of the total finance package of the SME. 

Calculations from one of our members show that the required additional financing resulting from this version of the directive is €2 trillion with an additional finance cost of €100 billion. 

It is questionable whether this would be available and is sure to have a detrimental effect on the price of financing.”

Counterproductive for factoring

The European Federation for Factoring and Commercial Finance (EUF) criticises the strict cap on payment periods, arguing that it lacks balance and could be counterproductive.

They stress the importance of supporting innovative financing solutions like factoring, which can help mitigate late payment issues. 

The EUF’s stance reflects a broader concern that the regulation, in its current form, might overlook the nuanced needs of different business models and sectors.

Magdalena Wessel, Vice-chair of the EUF and Chair of the EUF Legal Committee told TFG, “Limiting the extent of trade credit between businesses may result in reduced transactions and adjustments of the value chain and financing to the detriment of especially SME; technical, compliance and organizational reasons for payment delays and (temporary) liquidity issues of businesses also need to be taken into consideration more when drafting rules to combat late payments.”

Retail dilemma

As first reported by the Financial Times, the retail sector faces a particular challenge with the proposed Late Payments Regulation.

Where companies have the choice of sourcing goods from within or outside the EU, this directive may have negative consequences for EU-based SMEs. 

The Financial Times mentioned DIY company Bricomarché, which has the choice of sourcing goods from Europe or from no-EU suppliers. 

The company clearly stated that it would change parts of its supply chain on the basis of the new regulations.

The 30-day limit could force retailers to adjust their pricing strategies, potentially leading to higher consumer prices.

This shift could also incentivise retailers to source more from non-EU suppliers, who offer more flexible payment terms.

​​EuroCommerce, the association representing the interests of retailers and wholesalers throughout the EU estimated that the regulation will have a negative impact on buyers, including SMEs, creating a €150 billion financial gap that will have to be filled.

For SME buyers, this will be very challenging as most of their financing comes from their receivables in the EU, and now they will have to find additional fixed assets to pledge (which in many cases do not exist) to obtain financing.  

Balancing SME protection with market realities

While the EU Commission’s intention is to protect SMEs from the impact of late payments, the regulation’s one-size-fits-all approach raises questions about its practicality and fairness. 

Mulroy said, “The value of consumer goods and services imported into the EU equates to over €1 trillion, most of which would be subjected to this regulation. 

Hence, EU buyers, which also includes SMEs will now be required to pay much earlier, creating a significantly increased cost of capital, and added stress on importers throughout the EU. 

Also, the reason for longer terms in foreign trade is the duration it takes to have goods shipped from one market to another. 

This requirement would eliminate that flexibility and cause undue harm to EU Importers.”

Ultimately, the EU’s proposed 30-day payment term regulation, while well-intentioned in its aim to protect SMEs, presents a complex array of challenges and implications for various industries.

It underscores the need for a more nuanced approach that considers the specific needs and dynamics of different sectors, ensuring that the regulation does not inadvertently create new problems while trying to solve existing ones.