Last December, the Government announced that the insolvency exemption from the provisions of the Legal Aid, Sentencing and Punishment of Offenders Act 2012 (LASPO) would end. With effect from April 2016 the success fee and the adverse costs insurance premium will no longer be recoverable from the losing defendant in insolvency cases.

This legal change means that small and medium businesses are at risk of unscrupulous or illegal behaviour by customers and suppliers, as they are no longer assured of the ‘safety net’ legal recourse would provide. Many businesses will no longer be able to afford the success fee and insurance premium incurred when taking legal action against businesses that owe them money.

According to a survey of lawyers and insolvency professionals carried out by Encompass Corporation, over 40 per cent believe that claims will not proceed because of the change in the law and a lack of available funding. 78 per cent believe that there will be an increase in unscrupulous business practices with this legal change, since a lot more grievances against smaller businesses can now go unaddressed in court.

Wayne Johnson, founder and CEO at Encompass, emphasised the need to get a lawyer involved ahead of agreeing to any new contracts. He also suggested conducting a thorough background check, including ascertaining whether any director has a history of involvement with repeatedly failing companies. “This change in the law may make pursuit of a claim too costly for creditors owed money by a company with assets of value but made insolvent by its directors,” he said.

Over 60 per cent of the surveyed law professionals think that small and micro businesses are at greatest risk as they may not have the financial resources to pursue a company out of their own business funds. As a result 94 per cent recommended that businesses should be much more careful when entering into contracts.

The cashflow conundrum

According to research from the Asset Based Finance Association, SMEs are owed up to £64.2 billion in unpaid invoices, a figure that has increased by 36 per cent since 2011. The impact of these unpaid invoices on business cashflow is almost immediate, with a domino effect trickling down the supply chain.

Despite industry efforts to eliminate the problem, including strengthening the Prompt Payment Code backed by 1,800 UK businesses, 3 per cent of UK SMEs report having to wait four months for payment in their contract terms.

The Prompt Payment Code Advisory board was set up in 2014, with the remit of supporting and advising on the strengthening of the code that encourages businesses to pay their suppliers within 60 days, and move towards 30 days as a norm. The code was strengthened in March 2015, with the introduction of a compliance board to ensure that terms were being met. From 2016, this has become a formal requirement for all members.

“Too many SMEs struggle to span the working capital gap between completing a job and getting paid. After paying out their costs, they often have to wait too long for their customers to pay them,” Rick Hurwitz, CEO of Tungsten Corporation, said. As a supporter and sponsor of the Prompt PaymentCode, the FinTech firm is active in providing SMEs with easier access to capital, including supply chain financing.

According to Hurwitz, an unpaid invoice can mean the difference between a successful month of trading and a dangerous financial shortfall, even potentially leading to insolvency. 

“There are many reasons for late payment. Sometimes buyers will wait until the last day before the invoice is due only to tell their supplier that it is missing vital information. This creates unnecessary delays. Advances in technology mean that many payments can now be processed electronically, which ensures invoices have all the necessary information, but e-invoicing was only used by a quarter of the small businesses we spoke to,” he said, referring to a a study conducted by Tungsten last August, which revealed that nearly a quarter of the surveyed 1,000 SMEs have been put at risk of insolvency over late payments.

Freelancers feel the cash crunch

The Office for National Statistics revealed in 2015 that 4.55 million people in the UK are now self-employed. The Association of Independent Professionals and the Self-Employed (IPSE) found three in five businesses agree that it would be difficult to operate without hiring freelancers, underscoring the importance of this fluid and mobile workforce. However, UK freelancers are even more susceptible than smaller businesses to late invoice payments. Recent research revealed that worries over continued late payment the stress of having enough cash to live on are prompting freelancers to reconsider their line of work.

This research comes from fintech start-up Ormsby Street, which surveyed more than 1,000 freelancers and sole-traders earlier this year. It also revealed that one in 10 freelancers have faced difficulties paying their mortgage or rent because of late invoice payment, and many have turned to family or payday loans companies to cover a shortfall brought about by late payment. The research rounded the outstanding payment figure to £5,431.03 on average.

“For a freelancer to be owed more than £5,000 is clearly unacceptable and threatens the emerging freelance economy in the UK, which brings flexibility and work / life balance to so many,” Martin Campbell, managing director of Ormsby Street said.

The Ormsby Street survey also revealed that 40 per cent of respondents have taken out a County Court Judgement (CCJ) in the last year to chase a bad debt, and more than half say that late invoice payment is getting worse not better.

According to Campbell, freelancers should run their a credit check on their clients, just as businesses would their suppliers and customers. “Credit-checking potential customers and partners is straightforward to do and should be done by a freelancer every time they work with someone, to protect themselves against late payment,” he explained. Ormsby Street is the company behind free credit-checking tool, CreditHQ, which allows small businesses to check the credit status, payment performance and general financial health of any customer or partner. The company stated that a version specifically for freelancers is on the horizon.

Everybody loses when payments are late

According to e-invoicing provider Basware’s Jonathan Horne, it is the supply chain relationships both inside the company and with buyers that suffer most as a result of late payments.

“When we think about how late payments effect the SMB enterprise we traditionally tend to focus on the pure capital aspect of the cash not coming in on time, and the pressure this has on the bank balance. Whilst not dismissing this pain point area, there are also many operational and social pressures that are also the results of late payments that equally effect the continuity and effectiveness of the SMB,” he said.

“When we thrown in not just late payment, but also an unknown payment date it is not surprising that the one of the first potential casualties of the business will be its staff. This then has a very unstable effect of the operational aspects of the entire business as it tries to do more with less,” he added.

In addition to affecting employment, late payment’s domino effect affects big buyers at the top of the supply chain as well, as they scramble to revamp their supply base. “This in turn pushes up the cost of the end product that us consumers buy so we too have to share part of the burden,” according to Basware’s Horne.

Ultimately, legal action was a comforting last resort for businesses chasing payment, but with the new legal change, this may be an unjustly expensive recourse for companies only asking to be paid what they’re owed.

See also: Open banking could be the late payment solution for businesses – The average small business spends £90,000 a year chasing overdue payments in lost time and manpower. And the late payment problem is getting worse. Open banking could provide frictionless, instant payments, says Nick Raper