Legal: Supply chain finance

The supply chain finance initiative: 10 things you need to know.

The supply chain finance initiative (SCFI) was launched by the Prime Minister in October 2012 to improve cash flow for small businesses in the supply chain. At the time some commentators felt that SCFI could entrench a culture of late payment among Britain’s largest companies and then during March Carillion said it would introduce 120-day payment terms. Professor Rudi Klein identifies 10 things you need to know about it.

1. What is the supply chain finance initiative (SCFI)?

The SCFI was launched by the Prime Minister in October 2012 to improve cash flow for small businesses in the supply chain. It works like this. Once a large company has approved an invoice for payment the bank will be able to provide a 100 per cent advance to a firm in the supply chain at lower interest rates. This is in the expectation that the large company will ultimately pay the invoiced amount. The government estimates that over time the SCFI will deliver as much as £20bn of cheaper financing to small businesses.

2. Does this apply to construction?

Yes; the first large companies to sign up to the SCFI were Balfour Beatty and Carillion.

3. Isn’t this just like factoring?

Sort of. Traditional factoring of invoices allows you to obtain cash up front but the discount could be as much as 20 per cent (depending on the strength of your own balance sheet) leaving you with 80 per cent of your invoiced amount. But with the SCFI the bank can rely on the larger company’s stronger balance sheet to provide the advance to the smaller firm at favourable interest rates. For this reason the SCFI is known as reverse factoring.

4. Is this likely to be taken up by large contractors other than the two mentioned?

Very likely; the recession and measures such as the use of project bank accounts have placed increasing strains upon their cash balances. IT recently revealed that the net cash holdings of the UK’s top five listed contractors, by turnover, fell almost 90 per cent between 2011 and 2012 – from £621m to £46m!1 This is very worrying given that these firms are letting out billions of pounds worth of contracts.

5. So, this SCFI is win-win for all?

When launching the SCFI the Prime Minister did say that it was a win-win situation for everybody. But – and there is a very big but here – it raises more questions than answers. For example:

• If the payer has approved an invoice or application for payment why doesn’t he simply pay it?
• Why doesn’t the payer – rather than the payee – apply for the finance?
• Isn’t there a risk that the payer will simply take longer to pay thus bumping up the interest or finance charge to be paid to the bank by the payee?
• If, as a consequence, the payer decides to increase his payment periods won’t this impact on all suppliers, irrespective of whether or not they are involved with the SCFI?
• Given that the government pays its bills to direct contractors within 10 days, why can’t it simply insist on this all along the supply chain2?
• It does appear that the main winners are the large firms and the banks which – respectively – benefit from being able to maintain or expand their payment periods and from the finance charge for providing the cash up front.

6. Is there any evidence that, as a consequence of the SCFI, payment periods have been extended?

Yes. It is now common knowledge that Carillion has almost doubled its standard payment period from 65 days to 120 days! This is now likely to apply to all subcontractors irrespective of their involvement in the SCFI scheme being promoted by Carillion although Carillion publicly maintains that suppliers can still opt to remain on 65 day payments. Firms receiving tender
inquiries from Carillion should carefully scrutinise their payment terms.

The 120 days commences from the date of application. Carillion describes the SCFI as its
early payment facility which “enables our suppliers to receive payments in advance of their current contractual terms”. Carillion will, however, take up to 30 days (from date of receipt) to approve a payment application or invoice. Furthermore Carillion maintains its right to issue a pay less notice and, therefore, recover the amount stated in that notice.

7. Are there any more details about the Carillion scheme?

According to Carillion firms intending to opt for the 120 day payments can have their approved invoices/applications settled by the Royal Bank of Scotland. It is up to the firm to decide which of their invoices/applications will be settled in this way and also how early they want them paid3. On average the interest rate is likely to be in the region of two per cent. Carillion will repay the bank the amounts paid out to its subcontractors.

On public sector works Carillion should be adhering to the government’s policy of paying within 30 days.

8. Is Carillion’s scheme legal?

There is no obvious illegality about Carillion’s scheme or, indeed, about the SCFI in general. But there could be if, for example, subcontractors have been forced into joining Carillion’s scheme as a result of undue commercial pressure (for example, future contracts are dependent upon you joining the scheme). Such agreement may be nullified because of economic duress. This could even apply if subcontractors were forced to join the scheme as a result of Carillion almost doubling its payment periods.

Carillion’s scheme may also be affected by the Late Payment of Commercial Debts Regulations
which came into force on 16 March 2013. Under these regulations payment periods must not exceed 60 days. An exception is where the parties agree an extension to 60 days which is not “grossly unfair”. An extension is grossly unfair if it deviates from good commercial practice and is contrary to good faith and fair dealing. Carillion’s scheme could be challenged as grossly unfair in which case it could be liable to pay interest to its subcontractors for the extension.

9. What happens if Carillion was to pay late (after the 120 days)?

On the assumption that the subcontractor was in Carillion’s scheme this would not matter since he has already received from the bank the amount initially approved by Carillion4. This, therefore, would be a matter for the bank when recovering the money from Carillion. If a subcontractor was not a participant in the Carillion scheme he would be entitled to statutory
interest for late payment and also to suspend any or all of his obligations under the Construction Act.

10. On the whole should one get involved in a SCFI scheme?

The answer to this has to be a commercial one. But remember you are paying for a facility that enables your payer to either maintain lengthy payment periods or even extend them (as Carillion has done).

References

1 – The top five are Balfour Beatty, Carillion, Kier, Morgan Sindall and Costain.
2 – The Business Department claims that it pays over 90 per cent of its bills within five days.
3 – Carillion also maintains that it will reimburse its subcontractors the finance charges which are applicable to any period between 65 days and 120 days. It is not absolutely clear when these charges will be re-imbursed.
4 – An issue which will also arise is what happens if Carillion does not approve the invoice/application (which is necessary to trigger the payment from the bank). Carillion will have to issue a payment notice under the amended Construction Act (unless the subcontract states that this is to be issued by the payee). The likelihood is that the amount stated in
the payment notice will only be paid 120 days after the due date or, possibly, after submission of the invoice/application.