Considered in Grand Committee
My Lords, this instrument has a simple aim. It seeks to free small and medium enterprises from onerous contract terms that currently restrict their ability to raise finance. The terms in question are found in many purchase contracts. They prohibit the supplier from assigning to a third party the value of amounts owed to them, referred to as receivables. The supplier is typically unable to negotiate any changes to these terms. Their bargaining position is weak. If they want the work, they had better accept the standard terms of purchase. The impact of such a contract term is to cut the supplier off from an option that would otherwise be open to them, which is to use invoice finance. The aim of this instrument is simply to restore that option.
There is some debate as to why these restrictive terms persist in ordinary purchase contracts. In some cases the intention is to prevent subcontracting, but the term is drafted so widely that it affects assignments of all kinds. Whatever the reason, the impact is the same: the denial of choice to suppliers, which may need to resort to expensive short-term credit to fund their working capital needs. There are, of course, legitimate reasons to prohibit assignment: for example, in financial services, in long-term project agreements and in contracts for the sale of a business. These cases are excluded from the scope of these regulations. Some of these exclusions were anticipated in the enabling Act and others have been added later, as I shall describe in a moment.
These exclusions ensure that the impact is focused, as intended, on invoice finance. This is an arrangement whereby a supplier receives an advance of funds on the invoices that they issue. The advance may be 80% or even 90% and is typically received within a few days. Invoice finance is not borrowing. The supplier is receiving advance payment for an asset—the receivable—that they already own. In this way, the supplier can pay their costs before the customer settles the invoice. Once this is paid, the finance provider deducts its fee and pays the remaining balance to the supplier.
There are currently some 40,000 businesses using invoice finance, of which the majority—38,000—are small and medium-sized enterprises. They account for roughly half of all advances drawn down, which is to say about £9.5 billion out of a total of £20 billion. There are 5.7 million businesses in the United Kingdom and your Lordships could be forgiven for thinking that this is a marginal issue. Yet that is precisely the point: the use of invoice finance is less than it might be, because of the restrictions to which I referred. In fact, the Government estimate that the number of businesses which could potentially use invoice finance is 10 times the current figure. The financial benefits have been calculated from survey evidence and follow-up research. In summary, this instrument brings both direct and indirect benefits, with a net present value to the economy of some £966 million—just short of £1 billion. This figure reflects savings to existing users of invoice finance and the additional growth and profit generated by new users. The underlying figures are available in the published impact assessment.
During the preparation of this instrument, concerns were raised about the impact on the attractiveness of English law. English law is one of this country’s most valuable exports and forms the basis for contracts in areas as diverse as aircraft leasing, project finance and infrastructure. The Government are determined to ensure that there will be no adverse impact from these regulations and undertook extensive discussions with the City of London Law Society and others. As a result, the regulations were substantially amended. I am glad to say that the draft regulations before the Committee incorporate changes and exclusions that meet the concerns raised.
In the debate in another place, the point was made that invoice financing is not the whole answer to the challenges of SME finance. I agree wholeheartedly; I also agree that invoice financing is no substitute for a culture of responsible payment. We should not expect suppliers to seek finance to subsidise their larger customers. That is why the Government have taken extensive and decisive steps towards eliminating late payment, including the appointment of the Small Business Commissioner one year ago and the requirement for all businesses to report on their payment performance. Earlier this month, we launched a call for evidence to invite proposals on further measures. It is not always appreciated that the value of late payments outstanding has halved in the past five years. The problem is obviously not yet solved but we believe that is a promising start.
These regulations will give businesses freedom to access invoice finance when they wish without being prevented from doing so by their customers. It will bring a worthwhile benefit to the economy with a net present value of just under £1 billion without imposing a burden of compliance or reporting and while preserving the attractiveness of English law. I commend these regulations to the Committee and beg to move.
My Lords, these regulations address a problem that I did not know existed. The colloquial expression for “assignment of receivables” is factoring, and that is what I know it as. Why would companies build these terms into contracts, with the exceptions permitting, unless there was a question mark about their payment? I will be interested to hear the Minister’s comments about that. It seems unjustified. I understand the importance of being able to get hold of money for your contract early on, but if companies paid in a more timely way, factoring would perhaps not be necessary. Those are just a couple of comments, but I wholeheartedly welcome the regulations.
Will the Minister explain paragraph 10.13 in the Explanatory Memorandum? It is headed “Additional Exclusion”. It states that contracting parties need to be certain that they are dealing with each other rather than an assignee. Does the Minister understand that to mean subcontracting? If he does not, are there other examples of what could be meant by that? Other than that question, I welcome this legislation.
I am grateful to the Minister for the introduction to this SI. This is my sixth week in your Lordships’ House and it is a pleasure to be speaking on my first SI. If I make any procedural or other errors, please forgive me. I am still learning and have a long way to go.
Invoice financing as set out in paragraph 7 of the Explanatory Memorandum is one way of securing working capital. More simply, it is the ability to borrow money against unpaid invoices to improve cash flow. We on this side agree that invoice financing has its place, but it is not always the solution to the problem. When laying these regulations, Her Majesty’s Government have missed a great opportunity to sort out the wider issue, which the Minister touched on, around payment culture. The recent consultation on prompt payment received some very good responses on the wider issue of late payment which simply must be addressed soon. In excess of £2 billion a year is owed to SMEs in late payments—payments past the agreed invoice payment date. Does the Minister agree that this is a far larger and more easily solvable problem?
I was general secretary of the Labour Party before coming here. The Labour Party led on this by example and had 30-day payment terms. More widely, there is the absurdity of having a voluntary prompt payment code. Many large firms are signatories but there is no enforcement, so in real terms the code is worthless, especially as many companies have 60-day terms.
What if a company breaches those terms? Let us not forget that Carillion was a signatory but then went on and changed its payment terms to 120 days. Does the Minister agree with me that a sensible term for the code, even in its voluntary state, would be 30 days? Why has the prompt payment code not been made compulsory? Why has consideration not even been given to making it so? These reforms would help to solve the problem that IF looks to solve.
The correspondence with the Secondary Legislation Scrutiny Committee touched on the question of implementation dates. I note the Government’s response supporting the status quo, but do they still believe that there is any point in having common commencement dates? The CCDs of 1 October and 6 April each year are introduced to help businesses to plan for new regulations and increase awareness of the introduction of new or changed requirements, yet these regulations are to be introduced 21 days after they are passed. As the correspondence with the Secondary Legislation Scrutiny Committee reveals, it is not as if there has been a great rush to get these regulations in. As we can see from the Explanatory Memorandum, the first discussion paper was published in 2013, so I am sure that another few months’ delay to ensure better regulation would not have hurt.
I congratulate the Business, Energy and Industrial Strategy team on their detailed and helpful work on the impact assessment and the Explanatory Memorandum. Having said that, I think the committee has done a brilliant job of sorting out the documents before us and holding the Government to account for a certain amount of confusion. It might have taken time, but I believe it would have been better if the Government had issued new documentation following the consultation. As the Minister said, substantial amendments to the regulations were made, so was the impact assessment carried out after they were made or before, in 2013?
I turn to the substance of the regulation. Could the Minister satisfy me that no problems or unintended consequences of these regulations may arise in the accounting treatment following the introduction of these regulations? I am thinking particularly of when income from invoice financing is to be recognised in the accounts of a trading company when that is not done through factoring. If the Minister is unable to give me a direct answer today, I am more than happy for him to write to me.
Paragraph 7.4 of the Explanatory Memorandum states that this regulation will help diversify finance markets and encourage competition. Could the Minister expand a little on how exactly that will happen? The bit that confuses me is the exclusion of large companies from IF. Could the Minister explain why they have been excluded, especially as paragraph 10.7 of the Explanatory Memorandum, as he touched on earlier, outlines the problem with large commercial contracts, not large commercial companies or businesses per se? Paragraph 10.8 then outlines the solution of banning large companies from IF. This appears to be a completely different answer to a completely different question. Maybe the Minister could explain what the persuasive arguments by the legal profession were and how these led the Government to exclude large companies from IF.
In the Explanatory Memorandum, under the heading “Territorial Extent”, the paragraph following Paragraph 10.14 is labelled 10.1. I think that this is just a typographical mistake but it should be picked up on. The serious point here is that the regulations appear to interact with powers devolved to the Scottish Parliament. Is that right? If so, did the Government consider seeking a legislative consent Motion? If not, why not?
As I said at the start, the Opposition will not oppose these regulations on invoice financing, but it is a shame that the Government missed the opportunity to bring forward legislation to improve invoice payment practices within these regulations.
My Lords, I offer my welcome to the noble Lord, Lord McNicol, on his first appearance at the Dispatch Box. I look forward to many more in the future. He will know that it was during the opening of the batting, as it were, of my honourable friend Kelly Tolhurst that she brought these regulations before another place some weeks ago. She was probably grateful for the noble Lord’s opposite number in another place for giving her a relatively easy run on them.
I think that I have broad agreement from both the noble Lord, Lord McNicol, and the noble Baroness, Lady Burt, that the regulations are doing the right thing, but obviously they have wider questions. Some of them are impossible to answer at this stage. For example, I think it was the noble Lord who asked whether I could give a guarantee that there would be no unintended consequences as a result of this. That goes slightly wide in that one never knows whether there will be unintended consequences until the unintended consequence hits one in the face. However, we certainly will, as with all matters, keep these under review as they develop.
I will start dealing with some of the more detailed questions. The noble Baroness, Lady Burt, asked a very sensible question as to why some companies have these contract terms. I think that I made it clear in my opening remarks that we were not absolutely sure. I think I quote myself in saying that there is some debate as to why these restrictive terms persist in ordinary purchase contracts. Some suppliers suggest that this is a deliberate attempt. I have to say that the evidence is mixed. Either way, these regulations will resolve this issue and those terms will be removed, but, to come back to the point that the noble Lord made about unintended consequences, and as the noble Baroness said with her detailed questions about I think paragraph 10.13, we consulted very carefully on these regulations and we want to make sure that we get them right.
On paragraph 10.13, there are situations where companies need long-term, trusting relationships. That is why, in that case, assignment can be undesirable. We do not know precisely and we will keep them under review, but we hope that these regulations will get to the heart of the matter.
However, that takes us on to the broader question that both noble Lords raised, particularly the noble Lord, Lord McNicol, about the wider problem of prompt payment. That is why I quoted the figures earlier. We have seen some improvement. The number of overdue debts outstanding has halved in the past five years, which is pretty good; it is down from 30 billion to 14 billion. I want to make it clear to noble Lords—this goes way beyond the regulations—that we are not complacent about this matter. Further action is under way to bring that number down further. We do not believe that companies having to make use of invoice financing is a substitute for prompt payment by those who owe them money.
We have a number of specific measures in place to tackle late payment, such as the Small Business Commissioner, addressing small business complaints about late payment and fostering cultural change. Other noble Lords on the Committee will remember that we had a debate about this last year; there have been questions in this House and another place about this matter, which we will continue to press on. The payment performance reporting duty has also created more transparency in payment behaviour, while the Prompt Payment Code is setting standards and best practice in payment culture. Again, that makes a difference.
I remind the noble Lord. Lord McNicol, that earlier this month, on 4 October, my department published a call for evidence to assess what further steps and intervention may be needed to create a responsible payment culture. Now that he has been released from the rather intractable problems of his previous job, he may like to devote more time to that issue. Alongside that call for evidence, the Secretary of State announced further immediate measures he will take to tackle late payment but even without those measures, we welcome the views of the noble Lord and his colleagues. We have already appointed a Small Business Commissioner; the Secretary of State has appointed him to the Prompt Payment Code Compliance Board and wants to explore whether all company boards should give one of their non-executive directors responsibilities for prompt payment. Further ideas will come, including from the noble Lord, and I hope that the call for evidence will explore those matters.
As I said, invoice financing is not the sole answer, although it is very helpful for small and growing businesses. We hope that the instrument will allow them to seek the increased value of invoices outstanding, ensuring that they have the appropriate funds. It may be less suitable for long-term investment or asset purchases, but that is for the companies to decide. These regulations make that small change and deal with that small problem identified by the noble Baroness, Lady Burt, and the Government. We do not quite know why it is there. We think that we can deal with it through the regulations but because of potential problems—I spoke earlier about the attractiveness of English law and so on—the issue was one worth consulting on and one that I hope we have got right. As I said, we will keep it under review and note the points made by noble Lords, whom I thank for their contributions.
There was a specific issue with larger companies. I am still struggling to understand why they were excluded. What was the reasoning behind that? The impact assessment was carried out with the inclusion of large companies. If we look at the bottom of its front page, the assessment was signed on 4 July 2018 although it took place earlier, in 2015. That is three and a half years out of date. Is that normal? As I said, substantial changes were made; I would appreciate more information on that.
Obviously with the larger companies there is less of the problem of what one might refer to as the imbalance of power between the two parties. For that reason, we thought it was easier for them to negotiate the appropriate terms. Whether we have got that precisely right in terms of the size, I do not know—again, these matters were consulted on—but I hope we have. There was the question of whether, where there is no imbalance, they might feel the need to keep these terms on those occasions. If I wish to add a little more to that, I will consider very carefully what I have said and write to the noble Lord.