The EU Directive on Late Payments

The EU directive on Late Payments (2011/7/EU) is just around the corner.

The new Directive will have to be transposed into national law by 16 March 2013 at the latest by all countries in the European Union. The provisions of the new directive include, among others:

• Public authorities will have to pay for the goods and services that they procure within 30 days or, “in very exceptional circumstances”, within 60 days
• Enterprises will have to pay their invoices within 60 days, unless they expressly agree otherwise and if it “is not grossly unfair to the creditor”
•  Invoices trigger requests for payment and are important documents in the chain of transactions for the supply of goods and services and for determining payment deadlines
•  Member States should promote systems in the field of electronic invoicing (e-invoicing) where the receipt of invoices could generate electronic evidence of receipt

Apparently the situation for small and medium enterprises (SMEs) will improve once the EU directive is enforced in all European major countries. The directive is quite stringent for the government-to-business (G2B) space, while it leaves room for interpretation in the business-to-business (B2B) arena.

The EU Directive on Late Payments appears to be the right counterpart conceded by governments to their suppliers that are continuously forced to send invoices electronically. SME suppliers however do not enjoy any significant benefit by sending invoices electronically if the only attainable result is increased efficiency due to reduced manual operations and less paperwork. The frequency an SME sends it invoices to a large customer—usually this is the size of organizations that demand to receive e-invoices—never goes beyond a monthly issue. With such a low frequency of invoice exchange no efficiency can be achieved by moving from manual to electronic. Moreover, SMEs still have buyers who do not ask to receive invoices electronically. So e-invoices for SME suppliers turn to be an additional layer of complexity instead of representing a tool to enhance efficiency.

If the e-invoice process is instead offered as a means to access better financing, then the story changes and there is a benefit for the SME as well. It is well renowned that the current credit crunch is forcing companies of all sizes—especially SMEs—to seek for sources of liquidity alternative to the traditional bank channel. Supply chain finance refers to the financial instruments that support a company’s working capital through targeted financing of the company’s supply chain processes. The EU Directive on Late Payments goes into the direction of supporting one of the most relevant components of working capital: receivables. By reducing payment delays and fixing an exact date for payments, public authorities allow their supplier counterparties to cash in earlier, thus reducing their days sales outstanding (DSO) exposure.

As good as it can look on paper the Directive contains elements of concern. The main problem inherent the EU Directive on Late Payments is the asymmetry between buyer and supplier.

Companies supplying to government offices—whatever the size of these—will benefit from the EU Directive on Late Payments because their clients will be forced to reduce payment delays and commit to fixed payment dates. The situation is instead likely to remain unchanged in almost all private business-to-business scenarios where the buyer has higher—or at least equal—negotiation “power” vis-à-vis its supplier. The EU Directive on Late Payments is applied unless business parties expressly agree otherwise and if the deal “is not grossly unfair to the creditor (i.e., the supplier)”. It is very unlikely that an SME supplier can impose a change in the contractual conditions with its large buyer by claiming they are “grossly unfair” without running the severe risk of losing the business. 

Things may change significantly—instead—in the private business-to-business space when the relationship is between a small buyer and a large supplier (i.e., b2B). This is the case when the large supplier can “impose” its smaller client to change the contract by significantly reducing the days of payment and comply with the provisions of the EU directive on Late Payments. The buyer is now faced with the risk of losing important supplies from its dominant vendor. A contractual reduction of days of payment represents reduced DSO for the (large) supplier and reduced days of payments (i.e., days payables outstanding- DPO) for the buyer. With no doubt this is a severe hit to the buyer’s working capital ratio.

Bottom line: The effects of the EU Directive on Late Payments must still be analyzed within the context of each country. While benefits for small suppliers of government agencies are clear, the same cannot be said for those operating in the private business-to-business space. Easy optimism must give way to careful assessment of possible scenarios.

(This article was first published in GTNews in December 2012)