Late commercial payments – should regulators step in?

LATE payment in commercial transactions has always been cited as a major problem facing small and medium-sized enterprises (SMEs), be it in Malaysia or the rest of the world. In the UK and the European Union (EU), the regulators use legislations to enforce statutory rights to interest on late payment and payment terms since 1998 in UK and 2000 in the EU. The regulators intervene because the entire EU and UK economy is negatively affected by late payment. As access to finance becomes less available due to mounting unpaid debts, late payment by debtors causes thousands of SMEs to go bankrupt due to disruption of cash flow. Jobs are lost and cause financial and administrative burdens within UK and EU nations’ cross-border trade.

In emerging countries like Malaysia, there is no intervention by the regulators as yet. Amid the Covid-19 pandemic, late payment by debtors became more acute and hit SMEs. As such, in September 2020, the Bank of Thailand (BoT) announced the plan to punish large firms who delay paying their SME companies’ debts by introducing a compulsory credit term (possibly 30 to 45 days) if given the go-ahead. The rule would be first applied to large corporations – manufacturing and service sector corporations with annual revenue of more than 500 million baht (RM66 million) and 300 million baht, respectively. Should Bank Negara Malaysia and the Securities Commission of Malaysia intervene?

Modelling the UK and the EU, for regulators to intervene, the governments need to take the lead to pay promptly, ahead of enterprises. The public authorities in the UK and the EU have to pay for the majority of their procurement within 30 days as compared to the 60 days credit term given to enterprises (credit terms for enterprises can be longer if the counterparty expressly agrees, and provided the credit term is not grossly unfair).

Could the governments in this part of the world walk-the-talk by committing to pay promptly before considering regulating the credit terms as planned by BoT? Instead of regulation, better discipline by the governments in adhering to agreed or contracted payment terms can boost economic activity as government late payment affects the domestic economy.

At the firm level, payment beyond the credit period granted is prevalent in Malaysian businesses. A quick calculation of the days sales outstanding based on the audited financial statements of Malaysian corporations compared with the normal credit period granted as disclosed in the notes to the accounts will show that the average collection period exceeds the credit terms in the majority of listed firms in Malaysia (60% – based on my study on the manufacturing sector), indicating that late payments are indeed a major problem in emerging countries like Malaysia.

Some common reasons for late payment in Malaysia are economic and market factors – Covid-19 pandemic impact is a good example; internal administrative reasons like delays in invoicing due to various reasons; unclear payment agreements – payment terms not spelt out clearly; inadequate working capital financing – can be due to lack of access to finance or overtrading; dunning system is not adequate or too lax, meaning no one is actively chasing after the payments that are due; unsatisfactory customer service – especially concerning goods returns; the culture of prolonging payments for undisclosed reasons – utilising other people’s money that is free from financial charges rather than using banking facilities that incur interest. Could regulators’ intervention solve this late payment issue? Is it best to leave it to the prerogative of businesses, provided it is not grossly unfair (due to the use of price discrimination or market power) to the counterparty?

When the Construction Industry Payment and Adjudication Act (CIPAA) was introduced in 2012, it was touted that CIPAA is the “ultimate” solution to cash flow issues in the Malaysian construction sector. To date, the industry is still plagued with payment woes for contractors. It appeared that utilising CIPAA as a solution to the cash flow issue neglects some of the underpinning theories of trade credit extension.

For example, developers are holding up payments for some time for independent verifications on the quality of sub-contractors’ work, allowing them time to check and test on the quality of work and ensuring the sub-contractors do not overclaim.

In addition, the delays in payment can also be explained by applying the transaction cost theory. Instead of paying at closer intervals (weekly or fortnightly) that incur high transaction costs, payments are scheduled to synchronise with the issuance of the architect’s certification on the progress of the work that serves as the basis for paying the contractor’s progress claims, and at the same time enable invoicing the principal/buyers to match the cash flows. In essence, credit extension allows the developer to pay the sub-contractors on a less frequent basis, but be regularly in line with the progress of the construction contract to justify the economies of scale in payment processing and drawing down a larger amount of financing to reduce transaction costs.

In summary, applying the theories underpinning credit extension is vital in understanding why payments are deferred. In combating late payment by debtors via credit term limit, regulators should not intervene unless the government can promptly pay their contracts, which would boost the domestic economy. In doing so, the government can encourage their tender awardees to be prompt paymasters in the supply chain. This augurs well in promoting voluntary adherence to the credit terms rather than enforcing regulations that incur compliance costs, yet having late payments persist.

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