Business minister Ed Davey has revealed that the government will implement the new EU payment directive a year ahead of its March 2013 deadline.
The directive will force private business to pay invoices within 60 days and allow small companies to charge interest at 8% over LIBOR plus a €40 (£35) handling fee for late payment.
In the event of late payment, creditors will be able to charge interest without giving any prior notice reminding the debtor of his obligation to pay. They will also be entitled to reimbursement of recovery costs, including legal fees or costs incurred by employing a debt collection agency.
Contractual terms that do not comply with the directive, for instance where payment exceeds 60 days, will be unenforceable and could result in claims for damages.
"The directive will give better protection to creditors, in most cases SMEs, while respecting the freedom of contract", said European Commission President José Manuel Durão Barroso.
At a Commons debate on late payments last week, Davey said that the government would undertake a second consultation on the directive this winter and then transpose the legislation into UK law in the first half of 2012.
The debate was tabled by Debbie Abrahams, Labour MP for Oldham East and Saddleworth, who launched the "Be Fair, Pay On Time" campaign in June in response to late payments being made to her constituents.
She said that large companies in particular were not paying the invoices of their SME suppliers in a timely manner and that those SMEs were often afraid to come forward for fear of being blacklisted for future work.
Abrahams cited research by the Federation of Small Businesses (FSB), which found that 73% of businesses have been paid late in the past year and that more than a third of a company’s turnover is tied up in late payment.
"The FSB’s survey indicates that manufacturing is the worst industry sector for making late payments, followed by the construction industry," she said.
"Although the private sector is the worst culprit for late payments, according to 77% of FSB members a significant section of the public sector still fails to pay promptly as well, including local authorities and Departments."
Anne Marie Morris, Conservative MP for Newton Abbot, backed the call for action and said the "biggest offenders…are the large British corporates" and that "some SMEs are waiting six months [for payment]". "That is not in any way acceptable," she added.
"One of the main problems is the imbalance of power. The large companies have significant trading power over the smallest, and as the recession has bitten, so all the very small companies are fighting for every contract that comes through the door and do not necessarily think as strategically as they might about whether a contract is a good one or a bad one."
According to Morris, SME's could help themselves by making sure they have written contracts in place with their clients and by undertaking credit checks.
"I was surprised by how few small businesses do any form of credit check," she said. "According to the Institute of Credit Management, 25% of businesses make no checks at all. If people make those checks, they can be a little more streetwise in terms of how they negotiate the contract and they might think about some form of part-payment in advance."
