Is the Clock Ticking - Defining a Contract’s True Payment Trigger
Introduction
Invoicing under a contract - image showing one person’s hand with an envelope of cash and another receiving
Image credit - Unsplash
One would be surprised at the number of differences and disputes that come out of unclear, ambiguous or contradictory payment terms in contracts. Not every dispute goes to court - a lot of disputes means wasted resource time and spoilt relationships, by arguing about what an unclear clause meant and delaying execution.
The trigger of payment under contracts - work done, deemed acceptance, invoice, etc.
It’s helpful to first understand when the invoice is to be raised - this depends on the nature of services, for example:
· Is it milestone based - common for project-based scope which has work delivered over phases
· Is it at a regular frequency - common for routine maintenance contracts
But the real trigger is the steps required before raising an invoice:
As an example, for milestone-based payment - is it delivery, or acceptance?
They are not the same, in case you were wondering - delivery is when the vendor claims the work is delivered, while acceptance is when the client has proactively accepted it.
Going a step further - does the client get forever to accept it, or is there a deemed acceptance clause. Deemed acceptance clause means - the vendor will say that if the client does not respond within 3 working days, the deliverable shall deem to be accepted. The timeline can be different of course - it’s the concept which matters.
Going even deeper - what does respond really mean, what if the client does not approve or reject, they just say they acknowledge receipt and are looking into it. Will that not extend the timeline indefinitely and defeat the purpose of the deemed acceptance clause, keeping the vendor at the client’s mercy.
And what if the client repeatedly rejects - until how many rounds will the vendor fix it. From the client’s side it’s fair that they get the product/service they signed up for, but they should not be misusing it for microscopic issues either.
Many a time I have seen that vendors want to limit their “fixing” during an acceptance process to be limited to material deviations only - but that doesn’t quite make sense. What’s the point of agreeing to certain specifications if the client can only object to material deviations, and rest has to be forced to accept in whatever way the client receives it. And who decides material in such cases - another potential cause to disagree.
This is another reason scope is so important, because if it’s not in the scope, the client can’t ask the vendor to do it.
And the final step - when is the payment due, after invoice? Does it start from receipt of invoice, or the date of invoice.
Let’s check the difference via an example:
Let’s say the vendor issues the invoice on 5 January, sends it to the client’s contact on 10 January - if the trigger is receipt of invoice, client still has 30 days to pay from 10 January. If the trigger is date of invoice, the client has already lost 5 days.
So when you have to pay, for sure you must say it’s from the date of receipt of invoice. If you are the one invoicing, it’s ok to let it run from the date of the invoice, but then make sure to do your bit and send the invoice as soon as it’s raised.
In short, the clearer the clause, the less such confusing questions later. The above are just a few examples to make you think how you would like to define and simplify a payment clause. All that is required is to think of the workflow and sequence in your specific case, and then ensure that, after negotiating with the other side, you are still comfortable with the final outcome.
Consequences of late payment in a contract
Consequences of late payment under contracts e.g. interest - image showing a hand pointing towards percentage sign
Image credit - Unsplash
There are a variety of consequences of late payment, depending on what the parties have agreed to under the contract:
(1) Interest - Late payment interest is common in many contracts. In countries where interest is prohibited, this needs to be reviewed accordingly.
(2) Termination - The contract can be terminated because of payment being late.
Pro tip: If such a clause exists, build in a layer into the clause that they should send a formal payment default reminder and then give 30 days to pay, and if that’s not done then the termination right can be invoked. This serves as an active process and not a terminated contract due to a forgotten payment and emails between project teams and not available with relevant teams like Finance, Legal or the senior/executive management.
This is of course if you are the client and the one paying. Always weigh the clause from your side.
(3) Suspension - Services can be suspended, but the contract will stay. This actually makes more sense because, termination of contract means the contract has to be made all over again if the parties ever decide to work together again, it’s kind of a final step.
Even for suspension, similar to the above - if you are the client and making the payment, ensure there is a formal notice and remedy period to fix the payment delay before the services can be suspended.
Sometimes industry specific contracts will have other clauses - e.g. logistics contracts might have vendors retain the right to lien in case of payment defaults/delays, i.e. they will not return the goods. No client will want that of course. Sometimes the value of those goods can be very high, even more than the service charges.
Alignment of payment terms with facts
Lastly - always check if all payment terms are aligned with the facts.
For example, I have seen many contracts where the terms say payment in advance, and also late payment interest. But on the other hand, contract is still under negotiation and not signed, because of which the Finance department does not release payments (due to company policies), making the company already in breach. In such cases, it’s better to say that the payment will be made after contract signature, and mention a timeline from that trigger.
Also, going a step further, if the Finance department pays only upon receipt of invoice which most companies do, make sure that the invoice is raised after contract signature and not earlier, and mention that in the contract.
Just as a simple example – the Client shall make the payment within 30 days of receipt of invoice, which shall be raised by the Service Provider upon signature of this contract.
Bearing in mind that this is situation specific and should not be used in other situations - for example, if you want to pay at the end of every half-year, and you mention the above line for a contract which gets signed in advance, then you will have to pay in advance.
And if you are still following wet-ink/manual signatures and have not moved to DocuSign/Adobe/similar, then you again need to ensure that the invoice is raised after you receive a copy of the fully signed contract. Imagine that you received an invoice because the other side said they signed the contract, but you still have not received a copy of the signed contract from them, again placing you in the same situation with your Finance team. The above clause works for electronic because under DocuSign/Adobe/similar all people who were in the workflow/copied automatically get a fully signed copy the moment it’s done.
Always customize your contract for your facts, and seek the advice of professionals where required.
In a nutshell:
If you are the client - check if the trigger of payment is when you will be actually ready to pay, or by an early trigger you are falling into breach of contract.
If you are the vendor - check if the trigger of payment delays the payment in any way for you or makes recovery difficult, by thinking through the above steps and examples.
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