Although pricing will often loom large in negotiations, provisions setting out the mechanics of the payment process and related terms don't always get the attention they deserve – which can lead to problems once the contract is being performed. In this briefing, we look at some key issues that suppliers and customers need to watch out for.
Payment terms: what to watch out for
Overview
What's the trigger for payment?
A key distinction here is between contracts which are "entire" and those which are "divisible". If the contract is "entire", the customer does not have to pay until all of the supplier's obligations to carry out the work are fully discharged. So even if 95% of the work has been carried out satisfactorily, the customer can refuse to pay the whole amount due until completion.
In view of this, suppliers will typically prefer a "divisible" contract – such as one which envisages staged payments according to a timeline (e.g. submission of monthly invoices) or achievement of particular milestones (and customers will often prefer this latter option in divisible contracts because it ensures that payment is only made against a set of pre-agreed deliverables). But if adopting this approach, it needs to be clear when each staged payment falls due. In practice, contracts typically require the supplier to submit a valid invoice before the customer is required to pay – but again, the trigger event for submission of that invoice needs to be clear.
Entire contracts: how to avoid problems in practice
In PC Harrington v Systech International (2012), the Court of Appeal ruled that an arbitrator was not entitled to claim his fees because the contract was entire rather than divisible and – despite doing a considerable amount of work on the case - he had failed to deliver a final decision, as required. This highlights the importance (for suppliers) of being alive to the risk of a finding that the contract is entire. In practice, there are two main ways of avoiding this:
- Lack of conditionality and substantial performance: the arbitrator could have provided that his fees were not conditional on delivery of a decision. This would probably have allowed him to use the doctrine of substantial performance to claim fees where he could show that he had done most of the work required by the arbitration process, short of delivering a final decision.
- Staged payments: alternatively, the arbitrator could have insisted upon staged payments, which would probably have made the contract divisible.
What should the credit period be?
Unless the contract provides that, for example, a payment is due on or before a particular date, there will typically be a credit period following the submission of the supplier's invoice, during which the customer does not have to pay. The contract will normally define the length of this credit period but may not be clear about when it starts – so make sure this is specified (the date that the invoice is issued or received is typically used). From a cashflow perspective, suppliers will obviously want the credit period to be as short as possible, whilst customers may wish to push for longer.
Constraints on duration of credit periods
There is currently no upper limit on the maximum credit period that can be agreed as between private sector businesses. However, it is generally preferable (even for customers) to avoid periods longer than 60 days – particularly against the background of the ongoing Payment and Cashflow Review. For more explanation, see our briefing "Late payment clauses: time for a review?". As explained in the same briefing, if the contract is silent as regards the payment date and the supplier is entitled to claim interest on late payment under the Late Payment of Commercial Debts (Interest) Act 1998, payment will be deemed late after 30 days.
What happens if payment is late?
The Late Payment of Commercial Debts (Interest) Act 1998 requires there to be some form of meaningful remedy for suppliers if payment is late. In most commercial contracts, this takes the form of a clause allowing the supplier to claim interest on late payment. For more detail, see our briefing "Late payment clauses: time for a review?"
Should time for payment be 'of the essence'?
If time for payment is stated to be 'of the essence', it will be regarded as a condition of the contract; as such, failure to pay on time will normally allow the supplier to terminate the contract at common law for the customer's repudiatory breach. Customers will typically resist this – and if unable to strike it out, should seek to ensure that they are not at risk of termination where there is a genuine dispute over the amount payable (see "Disputed payments and set-off rights" below).
Termination rights and failure to pay
Even if time for payment is not "of the essence", suppliers may be able to terminate for material breach in accordance with their contractual rights where reasonably significant sums are outstanding. For example, in Dalkia v Celtech (2006), a failure to pay 3 instalments totalling £350,000 (out of a total of £15 million payable over the life of the contract) was held to be a material breach. Suppliers may sometimes also be able to terminate if the customer is in financial difficulty, although this is subject to a number of constraints under insolvency law and is rarely straightforward.
Disputed payments and set-off rights
Customers may wish to ensure that where there is a genuine dispute over the amount payable, there is an express right to withhold payment and any remedies for late payment (see above) are suspended until the dispute is resolved (without this, customers may end up having to "pay now and argue later"). Suppliers are often willing to accept such clauses subject to a proviso that the dispute over payment must be genuine and raised in good faith.
Customers may also wish to retain a right of set-off entitling them to make deductions from the amounts due to reflect any losses they have incurred as a result of supplier under-performance and/or where the supplier owes them money under an indemnity or liquidated damages provision. However, such set-off rights are typically contentious and suppliers will often look to exclude them.
Is non-payment carved out of any liability cap?
Most commercial contracts contain liability caps limiting one or both parties' maximum liability to a specified sum. Where the customer's liability is subject to a cap, suppliers should ensure that failure to pay is carved out - otherwise customers may argue that any losses the supplier is claiming based on withholding of fees are limited to the amount specified in the cap (which may be lower than the total amount in outstanding fees).
More information
This is the fourth in a series of briefings about pricing and payment issues in commercial contracts. The first three briefings were:
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