Payment terms are a frequent source of controversy when negotiating a contract. However, even if you've achieved favourable payment terms in your contract, the reality of getting paid fully and on time can sometimes be very different.
This article looks at the tips and traps of payment terms.
What are payment terms?
The term "payment terms" refers to the method and timing of payment. For example, payment terms may specify that payment is to be paid by cheque, electronic funds transfer (EFT) or credit card. Generally, the method of payment is not controversial, but the timing of payment can cause issues.
Payment terms are often included on an invoice and set out how much time the buyer has to make payment on the purchase of the goods and/or services. Payment terms can allow for additional information such as whether any discount will be provided.
This Australian government has also published this useful information on payment terms.
What are considered "good" payment terms?
What can be considered "good" payment terms really depends on the position of the business or person who will receive the funds. For example, there is a big difference between a multi-million dollar company with plenty of cash reserves to manage overheads while waiting for funds to come in, and a small business or sole trader. Moreover, if a business is reliant on a small pool of customers for cash flow, payment terms will become an increasingly important part of their business.
Many customers take payment terms for granted and in Australia (like many other countries) it is considered a standard part of business-to-business (or B-2-B) transactions. However, it's important to remember that payment terms are the same concept as offering credit. The vendor or business providing the goods or services, is fronting the payment, because the good(s) or service(s) are being provided before payment, and is then reimbursed by the client.
Offering payment terms at all to a customer is, on the part of the customer, a privilege. What it means is that the vendor considers the customer to be financially viable and trust the customer to pay for the good(s) and service(s) when the relevant payment term expires and payment falls due.
Depending on your industry, and if you not a small business or sole trader, 30 days from the date (or receipt of) the invoice, with an invoice to be submitted monthly for good(s) or service(s) provided during the previous month, is fairly standard. Even better, however, is payment upfront for a portion of the fees (like a deposit), which can help ease the burden of cash flow on small businesses.
For small business or sole traders, 7 or 14 days from the date of the invoice, with an invoice to be submitted at regular (perhaps weekly) intervals, may be considered reasonable.
In many industries, like the building and construction industry, pay-when-paid clauses are unlawful and expressly prohibited by law. Many businesses involved in the building and construction industry are wrongly advised by their clients that they can only be paid once their client receives payment from and upstream principal. In these circumstances, not only is the pay-when-paid payment term invalid and unenforceable, but the client entity may also be engaging in misleading and deceptive conduct under the Competition and Consumer Act 2010 (Cth).
In Queensland for example, s 16 of the Building and Construction Industry Payments Act 2004 (Qld) provided that:
a pay when paid provision of a construction contract has no effect in relation to any payment for construction work carried out or undertaken to be carried out, or related goods and services supplied or undertaken to be supplied, under the construction contract
In Maxcon Constructions Pty Ltd v Vadasz  HCA 5, the High Court of Australia took a broad view of the pay-when-paid prohibition in equivalent South Australian legislation and held that provisions which make the release of retention under a subcontract contingent on an event under a head contract, are void and therefore unenforceable. The High Court reasoned that the due dates for payment of the retention sum were dependent on events which were unrelated to the subcontractor's performance. Because payment of the retention sum was dependent on the completion of the head contract (which had nothing to do with the subcontractor's performance), the head contractor had no right to deduct the retention sum from subcontractor's claimed amount.
The Australian Building and Construction Commission has also published this helpful information regarding security of payment and pay-when-paid clauses in Australian contracts relating to the construction industry.
There are other countries which also do accept the validity of pay-when-paid clauses, such as Singapore (in the context of the building and construction industry).
What is "supply chain finance"?
Supply chain finance is becoming an increasingly attractive option for bother buyers and sellers in the supply chain. So, what's is supply chain finance? It's simple; suppliers get quicker access to money that they are owed and buyers get more time to pay off the balance owed. Both parties can use the increased cash on hand for the benefit of each of their businesses.
The process involves:
Buyer issues an order to the supplier;
Supplier fulfils the order and send an invoice to the buyer;
The buyer approves the supplier's invoices and confirms that when the invoice falls due, it will pay the financial institution (which acts as the payment intermediary);
The supplier applies a discount to the invoice and 'sells' the discounted invoice to the financial institution;
The supplier receives the funds from the financial institution;
The buyer pays the financial institution when the invoice falls due.
This infographic also explains the process:
Good payment terms, bad payer
If your business has managed to negotiate favourable payment terms - great! However, if your client is notoriously bad at paying on time and in full, or you don't know your client particularly well, you need to ensure that your business maintains some leverage throughout the product / service delivery process so that you are able to compel your client to pay your invoice, without having to resort to expensive (and relationship-ending) legal tactics.
This might be as simple as:
for sale of goods, ensuring that title does not pass until payment is received in full, and registering those goods on the personal properties security register (commonly referred to as the "PPSR");
for services, ensuring that the client has no intellectual property rights unless and until payment is received in full and keeping draft watermarks on deliverables until payment is received.
If your business is part way through its agreement to supply goods and/or services, and it becomes clear that your client is not going to pay (at least reasonably on time), it's important that you do not explicitly refuse to carry out the rest of your agreement unless you have an express contractual entitlement to do so.
If your agreement doesn't give your business the right to stop supply or performance, and you refuse to do what you're contractually bound to do, you may be considered to have repudiated your agreement. Repudiation occurs when a party demonstrates, by words or conduct, that they do not intend to be bound by their agreement. There are significant consequences for repudiation and it's therefore important to consult with a lawyer before your business takes any significant steps due to non-payment of invoices.
Milestone payment terms
Another way of structuring payment terms is to have milestones which tie the right to claim payment to specific, measurable targets rather than to time. This type of structure is common in domestic building contracts, where a builder has a right to claim payment upon achieving a particular stage of construction.
An example of a milestone payment term (in the contact of a domestic building contract) is set out below:
deposit - 5% of the fee
frame - 15% of the fee
enclosed - 20% of the fee
fixing - 25% of the fee
practical completion - 15% of the fee
Milestone payment terms can, however, be problematic in other settings. For instance, a the achievement of a milestone may be dependent on your client doing (or not doing) something, on third parties or on industry, economic or other environmental factors which are outside the control of your business
Further, milestone payments can be problematic for cash flow. If your business isn't paid for the goods and/or services provided until it has achieved a certain milestone (generally after the relevant goods and/or services have been provided), your business has to fund the progress up to the point it receives payment.
If you are going to use milestone payments to structure your payment terms, it's important that you ensure that the milestone events are things that are entirely within the control of your business, and not subject to third party approvals or events which are outside your control.
Examples of milestone payment terms which may put your business at risk of not receiving payment in full or at all are:
the seller may submit an invoice for payment upon once the deliverable has been approved by the head client (what if the client never approves the deliverable; and
the seller may submit an invoice for payment upon the achievement of 50% of the services (and both the seller and the client dispute whether 50% of the services have been completed).
Another problem which is often seen (and evident in the above two examples), is poorly defined milestones. If the milestone is not sufficiently defined, disputes can arise between the parties about whether that milestone has been reached.
How can Prosper Law help?
Prosper Law is managed by Farrah, an expert business lawyer based in Brisbane. Farrah helps businesses with commercial and legal issues, right across Australia. Farrah is a top lawyer with experience dealing with payment terms in contracts. Contact Farrah using the details below and arrange a free consultation with a business lawyer to discuss your legal matter today.
Author: Farrah Motley | Legal Principal
PROSPER LAW - A Law Firm for Businesses
M: 0422 721 121