Contract Basics Series # 9: Payment terms
Published 1 February 2016
As highlighted in our briefing note #5, it is for the parties to a contract to ensure that the terms of that contract are sufficiently clear and unambiguous, so as to avoid leaving them open to unwanted interpretation.
This is particularly true in relation to payment terms, for instance:
As a supplier, you will want to ensure that:
- You get paid and on time;
- You not only recover your costs/investment in carrying out works, or providing goods/services during the term of the contract, but you also recover an acceptable element of profit on top.
As a customer, you will want to ensure that:
- You don't pay in excess of the price originally quoted for the works/goods/services;
- You don't pay for works/goods/services not carried out/provided, or not carried out/provided to the standard required under the contract.
In this note we look at payment terms in more detail and how these should be captured in the contract, depending on whether you are a supplier or a customer.
The contract should specify whether the price is fixed or variable and whether or not it is exclusive of VAT. Be aware that, if you fail to make clear that a price is exclusive of VAT and that VAT is additionally chargeable, then the normal rule is that it will be deemed to be inclusive of VAT.
If the price is fixed, then be precise about which works/goods/services are within the scope of the contract (and therefore included within the price) and which are "extras".
The contract should include a clear specification for the works/goods/services and price schedule. If you are a customer, you should give consideration to fixing the price of any optional extras, as far as possible. For a works or services contract, you might do this by including £/man-day and for a goods contract, by including a catalogue of goods you may want to purchase in the future together with their accompanying price list. As a supplier, you probably won't want to do this, as forward pricing may well create an element of financial risk on your part in which case it would be best to agree the price of any extras at the time the customer actually requires these.
If the price is variable, then the contract should set out a clear mechanism for how and when it might vary e.g. if by inflation, it should be clear how often the price might be adjusted (for instance annually) and which index is to be used to calculate any increase (such as RPIX).
It is just as important to correctly set out the “payment terms” as it is the price. These govern how and when the price should be paid. If you are a small supplier or will be incurring costs at an early stage in performing a contract, you may want to be paid at least a proportion of the price in advance, in order to be able to obtain the resources you need to be able to carry out the works or provide the goods or services. If you are a customer, you will want to hold off from making payments until you are satisfied that the works have been carried out or the goods/services provided in accordance with the contract.
At the very least, you should ensure that your contract covers the following:
When payment(s) will be made:
- How will the price be paid over the term of contract
This of course will very much depend on the nature and complexity of the contract; the price could simply be paid fully, in one lump sum (e.g. for payment of goods, on receipt of all of the required goods) or as each delivery of goods or services takes place, or in regular instalments (weekly, monthly or annually) perhaps with some sort of reconciliation being performed at regular intervals to tally with actual goods or services delivered.
For more complex contracts, we would expect to see quite structured payment terms, with once only elements of the price being paid when the supplier has met certain specific requirements (often by a predetermined deadline, known as a “payment milestone”), and ongoing payments being made on a monthly or quarterly in arrears basis, for services intended to be delivered on a regular or routine basis throughout the term of the agreement. The once only payments may, of course, be distributed in such a way that they benefit both parties by covering supplier cost at their lowest level and ramp up to reflect the delivery of value to the customer, as the contract works progress. They may also be designed to mitigate risk by holding back a suitable proportion of the price until the customer can be sure that the contract has been properly performed.
- On receipt of an invoice/statement?
In most cases, payment will be conditional upon the receipt of an invoice or statement. If so, the contract should state when such invoice/statement may be issued by the supplier and when (assuming the work has been properly performed) the customer will pay it (note that public sector customers ought to pay their suppliers within 30 days of receipt of a valid invoice). The contract should also make clear what sort of information should be included in the invoice (a customer will want the invoice to be as detailed as possible and will often ask for a full description of the works carried out/goods or services provided and related price and any supporting evidence, particularly if any extra costs have been incurred etc.).
How payments are going to be made: most commonly, this will be by bank transfer but it may include other forms of payments as well e.g. cheque.
For overseas supplies, you may want to be precise about the currency of any payment(s) due to be made
Deductions and/or set-offs - from a customer's perspective, you will want to consider including rights in the contract for you to:
- Make deductions from any payments due – e.g. where the supplier has not carried out the works or provided the goods/services in accordance with the customer's requirements – in such cases, it should be clear when deductions may apply and how they are calculated;
- Set-offs - If the customer has incurred additional costs as a result of the supplier not carrying out the works or providing the goods/services in accordance with the contract, it may want to set these off against the payments to be made to the supplier under the same (or indeed another) contract.
Timing of payment and interest on late payment - from a supplier perspective, you will want to consider whether:
- The timing of any payment should be “of the essence” i.e. whether non-payment amounts to a material breach of the contract which entitles the supplier to terminate? (please see our briefing note #6 in this respect);
- Interest should become payable on late payment, at what rate (typically set at a percentage above the annual base rate of the supplier’s bank) and over which period (typically from the original due date until the actual date of payment).
It can be seen from the above that what might appear to be a relatively simple concept – payment for services/goods rendered – can actually be quite complex in practice. If you require any help or assistance in reviewing or drafting contract provisions relating to payment terms, please do not hesitate to contact us - Helen Simpson or Carole Poletti.