CHAPTER 1
Payment Terms

Payment terms define the number of days used to calculate when seller gets paid. Buyer and seller can agree to one of the following terms: (1) no payment terms, implying that payment is made at contract completion; (2) payment will begin from a particular start date; or (3) payment will commence when an event happens, e.g., when buyer receives the product accompanied by a valid invoice.

In scenario (3), the contract may read that buyer has Net 30 days to pay seller after receipt of product. Net 30 days means that buyer has 30 days to make payment without penalty. Payment anytime after 30 days may be subject to monetary penalties depending on the contract’s terms and conditions. When credit is a concern, other payment terms may be considered, such as prepaid and add. Prepaid is defined as money paid up front, such as via a credit card or cash in advance (CID). Cash on delivery (COD) is payment made at time of delivery. These are payment terms and provisions that establish the monetary settlement of a transaction.

Defining the payment due date is always a concern to seller. The parties have a variety of avenues to determine when payment is due. It may be 30 days after receipt of goods or services, when seller achieves particular milestones in the contract, or some other marker the parties agree upon. Regardless of what payment schedule the parties decide upon, it is important that seller pays attention to the compensation language, to ensure that buyer has not incorporated language that may stall payment for any length of time or possibly in perpetuity.

Three specific payment provisions to pay attention to are: (1) acceptance and payment, (2) pay-when-paid, and (3) pay-if-paid. Let us review the definition, associated risks, and risk mitigation techniques for each.

ACCEPTANCE AND PAYMENT

Acceptance and payment requires that payment be made within a specified number of days from the date buyer accepts seller’s goods or services. An example of an acceptance and payment provision may read as follows, “Seller shall provide a valid invoice with each deliverable. Payment will be made thirty calendar days after the product is accepted by buyer.”

RISK

Accepting open-ended or vague language such as “payment will be made when product or services is accepted by buyer,” leaves the date of payment entirely up to buyer, i.e. seller may not be paid until such time that buyer elects to accept or reject the product or service. Absent a specific time frame for buyer’s acceptance or rejection of the products or services, the payment schedule is open-ended. Seller does not know when payment will be made, since buyer has no requirement to pay seller within a reasonable period of time.

RESPONSE

When responding to buyer’s acceptance criteria, seller should ensure that a reasonable period for acceptance is noted in the contract, e.g., approval or disapproval within 30 days from completion of services or date of product receipt. If not approved or disapproved within these 30 days, implication is made that the product has been approved and is subject to payment within a specified period of time. A typical time frame may read: Net 30 days from buyer’s receipt of an acceptable product.

In addition, it is important that the acceptance criteria be clear, concise, and consistent in any existing statement of work (SOW). The SOW is the measure used to determine whether payment is due.

PAY-WHEN-PAID

Unlike a pay-if-paid provision, which may result in a waiver or forfeiture of payment, paid-when-paid means that seller will be paid once buyer has been paid by their customer. An example of a pay-when-paid provision may read as follows:

Buyer will pay seller on all non-disputed invoices or undisputed portions no later than five business days after buyer receives payment from the government for same, unless otherwise agreed by both parties in writing. Seller agrees to submit accurate bills and will follow buyer’s invoice instructions as stated on buyer’s purchase order or task order. Buyer shall pay invoice amounts, less any specific amounts disputed in good faith, in accordance with the schedule specified in this clause.

RISK

Net payment terms are typically provided to a buyer with good credit, lending them ample time to make payment on an invoice. A pay-when-paid provision, on the other hand, defers payment until such time when buyer has been paid by their customer. Given that seller has no control over buyer’s customer, payment may be stalled for a period of time.

Even with the presence of a pay-when-paid clause, buyer is still obligated to pay seller within a reasonable period, provided that the cause for non-payment to seller is not related to seller’s provision of a non-compliant good or service. If seller does not receive payment from buyer, and it is through no fault of their own, buyer is ultimately liable for making good on the payment, regardless of whether they were compensated by their customer.

RESPONSE

Pay-when-paid provisions are used by big and small businesses alike as assurance that they remain solvent in the event that payment from their customer is late. Seller’s concern is that they have no control over when or if payment will be made by buyer’s customer. This is particularly true in subcontracts containing provisions stating that seller may not discuss matters relating to their subcontract with buyer’s customer. Before considering agreeing to such a provision, seller should recognize that buyer may defer payment for quite some time. Getting buyer to release payment before they have been paid, even if that time delay is considered by seller to be unreasonable, is a very difficult task, which may require arbitration in a worst case scenario.

The following are things that seller may want to consider when reviewing a pay-when-paid provision:

1) If buyer is a large corporation, recognize that they have deep pockets and that seller should request net payment terms rather than pay-when-paid terms. Monies owed to seller are easily paid by buyer, regardless of whether they have been paid by their customer. In support of this proposition, argue that seller has no control over buyer’s customer. Therefore, seller does not have the leverage required to ensure quick and timely payment. Specific areas that are beyond seller’s control include, (a) buyer’s submittal of a proper invoice to their customer, (b) the time it takes for buyer to create and submit a proper invoice to their customer, (c) whether buyer’s final product to their customer complies with the quality control standards of buyer’s customer, etc. Any one of these instances may result in buyer’s invoice being rejected, resulting in a delay in seller being paid by buyer. Only faulty workmanship should be a consideration for stop payment on seller’s invoice.

2) When seller has no choice but to enter into a pay-when-paid provision, try negotiating a not-to-exceed term. In drafting language, this means that payment will be made within a specified period of time, regardless of whether buyer has been paid by their customer. For example, seller may propose incorporating the following language into the subcontract:

Buyer will pay seller on all non-disputed invoices or undisputed portions of an invoice within five working days after buyer receives payment from its customer for same, but no later than sixty days after receipt of a valid invoice from seller.

3) If seller fails to settle on any of the above-mentioned provisions, request incorporation of an interest provision. Propose that interest accumulate each month at a specified percent from either (a) the date buyer receives payment from customer, or if applicable, (b) the commencement date of buyer’s interest provision with their customer. When subcontracting to a government prime contractor, it is a fair and reasonable request to receive interest payments starting from the date buyer begins collecting interest from their customer, given that prime contracts are entitled to interest payments per CFR Section 1314.4.

4) Omit any references to pay-if-paid provisions.

5) If seller considers agreeing to a pay-when-paid provision, review buyer’s credit rating via Dun & Bradstreet. A strong credit rating provides evidence that a buyer can make good on payment.

PAY-IF-PAID

Pay-if-paid precludes seller from receiving payment from buyer in the event that buyer’s customer does not pay buyer for work performed. It is not a matter of when buyer is paid by their customer—as is the case with a pay-when-paid provision—rather, it is a matter of if buyer is ever paid. The following is an example of a pay-if-paid provision:

The buyer shall be under no obligation to make any payment to the seller except to the extent that the buyer has received funds from the owner for the work performed by the seller; that is to say, the seller shall not be entitled to payment if for any reason, including the owner’s financial situation or lack of available funds, the owner fails to pay the buyer in accordance with the general contract.

RISK

The implication that seller may not be paid if buyer’s customer’s owner has not paid buyer has been debated by the courts for years; some have interpreted the pay-if-paid provision to mean that payment is only reasonably delayed. Other courts of competent jurisdiction have ruled that seller will only be paid when buyer has been paid by their customer. In the latter instance, the language in the body of the contract must be unambiguous for this to be true.

RESPONSE

Pay-if-paid clauses should be resisted by seller, because if buyer is not paid by their customer, depending on the competent court of jurisdiction, buyer may not be liable to seller despite seller’s provision of valuable work. This holds true even if the end customer cannot pay for any reason, including bankruptcy.