Payment Terms

Written by: Patrick Shaunessy

23 minute read

What are payment terms?

Payment terms are contractual provisions that establish rules for when and how payment for goods or services supplied under a contract must be made. As the examples below illustrate, a contract’s payment terms often appear together either as a standalone “payment terms” (or similarly labelled) section or as part of the section addressing pricing terms more generally. Note, however, that in some contractual arrangements, the payment terms may not be specified in the agreement itself - for example, the party supplying goods or services may set out the payment terms in its invoices and/or there may be a separate document detailing its “standard terms and conditions” for payment. In any event, where the agreement itself does not provide this information, it should state what document(s) the parties can reference to confirm the applicable payment terms.

Why do payment terms matter?

No matter what their role in the contract, businesses generally consider payment terms to be among the most important aspects of any commercial arrangement. For those supplying goods or services (sellers), the payment terms are critical to revenue and receivables management, as they help sellers assess the timing of cash inflows, determine transaction prices, and evaluate the collectability of accounts. For those receiving goods or services (buyers), the payment terms are critical to payables management, as they help buyers assess the timing of cash outflows as well as the degree of flexibility, if any, they have in paying their trade accounts. Indeed, in many business-to-business transactions, sellers will typically allow buyers to buy goods or services and pay for them later. This ability to defer payment for a given period (often between 30 and 90 days), including the option to receive a discount for early payment, is known as trade credit, and it is an essential source of short-term financing for many businesses. Accordingly, having a firm grasp of the payment terms in their contracts allows businesses to manage cash flow effectively and make important financial and operational decisions.

How do you review payment terms in contracts?

When payment terms are set out in their own section or are included in the pricing section of an agreement, finding them is generally straightforward. As the examples below illustrate, however, these sections can be fairly dense, requiring careful review to identify all the essential payment-related information. Furthermore, terms like penalties for late payment, although often included with the rest of the payment terms, are not always so included. And so, even when an agreement has a pricing or payment terms section, be sure to confirm that all relevant terms are accounted for, and if any are missing, check to see whether they appear elsewhere in the agreement.

After locating all the payment terms in each agreement, some important things to focus on when reviewing these provisions include:

  1. Payment due date and early payment discount. The payment due date is the date by which payment for goods or services delivered (or to be delivered) under a contract must be made. As the examples below illustrate, the due date is often stated as a number of days from the invoice date. However, as discussed in point 3 below, sometimes agreements stipulate that certain amounts must be prepaid before an order is processed, and, as is the case in example 2 below, the prepayment amount often becomes due when the seller confirms receipt of the order. A contract’s payment terms may also include an early payment discount. Section 4.3 of example 1 below illustrates how this early payment discount is typically indicated: “2% / 15, Net 75 days.” For those unfamiliar with this shorthand, it means that the buyer is entitled to a discount of 2% if it pays the invoice within 15 days; otherwise, the invoice must be paid in full no later than 75 days from the invoice date. When evaluating whether to take advantage of an early payment discount, buyers will want to consider the cost of trade credit - that is, the cost of paying the full amount rather than the discounted amount. Cost of trade credit is highest immediately after the early payment deadline and lowest at the final payment due date. Using the terms of example 1 below to illustrate, the cost of trade credit (in annualized terms) for payment in full after 75 days is [1 + (0.02/(1 - 0.02)) ^ 365/(75 - 15)] - 1 = 13.08%. If Customer’s (the buyer’s) incremental short-term borrowing cost from other sources is greater than 13.08% per year, then it is better to delay payment until the final due date; otherwise, it should take advantage of the early payment discount.
  2. Payment method. The payment method is a payment term that is not always included in the agreement itself and instead may be stated in the seller’s invoices (or in its standard payment terms and conditions, if applicable). For instance, out of the fifteen examples below, only example 2 specifies the payment method (see section 6.5.4). In either case, be sure to note the acceptable methods of payment and any details relevant to such method (e.g., bank information for electronic funds transfers, address for sending payments if by cheque, etc.).
  3. Timing of payment. As noted above, the payment due date specifies the date by which payment must be made; whereas the timing of payment considers when the obligation to pay arises relative to the delivery of goods or services. Some agreements, like example 2 below, may stipulate payment in advance for goods or services (or, alternatively, they may require a deposit on account of the purchase price, which is then drawn down as goods or services are supplied to the buyer). For sellers, being able to receive payment in advance is beneficial from both a cash-management and credit-risk perspective. Sellers (or their finance teams), however, will want to understand when and over what period they will perform the obligations related to any advance payment to ensure that (i) the recognition of revenue follows applicable accounting standards and (ii) these advance payments are accurately reported in their financial statements (typically, they are booked as “deferred revenue” - a balance sheet liability - until recognized). For buyers, contracts mandating up-front payment decrease their available cash and/or require them to use available credit facilities sooner rather than later, thereby exposing them to potential opportunity costs and/or excess financing costs. Therefore, all else equal, buyers generally prefer to buy goods or services on account (i.e., using trade credit).
  4. Invoice requirements and frequency. To avoid a delay in payment due to a defective invoice, sellers will want to check the payment terms to see if there are any prescribed invoice requirements. Example 1 below, for instance, states that any taxes or duties for which the Customer (the buyer) is responsible must be listed on a separate line in each invoice. Note, as well, details about invoice frequency. For sellers, this information lets them know how often they will need to issue invoices to the customer; and for buyers, it lets them know how often to expect payment requests throughout the term. Section 5.4 of example 4 below, for instance, states that Consultant (the seller) will provide Customer (the buyer) with invoices for fees and expenses on the last business day of each month. Similarly, example 5 below states that invoices will be issued on the first of each month (and also requires each invoice to include details of any Subscription Software placements then in use).
  5. Taxes and duties. The payment terms often indicate who is responsible for paying applicable taxes or duties on the subject goods or services, and, in many cases, it is the buyer who bears this cost. Yet, even when this is the case, the buyer should pay attention to when this responsibility arises. In example 1 below, for instance, section 4.4 states that Customer (the buyer) agrees to pay all taxes or duties on the OEM products that Supplier (the seller) may be required to collect or pay (other than taxes levied on Supplier’s income, which is a typical exclusion), relating to the period after delivery to the designated destination. In other words, if there are taxes or duties to be paid on the OEM products up to the time of delivery at the designated destination, Supplier pays them (and perhaps passes those costs on to Customer indirectly through its prices). In addition, be sure to check the shipping terms for additional details such as Incoterms, as these can also help identify the point at which responsibility for things like taxes and duties passes from seller to buyer. Returning to example 1 below, the shipping terms in that agreement should specify what the “designated destination” is so that Customer can readily assess the taxes or duties for which it is directly responsible.
  6. Interest on overdue amounts. As the examples below illustrate, the payment terms will often specify the amount of interest payable on overdue amounts (penalty interest). Like the cost of trade credit, penalty interest represents a financing cost to buyers. When deciding whether to delay payment beyond the applicable due date, one factor buyers will consider is the difference between the annualized penalty interest rate and their incremental short-term borrowing rate from other sources. All else equal, if the penalty interest rate is less than the incremental borrowing rate, it will be cheaper for buyers to delay payment rather than borrow to pay the amount on time. In addition, to avoid penalty interest being disqualified under applicable usury laws, agreements may qualify the amount of penalty interest as being the lesser of the (i) the maximum rate allowed under applicable law and (ii) a fixed rate (see examples 2 and 3 below). In such cases, to confirm the maximum allowable rate, check the governing law section to determine what jurisdiction’s laws apply to the agreement.

As with the review of any contractual provision, it’s also important to be aware of other provisions that may affect the payment terms. The shipping terms, for example, were mentioned in point 5 above and the governing law section in point 6 above. The pricing terms establish the amounts that will be charged for goods or services, including details about currency, price adjustments, minimum purchase requirements, etc., which help parties verify the accuracy of any invoices issued pursuant to the agreement. Note that specific pricing terms, like payment terms, may be included in the agreement itself (including as a schedule attached to the agreement) or they may be detailed elsewhere. In addition to early payment discounts, other provisions addressing discounts (e.g., volume discounts, etc.) as well as product defects, rights of return, refunds, rebates and credits are also important to consider when looking at payment terms. Set-off provisions clarify whether a party has the right to deduct amounts it is owed by the other party from any payments it makes pursuant to the agreement, which may be of particular interest to buyers (e.g., in circumstances where a refund payment is outstanding). Finally, the events of default section (or, alternatively, the termination section) will typically list the failure to make timely payment as a default, and it may also state an amount of time (or cure period) that the defaulting party has to fix this problem before the other party can invoke its remedial rights (including, possibly, the right to terminate the agreement). For buyers that may be experiencing financial difficulty, knowing these absolute limitations on late payment can help them assess how much leeway they have to weather a difficult period without (i) losing the benefit of critical goods or services (or of entire agreements altogether) or (ii) incurring significant penalties that would worsen their financial situation.

Software that uses AI to identify and extract payment terms (as well as other terms that may affect their interpretation) can accelerate the work of finding these provisions and enable a more comprehensive review than can otherwise be done manually.

Examples of Payment Terms

Below are some examples of payment terms from different kinds of agreements. While these examples do not necessarily cover the full range of payment terms one may encounter, they are meant to illustrate the degree to which these provisions can vary from contract to contract.

Example 1: From a Purchase and Supply Agreement

PRICES AND PAYMENT TERMS

4.1 OEM Product Prices. Supplier’s prices for the OEM Products are listed in Exhibit B, in U.S. currency unless otherwise stated, and may not be increased without Customer’s written consent. The prices for Parts and Accessories will be Supplier’s published prices, less any applicable discounts as set forth in Exhibit B, unless the parties agree to a price schedule for Parts and Accessories. OEM Products and Parts will also be subject to any applicable prompt payment discounts.

4.2 Changed Prices. If during the Term changed prices or price formulas are put in effect by mutual agreement of Customer and Supplier, or reduced prices or price formulas are otherwise put in effect by Supplier, such prices or price formulas (if resulting in lower prices than the then current price) will apply to all Orders issued by Customer after the effective date of such prices or price formulas and to all unshipped Orders.

4.3 Payment Procedure. Payment for OEM Products will be 2% / 15, Net 75 days from the invoice date for the OEM Products following shipment by Supplier. Customer will not be liable for payments or any costs related to unordered or Noncomplying Products.

4.4 Sales Taxes And Duties. Prices are exclusive of all taxes or duties after delivery to the designated destination (other than taxes levied on Supplier’s income) that Supplier may be required to collect or pay upon shipment of the OEM Products. Any such taxes or duties must appear as a separate item on Supplier’s invoice. Customer agrees to pay such taxes or duties unless Customer is exempt from such taxes or duties. Where applicable, Customer will provide Supplier with an exemption resale certificate.

Example 2: From a Manufacturing and Supply Agreement

6.5 Payment Terms.

6.5.1 For any Materials and equipment to be ordered by Supplier specifically for Client under this Agreement, Client will issue Purchase Orders for such Materials and equipment pursuant to this Agreement and Client will pre-pay Supplier for one hundred percent (100%) of the cost of the ordered Materials and equipment (plus any associated services fees. see Section 9.7) when Supplier confirms the Purchase Order. Supplier will not order any Materials and equipment contained in any Purchase Order until pre-paid in full by Client.

6.5.2 For all other services performed by Supplier hereunder, including without limitation Production of Product, Client will issue Purchase Orders for such services pursuant to this Agreement, and Client will (i) pre-pay Supplier for fifty percent (50%) of the total amounts contained in the Purchase Order when Supplier confirms such Purchase Order, and (ii) pay Supplier the remaining fifty percent (50%) of the amounts contained in the Purchase Order upon completion of the services. The amounts contained in Client’s Purchase Orders for services will coincide with those amounts for services contained in Supplier’s proposal dated July 22, 2015, as adjusted pursuant to this Agreement. Supplier will issue an invoice upon its completion of the services and Client will pay the amount of such invoice within thirty (30) days of receipt thereof. Supplier will not release any Product to Client until paid in full by Client.

6.5.3 Client shall pay for stability testing as invoiced by Supplier within thirty (30) days of the invoice date.

6.5.4 All payments shall be made by wire transfer to a bank account specified by Supplier. All payments shall be made by Client in accordance with the terms noted above. All prices quoted by Supplier, e.g. in the Product Master Plan, are ex value added taxes and in Euros. Any payment due under this Agreement not received within the times noted above shall incur finance charges at the lesser of (a) the maximum rate permitted by law, or (b) one and one-half percent (1.5%) per month on the outstanding balance.

Example 3: From an End-User License Agreement

2.1 PRICING AND INVOICES. End User will be invoiced (an “Invoice”) for those amounts and at those prices set forth in the Order Form for the Term indicated therein, provided, however, that, for Evaluation Use, End User shall not be billed unless otherwise specified by AppDynamics in writing prior to End User accessing the Services. Fees do not include any customization of the Services.

2.2 PAYMENTS. End User shall pay Invoices within thirty (30) days of the date of receipt thereof (the “Invoice Due Date”). All payment obligations are non-cancelable and all amounts paid are non-refundable, except for amounts paid in error that are not actually due under this Agreement. The fees paid by End User are exclusive of all taxes, levies, or duties imposed by taxing authorities, if any, and End User shall be responsible for payment of all such taxes, levies, or duties, excluding taxes based on AppDynamics’ income. End User represents and warrants that the billing and contact information provided to AppDynamics is complete and accurate, and AppDynamics shall have no responsibility for any invoices that are not received due to inaccurate or missing information provided by End User. End User shall pay interest on all payments not received by the Invoice Due Date at a rate of one and one percent (1%) or the maximum amount allowed by law, whichever is lesser. Following fifteen (15) days written notice, AppDynamics shall be entitled to terminate or suspend End User’s access to the Services if payments are not received within forty-five (45) days of the Invoice Due Date.

Example 4: From a Consultancy Agreement

  1. FEES AND EXPENSES

5.1 The parties have agreed that as consideration for the provision of the Services, Consultant shall be entitled to receive a fee at a rate of US$20,000 per month (the ‘Fee’), in accordance with clause 5.2 below.

5.2 The Fee detailed in clause 5.1 above shall be paid monthly in advance and shall be paid on the first day of each calendar month, beginning with the first month following the month in which the Commencement Date occurs; provided, however, that the first payment made to Consultant hereunder shall consist of the monthly Fee detailed in clause 5.1.2 plus a pro rata portion of the monthly Fee for the preceding month in which the Commencement Date occurs based upon the number of calendar days in such month following the Commencement Date.

5.3 In addition, Consultant shall be entitled to be reimbursed by Customer for any Expenses incurred by Consultant in performing services under this Agreement. All Expenses must be expressly agreed with Customer in writing before being incurred.

5.4 Consultant shall submit invoices to Customer: (i) for any Fees payable under clause 5.1; and (ii) for any Expenses payable under clause 5.3, at monthly intervals on the last Business Day of each month.

5.5 Each invoice submitted to Customer in accordance with clause 5.4 shall clearly show: (i) the period in respect of which the invoice is issued; (ii) the total amount payable; (iii) the calculation of the amount payable, including attaching any invoices or other proof of payment for any expenses incurred in the provision of the Services; and (iv) the amount of any value added tax or other applicable tax which is additionally payable.

5.6 Customer shall pay each of Consultant’s invoices for its Fees and Expenses due in accordance with this clause 5 (provided such Expenses were approved in accordance with clause 5.3). Payment in full or in part of any Fees or Expenses shall be without prejudice to any claims or rights of Customer against Consultant in respect of the provision of the Services.

5.7 Customer shall be entitled to deduct from any Fees, Expenses or other amounts due to Consultant any sums that Consultant may owe to Customer at any time.

5.8 For the avoidance of doubt, no Fees shall be payable in respect of any period during which the Services are not provided.

5.9 The Parties agree that Consultant will act as an independent contractor in the performance of its duties under this Agreement. Accordingly Consultant shall be responsible for payment of all taxes arising out of its activities in accordance with this Agreement.

5.10 In the event that for any reason Customer fails to pay when due all or any portion of any fee payable to Consultant in accordance with this Agreement, interest shall accrue and be payable on the unpaid balance from the date when first due up to and including the date when actually collected by Consultant, at a rate equal to seven per cent. (7%) per annum computed on a daily basis.

Example 5: From a SaaS License Agreement

Section 5. Payments and Terms. LICENSEE agrees to pay the Software Subscription Fee for the software delivered to LICENSEE’s clients according to the terms set forth in Schedule 1: Products and Pricing. LICENSOR will invoice LICENSEE the first of each month for the number of Software Subscriptions then in effect, providing a detail of the Software Subscription placements in use. All invoices are due net 10 days. Payments due LICENSOR pursuant to this, Section 5, of the Agreement which are not received on time are subject to and will be assessed late charges equal to one and one half (1.5%) percent per month calculated daily from the due date of the invoice. Failure to make timely payment for the LICENSOR Software or for additional LICENSOR services may result, in LICENSOR’s sole discretion, in terminating such services without violating this Agreement. LICENSOR agrees, however, not to terminate such services unless it shall have first given written notice to LICENSEE of the default in payment and full payment (including any late charges) is not made within ten (10) days from the date of such notice.

Example 6: From a Manufacturing and Supply

8.3 Payment Terms. Manufacturer shall invoice Customer for the Purchase Price at the time of delivery, and Customer shall pay each such invoice within thirty (30) days after its receipt of the invoice; provided, however, that if Customer rejects a shipment pursuant to Article 9 of this Supply Agreement, then payment shall be due within thirty (30) days after receipt by Customer of notice from the laboratory pursuant to Section 9.3 of this Supply Agreement that the invoiced Product is conforming, or the receipt by Customer of replacement Product, as the case may be. Except as may be required under Sections 4.7 or 4.8 with respect to Product that conformed to this Agreement prior to the applicable changes, Customer shall not be required to pay for non-conforming Product.

Example 7: From a Service Agreement

  1. PAYMENT

Upon execution of this Agreement by Company, Company agrees to pay Service Provider 50% of each pre-purchased unit upon delivery by Service Provider. Upon receipt of the initial prepaid order, all goods will be delivered to Company within 30 days. Company agrees to pay Service Provider net 30 days all balances for each and every order.

Schedule A is expressed in US dollars.

All rates as quoted in Schedule A will remain in effect for a full 12 months commencing with the signing of this agreement.

Example 8: From a Transitional Supply Agreement

2.5 Payment Terms. Purchaser shall pay all undisputed invoices within [] end of month after receipt of such invoice for the order, provided that the relevant Certificate of Analysis, Certificate of Conformance and all other appropriate transport related documentation have been provided to Purchaser. Such invoice shall be sent at the time of delivery of such Products to Purchaser or its Affiliate in accordance with Section 8.1. All payments made hereunder shall be in U.S. Dollars. Any payments not made within the specified period of time for payment shall incur an interest charge at the rate of the Default Interest Amount on such overdue amounts, excluding any amounts that are subject to a bona fide dispute between the Parties. In addition, Manufacturer may withhold delivery of Products if Purchaser fails to make any payment required under this Supply Agreement (except for any amounts that are subject to a bona fide dispute) [] days after the due date for such payment. Manufacturer will accept payment by wire transfer, provided that any wire transfer will include a reference to Manufacturer’s sales invoice number.

Example 9: From a Supply Agreement

3.2 Invoicing. Supplier may invoice for Products as early as the date upon which the Products are shipped. Customer shall pay Supplier undisputed amounts due under this Agreement within 45 days after receipt of the invoice. Customer may withhold payment of charges that are the subject of good faith disputes and both Parties agree to cooperate and use reasonable efforts to promptly resolve the dispute in accordance with the dispute resolution process set forth in Section 1.4 above. The invoice dispute procedures set forth in this paragraph shall not limit the scope of the warranty and quality control obligations of Supplier hereunder

Example 10: From a Manufacturing and Supply Agreement

4.3 Payment Terms. Payment for each order of Product placed by Purchaser shall be made as follows: 20% of the total payment for the number of units ordered shall be paid by wire transfer of immediately available funds, upon the placement of the order, with the balance due before shipment arrives at the U.S. port of destination. Manufacturer will notify Purchaser of the shipment date and anticipated arrival date. Manufacturer will release the Bill of Lading to Purchaser or its designee within three (3) business days after receiving payment as set forth herein regardless of whether the shipper has arrived in port. Any amounts not paid when due shall bear interest at the rate of 1.5% per month or the highest rate allowed by law. Any storage or demurrage charges incurred at the port pending receipt of Purchaser’s payment shall be paid by Purchaser. Manufacturer will consider in good faith proposals from Purchaser for alternative financing which provide Manufacturer with equal or greater security for payment, but Manufacturer shall have sole discretion to accept or reject any such proposal.

Example 11: From a Manufacturing and Supply Agreement

(A) Terms of payment are net 30 days from date of invoice. Invoices not paid within 30 days from date of invoice shall be subject to a one and one half percent (1.5%) per month late payment charge (or in the event such late payment charge is deemed to be interest, the maximum interest rate permitted by law, whichever is lower) on the overdue amount from date of invoice to the date of payment.

Example 12: From a Commercial Supply Agreement

Payment. Company shall pay to Manufacturer a deposit for each Purchase Order in the amount of fifty percent (50%) of such Purchase Order upon acceptance by Manufacturer thereof, and Company shall pay to Manufacturer the remaining balance prior to shipment thereof.

Example 13: From a Manufacturing Services Agreement

7.4. Invoice & Payment

7.4.7. Purchaser agrees to pay all invoices within 7 business days of receipt for Engineering and Tooling charges and Pilot Production shipments; and net 45 calendar days from date of invoice within bank credit limit. For invoices exceeding credit limit, Purchaser agrees to pay 50% deposit upon placing order and the remaining balance before Manufacturer ships Product.

Example 14: From a Supply Agreement

5.1 Supplier shall invoice Distributor for all product sold to or on behalf of Distributor, and Distributor shall pay said invoice within 2% 10 days, 20 days net, from receipt of said invoice.

Example 15: From a Licensing and Supply Agreement

  1. Terms and Conditions of Orders. Sections 1, 2, 3, 4, 5, 6, 7, 8a, 11 (except the last sentence), 13 and 14 of Licensor’s Standard Terms and Conditions of Sale, a copy of which is attached hereto as Exhibit C, shall apply to this Agreement. Payment terms shall be net 30 days from the date of Licensor’s invoice. Acceptance of OVP supplied under this Agreement for conformity with the shipping documents shall occur within 30 days after delivery to Licensee. In the event that Licensee fails to make payment within such 30-day period or as long as such payment remains unpaid, Licensor may in addition to any other remedies available to it, at its option, (i) make immediately due and payable any subsequent invoices delivered by it to Licensee; (ii) suspend all deliveries; or (iii) require that Licensee pay Licensor’s finance charge at the maximum rate permissible by law not to exceed 1% per month on the unpaid balance of Licensee’s account from date of Licensor’s invoice.