9 Issues to Look for in the Payment Provisions of a Contract

Virtually all contracts have payment-related provisions which can span a wide variety of ancillary issues, including invoicing, disputes over invoiced amounts, timing of payments, and remedies for late payments. When reviewing these provisions, your position will, naturally, depend on your role in the agreement: are you the vendor collecting payment or the customer making payment? In some situations, such as in co-marketing deals, payments will be flowing in both directions.

Although I regularly represent clients on both sides of the table, in this post, I will focus on the buyer’s perspective by offering nine (9) key issues that should be considered when reviewing proposed payment terms.

1. Payment Amount
Beyond simply stating a number, the payment amount, as well as how it will be calculated, should be clear and mutually agreed upon. To reach this level of clarity, the buyer should consider the following questions:

a. Are fees fixed or variable?

b. Does the price include a volume discount or tiered pricing?

c. Is there a cap on variable fees?
For example, if fees are based on hourly work, must the vendor seek the buyer’s written consent for fees in excess of a certain amount?

d. Are fees fixed for the entire initial term of the contract?

e. Can fees be increased on renewal? If so,

(i) there should be a cap on the increase (e.g., no more than 3%, or the increase in the CPI index); and
(ii) the vendor should be required to give advanced written notice of the increase in the renewal price. Ideally, this notice should be far enough in advance of the buyer’s renewal decision in order to preserve the buyer’s right to terminate. For example, if the buyer is required to opt out at least 60 days before the end of the term, then the vendor must notify the buyer of pricing changes at least 60-90 days before that date, rather than just before the term end date.

f. Is payment based on a percentage of something else?
In some contracts, payment may be based on a percentage of the buyer’s revenues from the agreement (revenue sharing arrangement), or based on a percentage of collections made by the vendor on behalf the buyer.

If so, the buyer should seek to clarify:

(i) Scope: The buyer only wants to pay fees on the percentage of revenues or amounts collected that are directly attributable to the vendor, not on those generated by the buyer outside the scope of the agreement.

(ii) Deductions: Most percentage payment provisions carve out deductions for items such as subsequent refunds or chargebacks due to cancellations or errors, taxes, shipping costs, etc. Deductions for things like refunds, taxes and shipping should apply even if you are using a percentage of “gross” price instead of “net” (see more below), because these are, effectively, not even a part of the purchase price at all.

(iii) Gross vs. Net: The buyer should clarify whether payment will be tied to a percentage of “gross” or “net” amounts. With a “net” arrangement, since the percentage is applied after all deductions have been made, it is important that the buyer list with specificity all qualifying deductions, which may include, in addition to those listed in (ii) above, deductions for cost of sales, sales commissions, revenue shares to other parties, overhead, marketing costs, etc.

2. Timing of Payments
In most situations, payments are usually due with 30 or 60 calendar days (referred to as net 30 or 60 days). Vendors will prefer net 30, while you may prefer net 60, but net 45 is a fair and common compromise.

3. Starting the Clock
Let’s assume that the parties agree to “net 45.” Now, it must be decided when the clock starts on the 45 days. The vendor may propose that the window for making payment begins on the “invoice date,” which could mean the date the invoice is mailed or the date listed on the top of the invoice (even if the invoice is “backdated”). Both options can leave the buyer at a disadvantage, especially when the invoice is mailed via snail mail. Preferably, a buyer should request that the payment clock begin on the date the invoice is actually received.

4. Payment Disputes
As a customer, you will want the right to dispute invoices in good faith and the obligation to pay only “undisputed” or “correct” invoices. In the case of partially disputed invoices, typically, the buyer should agree to pay all undisputed amounts and withhold the rest, pending the resolution of the dispute.

5. Dispute Deadlines
Often, a vendor will seek to include a deadline by which the buyer must dispute any invoice. For example, the vendor may propose that the buyer’s right to dispute is considered waived if an invoice is not disputed within 30 days of receipt. However, this position feels rather draconian, particularly for those deals where it might take longer to discover an invoicing error.

Instead, a buyer should request a longer window (e.g., 90 days) in which to report a dispute; and/or even better, argue to eliminate the waiver of rights at the end of the dispute period and replace it with a shifted burden of proof which states that, in the absence of clear evidence to the contrary, the invoice will be presumed correct, unless the buyer objects within x days.

6. Payment of Overages or Extras
Similar to limiting the buyer’s right to dispute an invoice, the buyer may wish to limit the window of time in which a vendor can charge for overages or extras. This clause protects a buyer from being charged for expenses that are tied to a previous quarter or year. For example, the vendor may be asked to waive its right to invoice for overages that are beyond a certain number of days old.

7. Interest or Penalties
It is common for vendors to ask for the right to charge interest on late payments. Buyers should try to delete this provision entirely, especially when the buyer is a big company that does not pose a payment risk to the vendor. If this request is met with resistance, the buyer should seek to limit this right by restricting its applicability to undisputed amounts only, and/or by lowering the amount of interest. For example, if the vendor asks for one and a half percent per month, propose one half percent per month instead.

8. Payment Schedule
The payment schedule is critically important. If the vendor wants payments in advance, the buyer might push back and ask for payments in arrears. If payments must be made in advance, the buyer can try to increase their frequency. For example, if the vendor proposes an annual payment in advance of performance under the contract, the buyer should counter by requesting quarterly advanced payments. Why? Quite simply, cash is leverage. By pre-paying, the buyer is left with little to no leverage in the event there is a dispute, such as over the quality of the services. With the cash payment still in hand, however, the buyer will likely have the vendor’s full attention to try to resolve the issue. Therefore, it is important for the buyer to negotiate the right to withhold payment when the vendor is in breach of the agreement (see # 4 above).

9. Reimbursable Expenses
If the buyer agrees to reimburse any of the vendor’s expenses, reimbursement should be conditioned upon limitations such as including only those expenses which are (i) reasonable and necessary, (ii) evidenced by receipts, (iii) pre-approved in writing by the buyer, (iv) passed through to the buyer at cost, without markup; and (v) in compliance with the buyer’s applicable travel and expense policies.

As a buyer, it is smart to clarify these issues before entering into a contract, especially when it is with a new vendor. Understanding how these nuances will be handled can go a long way in avoiding potential disputes down the road. 

Brian Heller is a Member of Outside GC’s Washington D.C.-based team, and is an experienced technology and deal attorney, specializing in SaaS software licensing, Virtual Reality (VR) products and services, digital and social media, online advertising, mobile apps, cloud services, terms of use, data use and protection and content licensing. Brian has represented both vendors and customers and uses this experience to present reasonable positions on behalf of his clients. Brian can be reached at [email protected].