Default Interest in Commercial Contracts: Protecting Against Late Payment

The difference between collecting a receivable and collecting it on time becomes, in a period of high inflation, as important as the receivable itself. Where that difference lands is decided by the contract.

When default begins

In the supply of goods and services between commercial undertakings, the debtor falls into default on the agreed payment date, or on expiry of the statutory periods where no date was agreed, without any need for notice.

That is a real convenience for the creditor. But it concerns only when time starts to run; which rate applies is a separate question.

The statutory rate is often not enough

Where the contract sets no rate, the law applies a rate tied to the Central Bank's advance interest rate for commercial transactions.

The issue is not that the rate is low, but that it frequently fails to cover the creditor's actual cost of funds. A business that cannot collect draws on credit to cover the working capital gap, and that credit usually costs more than the default interest recoverable. Absent a contractual provision, the difference stays with the creditor.

What the contract should say

Five lines settle the question. Left unwritten, the parties fall back on the general law.

• Rate. State the default interest rate expressly. A formula tied to a reference rate often works better than a fixed number.
• Start. State the date from which interest runs.
• Due date. Tie the due date to delivery or acceptance rather than the invoice date, and the argument about late invoicing disappears.
• Application of part payments. Say whether they are applied to interest or to principal first. Without it, long-running relationships produce serious accounting disputes.
• Liquidated damages and security. Delay can be sanctioned by liquidated damages as well as interest.

Can interest be charged on interest

As a rule, no. In commercial matters it may be agreed on a limited basis in current account and loan relationships where both parties are merchants and the statutory conditions are met.

Outside those limits, compounding clauses may be held invalid. In practice a portion of an impressive-looking interest calculation falls away at trial for exactly this reason. A sound provision at drafting stage is worth more than a large calculation afterwards.

Before signing the counterparty's standard form

In most commercial relationships the counterparty drafts the contract, generally in its own favour. Three clauses recur:

1. The due date tied to service of the invoice, with the method of service left vague,
2. No default interest clause at all,
3. An unreasonably short period for notifying defects.

Reviewing these before signing is always cheaper than arguing about the same document afterwards.

Conclusion

Late payment is an unavoidable part of commercial life. What is avoidable is the creditor bearing its cost. A clear interest provision may not speed up collection, but it puts the burden of delay on the right side.