How to Reduce Payment and Debt-Collection Risks When Signing a Contract

The goods were delivered, the service was provided, and the invoice was duly issued. The deadline for payment has expired, but the money has not been paid. The business partner first asks for additional time, then stops responding, and finally begins to challenge the quality, quantity or scope of the work performed.

At that point, the creditor usually begins to consider a warning, a lawsuit, or collecting the claim through civil or enforcement proceedings. However, the payment problem did not arise only when the debt fell due. It arose earlier, when the job was accepted without a serious check of the partner, when the contract did not define the obligations precisely enough, or when appropriate security mechanisms were not agreed.

A good contract cannot guarantee that every debtor will pay. It can, however, significantly reduce the risk of non-payment, limit the possibility of subsequent debt disputes, facilitate the proof of claims and improve the creditor’s position if collection becomes compulsory.

Therefore, preventing a collection problem does not mean just predicting what will happen when the debtor is late. This means arranging the entire business relationship so that risks are recognized and limited before delivery of goods, performance of work or provision of services.

Business partner verification precedes the contract

Contractual protection begins before the contract is signed.

Before entering into a significant business relationship, it is necessary to check basic information about a potential partner. This includes checking registration, representative, status changes, publicly available financial reports and data on whether the business partner is in the record of debtors in enforced collection of the National Bank of Serbia.

Such a check does not provide a final assessment of solvency. However, it can indicate whether there are serious reasons for caution.

Special attention should be paid when a business partner:

• asks for an unusually long payment term
• refuses to provide basic business information
• does not want to offer a security instrument
• frequently changes business information, agents or affiliates
• insists on starting work without written documentation
• requests a new delivery even though previous obligations have not been settled

The fact that a company is formally registered does not prove that it has sufficient funds or assets to meet future obligations.

Checking partners is therefore not an expression of distrust, but part of responsible business risk management.

The subject of the contract must be precisely determined

One of the most common reasons why the debtor disputes the invoice is the claim that the goods, services or performed works did not correspond to the agreement.

Such an objection is much easier to raise when the contract contains only general wording, such as “providing consulting services”, “performing the agreed works” or “delivery of the required goods”.

The contract should specify:

• what exactly is delivered or executed
• in what quantity and scope
• according to which offer, specification or project
• within what time frame
• what quality standards should be met
• who is authorized to receive the goods or confirm execution
• how changes to the initial agreement are recorded

For more complex tenders, the technical specification, purchase order, project task or activity plan should be linked to the contract and clearly marked as its constituent parts.

For example, if “maintenance of the information system” is contracted, and it is not specified which services are included in the monthly fee, the client can later claim that additional interventions were already included in the price. If the scope of the service, the number of hours and the method of approving additional work are precisely regulated, the scope for such a dispute is significantly smaller.

The more specific the obligation, the less room there is to raise the question of what was actually contracted when the invoice is due.

The price and payment term must not remain undetermined

Formulations such as “payment upon completion of work”, “payment according to agreement” or “the price will be determined later” can create serious problems.

The contract should clearly determine the amount of the price or the method of its calculation. It should also be stated whether the price includes taxes, transportation costs, material, travel expenses and other related expenses.

Equally important is the exact payment term.

The contract may provide for:

• advance payment
• payment by completed stages
• payment in installments
• payment of a certain number of days from the issuance or receipt of the invoice
• payment after signing the minutes
• retention of part of the fee until the final handover

In the case of commercial transactions, the legal rules on payment deadlines should also be taken into account, because the contracting parties do not have complete freedom to set an indefinitely long payment deadline in any case. Particularly risky is the provision according to which the term begins to run “from the date of receipt of the invoice” if the contract does not specify how receipt is proven.

If the invoice is delivered electronically, the contract may specify the relevant electronic address, the person in charge of receipt and the moment when the invoice is considered to have been delivered. When regulations on electronic invoicing are applied to a specific relationship, the method of issuing and delivering invoices must be in accordance with those regulations.

Without clear proof of delivery of the bill, the debtor can claim that the payment term has not even started to run.

The contract must regulate the proof of performance

It is not enough for the creditor to fulfill his obligation. In the event of a dispute, he must be able to prove what he did, when and to what extent.

Depending on the type of work, evidence can be:

• signed delivery note
• handover record
• confirmation of the service performed
• work order
• construction situation
• report on the activities carried out
• signed specification
• electronic correspondence
• confirmation of receipt of goods
• proof of submission of documentation

The contract should determine who on the client’s side is authorized to confirm execution. Otherwise, it may happen that the document is signed by an employee whose authority is later contested by the other party.

For example, the goods may be properly delivered to the warehouse, but if the delivery note is not signed or it is not clear from it who received the goods, the customer can later dispute the delivery. The creditor then has to prove the execution through correspondence, witnesses, transport documents or other circumstantial evidence.

With services that do not leave a tangible result, it is especially important to agree on the method of reporting, approving individual stages and recording additional client requests.

Oral agreements may exist, but are much more difficult to prove. Therefore, any significant change in scope, price or deadline should be confirmed in writing.

Complaints should be settled before a dispute arises

If the contract does not regulate the complaint procedure, the client can claim that he is not satisfied with the quality of the work for the first time only after the invoice is due.

Therefore, the contract should specify:

• deadline for submission of objections
• the manner in which the objection is submitted
• information that the complaint must contain
• evidence supporting the deficiency
• the deadline for eliminating the justified deficiency
• the impact of the complaint on the undisputed part of the bill

The aim of such a clause is not to prevent a justified complaint, but to prevent unspecified and unjustified complaints from being used only as a way of delaying payment.

For example, if the client uses the supplied software solution for six weeks without complaint, and only after the invoice is due claims that it “does not work as expected”, a clearly agreed procedure for testing, handover and reporting defects can be of great evidentiary value.

However, the provisions on complaints must be adapted to the type of contract and harmonized with the law. It is not legally safe to simply state that the silence of the other party in every situation is considered a final acceptance of the work.

The legal effect depends on the nature of the work, the behavior of the contracting parties, relevant regulations and specific documentation.

Default interest and contractual penalty are not the same

These two institutes are often mistakenly equated in business contracts.

When the debtor is late with the fulfillment of the financial obligation, in addition to the principal, he also owes the statutory default interest, calculated from the day of the delay until the day of payment.

A contractual penalty has a different function. It can be contracted for failure to fulfill or irregular fulfillment of a non-monetary obligation, for example for delay in completion of works, delay in delivery or breach of confidentiality obligation.

According to the rules of the law of obligations, a contractual penalty cannot be contracted for a monetary obligation. This means that a provision that imposes an additional “penalty” on the debtor simply because he did not pay the bill on time may be legally unsustainable.

In the case of monetary obligations, protection is primarily achieved by default interest, appropriate security instrument, clearly agreed consequences of delay and timely response of the creditor.

Security Instruments Should Be Agreed in Time

The best time to ask for collateral is before the business starts, not after the debtor has already stopped paying.

The appropriate instrument depends on the value of the deal, the duration of the cooperation, the financial strength of the partners, the available assets and the negotiating position of the contracting parties.

Advance payment

The advance immediately reduces the amount that the creditor will have to collect later. It is especially justified with new clients, goods made to order, higher initial costs or jobs where the result cannot be sold to another customer.

However, an advance is not the same as a down payment. Their legal consequences are not equal, so the contract must clearly state the nature of the amount received.

Bill of exchange

A promissory note can provide the creditor with a more favorable procedural position and enable a more efficient initiation of enforcement proceedings for commercial claims if it is properly issued and if the supporting documentation is in order. Its value, however, is not unlimited.

A promissory note does not create property where none exists. If the debtor has no money in the accounts or other assets from which enforcement can be carried out, even a properly issued promissory note does not guarantee actual collection.

That’s why it’s important to check:

• who is the issuer of the bill
• who is authorized to sign it
• whether there is an appropriate bill of exchange authority
• to which obligation the promissory note refers
• under what conditions it can be filled
• whether there is a promissory note guarantor and what is his solvency

A promissory note should be part of a broader security strategy, not a substitute for due diligence.

Suretyship

With a surety, a third party undertakes to fulfill the obligation of the debtor under the conditions specified by the contract and the law.

A guarantee has real value only if the guarantor is financially capable. The guarantee of a business owner without assets or regular income may formally exist, but in practice it provides very limited protection.

That is why it is not enough to check only the main debtor. The person giving the surety should also be assessed.

It is especially important to precisely determine the scope of the guarantor’s obligation and to clarify whether it is an ordinary guarantee or a payer’s guarantee. In the case of ordinary suretyship, the creditor, as a rule, addresses the principal debtor first, while the paying guarantor answers to the creditor as the principal debtor. The difference directly affects the position of the creditor and the method of collection.

Bank guarantee

A bank guarantee can provide a high level of protection, especially for high-value transactions. Its advantage is that the bank assumes the obligation to pay, under the terms of the guarantee.

However, the guarantee increases the costs of the work and its practical value depends on precisely formulated billing conditions.

You should check carefully:

• the amount of the guarantee
• validity period
• requirements for submitting a request
• documentation to be submitted to the bank
• reasons for which the bank may reject the request

Pledge and mortgage

For larger claims, it is possible to consider security with a pledge on movable property, rights or claims, or a mortgage on real estate.

Before accepting such security, it is necessary to check ownership, existing encumbrances, the priority order of creditors and the real market value of the security object.

Assets that already serve as security for a number of creditors may have significantly less practical value than it appears at first glance.

Acknowledgment of debt

A written acknowledgment of debt can have significant probative value, especially if it clearly contains the basis, amount and maturity of the obligation.

It can also be important from the point of view of statute of limitations, because recognition of debt under legal conditions can lead to the termination of the statute of limitations and the beginning of its new course.

However, not every acknowledgment of debt is an automatically enforceable document.

Usually, the debtor’s signed statement can be strong evidence, but for the direct implementation of the execution, there must be a document that meets the requirements prescribed by law. The Law on Execution and Security governs which documents can be the basis for immediate execution.

Therefore, it is necessary to distinguish between:

• proof that the debt exists
• legal effect of acknowledgment of limitation
• the possibility of immediate initiation of enforcement proceedings

The mere wording in the contract that the document is an enforceable document is not sufficient if the legal requirements are not met.

Provide for Suspension of Performance and Early Maturity

Creditors often continue to deliver goods or provide services even when the partner is already in arrears. In this way, they try to save the client, but at the same time increase their own exposure.

The contract may provide for the creditor’s right to suspend further enforcement if the debtor:

• be late with payment for a certain number of days
• do not settle one or more installments
• fails to deliver the contracted security instrument
• exceeds the approved credit limit
• enters the blockade
• significantly worsen your financial position

When paying in installments, it is also possible to consider early maturity of the remaining debt if the debtor does not pay one or more due obligations.

Such clauses must be clearly written, proportionate and adapted to the nature of the specific business.

Limit the Amount of Outstanding Debt

Long-term cooperation often leads to loosening of internal control.

New deliveries are approved for the customer even though previous invoices have not been paid. The debt gradually grows, and the creditor practically becomes an informal creditor without proper risk analysis and adequate security.

The contract or internal business rules may determine:

• maximum amount of open debt
• maximum number of unpaid bills
• automatic suspension of new deliveries
• mandatory advance payment after the first serious delay
• periodic reconciliation of open items
• obligation to provide additional security instrument

A business relationship should not be terminated because of every short delay. However, continuing unlimited deliveries to a non-paying partner is not preserving cooperation, but rather taking on increasing risks.

Regulate Service of Notices and Jurisdiction Before a Dispute Arises

The contract should specify jurisdiction when such an agreement is permitted, as well as the addresses to which bills, notices and other notices are to be delivered.

It is important to edit:

• the address of the delivery seat
• relevant email addresses
• obligation to report data changes
• the person in charge of receiving documentation
• the moment when the notification is considered delivered

In the case of international business relations, it is necessary to additionally consider the applicable law, the competent court, the possibility of arbitration and the execution of the decision in another country.

Arbitration is not automatically better, faster or cheaper. Its justification depends on the value of the work, the international element and the complexity of the specific relationship.

The Most Common Mistakes That Make Collection More Difficult

The problem with billing usually does not arise because of one big mistake, but because of a series of smaller mistakes:

• the contract is signed by a person whose authorization has not been verified
• the subject of the contract is not described precisely enough
• the payment term is not clearly defined
• there is no proof of invoice delivery
• the delivery is not confirmed by the delivery note or record
• additional works are contracted orally
• there is no deadline for filing a complaint
• creditor continues deliveries despite accumulated debt
• bill of exchange is accepted without proper supporting documentation
• the guarantor’s financial capacity has not been verified
• collateral is required only after the debt has been incurred
• waiting too long to send the first warning

None of these errors necessarily precludes billing by itself. However, each one increases the scope for disputes, prolongs the procedure and weakens the creditor’s negotiating position. If the debt is already due, the next steps depend on the available documentation, the debtor’s financial situation and the choice of the appropriate procedure for collection of claims from the company.

Checklist before signing the contract

Before starting work, check:

Is the other contracting party properly identified and is the contract signed by an authorized person?

Are the goods, services or works described precisely enough?

Are the price, method of calculation and payment term clear?

Is there reliable proof of receipt?

How is it confirmed that the obligation has been duly fulfilled?

Who is authorized to sign the dispatch note, record or confirmation of execution?

In what period and in what way can the other party file a complaint?

What happens if the debtor is late with the payment?

Has a suitable security instrument been contracted?

When can the creditor suspend further deliveries and is there a maximum allowed amount of open debt?

Are the jurisdiction and method of delivery clearly regulated?

Payment Problems Should Be Prevented Before the Debt Falls Due

A quality contract is not an administrative formality or a document that should be opened only when a dispute arises. It is an instrument of business risk management.

A well-organized business relationship can significantly reduce the possibility that the debtor disputes the obligation, refers to unclear documentation or continues to increase the debt without consequences.

In order to prevent problems with billing, it is necessary to check the partner before the start of the work, precisely define the subject and the price, arrange the method of proof of execution, set clear deadlines and choose a security instrument that corresponds to the specific risk.

A generic contract form can rarely protect a seller of goods, a contractor, a consultant and a digital service provider equally well. The clauses should be adapted to the type of business, the value of the transaction, the method of payment, the debtor’s available assets and the real negotiating position of the contracting parties.

Therefore, legal verification of the contract before signing is usually simpler and cheaper than a subsequent attempt to collect a claim arising from an incomplete, unclear or inadequately secured contract.

A lawyer can help to recognize the risks of a specific business in advance, to adapt the contractual clauses to the actual business relationship and to choose a security instrument that has practical, not just formal, value.

Frequently asked questions

Does a well-drafted contract guarantee payment?

No. The contract cannot guarantee that the debtor will have funds or assets from which the creditor can be collected. It can, however, reduce risk, facilitate proof of debt and improve the creditor’s position in the collection process.

What is the best means of payment security?

There is no one best tool for every job. The choice depends on the value of the contract, the financial capacity of the partners, the duration of the cooperation, the available assets and the negotiating position of the parties.

Is the promissory note sufficient protection for the creditor?

Not necessarily. A promissory note may facilitate the initiation of enforcement proceedings, but it does not create an asset from which the debt can be collected. Its practical value depends on the correctness of the documentation and the actual ability of the debtor or promissory note guarantor to settle the obligation.

Can a contractual penalty be negotiated for late payment?

A contractual penalty cannot be agreed upon for non-fulfillment of a monetary obligation. In case of delay in payment, the rules on default interest and other permitted means of protection of the creditor are applied.

When should further deliveries to a late payment customer be suspended?

It depends on the contract, the duration of the delay, the amount of the debt and the risk assessment. When the partner exceeds the agreed limit, does not respect the agreed payment plan or there are signs of serious insolvency, continued deliveries without additional security may unjustifiably increase the creditor’s loss.

This text is informative and does not constitute legal advice for a specific business relationship.