There are a large number of legal reasons why people in small business do not get paid. Not all of them apply to all businesses, however some of them will apply to just about every business.
Not getting the scope of the contract properly and clearly agreed
Lack of clear, written definition of exactly what the contract is about, in a single document, is a major cause of contractual disputes. Often contracts are negotiated by lengthy email chains, sometimes with intervening phone calls, with each party thinking they are clear on what has been agreed. When there is a dispute there is no single document that records exactly what is to be supplied. Often the email chain does not make as much sense to your lawyer, or the court, as you thought it did. At the end of the negotiation process, take the time to record everything in a single document and have both parties sign it.
Often that document will just be the definition of what has to be supplied but will not contain all the terms and conditions, like payment terms. If your standard terms and conditions are also intended to apply, and they should be, make sure that is stated in the scope of work document, and attach a copy of the Ts and Cs to it, before you sign.
Not getting variations in agreed in writing
You may have taken care to ensure that your initial contract was properly drafted, but then the customer/client (referred to as customer for convenience) wants to increase the quantity of goods you are supplying or the scope of work. That’s great, but as much care should go into agreeing any change to scope as goes into the initial contract. Many businesses have lost large amounts because they verbally agreed to vary the scope of the job, only to find the customer denies the variation was agreed to, or disputes the extent of it, or the addition to the price, when it comes time to pay. Make sure the amended scope of work, and the amended price, is clearly agreed to by both parties in writing and signed before you start work on the variation.
If you’re in business we have designed terms proposed by the customer, be careful about clauses where they can require you to vary the scope, unless the clause gives you freedom to quote a fair price for the varied work and does not oblige you to start work on the variation until the cost is agreed in writing. Tradespeople in the construction industry on larger jobs will find this is a particularly common source of disputes.
Termination or suspension
If you provide goods or services under an ongoing contract and your customer doesn’t pay on time you can’t necessarily terminate the contract or suspend performance. You only have a clear right to do so if the contract says so. So ensure that this right is in your Ts and Cs. Courts have often held that even very late payment is not a sufficiently serious breach of contract to allow the supplier to terminate, or even suspend performance, without a clause in the contract entitling them to do so. If you terminate or suspend when you’re not entitled to, you may be liable to the other party for damages.
Parting with goods before payment
Pre-2010 suppliers could obtain some protection by having a term in the contract stating that property in the goods did not pass to the buyer until they were paid for in full. This was known as the “retention of title” clause. Even those clauses had limitations in cases where goods supplied were raw materials which the customer would transform into something else, or use in building works. In those cases title automatically ended when the goods were transformed or incorporated into the building, despite the standard title retention clause.
It is possible to include a term in your contract that states that where goods you supply are incorporated into other goods in the process of manufacture, the supplier gets title in the manufactured goods and holds it until the raw materials are paid for. Customers are much less likely to agree to terms of that kind, however.
In 2012 the Personal Property Securities Act came into force. Under that Act, in general terms, if you own property and put it into someone else’s possession and they go into liquidation or get sued and the bailiff sells their assets, the liquidator/Bailiff can treat your goods as if they belonged to the debtor. That means liquidator/Bailiff can sell the goods and the money is shared out among all the creditors of the debtor, not just to you.
The only way to protect against this consequence is to register a security interest over the goods on the Personal Property Securities Register. You can only do this, in turn, if your supply terms say that you are entitled to do so. Registering a security on the PPSR is a relatively straightforward and inexpensive process.
Interest and enforcement costs
You are not entitled to charge interest on late payment or charge your customers for debt collector’s or lawyers’ fees, unless your contract says so. It is a simple matter to ensure that your Ts and Cs terms provide for this.
Personal guarantees
Ideally you would not extend significant credit to a “Pty Ltd company without a personal guarantee from the directors and/or shareholders. Even companies which seem to be doing very well may in fact have no net value, because of bank debt, or the fact that they do not own any of the assets which they appear to own. These assets may be owned by a related company and leased to the operating company. You should have a personal guarantee clause in your standard Ts and Cs.
Not all your customers’ directors will sign a personal guarantee, however. It usually comes down to bargaining power. But many customers won’t read your terms and conditions either. It is possible to put a guarantee clause in the contract without a separate line for the signature of the guarantor. It is the need for the guarantor to sign separately which tends to alert most customers that there is a personal guarantee in the contract.
To avoid this consequence the guarantee clause in your Ts and Cs can state that the person who signs the contract as director is also liable personally as a guarantor. There are competing ethical considerations about doing this. On one hand it could be seen as “sneaky”. Alternatively, however, many small companies are effectively the altar ego of their directors: and the supply of goods or services to the company directly benefits the directors. If the company does not pay then there is no moral reason why the directors should not pay you instead. It can certainly be argued that it is fairer that your customers’ directors be liable than that you, as supplier, go without payment. And, of course, if they read the contract before they sign it and they don’t wish to provide a guarantee, they can object to that provision.
This is also a warning to read the contract terms of your own suppliers carefully before you sign them, in case they contain a guarantee clause (or anything else) which you object to.
Deeming clauses
Many court cases are decided by who has the onus of proof, with the party who has that onus not being able to satisfy it. If you claim to have supplied goods or services to your customer but not been paid, you have to prove you supplied the goods or services. In some cases this can be difficult, even though you have done so, particularly in the case of services.
Your standard terms of contract can include a clause that states that you may give a certificate in writing specifying that you have supplied to goods or services, or that a certain amount is owing from the customer, and that this is deemed to be conclusive proof of its contents unless the customer proves otherwise. This will give you a significant procedural advantage in any court dispute which may arise. In that case, the customer will have to prove that you did not supply the goods or services. (It’s rather a radical measure, and there is some prospect that a court would not necessarily give it a great amount of weight, but it cannot do any harm to include it in your Ts and Cs.)
Taking security
Occasionally I get asked: “so and so owes me money, can I put a caveat over their house?” The answer is no, unless you have an agreement with them which says that you can.
For most purposes there are two different kinds of security: security over real estate and security over other assets. If you commonly supply to businesses, often enough they will not own any real estate. Your agreement can contain a clause to the effect that the customer grants you a general security interest over all its assets, including the goodwill of its business, to secure payment of any amounts owing that are not paid by the due date or if the customer becomes insolvent.
In order to be able to enforce this security in priority to other creditors, however, you must register it on the Personal Property Securities Register (PPSR). And if the customer has a bank loan, that will already be covered by a security on the PPSR, which will take priority over yours. But at least if there is equity in the business, you will have first claim on it, ahead of their unsecured creditors.
Your Ts and Cs can also state that if the customer owns any real estate it grants you an equitable mortgage (a mortgage that is not registered at Landgate) over that real estate to secure payment of amounts owing, and that you may lodge a caveat to protect that mortgage. The equitable mortgage will not take effect until you lodge the caveat, however. It may cause customer relations issues if you go around lodging caveats over your customers’ properties while you have a good ongoing relationship, however if they have stopped dealing with you or are struggling to meet payments, you may well have no qualms about doing so.
Limit your liability
Sometimes customers will make an excuse for non-payment, accusing you of supplying defective goods or services. They will claim that they are entitled to withhold all or part of the price as a result. In part two of this article series I consider strategies for reducing your liability risk in business.
One of those strategies includes having appropriate limits on, and exclusions of certain kinds of, liability in your terms and conditions. If your contract says, for example, that if you do happen to supply defective goods or services, your customer cannot claim the loss of profits it might suffer as a result, or that the maximum damages the customer can claim is limited to 50% of the purchase price, that will substantially reduce their ability to refuse to pay the price in such a dispute.
Follow-up actively and persistently
Find a good, cost-effective debt collector and have a system for promptly referring all debts beyond a certain age to them for follow-up. Suppliers who are persistent get paid first.
Ensuring the person who is signing has authority to bind the customer
If your customer is a company or partnership you will, of necessity, be dealing with one or more individuals on behalf of the customer. Most of the time they will have the legal authority to bind the customer, but sometimes they do not. If the person who purports to sign the contract with you on behalf of the customer did not in fact have the customer’s authority to sign, the contract will not be binding on the customer. (You can still sue the individual who signed, but they may well not be as good a target to sue as the customer you thought you were dealing with.)
For higher value contracts, you may wish to check whether the person signing has authority to bind the customer. In the case of a company you can obtain a “current extract” of the company from the ASIC website for $9. This will list the names of the directors. You can only safely rely on a document signed for a company as being legally binding if it is signed by:
– (in the case of a two-director company) two directors or one director and the secretary;
– (in the case of a one director company with a secretary) one director and a secretary if the secretary a different person or, if one person is the sole director and secretary, then that person;
– (If the company is a sole director with no secretary) In this case the person does not have authority to simply sign a contract and bind the company without the authority of a separate director’s resolution, which you would need to sight to be sure that they have authority to sign for the company. This is an absurd result, given that the director’s resolution will itself be signed by the same person!
Even if you know the names of the directors of the company that should be signing, in many cases you cannot tell from signatures that the person(s) named as a director on the ASIC extract is/are actually the person(s) who signed. Of course it is unusual for a person to sign their own name while someone else is supposed to sign, but it is not unheard of.
The ideal situation is that you have become familiar with your customer’s directors, you know they are and you see them both sign the contract. Of course that is not practical in many cases. When it is not practical for your customer’s directors to both be present and physically sign in your premises, then you should at least get them to write their full names in underneath their signature and you should check them against the ASIC search. That will improve your chances of ensuring that the correct persons have signed.
Ensuring the customer exists
Some customers will try to simply put their business name as the customer name on your contract. For example David Smith might have a business name “Dave’s Flowers”’. In that case the correct customer name is “David Smith”, not simply “Dave’s Flowers” although to be even more correct you can add “trading as Dave’s Flowers” for more definition.
A business name is not a legal entity: you cannot contract with it. The customer must either be a company (which may or may not be a company acting as trustee of the trust) an individual (which again may or may not be a trustee) or a partnership, which is two or more individuals.
The customer name on your contract must either be the full name of one or more individuals, or the name of a company (i.e. it will have Pty Ltd, or simply Ltd, at the end and the CAN). The ACN is critical, as it is part of the company’s legal name. If the customer is just named as “Dave’s Flowers” you may not be able to prove who you were actually contracting with it comes to a dispute, particularly if the business name is not registered.
Also ensure that the customer includes a full street address, rather than a PO Box, on your contract. Some names are common. An address is an important part of a person’s identification if a dispute arises as to who you were actually dealing with. If you need to serve the summons on the respondent in collecting proceedings you will need a physical address to which to send the summons, it cannot be sent to a PO Box.
Obtaining an ASIC extract of the customer will also confirm that the customer actually exists, and that you have the correct spelling of its name and it’s correct ACN. (Correct spelling of names can be critical, as there are many companies with similar names). Correct ACNs are vital for distinguishing between companies with similar names. It is not unheard of for a small proprietary company’s registration to lapse due to non-payment of ASIC fees. You cannot validly contract with a company whose registration has lapsed – it no longer exists!
Credit checks
If you are having significant payment defaults, or you want to reduce payment risk on larger contracts, you could find out whether it is economic for you to become a member of a credit reporting service, such as Dun and Bradstreet or Veda, and get credit reports on your customers before you do business with them. In this case your Ts and Cs will need to include a clause allowing you to get these reports.
“Battle of the forms”
Some customers, often bigger companies, order goods on the basis that their standard terms apply. If you do not agree with their standard terms then, if you have the luxury, don’t accept the order on those terms. Make it clear in writing that you’re prepared to supply the goods, but only on the basis that your terms apply. Wait for a written confirmation from the customer that it agrees before you supply the goods or services.
Conclusion
Many of the above issues can be addressed by having proper terms and conditions. At Fortuna Legal we can prepare these for you, or review your existing set. In future we will be rolling out a complementary set of standard small business contracting terms – please check back for availability. We can also assist with debt collection proceedings and all other business law matters.