In this uncertain economy, it is not uncommon for bills to go unpaid for 30, 60 or 90 days, or more. In such an environment, businesses must use every reasonable tool available to collect their receivables, and one of the simplest of these tools is interest.
Consider this: if you don’t charge interest on past due accounts — that is, if you are essentially carrying a struggling customer without any carrying costs — then that customer has every incentive to pay its other bills first. In order to change that dynamic, if only slightly, and to make your voice a little bit louder, your business may have to charge interest — or at least threaten to charge interest — to the extent that you are legally able to do so.
But when can you charge interest, and how much can you charge?
Generally speaking, Pennsylvania law provides that in the absence of an agreement to the contrary, liquidated demands bear interest, while unliquidated demands do not. A sum is “liquidated” when the amount is fixed or certain, such as a specific contract price where there is no genuine dispute as to whether that full contract price is due. A claim is unliquidated where the amount due, if any, is uncertain, such as where both parties have claims and counterclaims or offsets, or where a claim is grounded in negligence or other tort, where the amount ultimately owed is indeterminate until the claim is either settled or decided by a court.
In a nutshell then, a claim for an undisputed contract price generally bears interest. A claim for an uncertain sum typically does not bear interest.
To be precise, however, the law does not speak in terms of liquidated “claims.” It speaks in terms of liquidated “demands.” The reason for this is that the interest clock does not start running until the creditor has made a demand for the specific amount due, either by an invoice specifying a due date, or by some other request for payment of the liquidated sum. Thus, if an invoice specifies that payment is due within 30 days, then in the absence of a contrary agreement, interest starts running at the end of that 30 days. If an amount is due under a promissory note that does not contain an interest term, then in the absence of a contrary agreement, interest will generally be due from the date that the lender calls the note or demands to be repaid.
Once it is determined that interest is owing, the next question is: how much?
By statute, the legal rate of interest in Pennsylvania, in the absence of an express contract term calling for a different rate, is six percent per year. And although there is nothing illegal about compound interest when the rate adopted, in the aggregate, does not exceed the maximum legal rate, the law does not favor compound interest. So the general rule is that in the absence of an express or implied contract term or some statute authorizing compound interest, interest is not compounded. Instead, in most cases, interest is calculated as simple interest.
While the legal interest rate of six percent currently exceeds (by a lot) the interest offered by most banks over the past few years, the prospect of paying six percent interest on past due obligations still pales by comparison to the interest charged on most lines of credit and credit cards. As a result, the prospect of having to pay legal interest may not be enough to persuade your customer to pay its debt to your business, particularly where its cost of credit on other obligations is much higher. This is one reason why many businesses include terms to the effect that all amounts not paid within 30 days shall be subject to a finance charge equal to 1 percent or 1½ percent per month, equating to interest of 12 percent or 18 percent per year, respectively. This is significant for at least two reasons. First, these higher rates of interest provide debtors with a more meaningful incentive to pay off their obligations. Second, if the parties do not specifically contract that a higher rate of interest will be the applicable rate after the debt becomes due, then the interest rate fixed by law applies — six percent simple interest — from the due date going forward, even though the contract may have called for a higher rate to prevail prior to the due date.
Under Pennsylvania law, six percent per year is the maximum lawful interest on many non-business obligations. However, on business loans, finance charges of 1 percent or 1.5 percent per month are not prohibited by law. So there is nothing unlawful about charging 12 percent or even 18 percent interest on past due obligations between businesses.
But what if the contract or the exchange of purchase order and confirmation says nothing about interest?
Even if the original contract contains no reference to a finance charge, a finance charge of 1 percent per month or 1.5 percent per month can be effectively imposed after the fact by invoices providing for such finance charges on any bill more than 30 days past due. See Parker Oil Co v. Mico Petro and Heating Oil, LLC, 979 A.2d 854 (Pa.Super. 2009). As a result, when the original contract or the original exchange of purchase order and confirmation is silent on the questions of interest, interest can be tacked onto the contract by an invoice issued after the fact. In effect, this means that if the customer does not pay the invoice by its due date, that customer is deemed to have accepted the interest terms included in that invoice.
We have provided only the briefest of overviews of interest under Pennsylvania law. As with many areas of law, the laws governing interest are complex and overlapping. If you have any questions about whether you can charge interest or, if so, how much, it is recommended that you contact your legal counsel for an individualized assessment of your company’s rights.