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  • Writer's pictureFair Capital

Should I Charge Late Fees?

Updated: Jul 13, 2023

Late Fees: A Comprehensive Guide to Implementing, Managing, and Optimizing Late Payment Charges.

Late Fees

Dealing with late payments is a reality that every business, large or small, has to deal with. In a recent poll conducted by Fair Capital, 79% of the over hundred participants were in favor of adding late fees to past-due invoices. This is a significant majority, but the question still remains: Should you charge a late fee? And if so, how do you go about it?


This comprehensive guide delves into the intricacies of late payment fees. It explores the pros and cons, pitfalls, best practices, enforcement strategies, and alternatives.


Late Payment Fees – An Overview

Late payment fees, also known as late fees or late charges, are fees imposed by a business on a customer who fails to pay a bill or invoice by the due date. These fees serve multiple purposes: they compensate for the financial stress and administrative burden caused by late payments, encourage customers to pay on time, and allow businesses to manage their cash flow more effectively.


However, despite these apparent benefits, the decision to implement late fees is not straightforward. Businesses must weigh the advantages against potential drawbacks, such as strained customer relationships and increased administrative complexity. They must also consider the legal aspects of late fees, as regulations vary widely across jurisdictions.


Pros and Cons of Late Payment Fees

Late fees can offer several benefits to businesses, including:

  1. Promoting Timely Payments: Late fees can act as a deterrent, nudging customers to pay their invoices on time to avoid additional charges. This encourages a culture of prompt payment and reduces the incidence of late payments.

  2. Compensating for the Delay: Late fees provide some compensation for the costs associated with late payments. These can include administrative costs, such as the time and resources spent chasing late payments, as well as the financial stress caused by disrupted cash flow.

  3. Improving Cash Flow Management: By encouraging timely payments, late fees contribute to more predictable cash flow. This can make it easier for businesses to plan and manage their financial resources effectively.

However, there are also potential drawbacks to consider:

  1. Risk of Straining Relationships: Implementing a strict late fee policy may strain relationships with otherwise reliable clients who occasionally pay late. This can lead to the loss of valuable business, especially if competitors offer more lenient terms.

  2. Administrative Complexity: Tracking and applying late fees can add another layer of complexity to your billing and collections process. This can increase your administrative burden and potentially lead to errors.

  3. Legal Restrictions: There are often legal limitations on late fees, including how much can be charged and when fees can be applied. Businesses must familiarize themselves with the relevant regulations to ensure they remain compliant.


Do Late Fees Encourage Timely Payments?

A study by the National Small Business Association found that businesses that charged late fees were more likely to receive payments on time than businesses that did not charge late fees. The study found that businesses that charged a late fee of 1% per month collected an average of 30% more of their invoices than businesses that did not charge a late fee.


The Standard Late Fee on an Invoice

There isn't a universally "standard" late fee for invoices, as the amount can depend on various factors, including the industry, location, and specific terms agreed upon between businesses and their clients.


However, a common practice is to charge a small percentage of the overdue amount per month. This percentage often falls between 1% and 2%. For instance, if an invoice is $1,000 and is overdue by one month, a late fee of 1.5% would amount to a $15 late charge.


In some industries or regions, late fees might be a flat rate per day, week, or month, rather than a percentage of the invoice.


Legal Considerations for Late Fees

Most states allow businesses to charge late fees, provided they are reasonable. However, the specific requirements and restrictions vary widely. For example, some states may cap the amount charged as a late fee. They may also require businesses to prove that they have suffered a loss as a result of the late payment.


To navigate these complexities, businesses should consult with an attorney. They should also stay up-to-date with changes in relevant legislation and case law, which can provide valuable insights into how courts interpret and apply the rules around late fees.


Maximum Late Fee in New York

On March 22, 2000, the Assistant Counsel of the New York State Department of Financial Services released a note, which includes the following:


“Generally, Section 5-501 of the General Obligations Law provides that "[t]he rate of interest, upon the loan or forbearance of any money, goods, or things in action…[s]hall be 16% per annum..." This 16% rule is subject to several exceptions. Corporations are prohibited from raising a defense of usury in any action under Section 521(1) of the General Obligations Law, subject to the criminal usury exception contained in Section 5-521(3). Individuals are prohibited from raising a defense of usury for loans and forbearances exceeding (i) $250,000, unless secured by an interest in real property improved by a one or two family residence and (ii) $2,500,000 under Sections 5-501(6)(a) and (b) of the General Obligations Law, respectively. Since you have not provided any details concerning the delinquent amounts in question, we are assuming, for the sake of this discussion, that none of these exceptions are applicable.


However, the 16% rule only applies in cases in which there is intent to lend money, not to a late charge, which the courts of this State have determined does not constitute a loan or forbearance. The courts have reached this conclusion by treating a borrower as if he were in default and view the late charge not as interest, but rather a charge to cover the extra expense incurred by a lender due to a late payment. Thus, a penalty or late fee charged on delinquent accounts may exceed 16% per annum.


Please note, however, that since a late charge is considered liquidated damages it cannot be enforced absent an express or implied agreement providing for its existence. Therefore, a customer must be given notice of the existence of a late charge being imposed prior to incurring the obligation being subjected to the late charge. Further, while the civil usury laws do not apply to late charges, a rate in excess of 25% could be viewed by a court as illegal under the criminal usury prohibition contained in Section 5-521(3) of the General Obligations Law.”


Setting and Communicating Late Fees

There is no one-size-fits-all approach to setting late fees. The amount you charge should be based on a variety of factors, including your industry, the size and nature of your business, the average amount of your invoices, and the typical length of delay in payments.

As a general rule, late fees are often calculated as a small percentage of the invoice amount (1-2%) per month on late payments. However, it's important to ensure that your fees are fair and reasonable. Charging exorbitant late fees can backfire, damaging your reputation and potentially landing you in legal trouble.


Once you've decided on your late fee policy, it's crucial to communicate this clearly to your clients. This can be done through various channels, including your contract or terms and conditions, invoice templates, and direct communication with clients.


For example, you might include a clause in your contract like this:

"Any invoice outstanding beyond [30 days] will incur a late payment charge of [2%] per month."

Clear, consistent communication not only helps to prevent disputes and misunderstandings but also reinforces your commitment to timely payment and fair business practices.


A study by the Credit Reporting Bureau found that businesses that had a clear late fee policy on their invoices were more likely to receive payments on time than businesses that did not have a clear late fee policy. The study found that businesses with a clear late fee policy collected an average of 10% more of their invoices than businesses that did not have a clear late fee policy.


These studies suggest that late fees and reminder emails can be effective tools for encouraging on-time payments. However, it is important to note that these studies are based on averages, and the results may vary depending on the specific business and its customers.


Making Late Fees Enforceable

For late fees to be enforceable, they need to be agreed upon by both parties. This means they need to be incorporated into your payment terms and conditions and accepted by your client, typically through a signed contract or agreement. In addition, you should provide clear, timely notices of late payments and impending fees.


However, even with these measures in place, collecting late fees can be a challenge. Some clients may refuse to pay, while others may dispute the charges. In these situations, it's important to maintain a calm, professional approach and seek legal advice if necessary.


Should Businesses Pursue Late Fees?

While businesses have every right to collect late fees, they should consider whether it's worth the effort. The time and resources spent pursuing late fees could be better spent on other areas of the business. There's also the risk of damaging customer relationships, which could result in lost business in the long term.

Therefore, before deciding to pursue late fees, businesses should evaluate each situation on its own merits. Consider factors such as the amount of the late fee, the customer's payment history, and the potential impact on the relationship.





Alternatives to Late Fees

Late fees are not the only tool businesses can use to encourage prompt payment. Alternatives and complements to late fees include:

  1. Early Payment Discounts: Offering a small discount for payments made within a certain timeframe can incentivize prompt payment. However, businesses should be aware that offering discounts effectively means increasing prices, which may not be well-received by some customers.

  2. Payment Plans: For customers who are struggling to pay their invoices, offering a flexible payment plan can be a more effective strategy than charging late fees. This can help to maintain positive customer relationships while ensuring that you receive your payment, albeit over a longer period.

  3. Reminders and Follow-ups: Regular communication can play a crucial role in encouraging timely payment. This can include invoice reminders, follow-up emails or calls, and personalized messages to maintain a positive relationship.


Conclusion

Late fees are a powerful tool for businesses, but they require careful handling. By understanding the legal landscape, effectively communicating with your clients, and judiciously applying late fees, you can improve your cash flow while maintaining positive client relationships.




Q&A


Question: What are late payment fees and how do they benefit businesses?

Answer: Late payment fees, also known as late fees or late charges, are fees imposed by a business on a customer who fails to pay a bill or invoice by the due date. They serve several purposes. Primarily, they compensate for the financial stress and administrative burden caused by late payments, encourage customers to pay on time, and allow businesses to manage their cash flow more effectively. However, it's important for businesses to consider the potential drawbacks as well, such as strained customer relationships and increased administrative complexity, before implementing late fees.


Question: How can a business make late fees enforceable?

Answer: For late fees to be enforceable, they need to be agreed upon by both parties. This typically means incorporating them into your payment terms and conditions and getting acceptance from your client through a signed contract or agreement. In addition, businesses should provide clear, timely notices of late payments and impending fees.


Question: What are some alternatives to charging late fees?

Answer: Late fees are not the only tool businesses can use to encourage prompt payment. Some alternatives include offering early payment discounts, providing flexible payment plans for customers who are struggling to pay their invoices, and maintaining regular communication, such as invoice reminders and follow-up emails or calls.


Question: How do late payment fees contribute to improved cash flow management?

Answer: Late payment fees can contribute to improved cash flow management by encouraging timely payments, thus resulting in more predictable cash inflow. This can make it easier for businesses to plan and manage their financial resources effectively. However, businesses should also consider the potential downsides such as the risk of straining relationships with clients who occasionally pay late.



📍This post is intended for informational purposes only and should not be construed as legal advice. Always consult with a qualified legal professional before making any decisions regarding legal matters.

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Disclaimer: Any and all information is not intended to be, nor is it, legal advice. Please consult your attorney for information concerning allowable rates of interest.

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