The short version
- A charge for late payment is a liquidated damages term. Under UCC § 2-718(1) and the equivalent common-law rule, it holds only at an amount reasonable in light of the anticipated or actual harm — a term fixing unreasonably large damages is void as a penalty.
- Interest is easier to defend than a flat fee, because it scales with the size and length of the default and therefore visibly tracks the loss.
- Interest ceilings are state law and differ enormously. Most states exempt business-purpose borrowing; several set a separate criminal usury threshold above the civil one.
- In the US there is no general statutory interest on private commercial debt. In the UK the Late Payment of Commercial Debts (Interest) Act 1998 supplies it automatically, with no clause required.
A late charge has to compensate, not punish
A sum fixed in advance as the consequence of a breach is a liquidated damages term, whatever the invoice calls it. American law tests those the same way at common law and under the sales article of the UCC: the figure has to be reasonable in light of the harm the breach was anticipated to cause or actually caused, weighed against how hard that harm is to prove. UCC § 2-718(1) puts the consequence flatly — a term fixing unreasonably large liquidated damages is void as a penalty.
The label does no work here. Writing "as liquidated damages and not as a penalty" into the clause is drafting folklore; a court looks at the number. The good news is that the harm is easy to describe: you have extended credit you never agreed to extend, you are carrying the cost of covering the gap, and someone is spending hours chasing.
That is why interest survives challenge more comfortably than a flat fee. It scales with how much is owed and how long, so it visibly tracks the loss. A fixed charge moves with neither, which is what makes it look like a fine.
Two conditions, and only one quadrant that works
When was it agreed?
Is the number defensible as compensation?
Set to punish
Tracks the real cost
First appeared on the invoice
Nothing to enforce
A term the customer never accepted, at a figure they could attack even if they had.
An argument, not a right
Between merchants it may still come in on the paperwork. A new finance charge is exactly the kind of term that fight is about.
In the contract, before the work
Agreed, and still void
Consent does not rescue an unreasonably large sum. The penalty rule is not waivable by drafting.
Enforceable
Accepted in advance, and priced against a loss you can describe. This is the only reliable position.
The clause has to exist before the debt does
A late-payment charge is a term of the contract, not a feature of your invoicing software. Adding it to the footer of an overdue invoice is a proposal the customer can ignore; when invoice terms do and do not bind is covered in the guide to invoice payment terms. What matters here is what the clause has to say while you still have the chance to say it.
The six lines a late-payment clause needs
- What starts the clock — the due date, and whether a grace period runs before interest begins.
- The rate, and the period it is expressed in. State the monthly figure and its annual equivalent both.
- Simple or compound, said explicitly. Silence is read against the drafter.
- Whether a part payment is applied to accrued interest first or to principal first.
- Recovery costs — collection and legal fees, if your state allows the parties to shift them.
- The right to suspend work while an undisputed invoice is outstanding — usually worth more than the interest.
The suspension right is the one people leave out. Interest compensates you for waiting; suspension stops the exposure growing. A clause that gives you interest but obliges you to keep delivering into an unpaid account has solved the smaller problem.
Service agreement template
Full text, free to read and copy, with the payment, late-payment and suspension clauses drafted in the order a dispute actually tests them.
Interest, and the ceiling your state puts on it
Usury is state law and there is no national answer. Caps are defined and enforced by state statute, and the range is wide enough that a rate which is unremarkable in one state is a crime in another — some states have no general cap at all. Most also exempt business-purpose borrowing or corporate borrowers, on the theory that commercial parties can price their own credit, and several of those exemptions only bite above a dollar threshold.
Several states then run two tiers. Civil usury is the ordinary ceiling, and exceeding it typically costs the lender the interest. Above it sits a criminal threshold: in New York, charging or receiving interest above 25% per annum on a loan or forbearance is criminal usury in the second degree under Penal Law § 190.40, a class E felony. The two-tier structure is why overcharging is not simply trimmed back to the maximum.
One adjacent rule confuses consumer-facing businesses. Under Regulation Z, a charge for actual unanticipated late payment, delinquency or default is excluded from the finance charge on consumer credit. That is a disclosure rule about what belongs in the APR. It is not permission, and it does not displace the state cap underneath it.
Per month or per annum, simple or compound
Rates are quoted monthly because the number reads smaller. Convert before deciding anything, and convert again if the clause compounds — compounding lifts the effective annual rate above the stated one, and in some states it is the effective rate a cap is measured against.
| As drafted | Annual equivalent | What to watch |
|---|---|---|
| 1% per month, simple | 12% per annum | Comfortably inside most civil ceilings. |
| 1.5% per month, simple | 18% per annum | The most-copied figure in commercial templates, and above the general civil cap in several states. |
| 1.5% per month, compounded monthly | 19.56% effective | The compounding adds nearly two points. Say "simple" if you mean simple. |
| Prime plus a margin | Moves with the index | Fix the reference date, or the rate becomes an argument about which day you looked. |
| $50 flat per late invoice | Depends entirely on the invoice | On a $300 invoice paid ten days late, $50 annualises to over 600%. A court divides it out the same way. |
If you are drafting interest into a debt rather than a supply contract, the promissory note template sets out the same choices — rate, basis, compounding, application of payments — in the form lenders use.
Where the law charges the interest for you
Sometimes you do not need a clause. Under the federal Prompt Payment Act, an agency that misses the required payment date on a proper invoice owes an interest penalty accruing from the day after, at a rate the Treasury sets and publishes in the Federal Register — and 31 U.S.C. § 3902 makes it payable whether or not the contractor asked.
Most states have prompt payment statutes covering construction, some for public projects only and some for private work too. They set deadlines at each tier of the chain, attach statutory interest when a deadline passes, and several add attorney fees. Check the statute for the state the project sits in, not the one your office is in.
Outside those regimes, private commercial debts in the US carry no general statutory interest before judgment. You get what the contract gives you, and then prejudgment interest at the state rate once you have sued.
Contractual interest and statutory interest are not the same instrument
Your clause
- A rate you chose
- Grace period, suspension, recovery costs
- Only binds if agreed before the work
Both
- Simple interest is the norm
- Runs from a defined payment date
- Can be waived in a settlement
Statute
- Applies with no clause at all
- Rate set by reference, not negotiation
- Narrow: US federal contracts, state construction, UK and EU commercial debts
The UK and EU run this the other way round
For readers outside the United States the default is inverted. In the UK, the Late Payment of Commercial Debts (Interest) Act 1998 gives a supplier a statutory right to interest on an overdue commercial debt with nothing in the contract at all, at 8% above the Bank of England base rate. The mechanism people miss is that the base rate is not tracked live: it is fixed by reference to the official dealing rate in force on the preceding 30 June or 31 December, so once a debt goes overdue its rate is locked for that half-year. On top sits a fixed compensation sum tiered by the size of the debt, plus evidenced recovery costs above that.
Payment periods are constrained too: with no agreed date, payment falls due 30 days after the later of delivery and receipt of the invoice.
Whether to charge it is a separate question
Having a defensible clause and invoking it are different decisions, and the second one is commercial rather than legal.
Invoke it, or trade it
Charge the interest
- Moves the invoice up a payables queue
- Prices credit you never agreed to give
- Makes the terms credible next time
Waive it for immediate payment
- Gets the principal in this week
- Keeps a customer worth keeping
- Gives up money you had not budgeted
Worth having in every contract. Worth actually collecting in very few.
If you do waive it, say in writing that the waiver is for this invoice only and without prejudice to the clause. Repeated silent waivers are how a term quietly becomes unenforceable through course of dealing — the customer points at eleven months of invoices where interest accrued and was never pursued, and asks why this one is different.
And when the trade stops working, interest is not the remedy — it is a line in the demand letter and a small addition to the claim. The escalation that recovers money is set out in the guide on what to do when a customer will not pay. The clause earns its keep at one moment: the call where you can say interest starts on Friday, and mean it.
Sources
- UCC § 2-718 — liquidation or limitation of damages
- Cornell LII — usury
- New York Penal Law § 190.40 — criminal usury in the second degree
- 31 U.S.C. § 3902 — Prompt Payment Act interest penalties
- 12 CFR § 1026.4 — finance charge, and the late-payment exclusion
- GOV.UK — charging interest on commercial debt
- Penningtons Manches Cooper — how the statutory interest rate is fixed
- European Parliament Legislative Train — revision of the late payments directive
General information, not legal advice. This guide explains how these documents and rules generally work. Law varies by jurisdiction and changes, and none of it is applied to your circumstances here. For anything consequential, consult a licensed attorney where you are.
Frequently asked
Can I charge interest if it was never mentioned in the contract?
In the United States, usually not for the period before you sued. A charge for late payment binds because it was accepted before the debt arose, so adding it afterwards is a proposal the customer can decline. Once you obtain a judgment, prejudgment and post-judgment interest apply at the rate the state sets, regardless of what the contract said.
Is 1.5% per month a legal late fee?
It equals 18% per annum simple, which sits above the general civil usury ceiling in several states and comfortably inside it in others. There is no national answer. Check the ceiling in your state, check whether business-purpose transactions are exempt, and check whether a delinquency charge on a trade account is even treated as interest there.
What is the difference between a late fee and default interest?
A late fee is a fixed sum charged once for the breach, which is a liquidated damages term and has to be proportionate to the loss. Default interest accrues over time on the outstanding balance, so it scales with the debt and the delay. Interest is easier to defend, and the two are frequently combined — a small administrative fee plus interest running until payment.
Can I claim my collection costs as well as interest?
Only if the contract says so and your jurisdiction allows fee-shifting by agreement. The American rule is that each side bears its own legal costs absent a statute or a contract term, so a clause covering reasonable collection and legal costs is worth including. In the UK, the late payment legislation supplies a fixed compensation sum automatically, tiered by debt size.
Does a customer have to pay interest on a disputed invoice?
A genuine dispute over part of an invoice does not excuse the undisputed remainder, and the cleanest position is to invoice and pursue the two separately. Where the dispute turns out to be well founded, interest on that portion falls away with it. Where it was raised only to delay, the interest continues to accrue and the record of the objection helps you rather than them.