Debtor default

What it means

Debtor default occurs when a debtor fails to perform an obligation properly and on time. Most often it means not paying an invoice by its due date, but one can also be late in delivering goods, handing over work or returning an item. Default arises automatically on the day after the deadline passes unmet; the creditor does not need to announce it.

Default gives the creditor statutory claims. For a money debt there is a right to late payment interest and, in business relationships, to fixed compensation for recovery costs. If the contract contains a contractual penalty, the creditor can claim it alongside interest unless the contract says otherwise.

Debtor default must be distinguished from creditor default, where the creditor does not accept performance properly offered or fails to give the necessary cooperation. If the debtor could not perform because of an obstacle on the creditor's side, it is not in default. In a dispute it therefore matters who offered what to whom and when.

How it works in practice

For overdue invoices we recommend a fixed procedure: a reminder shortly after the due date, a formal dunning letter setting out interest and the fixed compensation, then a pre-action demand and finally court debt recovery, for example through a payment order. Each step should be documented because it will have to be proved in any dispute.

If the parties did not agree late payment interest, business relationships use a statutory rate derived from the ECB rate plus a set number of percentage points. The fixed compensation for recovery costs is a set amount per unpaid claim. Current values should be checked in the rules in force, since the ECB rate changes.

With longer default the creditor may, under the law or the contract, withdraw from the contract, suspend further deliveries or claim damages exceeding the interest. In the accounts, overdue receivables are tracked by ageing, and allowances are created for those overdue for longer.

What to watch out for

Many companies do not charge late payment interest so as not to damage the customer relationship. That is a business decision, but the claim becomes time-barred and not charging interest teaches customers to pay late. Clearly agreed payment terms and consistent but polite reminders help.

Watch the tax and accounting consequences too. Late payment interest charged is income, but under certain conditions it enters the tax base only once paid. For the customer it becomes a tax-deductible expense only after payment. Wrong timing can distort both the profit and the tax base.