According to the California Supreme Court, interest charges on unpaid invoices for goods and services are legal if the right to collect interest is set forth in your contract, or invoice, and if the mount of interest being charged is reasonable.

According to the California Supreme Court, contractual obligations for payment of interest charges (even if over 10% per annum) on late payments is valid, legal and not subject to California’s usury limitations. Unlike late charges which the law disfavors, interest or finance charges on unpaid bills is generally allowed so long as reasonable (up to 18%).

CAUTION: While 18% has been upheld in some courts, such a high amount of interest may be challenged as an unreasonable penalty, or liquidated damage.

If you provide services or materials, then you should include an interest provision in your contracts or invoices. For example, you may wish to include language to the effect that:

Payment is expected upon the provision of services / receipt of goods. If we do not receive payment in full on any invoice within ___ days, late charges at .8333% interest per month (10% per year) will be imposed on your unpaid balance after 30 days. Your unpaid balance is determined by taking the beginning balance of your account for each month, adding any new charges and subtracting any payments made to your account. We will then multiply this amount by the .8333% monthly periodic interest rate to compute the late charge for your account for that month.

A simpler version for placement in an invoice is: Payment Due Net 30; Interest at 1% per month after 30 days.

But what about Usury? Doesn’t California law limit interest to 10% per year?

California’s usury laws apply to loans and forbearance on a loan. See, Southwest Concrete Products v. Gosh Construction Corp., 51 Cal.3d 701 (1990). According to the court, the sale of goods and/or services to a buyer on credit is not a loan. Similarly, a forbearance is when the creditor agrees to refrain from enforcing the debt immediately and gives the debtor more time to pay. When a supplier of goods or services is charging interest on an unpaid invoice, such is not an agreement to refrain from enforcing a debt. Therefore, interest charges on unpaid balances for goods or services are not subject to California’s usury laws.

That all said individuals and small business should exert extreme caution if seeking to charge an interest rate of more than 10% per year on unpaid goods and/or invoices. While 18% has been upheld, that does not mean it will always be upheld.

The amount of interest charged must be reasonably related to the actual damages suffered by the creditor. Although the California courts have recognized that accounting and collection expenses are actual damages suffered by a creditor when a customer does not timely pay its invoices, the debtor may argue that a service charge provision is unenforceable as a liquidated damages provision that is not reasonably related to the actual damages suffered by the creditor as the result of non-payment (or late payment). It is therefore crucial for the creditor to document the extra effort, time, and expenses incurred as a consequence of each late payment.