What do you do if the customer does not pay the current milestone payment ?

it depend of the project situation:

- is that payment necessary to fund the project?

- is the customer have any financial problem?

- is the project execution  doesn't agreed?

but in general i refer to the first choice you suggested :"negotiate but never hold the project"

Refer the payment schedule and other terms & conditions in the Contract Document. Then refer to the legal terms & conditions for settlement of disputes, non-compliance and termination clause. 

First issue a formal written communication to the customer for compliance to the payment schedule.

If he fails to respond, then issue a second formal written communication to the customer for compliance to the payment schedule failing which you shall revoke the legal actions as per the contract.

If he still fails to respond, initiate the legal actions as per Contract terms.  

I believe the best answer is choice1 "negotiate but never hold the project"

At any rate we do not want to lose customer. While coming to payment, this is a common situation that customers doesn't pay on time and further demand a concession, etc. Well, I will go with the option "Negotiate but never hold the project".. 

Only when there is no way to recover money, and there is no way to get any further business in future I would go with the option of taking legal action...

 Negotiate but if the customer does not pay after2 weeks hold the project 

It depends on what you want from this question.  Are you seeking our professional opinion on how we deal with such situation in real life ?  or is it a PMP exam question  where one answer only would be considered the correct one ? and you want us to help you pick this correct answer ?

This must be in my risk register, and the action must be predetermined as per the contract.

If not, I will only use sure facts to conduct a cost-benefit analysis, including actual and opportunity costs of using the project's reserve funds against all benefits preserved from maintaining operations.

I will cease operation once the analysis’s balance fails below my profit margin. Mixing accounts is a taboo in my book.  

Vice versa:

If the customer expect to deliver the project on time but I did not fulfill his requirements, what will he do?

I prefer to negotiate immediately "not within two weeks" to know the root cause of changing the condition of payment, then legal case is the solution with full stop.

1. Connect with the Authority on the project on the customer’s side           a. To check if there is some hitch /they have any problems with your execution           b. To know if it just a temporary fund flow issue

2. In case it’s a temporary cash flow issue, discuss and finalize next date of payment and communicate in writing to them know about your action in clear terms in case the new dates are missed again. It will be of an added advantage in case you could politely add a reason because of which you shall not be in a position to take the project ahead.

3. Update the senior managers associated with the project in your organization know about it and take their opinion on the risks involved, future impact on your business, customer’s past dealings with your company and any news about your customer in the market.   

I will take the option1

 Negotiate but never hold the project

All the comments are on how to handle the problem. The problem is in not assessing the credit ability of the customer before giving credit. If you fail there you have many options left to you which takes time and money which should be avoided.

Dr Aloke Chakravartty, MBA