Tuesday, August 31, 2010

4 Practical Steps to Help Ensure Prompt Payment

If I have seen one trend in construction over the past couple years, since the downturn in the industry, it has been an increase in payment disputes. These have ranged from simple disagreements about the scope of work in a contract to an upstream party closing its doors and leaving its subcontractors with no payment and little practical recourse.

The conversation I most dislike having with my clients is telling them that yes, they are owed a significant sum of money, but due to the other party’s insolvency, they will probably never see a penny. While most contractors understand why they are not getting paid, it does little to ease the financial sting. To help avoid this conversation, here are four practical steps every contractor can take to enhance the likelihood of being paid on their contracts.

Practical Step #1: Know Who You’re Contracting With

As relatively small as the construction industry is, there are still a lot of players entering into contracts. Unfortunately, construction is one industry (among many others) that has its fair share of fly-by-night companies–ones that you’d never heard of 6 months ago and that you’ll never see 6 months from now. Other times, contractors will be generally familiar with a company, but not well versed in the nuts and bolts of how it operates, its track record of making payments, how it handles change orders, etc.

Perhaps most importantly, the financial stability of another company may not be well known to the contractor.

During the construction boom where there were plenty of projects for everyone, contractors could be a little more selective with whom they worked. If they didn’t feel completely comfortable with a developer, general contractor, or subcontractor, they could simply pass, as another project wouldn’t be far behind. But this is a different day, and contractors have gotten a lot less selective about they projects they take on (and the profits they will accept). As a result, there is a greater chance of contracting with a company you’re not familiar with.

I’m not going to advise contractors who are straining to keep their doors open or avoid layoffs to turn down potential business just because they do not know the other party. However, when working with a new company, it is wise to perform some due diligence, whether it is a developer, general contractor, or a sub.

Due diligence may not be the first step you take in the bidding process, but it should be part of your company’s protocol before signing a final contract and making a substantial commitment of time and money. Consider the care you take before simply hiring an employee–you request a resume or job application, conduct an interview, check references, sometimes conduct a second interview, and possibly require a drug test. Your process for evaluating companies you contract with and with whom you are committing thousands or millions or dollars should be no less strenuous.

Knowing a little more about who you’re contracting with will not prevent all disputes, but it will definitely help you avoid a great number of them.

Practical Step #2: Payment Bonds, Payment Bonds, Payment Bonds!!!

Surety bonds protect your construction investments! This is not only the title of a recent guest post, it is an accurate statement of the purpose of these instruments. Even the best developers and construction companies sometimes are unable to pay on contracts. Whether it’s an industry-wide downturn or a project that has simply been disastrous, sometimes a party simply cannot or will not pay their obligations. In that scenario, it is extremely important to have a financially sound bonding company in place that can step in and pay.

Obviously, the bigger the project the more important a payment bond is. As the contract price goes up, so does the potential negative impact of nonpayment.

However, I’ve seen many smaller projects where no payment bonds are used. I realize that at a low enough project price, the added expense of bonds make a contract economically unfeasible. But before you write off the importance of this added bit of “payment insurance,” ask yourself how your company could withstand the impact of nonpayment. Not slow payments, not partial payments, and not the ability to win a judgment in litigation. Can your company absorb a complete non-payment. If this scenario spells disaster for your business, it is critical to have a little insurance in the form of a payment bond rather than rolling the dice on another party’s ability (and willingness) to pay you.

Practical Step #3: File Your Liens...ON TIME

Mechanics liens are one of the easiest ways to ensure payment on a construction project, and yet they are one of the most commonly botched practices among contractors. All other tricks for getting paid on a project rely on the willingness, ability, and legal obligation of another party to pay up. Liens, on the other hand, place your remedy in the land and its improvements (which, in theory, always have intrinsic value).

Liens are generally fairly easy to perfect. However, they are highly technical and have strict deadlines that have to be met. Failure to strictly comply with these deadlines and other technical requirements can render your lien invalid (and could possibly subject to you liability for improperly filing a lien; the penalty in Texas is not less than $10,000).

The specific deadlines vary from state to state, but generally, a contractor must first provide notice to the original contractor and property owner within a couple months of the work or materials being furnished. Then, they must file a lien affidavit with the county clerk of the county in which the property is located. Notice should be given to the original contractor, the owner, and possibly the general contractor.

Liens on residential construction are usually a little more technical because state legislators tend to protect homeowners (who are generally less sophisticated than commercial developers). For example, Texas lien laws require residential construction contracts to be signed by both a husband AND wife. If you’re in the residential construction business, make sure you’re familiar with the nuances of your state’s residential lien laws, as a failure to follow them to the letter can render your security interest worthless.

Contractors should have protocols in place that make sure the prerequisites to filing a lien have been timely satisfied. Send out regular notices every month as work is performed. And most importantly, don’t keep waiting month after month after month for payment. As a construction attorney, I have told too many clients who come to me to file a lien that they have blown their deadlines and cannot lien property. The good news is that with a little advance preparation, that conversation can be easily avoided.

Practical Step #4: Be Proactive Once You See Trouble Coming

How many times have you heard this excuse: “We’re going to get you your payment–we just need to get paid on this next project and we’ll have your money.” Then ask yourself how many times that scenario had a happy ending. You patiently wait and wait only to be given a new excuse. Sometimes, this leads to lien deadlines being blown.

I am not one to advocate for litigation where it can be avoided or where it makes no sense economically. However, I firmly believe that contractors need to be very proactive when it comes to payment disputes. If you have a slow payer, send a demand letter for the amount owed. Many states require this as a prerequisite to being able to recover attorney’s fees in breach of contract lawsuits. At a minimum, it shows you’re serious and are creating a paper trail. Consult an attorney–sometimes lawyer letterhead has a way of getting a party’s attention. If my client is not interested in maintaining an ongoing business relationship with the other party, I will often send a draft of a lawsuit that will be filed if arrangements cannot be reached.

If the party you contracted with cannot pay you what is owed today, there is little likelihood that their situation will change in a week, a month, or a year. Take appropriate steps to protect your interests. Whether that is filing a lien or filing a lawsuit, it is important to make your company a priority to the other party. Don’t wait for them to pay other contractors or subs before getting to you.


MBrumback said...

Excellent post, Walker. I've written a similar (but abbreviated) post on this same topic today, "5 Ways to Ruin Your Business". (http://constructionlawnc.com/2010/08/31/ruin-your-business/). Knowing who you are doing business with up front is very important!

Melissa Brumback

Scott Wolfe Jr said...

Great post. Me - being such a fan of mechanic liens (operating the Construction Lien Blog, and especially focused on the 3rd Step - preserving and using a contractors / suppliers lien rights.

It's so unfortunate that lien rights are so commonly misused, as they are so effective.

To prevent the mis-use of lien remedies, and to take advantage of all of the other prompt payment protections you've named...perhaps another great step / tip would be this: Talk with a lawyer. Right?

A lawyer will be able to guide contractors through all of their complex options, and ensure they are putting the best foot forward at all times. Lawyers may cost money, but not getting paid on these projects will likely cost much more.

Unknown said...

Thank you for a great post--subcontractors and suppliers can frequently prevent many problems if they paid attention to your first point. If a company gets the right information up front, then payment issues might be avoided (e.g., review of their creditworthiness) or, if probelms do occur, collection procedures can be improved by the information (e.g., tax id numbers, location of other projects, etc.)

Jeremy said...

California Contractor Bonds is a surety agency specializing in quality California contractors bond at an affordable price. CCB specializes in $12,500 California Contractor's License Bonds for California Contractors.

Hi Vis said...

#1 "Know who you're dealing with" is great advice. However in hard economic times we might be inclined to deal with companies we may otherwise avoid. Then, if there's a payment issue, hire a good attorney who knows how to file and perfect a lien.

Hi Vis said...

Stay safe on the construction site by wearing a reflective safety vest.

Unknown said...

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