Lessons The Construction Industry Can Learn From The Foreclosure Crisis

One of the major headlines in the news lately has been the moratoriums banks have put on foreclosures. Some of the major lenders, including JP Morgan Chase, Bank of America, and GMAC, have voluntarily stopped foreclosing on residential properties due to questionable underlying documentation. Many state attorneys general have also come forward demanding that banks stop foreclosures until they can provide proof that they have all the proper paperwork on the properties in question.

No doubt, many of the properties subject to foreclosure formed the basis of the boom period for residential construction companies. But apart from the macroeconomics of supply and demand, are there any lessons the construction industry in general can learn from watching the banks?

Absolutely. The biggest problem I see with the banks was carelessness or sloppiness in their documentation and record-keeping.

Lenders relied heavily on forms with a few blanks to be filled in with the details of each transaction. With as many mortgages as were being sold, contracts, assignments, deeds of trust, and other critical documents were completed by unskilled employees who did not appreciate the significance of the documents they were creating or, more importantly, the consequences if they were not done correctly.

Unfortunately, I have seen these themes rear their ugly heads in the construction industry all too often.

Anyone who has spent any time in construction can tell you how critically important good record-keeping is. It is key in submitting payment applications, documenting compliance with scopes of work and code requirements, and proving claims or defenses if litigation arises.

When it comes to protecting your rights to payment through liens, accurate and proper documentation is indispensable. Liens are easy enough to perfect. However, they are also highly technical, and a failure to comply with the statutory requirements of your particular jurisdiction can render your lien unenforceable.

Of course, the most egregious sin of poor record-keeping in the construction industry–at least in my opinion–is the handshake contract. (A close second is the two-line purchase order that doubles as the contract for your major construction project.) In a perfect world, a handshake agreement would be fine. Unfortunately, we don’t live or work in that imaginary place. What happens when there is a question about scope of work? Or about how long construction will take? How are payments to be made, and what happens if there is a dispute about defects? When will as-built drawings be provided, and what happens if they aren’t?

The beauty of contracts is that they clearly define the duties and obligations of all the parties and eliminate ambiguity. Obviously, the larger the contract value and more complex the construction project, the more detailed the contract should be to address–in advance–all the potential ambiguities.

Banks and residential lenders have gotten themselves in trouble because they did not accurately document their transactions. Now they are paying the price by having difficulty foreclosing when borrowers have defaulted.

Contractors can learn a valuable lesson. Avoid headaches down the road such as payment delays, liquidated damages, or even litigation, by having good practices in place and accurately documenting your work.

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.

The Final 1%: Getting the Project Finished (and Getting Paid For It)

Who has the most touchdowns in NFL history? Most football fans can quickly tell you the answer is Jerry Rice. And most fans know that Brett Favre has the most touchdown passes. Touchdowns are an important statistic because they are so crucial to success in the game of football. Fans and students of the game also realize that it is difficult to get that final yard. It is much easier to move the ball half way down the field than it is to finally push it over the goal line. Not that the first 50-80 yards of turf are necessarily easy, but that last yard is always the hardest.

The same can be said of construction projects. Planning and designing a development, getting financing, winning contracts, and moving dirt all present plenty of potential pitfalls. However, that final push–moving a project from 99% done to completely finished–is many times the most difficult part. Parties fumble around as to details of their final responsibilities and, equally importantly, the timing of those obligations.

Far too often, in the rush to get a project started, final close-out matters are not thoroughly addressed (they definitely aren’t the sexiest part of a project). Parties ignore these details at their own peril.

To avoid disputes at the end of projects, take the time to give them proper attention in the contracting stage early on. For example,

• Have specific deadlines for when architects are to make final inspections and issue certificates for payment.
  
• Provide a definitive timeline for punch list items to be completed.
  
• Address all the lien waivers that are needed.
  
• Decide whether a surety needs to sign off on anything.
  
• Determine whether warranties run from substantial completion or when specific portions of the project were completed.
  
• Determine when as-built drawings are to be provided, to whom (and in some cases, from whom), and in what form (blueprints, CAD drawings, pdf, etc.).
  
• Most importantly, firmly lay out all the prerequisites that must be satisfied for before the final application for payment.

Most construction disputes arise from ambiguity–not knowing which party has what responsibility, and not knowing the time in which that obligation must be met. Fortunately, ambiguity it is a preventable ailment.

A smooth close out of a construction project begins long before the first shovelful of dirt is moved. All the parties may be rearing to start on the Next Great Building, but you can be assured everyone will be much less excited–and willing to cooperate–on the back end when trying to get that project from 99% finished to 100%.

Lien Waivers: Caveat Contractor!

Ok, my Latin may be lacking, but one thing I do know is that contractors should beware when lien waivers enter into construction contract negotiations.

Frequently, lien waivers are thought of in the mid-project, payment context. Basically, where a contractor or sub-contractor gets paid and signs a release of their lien rights. In this context, lien releases are harmless because the party has been paid. There is no reason, and in fact, no legal basis to file a lien. In this setting, lien releases actually serve an important role in getting a project to completion. At the end of the day, owners and developers need a building/structure/etc. that is relatively free and clear of encumbrances when they have paid those to whom they owe payments.

Where lien waivers get a little riskier is when they become an up front contractual requirement instead of post-payment documentation. In short, in these pre-construction lien waivers, upstream parties require downstream parties to prospectively waive their lien rights in advance. By entering into this type of arrangement, the downstream party essentially forfeits one of their most powerful tools to ensure payment for labor and materials–the mechanics lien/materialman lien.

Why have prospective lien waivers become an issue? From an owner’s or lender’s perspective, they are a great deal. Owners and lenders are able to limit the pool of potential parties who could place an encumbrance on a property should payment issues arise. This becomes even more attractive on larger projects where there are more subcontractors (i.e. the potential for more mechanics lien claims) and the property at issue is high value.

Lien waivers are not such a good deal for the downstream contractors and subcontractors, however. One of the best tools contractors have to make sure they get paid is the mechanics lien/materialmans lien. Companies become insolvent, financing falls through, but real property does not go away. And without payment, neither does a lien.

Contractors who enter into construction contracts that include prospective lien waivers should realize what they are agreeing to in advance. If the contract is lucrative enough, this risk may be worth taking on, given the potential profits. However, at a minimum, contractors should hedge their risk by insisting on a payment bond. This is common on larger projects, but payment bonds are not always incorporated into smaller ones. If a party is asking you to waive lien rights, they should at least provide some assurance that you will have a remedy if payments are not made.

Of course, lien waivers are deal points, like so many other things (including price). They can be negotiated. At the end of the day, if you are going to accept the risk that you will forfeit your lien rights, insist on some sort of consideration in return.

Top 10 New Year’s Legal Resolutions for Everyone in Construction

10. Know who you’re contracting with, and make sure they are financially viable (or have a bonding or insurance company that is).

9. Treat your employees and staff fairly and they will (usually) treat you fairly in return.

8. The best defense to an OSHA investigation is to prevent an OSHA investigation.

7. Prevent costly personnel ambiguities by having well defined, fair, written policies in place in advance–and communicate those policies to all employees.

6. Don’t agree to any indemnity provision unless you’re willing to financially be on the hook for another party’s own negligence.
OR
6a. If you negotiate indemnity from another party, make sure the indemnity provision in the contract is actually enforceable.

5. Do not include heavy-handed, punitive liquidated damage provisions in your contracts–courts will not enforce them.

4. Old emails never die–if you wouldn’t put it on paper, don’t type it and hit "Send."

3. Limitations of liability are serious stuff–if you use them, use them correctly.

2. Have good billing practices, know your lien deadlines, and stick to them!

And the #1 New Year’s Legal Resolution...drumroll please....

1. Read your contracts. Understand your contracts. Enforce your contracts!