The construction industry has one of the highest failure rates of any business sector. It’s important to be prepared for this reality when doing business in the construction market. Even the improving economy can’t help with this challenge. In fact, it may hurt, as research suggests that contractors are three times more likely to fail in an economic recovery than a downturn.
So, how can a subcontractor or supplier collect on an account if a contractor goes under?
First the bad news. A company may have options to collect in the face of a failed contractor, but most of these options must be preserved way before the insolvency. In other words, by the time it’s apparent a contractor is going under, it may be too late.
Following are two preventive steps to guard against an insolvent contractor.
- Make smart credit decisions and get personal guarantees. When starting a new project or starting to do business with a new customer, a company is making a very important decision that often in overlooked. Nevertheless, the construction industry’s high failure rates mandate a close evaluation of the new business. Companies without strong credit and finances should sign a personal guarantee. In the event of contractor insolvency, the company can collect from the company’s principal.
- Protect and monitor mechanics lien and bond claim rights. Mechanics lien and bond claim rights were invented for the express purpose of helping those in the volatile construction industry manage financial risk. These rights are used or protected thousands of times each day. Protecting mechanics lien or bond claim rights are a company’s greatest financial protection.
If a contractor goes under, the company likely will be able to still collect the debt by executing mechanics lien right,. This is because the mechanics lien remedy enables a company to simply skip the insolvent contractor. The company will be empowered to collect directly the property owner or bond, and the debt will be secured by the project job site itself.
Just as a bank can get repaid in the face of a debtor’s bankruptcy, so too can a contractor or supplier in the construction industry get paid in the face of contractor failure. It’s just essential to take measures to monitor and protect lien rights.
Reactive Measures to Take After a Contractor Fails
There are a few collection options after a contractor’s failure.
- Force an actual bankruptcy or receivership filing. It is very common for construction businesses to respond to debt collection attempts with the claim that they are unable to pay. Sometimes, they will even hire an attorney to send a letter threatening bankruptcy and offering to settle for pennies on the dollar. The company very well may be telling the truth and may be on the verge of bankruptcy. They may also be using the threat as a settlement tactic. When in receipt of a threat like this, don’t take the letter at face value. Dig a little. Think about forcing the party into bankruptcy. If they are hiring an attorney to send letters like this they are actively trying to avoid bankruptcy, and if push comes to shove, they may be willing to pay a little more of the debt to avoid the bankruptcy courts.
- Get involved with legal bankruptcy or receivership proceedings. Abuse of bankruptcy and receivership proceedings is common, but unfortunately the only parties that can catch abuse or fraud are creditors. Many companies get a bankruptcy notice, consider it too complicated, and then toss it aside and write off the debt. Don’t do this. Get involved with the bankruptcy proceeding. Either step in and identify bankruptcy process abuse and get the entire debt paid, or be part of a repayment plan negotiated in the bankruptcy court.
- Think about a Notice of Intent to Lien or Lien Rights. Section one touched on the preservation. However, lien rights can also be pertinent after the fact. If a company is unpaid, lien rights are the best option to collect in the face of an insolvent contractor. In the instance when there are absolutely no mechanics lien rights, there may be no recourse. As a last resort, bluff a little and send a “notice of intent to lien.” According to research, these notices are incredibly effective. Companies paid 47 percent of the time within 20 days. That’s a huge payoff for a very inexpensive and easy-to-send document.
If there is the right to lien, do it quickly. It is the best chance of getting paid.