The challenges inherent in the construction industry payment scheme can limit a company’s available cash, and result in large amounts of past-due A/R.
These challenges have led to construction companies failing at a rate higher than almost every other industry. And, even if the resulting problems are not significant enough to cause insolvency and failure, the headaches of dealing with aging or uncollectable accounts and restricted cash flow are burdensome and unwanted.
The two problems described above–getting invoices paid faster and reducing the number of invoices that are written off as uncollectable–are a direct result of the unique structure of the construction payment chain. Because of this, they can be controlled and significantly reduced by using tools specific to the construction industry, and specifically designed to reduce the financial risk of non-payment. These tools are mechanic’s lien claims and bond claims.
Lien and Bond Claims Provide Security
Mechanics liens (primarily on private projects) and bond claims (primarily on public projects) serve the same general purpose; each is an involuntary security interest provided to construction industry participants to protect them from the risk of non-payment for labor and/or materials provided on credit to improve property. So what does that mean?
Security interests provide a right to some asset that may be claimed in the event of nonpayment. This means that the asset subject to the security interest (or a part thereof) may be claimed or sold to satisfy the debt. In a construction context, the security provided is either the improved property itself (private projects) or a “pile of money” (public projects). Provided certain required steps are followed, a construction participant may make a claim against the collateral if that participant is not paid for the work done to improve the property at issue.
As may be obvious, secured debt is paid more often that unsecured debt. In fact, true secured debt is rarely ever avoidable by the indebted party. Therefore, thorough use of the security provided by law to construction industry companies can dramatically improve A/R aging and uncollectable accounts.
Step by Step
Once the decision to fully use the security rights afforded to construction companies has been made, the question then becomes how that decision is implemented. In order to implement the decision to fully utilize security rights and get paid every time, a company needs to keep its invoices in a secured position, as well as make sure everybody up the payment chain knows the company is performing work and that its invoices are secured.
Implementing a receivables funnel accomplishes all of these objectives and can be fully automated. The steps involved in a receivables funnel are as follows:
- At the beginning of a project, send a preliminary notice to protect security rights and provide visibility of involvement on project.
- After the account is in default, send a notice of intent to lien to prompt payment.
- If payment is not received after notice of intent is sent, file a mechanic’s lien/bond claim to perfect the security interest.
- If the mechanic’s lien not paid , send it to collections.
- If collection is unsuccessful after set period, file a foreclosure or bond claim enforcement suit.
Following these steps and leveraging the security provided to construction companies through lien and bond claims can dramatically improve A/R and cash flow, and has the added benefit of allowing companies to pursue more business. Fortunately for today’s construction companies, this type of security is getting easier to use.
Not only can the proper use of lien and bond claims provide a significant financial impact, but the historic challenges to their use are becoming obsolete. The number and complexity of the laws and requirements, which used to be a bar to full-scale adoption of these rights, can be managed and optimized through technology and compliance is no longer impossible from a practical standpoint.
Managing and tracking mechanic’s lien and bond claim requirements can be accomplished by software that provides the ability to decode and streamline the unique security circumstances and associated requirements for parties at both the top and bottom of the payment chain. As this new technology becomes more commonplace, the use of security in construction should become optimized and payment problems for companies in the know can become a thing of the past.