Construction payment is complex and full of challenges. Because payment in many aspects of construction projects depends on credit, the potential lack of visibility throughout a project can make payment issues hard to avoid.
However, subcontractors, sub-subcontractors and suppliers can correct the visibility problem through technology-driven notices, and reduce risk, get paid faster and write off less bad debt.
Payment Structure and Risks
Historically, construction industry participants have not had the easiest time getting paid on time or even getting paid what they deserve. And upon examination, it’s easy to see why. The construction industry is credit-heavy and complex, which can be a dangerous combination. With a significant amount of work or materials furnished on credit and a long and convoluted chain from the property owner sponsoring a project down to the end of the payment chain, there are many opportunities for money to fall through the cracks. Additionally, because the margins are razor thin and parties may need to wait to receive payment from above before paying the parties below, cash flow problems can become amplified easily. This can create problems all throughout the payment chain, from the general contractor all the way down to a supplier or a sub-subcontractor.
Quite often, subcontractors must wait until their own payment is received from above before they can pay their own bills. And because most work is performed on a credit basis, these subcontractors are awaiting payment after having already performed the work. As a result, the structure of financial risk on a construction project increases in proportion to a party’s distance from the source of the money.
There are many places for money to slip through the cracks on construction projects and just as many reasons why payment gets delayed. Because of the interconnectedness of the payment chain, any little inconvenience, delay or dispute about any component of the work can impact payment for everyone on the project, regardless of whether that party was directly involved in the situation.
Fixing the Visibility Problem to Reduce Risk
One particularly important reason payments can be late, or even remain unmade, is a lack of visibility. It is difficult for a party at the top of the contracting chain to make sure a subcontractor or supplier is paid if the paying party doesn’t even know that the unpaid party was on the project or that particular party is unpaid. While this appears to be payment abuse when viewed from the position of the unpaid party, it may be as simple as the fact that the party with the money doesn’t know the unpaid party has performed work or furnished materials for which it has not been paid. This is not an abstract or theoretical risk. Construction projects routinely have parties providing labor or materials that are unknown to the parties in control of the money. This means the top-of-chain parties are worried about the risk of double-payment or stoppages in work caused by lower-tiered parties’ usage of lien or bond claim rights, and have little ability to make sure everybody is paid.
If the top-of-chain parties do know who the project participants are, payments can be made, lien waivers obtained and participants tracked. In a perfect world of construction payment, every party on a construction project would be known to the party with the money, who would also know each parties’ payment and security status. Fortunately, technology can help subcontractors and suppliers become more visible, both in an absolute sense, and in terms of remaining in a secured position to receive payment.
Visibility can be promoted by lower-tiered parties (subcontractors, sub-subcontractors and suppliers) sending notices to the higher-tiered parties. Sending these notices protects the lower-tiered parties’ security rights, and provides upper-tiered parties with the ability to know and track the project’s participants and those participants’ security status.
Remaining in a secured position limits (and nearly extinguishes) the subcontractor’s risk of nonpayment, and the ability to track all project participants allows the upper-tiered parties to manage exposure by providing a made-to-order checklist of parties from whom lien waivers may be needed upon payment to a subcontractor, and providing control over the payment process. This visibility clearly benefits the lower-tiered parties by allowing the general contractor to view the parties that are currently unpaid and need to receive payment–especially because the unpaid parties are in a secured position with the ability to file a lien on the project.
Fixing the visibility problem, whether by using notices or some other method, is the foundation for a better construction payment process. Using notices to fix the problem greatly reduces the risk of nonpayment to subcontractors because not only does the top of the chain know the identity of every noticing party, all noticing parties also remain protected by the security built into the law for that purpose.