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Managing Financial Risk for Subcontractors

Some financial risk is inescapable on every construction project. The generally large number of parties performing work, and the fact that the money on the project must trickle down through many of those parties before others can get paid, results in slow (or sometimes non-existent) payment.

The further a participant is from the parties with the money, the more financial risk they may be forced to tolerate. Fortunately, however, there are steps that construction industry participants can take to mitigate this inherent financial risk.

Use Security and Don’t Worry About Payment

The laws of every single state allow construction companies to secure payment for labor and/or materials furnished to improve property. While the ability to secure the amount owed through a mechanics lien or bond claim is powerful, this ability is subject to strict statutory requirements.

Notice requirements, timing requirements, delivery/service requirements and more vary from state to state and project to project.

One of the most crucial requirements of remaining in a secured position regarding a company’s lien rights on a project—sending preliminary notice—provides multiple other benefits. Sending preliminary notice not only promotes visibility—which, in turn, promotes fairness and results in quicker payment—but also establishes the noticing party’s invoice or pay-app as one that should be prioritized. And ironically, sending notice limits the necessity of filing liens or bond claims at all.

Contracts May Attempt to Shift Risk—Check for It

Despite the power afforded by mechanics liens and bond claims, many aspects of financial risk can be controlled by the “fine print” of the contract itself. This means a company may be rowing upstream before the project even starts, let alone before encountering any potential payment issues.

Contract terms can, and do, have significant consequences in the event of non-payment. In fact, the consequences can be so drastic that, ideally, every contract could be examined by a competent construction attorney before execution.

It’s never a good idea to sign something without knowing what it says, and this is especially true for construction, where the contract can mean the difference between getting paid for the work performed or not.

While many of the risk-shifting mechanisms employed in construction contracts are unfair (or even unenforceable), it’s never a good idea to be surprised by some provision and be forced to litigate its effectiveness in court. It’s much preferable to see the clause and negotiate its removal prior to signing the contract and well before any potential payment issues can arise.

Credit Checks Still Have a Place

Construction projects are credit-heavy with a lot of labor and materials furnished prior to payment. It’s a general industry fact that contractors and subcontractors furnish their labor and materials and then wait for payment. Pay applications are always seeking compensation for work completed, not contemplated.

This means construction companies are forced to float their own project costs while waiting on capital from above. This can become difficult or even disastrous—and companies with a shaky credit history may not be worth the risk.

Not only should a customer’s credit be checked before a project, but also it should be monitored throughout the relationship. While security rights can limit the scope of the disaster if a customer defaults, enforcing a lien or bond claim can be a lengthy process. It’s much better (obviously) when a customer has the ability to pay. Using the available security instruments should always be a last resort.

Make a Policy and Use It

The most important thing that can be done to minimize financial risk is to make an effective policy and use it consistently. Consistency in effort will usually lead to consistency in results—and that is no different in the realm of construction payment.

There’s no excuse for construction companies to go without payment due solely to a lack of focus or a failure to commit to consistent procedures. Too many outside issues can create problems with payment in construction; internal roadblocks should never be the issue.

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