A certain amount of financial risk is part of every construction project. Most construction projects have multiple parties performing work, joined together in a complex payment chain. The more parties between a particular company and the person or entity with control over the money, the more financial risk the company waiting for payment may be forced to tolerate. Fortunately, however, there are steps that construction industry participants can take to mitigate much of the financial risk on every project, and get paid what they have earned. Some of these steps are discussed below.
Use Security to Not Worry About Payment
The ability to secure payment for labor and/or materials furnished to improve property is built directly into the laws of every single state in the country – all 50 of ’em, and all of the U.S. Territories too! These laws are incredibly powerful tools, however, you just need to meet the statutory requirements in order to leverage their power to help you get paid. This security is granted by mechanics liens or claims against a project’s bond, and when used appropriately, can get construction participants paid, and paid quickly, on virtually every project.
There is really no good excuse for failing to take advantage of the construction industry’s built-in security to guarantee payment. Not only does it virtually eliminate the worry about getting paid at all, but the steps are taken to remain in a secure position also provide many additional benefits. Promoting visibility and making sure it’s known you are on the project results in quicker payment and a better project for everybody.
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Examine Contracts to Check for Risk-Shifting
Despite the power afforded by mechanics liens and bond claims, many aspects of financial risk are ultimately governed by the terms of your contract. Because of this, your fate may already have been determined before you even start work, let alone before encountering any potential payment issues.
The terms contained in your contract can have significant consequences down the road in the event of non-payment, so it’s important to examine it carefully (or, have them examined by a competent construction attorney). This makes sense in every business, and for all companies – it’s never a good idea to sign something without knowing what it says – and this is especially important when the document at issue can make the difference of getting paid for the work performed, or not.
Construction contracts can easily become a battlefield of risk shifting, or attempted risk shifting. Nobody wants to bear the burden of financial risk, so parties with more leverage can sometimes insert specific language in an attempt to shift the financial risk of the project onto unsuspecting lower-tiered parties.
Many of these onerous contract provisions are unfair, and some can even be un-enforceable. But, in any case, they are not good for anybody on the project – even the party attempting to use them.
Check Your Customer’s Credit and Know Who May Be On Shaky Ground
Since construction projects are credit-heavy, there is a lot of work and materials that go into a project prior to the responsible parties receiving payment. Contractors and subcontractors furnish their labor and materials and then wait for payment – pay applications are always seeking compensation for work completed, not contemplated. While there are prompt payment rules in many states that provide some guidance as to the required timing in which payment should be made, those rules can have a minimal practical effect on parties struggling to meet their payment obligations to begin with. Floating more and more costs, while waiting for payment of their own, can become difficult – and companies with a shaky credit history may not be worth the risk.
Because of the above, it is critical for construction industry companies to have strong credit practices. As well as checking a customer’s credit at the beginning of the relationship, prudent construction companies should also monitor it throughout the relationship. Some slight credit problems can be effectively squashed if you use your security rights, but it’s very important to make a good determination that a customer has the ability to pay without the necessity of filing a lien – actually using the security instruments available (and foreclosing if necessary) should be a last result.
Essential Reading:
“Construction Payment and Financial Risk: A Primer” | by Levelset Chief Legal Officer Nate Budde (Nate is also the author of this article)
Consistently Utilize a Thorough Policy
It’s likely that the most important aspect of mitigating financial risk is to approach the problem with a consistent policy. Whether you’re talking about a personal hobby like exercise, or an essential business process like credit management, consistency in the effort will usually lead to consistency in results.
While there will always be a need for flexibility, companies should strive to increase consistency to help reduce confusion, wasted time, and faulty action. Construction industry participants sometimes go unpaid simply because they don’t have a consistent commitment to a specific method of vetting customers and following up for payment, or because they are too disorganized to follow-through on their policy’s application. Don’t let this be you. A step-by-step process can work wonders in this regard, helping you to not only close out all of those “over 90” accounts, but also to prevent them from happening to begin with.
