In today's construction market, contractors face increasing challenges thanks to a slowdown in construction projects, problems in obtaining credit, fewer investors for projects, high construction costs, and slow payment or nonpayment by clients. All of this can impact a contractor's ability to obtain payment. This article is intended to provide some guidance to contractors on how to protect their interests in dealing with owners, general contractors, and suppliers in the present market.
Do your homework: Require Personal Guarantees, Deposits or Bonds if Necessary.
Before entering into contracts, it is important to evaluate potential clients to assure they are capable of performing their contractual obligations.
Contractors should first determine whether the party they are considering working with is financially sound. If there are any questions in this regard, it is important to obtain financial information, check references, and ask questions of both project owner(s) and general contractors about recent projects. If applicable, you should also request information regarding project financing. These inquiries are particularly necessary if you have not worked with the client in the past.
If owners or contractors are reluctant to provide this information, that hesitance should raise a red flag and call into question whether you really want to be working with this customer. If the answers received in regard to your financial inquiries still leave concerns, it is appropriate to request larger deposits, bonds, or personal guarantees to assure that you get paid for the work. Remember the axiom that having no work is better than not getting paid for work performed.
Include Contractual Payment Terms which Protect Your Interests.
To the extent possible, subcontractors should attempt to negotiate payment provisions to protect themselves in their subcontracts.
An example of a key provision which subcontractors should always include in their contracts is a work-suspension provision. A properly drafted work-suspension provision will provide for an absolute right to stop work if a progress payment is more than a specified period of time late. The provision should provide that in the event of a work stoppage due to late payment, the subcontractor is entitled to additional costs, demobilization and remobilization expenses, and additional time to complete the contract. And in the event that the payment default is not cured, that the contractor can terminate the contract and seek past due payments and lost profits on unperformed work.
While it is always advisable to include such provisions in contracts, understanding, including, and enforcing such provisions in contracts is essential to protect contractors in the present economy.
Secure your Lien Rights.
Equally important to protecting your interest is knowing the rules of lien and other payment-security rights, which may exist.
The most common payment-security device utilized by subcontractors is the private construction lien, also known as a "mechanic's lien." Mechanic’s liens create statutory rights that attach to real property on private projects for the benefit of anybody providing labor, services, materials, or equipment to the project. If a party has lien rights, it can foreclose the lien subject to any other senior interests in the property (e.g., a deed of trust encumbering the property before the contractor commenced work) and be paid from the project proceeds. In order to preserve lien rights, contractors are required to follow strict statutory guidelines and provide pre-lien notices, which makes it important to know the applicable lien laws and/or consult legal counsel when liens may come into play. Successfully protecting lien rights and securing a proper lien are often a valuable payment tool, but unfortunately, the value of liens may be limited in the current economy where the equity in property is more and more often very limited.
Subcontractors should also familiarize themselves with the statutory procedures relating to "stop notice" rights. Stop notices are essentially "liens" on construction funds which exist on any private project in Arizona. When properly prepared and served, the stop notice “lien” attaches directly to the project funds and requires the lender to withhold payment of the funds or be subordinated to the entity providing the stop notice which has not been paid. The stop notice is an extremely effective, though often underutilized, collection tool.
Bond rights may also exist to assure payment to subcontractors and suppliers. Which entities may take advantage of a private-payment bond depends upon the language of the particular bond involved. At the onset of any project, subcontractors should ask what bonds have been provided to the project and review the terms of the bond.
Subcontractors should familiarize themselves with all requirements of lien, stop notice, and bond claims and consult an attorney early on should issues arise on a project. Most importantly, be diligent in pursuing collections when not timely paid and be careful with whom you do business to assure that other parties’ financial difficulties do not become your own resulting in nonpayment for your work.
Editor's Note: The original version of this article was published in the Associated General Contractors of Washington Newsletter, AGC Works.
For more information contact Jared M. Scarbrough at jscarbrough@holmwright.com or (480) 477-8589.
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