E very time you contract to participate in a construction project, you also contract to become a lender by extending interest-free credit—in the form of the value of your services—to the project owner or to the general contractor with whom you enter the contract.
Since some payment is always delayed until project completion, or well beyond, this means a significant risk to you, all the more so these days when banks still keep a tight rein on credit lines and new loans.
Still, there’s nothing for it: you have to extend this credit, that’s the nature of our business.
Or as Gabriel Castillo of Pillar Construction in Virginia puts it, "These days, contractors have become financing institutions, lending money at a very affordable zero percent. GC contract language used to contain an interest clause for overdue sums, but that disappeared some time back.”
With money tight, each rung on the payment ladder wants to hold on to its cash as long as possible. The owner will supply all manner of excuses to the GC why payments are slow; the GC will in turn "misplace” your invoices or be in the middle of an audit right now, and that’s why you haven’t been paid—with a new story each week; while you, now and then, have to sidestep your suppliers.
Still, crew have to be paid, there’s no way around that, and that takes cash, and it takes it now.
How, then, to collect? How successfully to fight the accounts receivable battle?
To solve any problem, we have to know the nature and extent of the problem, and slow receivables are no exception. The first thing, then, is to ascertain the exact amount of outstanding receivables.
There are many good software packages that do a great job of this, provided, of course, that the correct numbers (billed jobs, and monies received, etc.) are entered on a timely basis. Not even the best software on Earth will help you if you don’t enter good data. Perhaps you’ve come across the old software adage: garbage in, garbage out.
Given good data, a great gauge as to where you stand is the A/R Turnover Ratio, calculated by dividing the total amount billed in the current period by unpaid receivables. This number reflects how long your clients wait before paying what they owe you.
A high ratio means that your accounts receivable collection is very efficient.
Example: $100,000 billed for the period/$10,000 outstanding A/R = 10.0, which is very good indeed.
A low ratio means you are most likely not collecting from your clients as efficiently as you could.
Example: $100,000 billed for the period/$95,000 outstanding A/R = 1.05—not a good sign.
The place to begin improving your collections is your contract with the GC.
When it comes to money, the greatest concerns on a construction project is owner payment, because the main reason for slow (or no) payments is the owner’s temporary or permanent inability to pay the GC, and contractors need to agree whether it’s the general contractor or the subcontractor who should carry the risk of owner default.
These days GCs routinely attempt to shift the burden of owner nonpayment to subcontractors by the "pay when paid” or "pay if paid” provision.
Pay When Paid
The purpose of most pay-when-paid clauses is to delay the time for payment to the subcontractor, whereas a properly worded pay-if-paid clause normally shifts the burden of nonpayment to the subcontractor.
A typical pay-when-paid clause might read: "The total amount paid to [subcontractor] shall be [amount], no part of which shall be paid until 5 (five) days after payment is received from owner.”
Or, "The General Contractor shall pay the Subcontractor each progress payment and the final payment within no more than 5 (five) working days after the General Contractor receives payment from the Owner.”
It’s important to note that in the case of owner bankruptcy, this language has been deemed not to excuse a GC from eventually paying the subcontractor.
In Thos. J. Dyer v. Bishop International Engineering Co. (where a GC, when not paid for a completed project after the owner declared bankruptcy, in turn did not pay its subcontractor for work performed), the Sixth Circuit U.S. Court of Appeals refused to enforce the pay-when-paid clause.
The court noted that general contractors normally bear the risk of nonpayment due to owner insolvency and thus held that the pay-when-paid clause was only effective to delay payment "for a reasonable period of time after the work was completed, during which the general contractor would be afforded the opportunity of procuring from the owner the funds necessary to pay the subcontractor.”
Other courts have followed the Dyer rule.
In other words, the pay-when-paid clause is fairly safe and should not be a deal breaker. Ensure, though, that the wording does not specifically spell out that the GC has no obligation to pay the subcontractor in case of owner nonpayment due to bankruptcy, which in effect becomes a pay-if-paid clause.
"I wish I could use that language in my scope,” quips Gabriel Castillo. "We will pour the 6th floor concrete slab when and if we feel like it.”
Robert Aird, president of Robert A. Aird, Inc. in Maryland, sees his share of this clause. "I have to say that most, if not all, contracts today include a ‘pay when paid’ clause,” he says. "We strike it when we can, but some contractors prohibit that.
"If we have a history with a contractor that suggests pay might be a problem, then we might not accept the contract.”
Andre E. Grebenstein, director of operations of The Martin Group LLC (a general contractor) in New Jersey, confirms this use: "Our firm uses the ‘pay when paid’ clause, which is typically only contested by larger vendors like Schneider, Emerson and the like. However, we never use the ‘pay if paid’ clause.”
Pay If Paid
How does the GC fully shift the burden of nonpayment by the owner? He does so by stating it clearly as a contract provision.
A typical pay-if-paid clause might read: "The subcontractor shall be paid only if the general contractor is paid.”
Or, "The subcontractor will not be paid unless the general contractor receives payment from the owner.”
Or, "The subcontractor assumes the risk of nonpayment by the owner due to insolvency or other inability to pay.”
Language this specific has been held by many courts to shift the burden of nonpayment sufficiently to the subcontractor, leaving the sub little option but to take the loss.
Therefore, you should never, ever, agree to a pay-if-paid clause. You are much better off turning the project down and going after something else.
That said, some states have held that such shifting of the risk to the subcontractor violates public policy. The California Supreme Court, for one, has ruled pay-if-paid clauses to be unenforceable as a violation of California’s public policy.
In Wm. R. Clarke Corp. v. Safeco Ins. Co. of Amer., 938 P.2d 372 (Cal. 1997), the court noted that a pay-if-paid clause is an indirect forfeiture of a subcontractor’s constitutionally protected lien rights.
Likewise, the New York high court has also concluded that pay-if-paid clauses are void because they violate public policy.
Still, why take the chance? Don’t enter into agreements that shift the nonpayment risk from the GC to you.
Jim Weaver, president of Mirage Plastering in Arizona, has a different take on this: "Few GCs will, or can, pay you if they are not paid themselves, and the contract language we are required to sign stipulates this. When you think of it, GCs are seldom wealthy enough to pay subs if not paid—all work would cease. Our contracts obligate us in this way, and we share the risk.
"I am committed to continue to work and to keep my men employed. History has shown this practice to be low risk, in spite of the hysteria surrounding the issue. Some GCs are tough to collect from and we choose not to work for them.”
Roger Olson, president and treasurer of Sig Olson & Sons Plastering, Inc. in Minnesota, has this take on the issue: "These types of clauses have become more and more common. We try to battle them as best we can, but there is always someone out there who will take the job with this clause in place.
"Personally, we prefer working with a familiar GC working for a familiar owner, with a known and favorable history.
"I feel that, generally, federal, state and city government projects are pretty safe, especially if they are bonded, which is usually the case.”
The A/R Toolbox - Legal
Given a fair contract and well-performed work billed in a timely manner, what tools do you have at your disposal to improve the A/R Turnover Ratio?
Mechanic’s liens. You can record a mechanic’s lien against a construction project to secure payment for labor, materials, supplies and other services you provided for that project. This is not a simple process, and rules vary from state to state. Some states require a preliminary lien notice, others don’t. Be sure to keep up-to-date on the rules of the state where you do business.
Mechanic’s liens are not available on all projects. For example, a mechanic’s lien can often not be placed on public construction jobs, or on owner-occupied residential projects, unless you have contracted directly with the residential owner.
You must also ensure that you meet the deadline for recording the lien, which can expire as soon as 60 days after project completion.
Since it is virtually impossible for a property ownerto obtain financing against a property subject to a mechanic’s lien, many liens are paid promptly to allow the owner to borrow money against or to sell the property. Therefore, even though a mechanic’s lien can be cumbersome and hard to foreclose, it is still an effective tool in securing payment since they, as a rule, are paid without a lawsuit.
Payment bonds. Many states require GCs procure a payment bond from a surety company to secure payment for those who supply labor or materials to a GC on a public project.
An unpaid subcontractor or supplier may apply for payment from the payment bond without filing a lawsuit as long as the claim is timely and properly made. If the surety company denies payment, you have the option of filing a lawsuit asking that payment be awarded from the bond.
License bond claims. In some states, if you are owed money by a licensed contractor, you may also make a claim against such contractor’s license bond. (Most states require that all licensed contractors obtain a license bond to pay just claims filed against him or her.) The size of the license bond varies depending on the size of the contracting company and can be anything from $1,000 to $100,000.
Even though license bonds, as a rule, are smaller than the amount you claim, licensed bond claims are a useful tool because uncontested claims are paid promptly without the need for a lawsuit.
Should you go this route, be aware that such claims are paid in the order they are made. Once a bond is exhausted, no additional claims will be paid, regardless of the merit of such claims. In other words, act swiftly.
Stop notice. A stop notice is a notification given to a project owner or construction lender that you have not been paid for your work. Upon receiving such a notice, the owner or lender may withhold sufficient funds from the general contractor or from the owner to pay the claim.
Breach of contract complaint. Of course, lawsuits should be the last resort, but sometimes you don’t have a choice. In this case, the most common lawsuit collection claim is breach of contract.
Such a claim requires that you, as the plaintiff, prove the existence of a contract, a breach by the opposing party and the damages caused by such breach.
Many states uphold verbal contracts, but you always need to demonstrate privity (a direct relationship between two parties, recognized by law) of contract with the defendant. In other words, a subcontractor cannot bring a breach of contract claim against an owner if the subcontractor and owner are not in direct contract with one another. In this case, the sub can only bring a breach of contract claim against the general contractor.
Unjust enrichment claim. Unjust enrichment claims are simply claims that a person or entity has unfairly benefited at the expense of the plaintiff. Unjust enrichment claims are usually a fallback to a breach of contract in the event that the court declares the contract invalid.
Document your work. Be aware that the most common defense to these legal collection options is the allegation that you did not adequately perform what you contracted to do, and therefore are not entitled to payment. In other words, you must—as a matter of course—take steps to counter this likely argument on all projects, even before payment becomes an issue.
The best way to do this is by taking daily photographs of your high-quality work.
By the way, none of the above should be construed as formal legal advice. Should you have a question about a specific situation, you should consult your legal counsel.
The A/R Toolbox – Common Sense
Most of the time, your legal toolbox will (and should) sit in a corner collecting dust; you should only drag it out as a last resort.
And well before you reach that point, there are two common-sense things you can do to ensure payment of bills rendered for your services:
Screening. Ascertain who you deal with.
Mike Heering, president of F.L. Crane & Sons, Inc. in Mississippi, likes to know before he goes. "You are usually safe with a GC you have a relationship with,” he says, "but we will still check that the money is in place for the project.
"When it comes to an unfamiliar GC, be aware that he will make everything sound rosy, especially if you are the low bidder.
"Perform your due diligence. Check Dun & Bradstreet, and any lien registers to discover as much as you can about the GC. And know that he is most likely checking you out, too.”
Another good source of information is your competition: Ask other subs about their experience with the GC.
You can also do some research by Googling him or her.
You will never lose money on a job you turn down for good reasons.
Communication. No tool is as versatile and as effective as plain old person-to-person communication.
Aird agrees: "Communicate promptly and often. We usually get results after the 10th daily call. The bother of hearing us press for payment is oftentimes effective.
"If needed I’ll also call the GC’s chief executive. This has worked when everything else fails.
"Also, if it comes to it, I have no qualms calling the owner to obtain fair treatment, or to verify what the GC is telling me.”
For Dennis Jarvis, president of D.J.’s Drywall, Inc. in Florida, communication and persistence are the keys.
"I will call anyone that I can to collect,” Jarvis says. "I’ll even call the bank or lending institution. My advice is to be persistent and to stand your ground. If communication fails, a demand letter from our attorney usually does the trick.”
Heering is also a firm believer in communication. He says, "Communication is crucial. If you keep calling, they will eventually tell you what the problem is, which is usually that the owner has not paid up—in which case, we’ll call the owner—if for no other reason than to make sure the GC isn’t lying.
"Maintain good relationships with the GC all the way through the job. Talk to him, work with him. Maybe he is having a problem, and while his problems really are not yours, they have a way of becoming your problems anyway. Working with the GC tends to result in faster payment.
"If it reaches the point of legal, everyone lawyers up and digs in their heels, which usually ends up with retrieving cents on the dollar.”
Sun versus Storm
The sun and the storm made a bet to see who could undress the little boy the fastest. The storm, confident as always, went first.
And he blew, and he blew. But the harder he blew, the harder the little boy hung on to his hat and scarf and the tighter he wrapped his jacket around him. In the end, the storm gave up. The stubborn little boy would not let go.
The sun’s turn. And she shone, and shone. And the more she shone, the warmer the little boy felt, and so, off came the hat, off came the scarf and the jacket and soon enough he was swimming naked in the lake.
I heard this little parable in third grade, and I’ve never forgotten it. The storm is legal, the sun is communication.
You do what you have to do to get paid. You have to. But remember that the legal toolbox is best covered with dust.
Coeur d’Alene, Idaho–based Ulf Wolf writes for the construction industry as Words & Images.