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 from project owners or upper tier contractors or make payment to subcontractors and suppliers. This article is intended to provide some guidance to contractors, and specifically general contractors operating in Washington State, on how to protect their interests in dealing with owners, subcontractors 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 owners and subcontractors about recent projects. Request information regarding project financing and be prepared to provide the same information to subcontractors. This injury is particularly necessary if you have not worked with the client in the past.
If clients 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, general contractors should attempt to negotiate payment provisions to protect themselves in both their owner contracts and subcontracts.
An example of a key provision which contractors should always include in their owner 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 specified period of time late. The provision should provide that in the event of a work stoppage due to late payment, the contractor is entitled to additional costs, demobilization and remobilization expenses, 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.
In subcontracts, contractors should insist on including pay-if-paid provisions which require the general contractor to pay the subcontractor only if general contractor is paid by the project owner for the subcontractor’s work. Such provisions make receipt of payment from the owner by general contractor for the subcontractor’s work an absolute condition precedent to subcontractor’s right to payment.
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 a contractor’s interest is knowing the rules of lien and other contractor payment security rights, which may exist.
The most common payment security device utilized by general contractors is the private construction lien, known as a “mechanic’s lien.” Such liens are a statutory right that attaches to real property on private projects for the benefit of general contractors-or 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 in some instances provide pre-lien notices. Successfully protecting lien rights and securing a proper lien can be a valuable payment tool. The value of liens may be limited in the current economy where the equity in property is more and more often very limited.
Contractors 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 Washington where a payment bond has not been posted for half of the amount of the construction financing. When properly prepared and served, the stop notice lien attaches directly to the funds and requires the lender to withhold payment of the funds or be subordinated to the entity providing the stop notice who has not been paid. This can be an effective, though often underutilized, collection tool.
Bond rights may also exist to assure payment, though in most instances these bonds are provided for the benefit of subcontractors and suppliers, rather than general contractors. Who may take advantage of a private payment bond depends upon the language of the particular bond involved. At the onset of any project contractors should ask what bonds have been provided to the project and review the terms of the bond.
Contractors 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 who you do business with to assure that other parties financial difficulties do not become your own and you get paid for work performed.
Editor’s Note: The original version of this article was published in the Associated General Contractors of Washington Newsletter, AGC Works.