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March 27, 2003

3 ways to make sure you get paid

  • Contractors need to minimize their financial risks
  • By CHRISTOPHER A. WRIGHT
    Stanislaw Ashbaugh

    Wright
    Wright

    As the economy continues to struggle, it is more important than ever for all contractors and suppliers to take steps to minimize their financial risk on construction projects.

    If you have been in business long enough, you have either experienced or known of contractors and suppliers who have been devastated by nonpayment for work performed and materials supplied on construction projects.

    While everyone likes to believe that a new project will be a success, changes in fortune during the course of a project will often impact whether funds exist to pay for all of the work performed and materials supplied.

    Prudent contractors and suppliers can attempt to minimize their financial risks of not getting paid by:

    1. Taking steps to insure that money exists to pay them for work performed or materials supplied.

    2. Preserving their lien rights.

    3. Conditioning their responsibility to pay their own subcontractors and suppliers on receipt of payment from the owner or higher tiered contractor for the work performed or materials supplied.

    The ability to pay

    First, all contractors should take steps to insure that the owner has the ability to pay for work performed. Just like a lender on a construction project, contractors on private projects need to approach their financial exposure with the mindset of insuring adequate security exists for the payment of work performed or materials supplied.

    In the context of contract negotiations, it is appropriate for contractors to negotiate with the owner on a variety of issues that address the owner’s ability to pay for the work performed.

    Contractors can negotiate a form of payment security over and above the contractor’s lien rights, such as a payment bond. Contractors can request complete financial disclosure of the owner’s resources, to allow the contractor to determine whether sufficient assets exist to pay for work performed in the event of a dispute or other problem.

    Contractors also can negotiate a contractual right to obtain direct construction loan disbursements, such as an agreement that the construction lender only issues joint checks to the owner and contractor.

    Finally, contractors can request personal guarantees by the owner’s principals that the contract obligations of the owner will be performed. When dealing with corporations or limited liability companies with limited assets, such guarantees by the principals can be critical in the event disputes or payment problems arise during the course of the project.

    Whether any or all of these requests will be agreed to by the owner is an unknown. However, if an owner is unwilling to provide sufficient security for payment of work performed or materials supplied, that may be a red flag that sufficient security does not exist.

    Lien rights

    All contractors and suppliers regardless of tier need to adhere to the applicable mechanic lien requirements. While the ability to file a mechanic lien on private projects does not guarantee payment, it at least provides a measure of security in the work performed or materials supplied to the project.

    Unfortunately, many contractors and suppliers unintentionally forfeit their lien rights because they fail to give the proper notices or fail to timely file their lien on a private project within 90 days after the last date that they furnish labor, services, material or equipment to the project.

    Considering that the cost of ensuring compliance with the mechanic lien statutes is minimal, there is really no adequate excuse for not taking the necessary steps to ensure that your lien rights are properly perfected.

    With a little training, standard office procedures can be set up to help insure that mechanic lien rights are not unintentionally lost. This can prove to be a great benefit when payment problems arise on a project.

    Payment clauses

    Finally, all contractors and suppliers can minimize their financial risks by using “pay if paid clauses” with their lower tier contractors and suppliers instead of “pay when paid clauses.”

    Contractors and suppliers are rarely in the business of financing construction projects. As such, subcontracts and material supply contracts frequently include clauses that are intended to entitle lower tier contractors to payment only out of funds received from the owner or a higher tier contractor for the work or materials involved.

    However, many of these clauses may not achieve the desired result.

    Under relevant Washington case law, unless the clause clearly makes payment from the owner or higher tier contractor a condition precedent to payment to the lower tier contractor or supplier, the clause will only be interpreted as deferring payment for a reasonable period of time.

    In such cases, you may be required to pay your lower tier contractors or suppliers even though you have not received payment from the owner or higher tier contractor. When this occurs, whether you want to or not, you will find yourself in the position of financing the project.

    To avoid this situation, you may want to consider investing some time and money in reviewing your contracts and making any required revisions to minimize your risk of having to pay your lower tier contractors and suppliers before you have received payment. The time and effort spent on such a review will likely pay for itself if and when payment problems arise on a project. Given the ever tightening financial conditions, the chances of such problems occurring are greater than ever.

    While none of these three steps is a guarantee that you will receive payment for work performed or materials supplied on a project, they all lower your risk of performing work for free and becoming an unintended construction lender.

    In the end, following these three steps could be the tool that allows your company to succeed in these tight financial times.


    Christopher A. Wright is an attorney at Stanislaw Ashbaugh LLP, where his practice focuses on construction law. He can be reached at (206) 386-5900 or by e-mail at chrisw@stanislaw-ashbaugh.com.



     


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