Credit Management for Contractors and Suppliers
Pessimism is at a premium in today's economy. For construction-oriented credit managers it's more pronounced. The slump in the housing and commercial building sectors has translated into higher instances of delinquency and default in an industry where payment cycles are already normally drawn out. It also means that security rights—mechanic's liens and bonds—are worthy of elevated interest.
"In the current market we are in, you may have noticed that things have gotten a little tight," said Jim Fullerton, Esq., president, Fullerton & Knowles PC. "Defaults are up for materials suppliers particularly." Fullerton stressed that security rights are imperative on any construction project during the NACM-sponsored teleconference "Credit Management for Contractors and Suppliers" claiming, "That is your one ace-in-the-hole to survive a bankruptcy and to be able to collect your money despite the bankruptcy of your customer."
Mechanic's liens are typically for private projects. There are a variety of bonds for public projects, like highways, schools, firehouses and similar construction endeavors, and private owners of projects can also require some type of bond. The most common is a payment bond, in which a surety provides security that all persons supplying labor and materials to a project will be paid, with subcontractors and suppliers being third-party beneficiaries. If the principal on the project defaults, the subcontractors and suppliers have the right to sue the surety directly to receive payment, except in the event of a supplier to a supplier. Unfortunately, project participants are often guilty of an elementary mistake that can end up costing them dearly.
"The single biggest mistake I see that people make is not asking if a project is bonded," said Fullerton. "Before they quote, before they ship to a project—especially private projects—they should ask, 'Is this project bonded? Give me a copy of the bond.'"
Fullerton explained that companies can be more aggressive about pricing on a project if they know that they have security for the sales. "And that's a real life story," remarked Fullerton. "You really can sell cheaper. You can give extended terms. You can make a lot of accommodations to a customer if you know there's a reduced risk of taking a complete loss."
The other benefit is that after work has started it's much harder to get a copy of the payment bond once a problem has arisen. Often times, construction-oriented credit managers are under very tight deadlines to enforce their bond rights. Though the deadline is generally 90 days after last delivery to give notice, the realities of the situation are vastly different. Credit managers aren't going to declare a payment in default until 60 or 75 days after delivery. That means they'll typically only have a week to three weeks to make bond claims.
"At that point, your customer may not be responding to telephone calls anymore," said Fullerton. "The general contractor is not going to want you to get a copy of the bond because you are going to sue them if they give you a copy. Your best chance, generally, is to get it from the owner, but even here you can have problems, largely because the shortness of time."
Even on a public project, the contracting officer has up to 14 days to provide a copy of the bond under a Freedom of Information Act request.
"So, again, the bottom line is that there really is no substitute for getting a copy of that bond before you even quote that project," said Fullerton.
Another fundamental mistake is not paying enough attention to what type of bond is being used on the project. Failure to review the actual bond can result in government entities inadvertently exposing general contractors to more risk than required, private owners exposing general contractors to risks that do not aid the owner, general contractors exposing themselves to avoidable liabilities and subcontractors and suppliers failing to preserve rights that they didn't know that they had.
Above all, suppliers and subcontractors need to remain vigilant about their position in the ladder of supply to ensure that they are eligible for bond rights.
"You need to be careful with intervening contractors, what I call artificial tiers," warned Fullerton. "Unfortunately, this most often happens with minority contractors of various types. There's another sub in there that you may not even have been aware of and they were brought in to comply with certain minority contracting requirements. They may not even have a real active role on the project, but they're there, at least on paper, and the problem is that might put you one further step removed from the owner than you realized you were. And it can bump you out of bond rights."
In association with NACM, Fullerton authored the Construction Law Survival Manual, which is well known and widely used by participants in the construction process. The 545-page manual provides valuable information about construction contract litigation, mechanic's liens, payment bond claims, bankruptcy and credit management and contains over 30 commonly used contract forms and is available through NACM's Bookstore, the association's Resource Library and is constantly updated on the website www.FullertonLaw.com.
Matthew Carr, NACM staff writer