On September 20th at the McGraw Hill headquarters in Manhattan, general contractors, subcontractors, and suppliers faced off at the ENR risk summit. According to ENR’s summary of the conversation the obvious happened: Views Differ From Places on the Payment Flow Chart.
General contractors complained about construction risk referring heavily to subcontractor defaults. Subcontractors and suppliers, however, called for reform to payment procedures because the industry is riddled with subcontractor payment abuses.
What kind of subcontractor payment abuses, you ask? ENR states that these practices include “sitting on invoices, withholding final payments for years or inserting favorable dispute-forum-selection clauses.” These three examples, however, are just the tip of the iceberg. Check out our discussion from an article published here just yesterday: CFMA Says Owners Are Shifting Financial Risks Down The Contracting Chain – Here Are Your Options.
Subcontractors call these risk-shifting devices “payment abuses.” General contractors call them “risk management.” This is a big, big topic in the construction industry, but one thing should be clear to you: you cannot ignore this topic.
When you work on a construction project as a subcontractor or you furnish materials as a supplier you are extending credit to your customer. In the construction industry, this “credit risk” or risk of non-payment is a fact of life. When you work on a construction project as a subcontractor or you furnish materials as a supplier you are extending credit to your customer. Your company, in other words, is furnishing labor or material based upon a promise to get paid in the near or distant future. It happens every day. In the construction industry, this “credit risk” or risk of non-payment is a fact of life.
Companies respond to this risk in one of three ways.
- They aggressively protect themselves against the risk by preserving and using their mechanics lien and bond claim rights, and as a result, are almost always paid on projects in full and on time.
- They use their mechanics lien and bond claim rights intermittently, and in turn, get paid intermittently.
- They don’t use or poorly use their mechanics lien and bond claim rights, and as a result, they get abused and have cash flow problems, write-offs, high A/Rs, etc.
Let’s talk about this third category of folk. Those who do not or poorly use their mechanics lien and bond claim rights. The question to ask is why?
It’s all too often that a company will resist adopting an aggressive mechanics lien or bond claim policy claiming that their relationship with the customer is “too important” to jeopardize with such a lack of trust or what-have-you. This sentiment is astonishing to me.
In every case, these important customer relationships are riddled with financial risk shifting contractual provisions putting the subcontractor or supplier behind the eight ball with regards to payment. The sentiment about the importance of the relationship, in other words, is only going one way.
Most of us know how one-way relationships turn out.
Payment flow “abuses,” as they are often called, are an absolute staple of every construction project. This is not a fake problem, and it is something that affects your bottom line. There is a way to combat it. It’s too expensive for your company not to.
The ENR article about this topic includes this really telling quote:
When trouble with a subcontractor arises, said Doug Lareau, chief legal officer of Shawmut Design and Construction, “The first question I ask is, how much money are you holding on that sub?” Lareau said his concern was the anticipated cost of remedial measures.
This is not a sentiment unique to Mr. Lareau. Money is being held from subs and suppliers as a matter of course, and if you don’t protect yourself…you can finish this sentence.