As the holiday season winds down and 2012 approaches, everyone in the construction industry is looking back on the fiscal successes and failures from 2011, and making plans for the new year. Many businesses will be staring at a mound of “bad debt,” which may be written off when tax time approaches this spring. You may be wondering, what can I do to stop accumulating so much bad debt? Let us help you plan for 2012.
The High Costs of Bad Debt?
Think you can just write off your bad debt? It’s not quite that simple. While there are certainly deductions available to you under the tax code to accommodate some of your bad debt, it’s irresponsible for you to write off uncollected receivables year after year without analyzing its effect on your company’s bottom line. Unpaid receivables even in small amounts can have a very significant impact on your company’s profitability.
Let’s say you have just $5,000 of unpaid receivables, and you have a net profit margin of 5%. Your company will need to make $100,000 in revenue to compensate for the lost $5,000. That’s a significant amount of money to offset the loss of such a small debt. Now, think about $20,000 of unpaid receivables, $100,000, or more. The impact to a company’s bottom line can be staggering.
Filing Mechanic Liens Will Get You Paid More Often
Many feel that filing a mechanics lien is too aggressive, or that it will risk impairing a relationship with a good customer. The fact remains, however, that it’s hands-down the best way for someone in the construction industry to reduce their bad debts.
A few months ago I wrote a White Paper titled: 5 Ways A Mechanics Lien Can Get You Paid. To summarize that White Paper, mechanic liens have a host of consequences to a project, including freezing funds, eliminating the property owner’s ability to sell, refinance or transfer the property, securing your debt with the project’s property as collateral, and more. When you file a mechanics lien properly and timely, an entire symphony of pressure points are pushed, and this results in getting you paid more often than not.
If you have any unpaid receivables at the end of 2011, a well-executed plan to protect and exercise your mechanic lien rights is your solution. You’ll see a huge difference in your bottom line. To take advantage of the lien laws, however, you need to follow a lot of rules. Here’s what you’ll need to know.
Part I: Protect Your Lien Rights From The Start Of Work
In creating a mechanics lien plan, the first thing you need to know is that Filing A Lien Is A Discipline, And Not A Knee-Jerk Reaction. Namely, you have to begin protecting your lien rights by filing certain preliminary notices at the very beginning of every project.
I’ve discussed preliminary notices quite a bit on this blog (see Preliminary Notices category). The long and short of these discussions is that in many states, you’re required to deliver to certain parties a notice formally putting them on notice that you’re furnishing labor and/or materials to the project. This notice is due within a certain amount of time from when you begin work, and if you miss your window to send the notice, you will forfeit your lien rights. Ouch.
If you do three, four, five some-odd projects each year, sending the preliminary notice in-house is not going to be a big deal, although you’ll risk making a mistake. However, for those companies who have a lot of preliminary notice filings each month or quarter, it’s probably a good idea to outsource this service. Knowing when a notice is required is important, as is getting the notice prepared properly and sent timely. Without it, the mechanics lien plan just won’t work. Period.
Part II: Exercise Your Lien Rights If Unpaid
So, you’ve filed your preliminary notices when required and protected your lien rights. Things have been going well, but you’ve encountered a client who is not paying its invoice. What now?
The next step is to exercise your lien rights by filing your mechanics lien. Like preliminary notices, this must be filed within a certain amount of time, which each state having different claim periods (Calculate Lien Deadlines with Zlien’s LienPilot). Liens are typically filed after you’ve finished or stopped providing services, and after an amount of money has become due to you.
Be careful when filing your lien because there are lots of traps for the unwary. In fact, you may be well served to use a service like Zlien, who will prepare, file and serve your mechanics lien for a flat fee. Once your mechanics lien is filed and served, you can then make additional attempts to collect the debt.
A lot of times, the filing of a mechanics lien alone will be enough to turn things around and get payment. If you remain unpaid, however, you’ll need to move to the final step, as the mechanic lien will not tie up the property forever.
Part III: Enforce Your Lien Rights With Suit
The idea behind a mechanics lien is that you’re constricting alteration of the property’s title in any way, so that if you’re debt is not paid you could theoretically call upon the sheriff to seize the property and sell it to pay off your debt. If the filing of the lien alone does not produce payment, you will want to begin taking steps to enforce your lien and requesting the property’s acquisition and sale.
This request is done through an ordinary lawsuit filed against the property owner (and frequently also the prime contractor and party who hired you). You’ll be required to prove that your debt is owed, and if you prevail at trail and get a judgment, the judgment would request the sheriff to proceed to foreclose on the project’s property.
This is a long road and most liens get resolved before going this far…but, you must take those first steps in the journey and understand the procedure to most effectively use your lien rights.
When account receivables are at issue, it’s hard to guarantee anything. However, in my experience of helping suppliers and contractors around the country implement quality credit policies and mechanic lien plans, I can guarantee you that a well-planned and executed mechanics lien plan will nearly eliminate your bad debts in 2012 and beyond.
When thinking about a mechanics lien plan, understand that implementing it in-house will be very, very difficult. There are so many state requirements which differ depending on your tier in the project, the project type, and other variables. Keeping up with these changes and differences is impossible if you’re not in the business of doing it. Therefore, again, your best option is to outsource this stuff. And that’s a positive thing, because it means you can implement a mechanics lien plan, turn around your bad debt situation, and not create additional work for your business.