How to improve the collection process

Most plumbing and HVAC contractors are not bankers, and do not want to be in the financing business. Yet more than ever before, I see them turned into bankers — cash-flowing projects to keep owners, developers and general contractors afloat. This is happening everywhere, on the smallest remodels to the largest new construction projects. If you don't want it to happen to you, then you will need to take some pro-active steps to protect yourself.

Step No. 1: Don't count on lien rights, especially for new construction. Although mechanic's liens are viewed as the Holy Grail of security by many contractors, they only do you good if the property has value — so much value that the owner, lender or buyer is willing to pay off your lien to protect the property. But in the last year, there has been so little confidence in the real estate market that property values have been very unstable. If no one is willing to buy the half-built, under-water project, there is no source for money to pay off the liens. The market for new construction is still very volatile, and lien rights require a stable (preferably, growing) market to make them useful to contractors. So, at least for the short term, contractors need to find other back-up plans for troubled projects.

Step No. 2: Explore other sources of collateral. If you have any question about your customer's ability to pay, look for back-up collateral. Is there a related company, or individual owner, who can guarantee payment? Could you accept a credit card? For larger projects, what about a surety bond? If you are working for a general contractor, consult your attorney to find out if your state has a Construction Trust Fund statute that could give you protection too.

Step No. 3: Don't keep working without payment. This requires staying on top of your receivables so that you know what should have come in, from whom, and when. It is a tough call to pull off a job, since the time and cost of demobilizing and remobilizing can be a disincentive to doing it, and the closer you are to being done, the less sense it seems to make. But, the closer you are to being done, the customer also needs you less and less. The longer you work without being paid, the more you are giving up your bargaining power.

Step No. 4: Verify what you are being told. This may require straining relationships with customers who have given you business in the past, and say that they will give you more business in the future, but virtually every contractor I know who has ended up getting pennies on the dollar in a bankruptcy court started out having total faith in the now-defunct customer. It may be that your customer just has a "temporary cash-flow issue," with a refinancing "only a few days off," but how do you really know? "Trust but verify" applies to more than just the Arms Race. You are entitled to be given access to all documents, speak to bankers, etc. whom the customer says will solve the problem. If the customer won't do this for you, he or she is sending you all the wrong signals. If you decide to keep working without being paid, at least force yourself to do a brutally honest evaluation of why you are doing it.

Step No. 5: Get written agreements that let you walk away if you're not paid on time. Most "standard form" contracts were drafted in the good-old days when we all knew that we could generally trust our customers to pay in the ordinary course of business — thirty days was the norm. Most form contracts still require a contractor to give a notice of default, then wait weeks more before it can stop work. Since by the time a payment is 30 days late, you have now worked yet another month, you could easily find yourself bound by contract to keep working for 60 days or longer without payment (particularly if you signed an agreement with a lender that gives it more time to decide whether to step in and take over).

The way to protect yourself is to change that standard language by insisting on the right to stop payment immediately if you don't receive the money, in full, when it is due. (Remember: a "grace period" is an interest-free loan from you to your customer.) If you can't get that, get the shortest time possible for the right to stop work. Ask for bi-monthly payments, so that if you don't get paid, your subsequent investment is less. Insert in the contract that if you stop for non-payment, your customer will pay the cost of re-mobilizing if you come back. Watch out for "pay-if-paid" clauses in subcontracts, which pass on to you the risk of bad credit of someone you may not even know. These are not the only hard times the industry has seen, and contractors who are good money managers will make it through just as they always have.

Susan McGreevy is a partner at Stinson, Morrison, Hecker LLP, Kansas City, Mo., 816/842-4800, e-mail to [email protected].