Why the Construction Industry Is Unfair (and How to Level the Playing Field)

CONSTRUCTION PAYMENT FAIRNESS

presented by:

Construction Credit Knowledge

View anytime at:

http://www.zlien.com/credit-academy/on-demand-webinars/


What Makes the Construction Industry Unfair?

• What makes the construction payment process unfair?

• Why does it matter & how can it be fixed?


• in negotiation, if both parties feel the other side did better, you probably end up with a reasonably equitable result.

• so, if the parties on the top of the payment chain AND parties on the bottom of the payment chain both view the construction payment process as unfair - is it really?


Answer: YES

• In negotiations, it’s impossible for both parties to be correct in thinking that the other party got the better deal.

• regarding the construction payment process, however, it’s completely reasonable for both sides of the payment chain to be correct in feeling that the process is unfair.


Definitions:

• Top-of-chain: parties at the top of the payment chain are the parties closest to, and with the most control over the $$$. (Property Owners, GCs, Developers, Lenders, etc.)

• Bottom-of-chain: parties at the bottom of the payment chain are further removed from the cash. (Subcontractors, sub-subs, suppliers, etc.)


make no mistake, though.

• everybody has problems with the construction payment process, and everybody thinks that the process is unfair. and, each portion of the chain has specific complaints (which may or may not be true) directed toward the other.


construction project payment structure and risk overview:

• credit-heavy. nearly all labor and/or materials furnished on credit. and, many companies both extend credit and need credit extended to them.

• poor visibility. the volume of project participants can be large, and the further down-the-chain a party is, the less visible he/she becomes.

• payment timing constraints. quite often, businesses must wait until they receive payment before they can pay their own bills.

• low margins. margins in the construction industry are incredibly thin - this, when coupled with other issues, can create significant problems.

• high failure rates. the failure rates for construction industry participants are among the highest of any industry.

• etc. . .


• In general, when no actions are taken by any party, the further a party is from the $$$ the greater risk of nonpayment that party assumes.

• this makes sense. the more parties there are in between a party and the money, the more chances there are for the money to become stuck, non-prioritized, or for payment abuses to occur.


That looks like this:


• however, public policy in the U.S. has determined that the parties closest to the money are best positioned to bear the financial risk.

• to accomplish this, every state has payment security built directly into the law via mechanics liens and bond claims. while these instruments have specific requirements in order to be used, they have a significant impact when used appropriately.


the use of those instruments changes the structure to the following:

the ability to exert more leverage created by the proximity to the $$$ is offset by the security.


so, given that overview, what are the particular problems and how can they be solved?


top-of-chain issues/problems/complaints:

• no visibility

• unacceptable work

• “babysitting” unsophisticated lower-tiered parties

• hidden liens

• double payment


bottom-of-chain issues/problems/complaints:

• bullying by upper-tiered party with more leverage

• slow payment

• unfair lien waivers

• payment abuses

• risk-shifting mechanisms

• cumbersome and difficult process to use available protections


• Why should lower-tiered parties care about the top-of-chain parties’ complaints in addition to their own?

• If these can be solved, the payment process can be smoothed out and optimized - which means lower-tiered parties can be paid more quickly and write off fewer accounts.


visibility: why is it an issue / how can it be solved / how does it benefit everybody?

• one of the chief difficulties in creating a fair construction payment scheme is the lack of visibility. (And, for an owner or GC, the associated risk of liens from unknown parties far removed from the owner or GC).

• an owner or GC cannot control the money and make sure a supplier is paid if the GC has no idea that the particular supplier was even on the project.

• liens from unknown parties, and the potential resulting double payment are real difficulties for top-of-chain parties - fortunately, solving this problem for the top-of-chain party has real and tangible benefits for the lower-tiered parties.


visibility: why is it an issue / how can it be solved?

• worry over this gives rise to certain maneuvers designed to shift risk, which are pressed onto lower-tiered parties due to the top-of-chain party’s greater leverage.

• pay-if-paid or pay-when-paid clauses; strict noticing provisions; and “over-reaching” waivers are some of these mechanisms.

>View Webinars On-Demand about these topics



visibility: why is it an issue / how can it be solved?

• solving the visibility issue is relatively simple, and benefits both top and bottom of chain parties.

• send preliminary notices on every project, and send to all parties higher on the payment chain.

• this results in visibility to the top-of-the-chain

• this results in security for the bottom of the chain


sending preliminary notices on all projects can now be accomplished easily through the use of technology.


• historic challenges to the use of security rights / sending preliminary notice for companies in the construction industry are rapidly becoming obsolete.

• the largest obstacle in the use of security on every project has generally been the number and complexity of the laws and related requirements that must be met.

• compliance with these regulations was both time and cost prohibitive


• in the past, managing and tracking notice requirements was hard to implement and required bulky and cumbersome in-house departments or equally inefficient third-party outsourcing, which made it impossible to send notices on every project efficiently.

• this is no longer the case.

• software has the ability to decode and streamline security circumstances and requirements for parties at both the top and bottom of the payment chain


• since top-of-chain parties track the companies that do and do not send preliminary notice on projects, sending notices can be used to prioritize invoices, and get paid faster.


Average DSO 71 Days for projects in unsecured position (no notice sent)

Average DSO 33 Days for projects in secured position (notice sent)


lien waivers: the problem

• top-of-chain parties leveraging their greater bargaining position to obtain “over-reaching” lien waivers is another issue standing in the way of a fair construction payment process.


specific problems

• incorrect/not legally sufficient forms

• waiving more than contemplated

• signing an over-reaching waiver for the promise of payment


• the needs of the lower-tiered parties (getting paid quickly), and the needs of the upper-tiered parties (keeping the project free of lien claims and avoiding double payment) intersect at the lien waiver document.

• despite this, however, lien waivers are misunderstood, and the lien waiver exchange process is flawed and sub-optimal.


lien waivers: how to fix

• Waivers utilized properly and liberally (as provided below)

• Conditional waivers provided with every pay-app or invoice, and

• Automatic conversion of conditional waivers to unconditional waivers upon actual payment

• Protects top-of-chain parties from the risk of double payment / lien exposure,

• Protects bottom-of-chain parties from waiving security rights prior to payment.

• Solves the “false-problem” of needing an escrow service or intermediary to guarantee fairness / speeds payment process.


fixed through technology: not through “false solution” of escrow-type service.

• conditional waivers (conditioned upon the actual payment) should be sent by every party along with every pay-app or invoice as a matter of course.

• when that payment does occur, an unconditional lien waiver should be immediately generated and sent.


the result: faster payment & less lien exposure.

• by using the “conditional waiver” instrument, parties can avoid the hassle and wasted time of using an escrow-type solution.

• this solution promotes fairness, transparency, and relationships in the payment process, as opposed to the mistrust upon which the escrow solution is founded.


I am hopeful that this presentation gave you some points on which to

think, and some insight into construction payment problems and

potential solutions.


questions?

email me: [email protected]

mailto:[email protected]