Surviving a bumpy economic recovery

Aug. 1, 2011
Nothing relating to the last economic recession has been easy. Even the recovery is bumpy. And while we've come a long way from the massive job losses at the end of 2008, the tough times aren’t over yet.

Nothing relating to the last economic recession has been easy. Even the recovery is bumpy. And while we've come a long way from the massive job losses at the end of 2008, the tough times aren’t over yet. The economic numbers are still weak at best, meaning a full recovery is still months, even years, ahead. For the fortunate contractors that have survived so far, it's too early for complacency managing and minimizing risk is still paramount. This means reducing over-all risk exposure by taking pro-active steps up front to manage risk where possible, and making decisions to limit risk where managing it is not possible.

No one makes money by having to enforce lien rights in order to get paid. Not only is cash-flow hurt (forcing the firm to borrow on a line of credit), but the cost of hiring a lawyer will quickly wipe out any profit that could have been generated by the work. The key is to address risk before the problems arise.

Some ideas for risk management are:
Obtain, and use, the right to get financial information. Most standard form construction contracts give the contractor the right to receive reasonable evidence that the owner has financing lined up to cover the expected costs. There is no reason that a subcontract can’t also contain similar language, requiring that this information be shared. Lenders and their lawyers are very savvy as to the liability they may face if they misstate their commitments in such letters, so it takes some education to know how to read and interpret these commitment letters. Further, the contractor has to ask and demand answers as to how much of those funds are available for the actual construction, as opposed to the cost of land acquisition or soft costs.

Know who owns the property, and make sure it is someone with money and integrity. More often than you would expect, your contract is with one entity but the owner of the property is another entity. For example, you might have a contract with AAA Land Development LLC, but the owner of the property is AAA Land Holdings, LLC or some other entity with a very similar name to a wholly separate entity. In many states, your legal rights change if you did not contract with the actual owner of the property. And remember, the reason owners and developers set up various entities is to protect the owners’ assets, so it is important to ask questions to make sure you know who you are contracting with.

Monitor availability of funding throughout the project. One of the ways that projects get into financial trouble is if the owner doesn’t borrow enough money up front, so that overruns or change orders have no funding. Before the economic downturn, most lenders would probably just choose to advance additional loan dollars to avoid seeing projects stopped and their collateral deteriorate. Currently, there is a much higher risk that the lender will not step up. The 2007 AIA A201 general conditions no longer give a contractor the right to demand additional financial information unless cause exists, so if that form of document is used, the contractors should make sure that they have the right to monitor release of loan funds to assure that there will be enough to cover their costs. They should further provide that they can stop work, or refuse to perform changes, unless adequate evidence of ongoing financing is produced.

Watch for signs of financial distress. If you have been in business long, you know what I am talking about: people being laid off, slow pay, short payments with suspicious excuses, less equipment or materials on site. Listen for news of other projects being built by the same owners or contractors. You do not want to be the last passenger on a ship that is going down.

Get funds put in escrow. Particularly for residential construction, it is typical for contractors to insist that loan proceeds be placed with a title company or other escrow service, under a clear agreement that requires the escrow agent to use them only for this project. The agreement should be reviewed by your lawyer to make sure that it protects your interests.

Develop written agreements for service work, and take credit cards. It is much easier to enforce your rights for service work if you can show that the customer was provided all your rates and charges, and signed off on an estimate before the work was done. Your lawyer can help you develop forms that will hold up in court.

Know your lien rights and develop a cost-effective system for using them. Again, this should be a last resort, but it is an effective tool to protect the rights of contractors.

If we're luck we are heading towards more robust economic times. In the meantime, make sure you remember to use sound risk management techniques to help your firm weather what looks to be a bumpy recovery.

Michael Callahan is a partner at Stinson Morrison Hecker LLP (the same firm as long-time columnist Susan McGreevy) where he assists clients with all aspects of their construction law needs, including litigation.

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