Increase cash flow through mechanics liens and bond claims
Thursday, November 05, 2015
Construction industry payment challenges can limit a company's available cash and result in too much past-due A/R. Because of this, construction companies fail at a higher rate than nearly any other industry.
However, even when the problems are mere annoyances and frustrations and don't rise to a level critical for the solvency of the business, the associated headaches and the time consumed just trying to get paid can be severely burdensome.
These two problems — waiting too long for payment and having too many invoices written off as uncollectable — are especially thorny problems in construction. The convoluted nature of the construction payment chain makes payment struggles all too common and seemingly unavoidable.
But, because the problems are caused by the specific nature of the construction industry, the particular tools specific to the construction industry can be used to control and decrease these problems. Tools — mechanics liens and bond claims — were developed specifically for parties in the construction industry reduce the financial risk of nonpayment. Using them correctly and intelligently can be the difference between getting paid quickly and not getting paid at all.
Mechanics liens and bond claims, because security matters
Mechanics liens (the remedy primarily available for private projects) and bond claims (the remedy primarily available for public projects) are basically the same underneath. Despite each having a different overlay of requirements and a different underlying security, both are involuntary security interests provided to parties in the construction industry to provide protection from the risk of nonpayment.
If parties improve real property, they are granted security rights by statute. This is powerful payment protection.
A security interest is basically a right to an asset that may be claimed in the event of nonpayment. It's collateral. This means whatever is bound by the security interest may be claimed and/or sold to satisfy the debt. In private construction projects, this means the improved property itself. For public projects, the bond is the collateral for payment of the amounts due. If the necessary steps are followed, a construction industry participant can make a claim against the collateral to get paid.
Secured debt is much more likely to get paid than unsecured debt. Nobody wants to have his or her property burdened or encumbered by somebody else having the ability to take it. Since true secured debt is rarely ever avoidable by the indebted party, its use can virtually guarantee timely payment.
And timely payment means no more enormous aging reports and lists of uncollectable invoices.
How to use it
The first step to using the tools available is to decide to do so. This sounds trite, but many companies say they want to eliminate uncollectable invoices, but lack the discipline or fortitude to take, and stick with, the required actions.
Once the decision has been made, however, the company can begin to implement the decision. In order fully do so, and start getting paid on every project, a company needs to always remain in a secured position and make sure it is known and visible to all parties up the payment chain.
The easiest way to accomplish both of these requirements is to create and routinely follow an automated receivables funnel with the following steps:
- Send preliminary notice up the chain to protect security rights and provide visibility of involvement on project at the beginning of every project. (Note: Most projects never go beyond this step.)
- Send a notice of intent to lien to prompt payment, if the invoice goes into default.
- File a mechanics lien/bond claim to perfect the security interest if the notice of intent does not prompt payment.
- Send to collections for set period of time.
- File a mechanics lien enforcement action (foreclosure) or bond claim enforcement suit to recover.
Following these steps on every project not only increases cash flow and reduces default A/R, but it also allows companies to pursue more business. Business that was once thought too risky for credit can be obtained. The best part for construction companies is that this process can be easy and automated.
The proper and thorough use of security rights on construction projects can have a significant financial impact. These tools were specifically created to make sure construction participants get paid, but they are of no use unless actually used.
The historic challenges to their use are becoming obsolete through technology, and automating the process is possible. Using tools specific to the industry makes sense, and using those tools to make sure your company never needs to worry about payment makes a lot of sense.
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