Reduce your risk through better visibility
Wednesday, September 02, 2015
Construction payment is complex and full of challenges. The credit-heavy nature of construction projects and the lack of visibility throughout a project can give rise to critical payment problems that can reverberate up and down the payment chain.
Nobody wants a project to grind to a halt because of payment issues and associated mechanics liens or bond claims. Sometimes, what seems to be deep-seated payment problems turns out to be visibility issues, so setting up a company-specific culture of correcting those particular issues can reduce risk for all parties, and result in faster and more structured payment.
Construction payment structure has inherent risks
It's not difficult to see why parties in the construction industry have historically had a difficult time getting paid and/or avoiding risks from unpaid parties.
Instead of requiring payment prior to furnishing labor or materials, almost all work is furnished on credit all the way throughout the payment chain from the GC on down to material suppliers. When credit-based payment is coupled with razor-thin margins, changing project requirements and a large number of project participants, the result is a complex system that doesn't take much to bog down.
This payment structure, and the different security instruments available to "even the playing field" results in two competing financial risks:
- the risk of nonpayment increases in proportion to an increase in a party's distance from the source of the money
- the risk associated with mechanics lien claims (potentially from "hidden" parties) increases the closer to the money one gets
There are many places for money to slip through the cracks on construction projects, and just as many reasons why payment gets delayed. Because of the interconnectedness of the payment chain, any little inconvenience, delay or dispute about any component of the work can impact payment for everyone on the project, whether or not that party was directly involved in the situation.
Further, the ramifications of making a claim against a project's bond or filing a mechanics lien against the property can be felt by all of the project participants, and can sometimes result in additional payment problems.
The visibility problem and how to fix it
One particularly important factor in construction payment problems is a lack of visibility. Property owners or GCs can't make sure a subcontractor or supplier is paid if the paying party doesn't even know that the unpaid party was on the project.
Construction projects — especially large ones — routinely have numerous parties that are completely unknown to the parties with control of the money. These top-of-chain parties bear the risk of double-payment or stoppages in work caused by lower-tiered parties' usage of lien or bond claim rights, and have little ability to make sure everybody is paid.
While some states specifically allow property owners and/or GCs to request a list of everybody on the project from their subs, this is not always formally built into the law. While it doesn't hurt to make such a request, it may be an even more efficient solution for each party on the project to make itself visible without the request.
If the top-of-chain parties are made aware of the project participants, however, payments can be made, lien waivers obtained and participants tracked. In a perfect world (a world that new technology is getting closer to every day), every party on a construction project would be known to the party in control of the money, along with the parties' payment and security status. This would result in faster payment, fewer payment problems and a much more smoothly running payment process.
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