Why don’t construction companies use security as a matter of policy?
Wednesday, July 23, 2014
Companies in the construction industry are lucky. They have the ability to secure extensions of labor and/or material on credit built directly into the law and without the need to get approval from any other party. If a party to a construction project wants to be completely secured on all extensions of credit, they must simply heed the rules set out by the laws of the project state.
Companies in other industries would love this type of protection. Generally, security must be granted through some type of voluntary agreement, like a UCC financing statement or a personal guarantee. Even so, most industries in which security is available use it as a matter of course, even if the security must be granted voluntarily.
So, why doesn't the construction industry always use the security available to it?
Security: The tool that gets you paid
When a company is able to secure an extension of credit, the likelihood of payment skyrockets. It's no secret that a secured creditor is in a much better position to be paid than a general unsecured creditor, and therefore the extension of credit can be approached with a slightly more lenient credit decision.
So, what is secured debt, and how should your company's credit policy deal with it?
This is where a construction credit manager can take some hints from industries like banking, where security is used as a matter of course. Banks secure every extension of credit they make — if they didn't, there would be a lot of bankers looking for new jobs.
A tool that exists solely for the purpose of guaranteeing payment should be used by construction companies. Just like a bank wouldn't give a loan for a house or car without gaining collateral to guarantee repayment, construction credit professionals shouldn't extend credit without taking the steps necessary to secure it via mechanics lien or bond claim rights (or UCC liens, or personal guarantees, etc.).
Secured debt is a debt backed by a security interest in collateral. Securing the extension of credit with collateral reduces the risk associated with lending or extensions of material on credit. If a debt is "secured," it is backed by a right in an asset that may be claimed by the lender in the event of a default by an indebted party.
Long story short, security is a tool that gets companies paid. It protects against debtor default and provides leverage to prompt payment with the "stick" of foreclosure looming in the background. Professionals in the construction credit space can learn this lesson from professionals in the banking sector — being secured won't hurt you, but being unsecured may.
Why isn't it used more often?
Given the above, why isn't perfecting security rights an essential part of every construction company's credit policy?
Many businesses are reluctant to send preliminary notices because they worry about alienating customers by impugning the client's integrity, appearing that the company doesn't expect payment, or being combative or confrontational.
It's easy to see where this viewpoint comes from. Many successful businesses have been built on trust, mutual respect and the power of looking somebody in the eye, a handshake, or assurance that it's the "right" decision.
These fears — while real, and presumably based on some experiences — are not the prevailing view of the marketplace, however. The fact of the matter is that businesses have been securing the debts owed to them for a long time. This argument is generally raised by businesses that 1) are small- to medium-sized and/or 2) have much of their business conducted face-to-face, not through paper or electronic communication.
These businesses may not secure their extensions of credit because they are unfamiliar with the process. They don't understand how security works or why it would benefit them, and they can't spare the manpower and/or hours to properly secure their credit extensions or learn how to comply with the legal complexities.
Some view securing amounts due as something for a bigger business. And, if much of a company's business is conducted face-to-face, it may be uncomfortable to bring up security interests (at least at first).
The reality of the marketplace is that businesses either expect security to be used, or do not mind it.
Is it too costly?
Pretty much everything in business eventually comes down to a cost-benefit analysis. With advances in technology, gaining the benefit of security is easier and faster than ever. It is a fact that the laws can be convoluted, and that deciphering them can be difficult.
However, this argument is (generally) doomed to fail just like the argument above. Not only does new technology decrease the expenditures required, but the cost of not securing extensions of credit can be too high.
Given the above, the construction industry should emulate other industries, and use the security available whenever possible.
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