March 15, 2009
Risk management during an economic downturn: Part One
By Robert Kennaley
McLauchlin & Associates
As we move into uncertain economic times, contractors, subcontractors and suppliers should reassess how they manage the risk that someone above them in the construction chain may not be able to pay his bills. We know from experience that during a recession, many a good company can get seriously hurt when it lets debtors become too far extended and are unable to collect what is owed to them.
As is the case with most risk management strategies, we should start with the form of contracts and subcontracts we enter into. First, the payment provisions need to be spelled out in detail. If there is any ambiguity or vagueness about when you will be paid, the other side may argue (perhaps correctly) that you are not entitled to be paid until the end of the job. Your contracts and subcontracts should also specify how, and when, you will be paid for extra work. Again, in the absence of such provisions, you might not get paid until the end of the job. Finally, it is best to negotiate monthly progress payments, if possible. By doing so, you can limit the amount of time and materials you will have invested in the project at any given time. In any event, reasonable progress payments are important in these times.
Second, you should ensure that you are contractually entitled to at least stop work in the event that you have not been paid your progress payments, when due. If you do not, you may be expected to keep working while the dispute over non-payment is worked out.
Third, depending on your point of view, you might either utilize, or try to avoid, “pay when paid” or “pay if paid” clauses. These transfer the risk of non-payment by someone further up the chain to the subcontractor actually performing the work. Essentially, the contractor uses the clause to say to a subcontractor: “You will be paid if, and when, I get paid.” Subcontractors, of course, will want to avoid the clause, while contractors might want to utilize them. Subcontractors, who cannot avoid the clause, should at least ensure that they have the right to stop work if they are not paid (see above).
Fourth, if you have control over the terms of your contract or subcontract, you may want to specify the interest that will be charged on overdue accounts. You should ensure that the interest rate is stated as an annual rate, or it may not be enforceable.
Similarly, contractors may want to perform title searches to ensure that they are actually contracting with someone who owns the property. If, for example, you are contracting with someone who only leases the property (this is common in a commercial context), you will for all intents and purposes lose some of the leverage established by the Construction Lien Act.
In addition, in some circumstances you may want to make the contract or subcontract conditional upon a satisfactory credit evaluation. Whether or not you perform credit evaluations may depend on the circumstances of the particular case. As an example, you may determine that the owner you are contracting with is a corporation without assets, and/or does not own the land, therefore prompting you to ask that the contract be guaranteed by a principal of the company, or by another company with assets.
In this economic climate, if a client requests an extra, you need an immediate approval not only with respect to the work, but also with respect to the price of the work. Again, it is all too common for extras to be performed before the price is finalized and then, at the end of the job when the person you are working for has run out of money, he or she is suddenly objecting to the cost. In these times, contractors and subcontractors are encouraged not to perform extra work until they have agreements on the scope of that work, on its price and on when they will be paid for it. Payment, of course, should be on the next progress invoice (see above).
We will offer further comments on risk management in this economic climate next month. For the time being, however, contractors, subcontractors and suppliers are encouraged to keep their ears to the ground as work progresses. If you sense there may be a problem with payment, you need to take steps to manage the risk of non-payment immediately. Options you can take in this regard will be discussed next month, but in the meantime if you sense a problem you should contact someone familiar with collection issues. In this climate, the risk of insolvency above you in the construction chain can be catastrophic.
Robert Kennaley practices construction law in Toronto and Simcoe. He speaks and writes regularly across North America. He can be reached for comment at 416- 368-2522, or at kennaley@mclauchlin.ca. This material is for information purposes and is not intended to provide legal advice in relation to any particular fact situation. Readers who have concerns about any particular circumstance are encouraged to seek independent legal advice in that regard.
McLauchlin & Associates
As we move into uncertain economic times, contractors, subcontractors and suppliers should reassess how they manage the risk that someone above them in the construction chain may not be able to pay his bills. We know from experience that during a recession, many a good company can get seriously hurt when it lets debtors become too far extended and are unable to collect what is owed to them.As is the case with most risk management strategies, we should start with the form of contracts and subcontracts we enter into. First, the payment provisions need to be spelled out in detail. If there is any ambiguity or vagueness about when you will be paid, the other side may argue (perhaps correctly) that you are not entitled to be paid until the end of the job. Your contracts and subcontracts should also specify how, and when, you will be paid for extra work. Again, in the absence of such provisions, you might not get paid until the end of the job. Finally, it is best to negotiate monthly progress payments, if possible. By doing so, you can limit the amount of time and materials you will have invested in the project at any given time. In any event, reasonable progress payments are important in these times.
Second, you should ensure that you are contractually entitled to at least stop work in the event that you have not been paid your progress payments, when due. If you do not, you may be expected to keep working while the dispute over non-payment is worked out.
Third, depending on your point of view, you might either utilize, or try to avoid, “pay when paid” or “pay if paid” clauses. These transfer the risk of non-payment by someone further up the chain to the subcontractor actually performing the work. Essentially, the contractor uses the clause to say to a subcontractor: “You will be paid if, and when, I get paid.” Subcontractors, of course, will want to avoid the clause, while contractors might want to utilize them. Subcontractors, who cannot avoid the clause, should at least ensure that they have the right to stop work if they are not paid (see above).
Fourth, if you have control over the terms of your contract or subcontract, you may want to specify the interest that will be charged on overdue accounts. You should ensure that the interest rate is stated as an annual rate, or it may not be enforceable.
Know exactly who owes you
Contractors, subcontractors and suppliers should also take care to ensure that they know with whom they are contracting. If you think you are dealing with a corporation, the full corporate name needs to be determined. If it is not, you may not actually know who owes you the money. In the residential context, it is suggested that if you are working for a husband and wife, both should have their names on the contract. It is common, for example, for the husband to want the contract in his name because the wife owns the house.Similarly, contractors may want to perform title searches to ensure that they are actually contracting with someone who owns the property. If, for example, you are contracting with someone who only leases the property (this is common in a commercial context), you will for all intents and purposes lose some of the leverage established by the Construction Lien Act.
In addition, in some circumstances you may want to make the contract or subcontract conditional upon a satisfactory credit evaluation. Whether or not you perform credit evaluations may depend on the circumstances of the particular case. As an example, you may determine that the owner you are contracting with is a corporation without assets, and/or does not own the land, therefore prompting you to ask that the contract be guaranteed by a principal of the company, or by another company with assets.
Timely invoices important
As the project progresses, it is critically important in this economic climate that you not let the person who owes you funds get too far behind. This involves, of course, timely invoicing for progress payments and for extras on your part. It is all too common for contractors and subcontractors to get so preoccupied with performing the work, that their accounting gets behind and before they know it they have not issued invoices for an unacceptable period of time.In this economic climate, if a client requests an extra, you need an immediate approval not only with respect to the work, but also with respect to the price of the work. Again, it is all too common for extras to be performed before the price is finalized and then, at the end of the job when the person you are working for has run out of money, he or she is suddenly objecting to the cost. In these times, contractors and subcontractors are encouraged not to perform extra work until they have agreements on the scope of that work, on its price and on when they will be paid for it. Payment, of course, should be on the next progress invoice (see above).
We will offer further comments on risk management in this economic climate next month. For the time being, however, contractors, subcontractors and suppliers are encouraged to keep their ears to the ground as work progresses. If you sense there may be a problem with payment, you need to take steps to manage the risk of non-payment immediately. Options you can take in this regard will be discussed next month, but in the meantime if you sense a problem you should contact someone familiar with collection issues. In this climate, the risk of insolvency above you in the construction chain can be catastrophic.
Robert Kennaley practices construction law in Toronto and Simcoe. He speaks and writes regularly across North America. He can be reached for comment at 416- 368-2522, or at kennaley@mclauchlin.ca. This material is for information purposes and is not intended to provide legal advice in relation to any particular fact situation. Readers who have concerns about any particular circumstance are encouraged to seek independent legal advice in that regard.