Subcontractors and suppliers (collectively “subcontractors”) know all too well that cash flow is the lifeblood of your business. Yet many subcontractors overlook the vital role that subcontract clauses can have on affecting their ability to timely secure payment. Here are just a handful of tips about the top subcontract clauses that affect cash flow and tips to negotiate better terms.
1. Condition Your Bid on Acceptable Payment Terms
Always make sure that your proposal for the work is conditional upon acceptable contract language. If you fail to do this, you may have squandered the leverage you need to obtain good contract payment terms on a host of issues including those addressed in this article, particularly if the contractor has relied on your bid to win the job.
If you cannot secure fair payment terms, you always want to preserve the right to walk away from a bad contract to a safer job and it starts with conditioning your bid and then holding firm on the killer clauses that most threaten your cash flow.
2. Always do what is necessary to Preserve Your Mechanic’s Lien and Bond Rights
Lien and Bond rights are important in and of themselves, but have a huge and often underappreciated impact on cash flow in that subcontractors who take care to do what is necessary in their contracts and at the start of a job to preserve their lien and bond rights position themselves to go to the head of the line for payment even on projects where the owner or upper tier is getting cash-strapped.
This is because the payment security of a mechanic’s lien or payment bond means there is an additional party, and pool of money, to pay a valid claim. Subcontractors who are diligent in preserving their rights can distinguish themselves from other creditors, who will be more likely to be at the mercy of their customer.
Knowing the law of the state where you are working, and following it to preserve these important rights, is vital. Some states allow ‘up front’ waivers of mechanic’s lien and bond rights. Others prohibit such waivers. Some states require subcontractors complete and serve or record a preliminary document (at the start of their work) such as a Notice of Furnishing as a condition precedent to the subcontractor’s ability to later make a lien or bond claim. Other states have no such requirements or restrictions, but all have filing and notice deadlines of some sort that typically must be strictly followed at the risk of losing rights.
Every year ASA publishes a Review of Lien and Bond laws in the 50 States, together with contact information for ASA attorneys who contributed to the manual. Referencing that and getting a qualified construction attorneys’ input into your needs when starting a project are two of the most important things you can add to your contract management toolbox to better ensure a more consistent cash flow.
3. Avoid Pay-if-Paid Clauses like the Plague (use Pay-When-Paid as an alternative)
Agreeing to a ‘pay if paid’ clause in your subcontract can be a big mistake. In the states that allow “Pay If Paid” clauses (in some states such clauses are void as against public policy), if you agree to such a clause you will reduce your leverage to be timely paid. Even worse, you may increase the likelihood you will be subject to back charges if your customer is fighting with the owner for payment and negotiating back charges of its own.
In the first instance make sure to negotiate good contract language with your customers. In this regard the subcontractors who best set themselves up to be paid are those who negotiate and absolute obligation to pay, whether on its own (payment tied to invoice date, acceptance of work or monthly or other completion of services) or by converting a pay-if-paid clause into a ‘pay-when-paid’ clause that will allow your customer a reasonable period of time to pursue payment from above before an absolute duty to pay you kicks in.
4. Don’t overlook the financial backing or reputation of your customer’s customer
Don’t forget that your customer is in the same boat as you are because it too needs cash flow to pay its bills, which include your bill. Thus, keep in mind that even the best contract language you can negotiate may not ensure your timely payment if your customer is not being paid for any reason.
This means that when entering a contract you should not only consider what your contract says about payment terms, but should actively investigate the project’s financing and the reputation of those who control the cash flow in the tier (or tiers) above you. It is not only reasonable but prudent to ask for payment assurances. Indeed, many of the current industry forms like the ConsensusDOCs Subcontract Form expressly give subcontractors a contractual right to access information about the owner’s project financing.
If you cannot verify that the project has the financial backing to succeed, or are concerned about a party in the upper tier above your customer, that information may play a vital role in your decision on what to bid and the security you need to continue.
5. Consider a Joint Check Agreement
Ten years ago or more even raising the prospect of a joint check agreement would raise eyebrows. But in the last five years such agreements have become more and more common to the point that your company should seriously consider routinely asking for them, particularly when dealing with a new customer or if you have any concerns about either the owner’s financial backing or your customer’s reputation, willingness or ability to pay. A properly worded joint check agreement may be the best contract language you can negotiate for cash flow in that such agreements can create a direct pipeline from the owner to your company and eliminate the payment delays that are otherwise common when payment must be channeled through your customer before it gets to you. Subcontractors with a Joint Check Agreement on a Project are much more likely to be paid, even if your customer encounters financial difficulty, than the subcontractors who are relying on standard subcontract language.
But a joint check agreement is only as good as the language in its four corners. If you will use such an agreement always ask a good construction attorney in your state to prepare a form for you to use or, if you are being presented an agreement drafted by another party, have your attorney review that agreement to advise you on whether it is sufficient for your needs. Don’t be penny wise and pound foolish: Given how important such Agreements are to cash flow, the little bit you spend up front on an attorneys’ review and input is valuable insurance that when push comes to shove you have the protection you need.
The subcontractors and suppliers who know what to look for, know what to ask for, and are prepared to stick to the bottom line and timely address issues as they develop, will be much better for it in the long term. Simply put, incorporating these five tips into your credit strategy will help subcontractors and suppliers of all stripes become more profitable as cash flow and collection rates increase. And that’s a good thing.