In parts I and II of this article, we focused on specific “best practice” contract terms that well-drafted construction documents should address. Ultimately, it all boils down to getting paid for what you do. But even well-drafted contract payment provisions won’t guarantee that the owner will have cash available to pay what is owed, month-by-month.
The common practice of creating a single purpose limited liability company as the titular “owner” of a commercial construction project only enhances this concern. If the owner has no other business or assets, and can pay contractors only with borrowed money, the owner may be only one draw away from insolvency.
So what can be done to help insure payment?
Traditionally, contractors rely on their mechanics lien rights to secure payment. Often, a mechanics lien may have partial or even full priority over a construction mortgage. In some states, mechanics liens are not subject to a “pay-if-paid” defense. Typically, a prevailing lien claimant is entitled to recover interest and attorney’s fees.
Mechanics liens are very effective tools but they are not without drawbacks. Lien laws are complex and the deadlines are unforgiving. Not everything is lienable. Condominium projects present special enforcement difficulties. The filing of one lien often leads to a stampede of others. And a lien enforcement lawsuit could have dozens of parties, making it slow and expensive.
A properly perfected mechanics lien is a powerful tool to secure payment, but it’s an after-the-fact remedy that most contractors think about only when payments are overdue.
If a contractor is concerned about the viability of the owner or the security of payment, here are a few ideas for proactive protection:
- Include in the owner contract a provision that, upon written demand, the owner must produce satisfactory evidence of its financial ability to complete the project. Couple this with a right to terminate the contract and accelerate any retainage if the owner cannot provide sufficient assurances.
- Obtain payment in advance, if not directly to the contractor, then to an escrow with a neutral third party.
- Get a letter of credit permitting the contractor to get paid by simply certifying to the issuing bank that he or she has completed all work required under the contract.
- If contracting with a subsidiary corporation or a single purpose LLC, ask the parent organization’s individual principals for a guarantee of payment.
As always, the time to negotiate contract terms is before you sign the contract, not after problems arise. ■
About The Author:
Mr. Fylstra is director shareholder at the Chicago law firm Kubasiak, Fylstra, Thorpe & Rotunno, P.C. He concentrates his law practice in business litigation, including the representation of business organizations and individuals in all courts. With extensive experience representing contractors, industrial companies, and financial organizations, his litigation practice includes complex construction cases, insurance disputes, real estate litigation, oil and gas litigation, Uniform Commercial Code matters, and intellectual property litigation. He can be reached at .
Modern Contractor Solutions, July 2013
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