In Florida, during a three-week period in March 2021, four construction companies filed for bankruptcy. In Brooklyn, two major developers also filed for bankruptcy in the first quarter of 2021. Kroger, a multistate retail company, has several lien filings against it due to nonpayment on construction projects.

Unfortunately, stories like these are happening with increased frequency. Whether it’s due to the coronavirus, or companies just getting overextended, it’s a pattern that is likely to continue into the future. Construction companies need to be prepared to deal with these kinds of problems before they come up.

As the number of bankruptcies and lien filings rise, it’s more important than ever that construction companies prequalify their customers financially before starting work or providing materials. Prequalification gives companies the information they need to decide if a customer is a good credit risk. Companies should always follow a written credit policy to determine who to extend credit to.

The importance of a credit policy

The goal of a credit policy is to maximize revenue while minimizing risk. It provides guidelines for extending credit to potential customers, payment terms and the course of action the company will take for late payments.

A good credit policy sets expectations for potential customers and for a company’s internal credit department. Everyone knows what to expect and when to expect it throughout the credit relationship. Customers can’t claim that they didn’t know a lien was going to be filed when your policy clearly states that you will when payment is 30 days past due. This predictability helps build better business relationships.

Companies in the construction industry are able to have a more lenient credit policy due to the fact that they can rely on mechanics lien laws to protect their payment rights. This helps these companies increase revenue because they can extend credit to more customers. However, to take advantage of these lien rights, companies have to meet the notice requirements set down by each state’s laws.

Lien policy

A company’s lien policy is usually included as part of their credit policy document. The policy states when preliminary notices will be sent, who they will be sent to, when notices of intent to lien will be sent, and when liens will be filed.

Since each state has its own requirements for deadlines and documentation, a company’s lien policy should provide a template for the processes that will be used, with reference to the specific statutory requirements on a state-by-state basis.

The most crucial part of the lien policy is the sending of preliminary notices, since these notices can be crucial to maintaining a company’s legal right to payment. In many states, if a preliminary notice is not sent, a contractor or supplier loses their right to file a mechanics lien. Companies need to set clear expectations for when preliminary notices will be sent and on which projects.

Collection policy

Another key part of a credit policy is the collection policy. This section lists the steps that a company will take to secure payment from their customers. The collection policy streamlines business operations by reducing the decisions that have to be made by credit departments. It ensures that everyone knows what to do and when, as far as collecting payments.

A collection policy should include information about when and how to contact customers regarding payment, how disputes are to be resolved, when to use internal/external collectors, and when to write off debt or begin litigation. When all the steps are laid out clearly and everyone follows them, customers can be assured of a consistent experience.

Biggest mistakes in credit

The two biggest mistakes in credit policies and procedures are not sending preliminary notices and not getting a personal guarantee. Since preliminary notices are often the key to ensuring mechanics lien rights, they should be sent on as many projects as possible. If they aren’t sent, a company could lose its right to file a lien and would have to rely on collection efforts or a lawsuit to ensure they get paid.

The other big mistake is not getting a personal guarantee when processing a credit application. A personal guarantee ensures that one of the company’s officers will be financially responsible for any outstanding debt that can’t be collected from the company. It provides another alternative to collections or a lawsuit when trying to recover payment.

Conclusion

Construction companies need to protect themselves from potential credit risks during this volatile economic time. Companies can do this by prequalifying potential customers and closely following their credit policies to collect payment. Companies that don’t have these policies in place should start developing them to protect them in the future.

It’s important for construction contractors and suppliers to protect their payment rights through the use of preliminary notices and mechanics liens. Following the law on these processes will save companies time and money and help prevent expensive legal action.