There are ways for dealing with a broke customer.
By Jeremy P. Brummond
Contractors deal with customers of all sizes. Some customers are established with a history of good projects. Some customers are new (but a possible source of future work). Other customers are part of “one off” deals where, because of unique circumstances, it is very unlikely the contractor will ever deal with the customer again (outside of the current project). And not every customer is a Fortune 500 company.
Contractors who aggressively chase work frequently converse and deal with customers who are not financially viable (i.e. “broke”). Sometimes contractors incorrectly assume a customer will pay or will have funds available to pay based on superficial information (customer’s office space, number of people working for the customer, employee’s representations, etc.). Contractors without litigation experience may assume they don’t need to worry about the creditworthiness of their customer because, if the customer doesn’t pay, the contractor can “sue the heck out of them.”
In fact, a lawsuit, alone, is a poor way to ensure payment from a broke customer. At the end of a lawsuit, the contractor receives a judgment. But a judgment is not money. A judgment only becomes money when the contractor (or its lawyers) successfully “execute” on the judgment by finding and selling the customer’s assets or by getting an order or writ requiring third parties to pay money or wages due the customer directly to the contractor (commonly called a “garnishment”). A broke customer, however, may not have any assets to sell.
They also may not have any steady source of income to garnish. If the customer is savvy, assets may be held in other companies or in individuals’ names, and may be out of reach via the judgment execution process. And even if the customer has assets that can be found, it’s possible (if not likely) that other creditors (banks) have a “senior” lien on the assets so the contractor doesn’t get paid until the bank gets paid.
Experienced contractors know that ensuring payment requires investigation and action on the “front end” of the deal.
Investigate the Customer and the Project
An important first step that can be taken on the “front end” of any project to help ensure payment is to spend more time and money investigating the creditworthiness of the customer. The individuals with whom the contractor is dealing (principals of the customer) may have money and other assets, but what about the person or entity actually entering into the contract? The person or entity entering into the contract is the customer (and that person or entity may not be the same as the individuals with whom that the contractor is dealing). To investigate the customer, itself, a contractor can ask the customer for financial information (and hope truthful information is provided).
The contractor can also search public records to determine if the named customer holds any real estate or other assets, and searches can also be performed (at minimum expense) to see if there are any banks claiming interests in the assets. In addition, a contractor can search for judgments against the customer or lawsuits involving the customer which can be indicative of the customer’s financial situation.
Think About Payment Terms, Security Agreements and Guarantees
Assuming a contractor cannot verify the creditworthiness of the customer through bank or public records, a contractor should consider seeking, before entering into any contract, other protections to secure payment.
Best means to secure payment, of course, is to ask for payment “up front” before any work is performed. Many customers are hesitant to provide advanced payment. The customer, however, may be open to funding a draw down account where money is provided to a title company or bank before work is performed and is held in trust to pay the contractor. As long as the disbursing agreement used to establish the account sufficiently obligates the bank or title company to pay the money (or at least hold the money if there is a dispute about payment), a draw down account can provide almost as much security as “up front” payment.
If a customer won’t agree to a draw down account or advanced payment, other alternatives to be pursued to try and secure payment at the beginning of a deal include taking a security interest (a lien) in some of the customer’s property (assuming the property does not already have substantial liens against it), or asking for personal guarantees from the individuals behind the customer’s business operations. If security interests or personal guarantees are pursued, counsel should be consulted as to the proper form and filing requirements.
Know Your Lien and Bond Rights
Contractors often think about lien and bond rights on the “back end” of a deal when the customer is late with its payments. But a contractor needs to think about lien and bond rights before the project starts. Many projects (e.g. public projects) are not lienable, and if the contractor is too far down the contractual chain, or performing particular work (e.g. residential repair) it may not have lien or bond rights under state law (or its rights may be limited).
It is important for a contractor to know if it will have lien or bond rights at the beginning of a job, so alternative security (discussed above) can be pursued if necessary. In addition, for certain types of projects or work, contractors are required to file lien notices before or shortly after work starts to preserve lien rights. For these jobs, a contractor will not be able to preserve its lien rights if it waits to think about those rights at the end of the job.
Negotiate a Right to Stop Work
Another powerful way to secure the right to payment on the “front end” is to negotiate the right to stop work upon non-payment. Historically, many construction contracts preserved the contractor’s right to immediately suspend work if payment was not received. In some industries, there is a trend to eliminate this right or to impair this right by requiring substantial notice (e.g., seven days or even 30 days) before work may be stopped.
Retaining the right to stop work when payment is not immediately received when due, however, is important to a contractor’s ability to minimize its losses when dealing with a broke customer. Significant costs can be incurred over a seven-day period. The less time the contractor is required to keep working in the face of non-payment, the better. Stopping work (or the ability to threaten a work stoppage) will often get the customer’s attention and accelerate efforts to direct funding to the contractor.
A contractor can always take action at the end of a project to attempt to get paid. Assuming rights were preserved, a contractor can pursue lien and bond rights, and it can pursue civil claims against others who benefited from its work (including its customer). But the best way to ensure payment, especially when dealing with a “broke” customer, is to take action at the beginning of the deal.
Jeremy P. Brummond practices in the litigation department at Lewis Rice in St. Louis, with a focus on engineering and construction. He can be reached at email@example.com.