The construction industry brings unique challenges to contractors and subcontractors when it comes to credit management. Extending credit on large-scale construction projects can be risky, as projects require a large upfront investment of both labor and materials, and because projects can span years with payments made in installments.
Of course, extending credit and exposing oneself to risk is not unique to the construction industry. But the tools that exist to combat financial risk and secure payment in the construction industry are unique.
What are these tools? Mechanics liens and bond claims. Read on to learn how these legal tools, which are exclusive to construction industry participants, make the process of credit management in construction unique.
Lien Rights: What Are They?
Most parties who furnish labor or materials to construction projects are granted lien rights, in other words, the right to file a mechanics lien or bond claim in the event of nonpayment. These documents were introduced to the American legal system by Thomas Jefferson in the 1700s specifically to protect construction industry participants who performed work on credit from the risk that they wouldn’t be paid. To learn more about how and why lien rights were developed, read our article “What Are Lien Rights?”
While similar protections exist in some other credit-heavy industries, mechanics liens and bond claims are unique and exclusive to the construction industry.
Mechanics lien claims are unique legal tools designed to ensure that contractors, suppliers, and other construction participants secure payment for labor or materials furnished on private construction projects. (Private projects are residential, commercial, or industrial. For more on identifying project type, click here.)
A mechanics lien is a security interest in the improved property. The lien encumbers the property, preventing sale or transfer of ownership, which motivates the property owner to make payment. If a claimant files a mechanics lien and remains unpaid, they may enforce the lien in court and foreclose the property. The claimant then collects payment from the proceeds of the property’s sale.
Bond claims serve a parallel function to mechanics liens, but they are used on public projects (municipal, state, or federal projects). Bond claims are distinct from mechanics liens because while a lien claims a stake in the improved property, bond claims attach to the surety bond set aside at the beginning of a project. This is because it is impossible to claim partial ownership of government-owned property.
Unique Solutions with Unique Requirements
Mechanics liens and bond claims are unique to the construction industry. But the rules and requirements that govern them are unique to each state. And these rules must be followed to ensure that a mechanics lien or bond claim is valid.
Nearly 40 states require that lien claimants send some sort of preliminary notice near the start of a project in order to secure the right to file a mechanics lien. Failing to send a required notice may invalidate lien rights, and leave an unpaid construction party with little recourse other than filing a lawsuit.
Lien-related documents vary by state. Some states require that preliminary notices contain specific language, some states require that lien waivers follow a statutorily-required template – the list goes on. Be sure that any notice, claim, release, waiver, or other documents follows the requirements set forth by the state in which work is performed.
Another key requirement that varies by state? Deadlines. Deadlines for sending notices, filing claims, and enforcing claims differ by state. Identifying and meeting deadlines is essential to successful credit management through securing lien rights.
Credit Management in the Construction Industry
Lien rights are certainly not the only element of credit management in construction. But they are unique to the construction industry, and credit managements who understand these tools can take advantage of them. Benefits of employing lien rights are improved cash flow, reduced DSO, minimized financial risk, and greater confidence when extending credit and taking on new business.
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