This blog’s focus is traditionally on mechanics lien and bond claim laws. When providing services, materials or labor to a construction project, I feel it’s best to understand and utilize the lien-like remedy available to those furnishing. It provides security for the credit you’re extending to your customer.
However, when working with folks in the construction industry, we encounter different and unique situations all the time. Sometimes, our clients are faced with situations when there may not be any lien or bond claim rights. While your company can usually find security in your lien and bond rights, what can you do to protect yourself in these situations when there aren’t lien or bond rights?
Examples of When You May Not Have Lien or Bond Claim Rights
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Wait. What am I talking about? You thought whenever you furnished labor or materials to a construction project, you’re always with bond or lien rights…
Well, unfortunately, the law is never black and white, and if there is one rule to which there is no exception, it is the rule that there are always exceptions. In the mechanics lien and bond claim world, those furnishing labor or materials to a construction project usually have the right to file a mechanics lien or bond claim. Here, however, are some circumstances when those rights may not exist:
- Suppliers to Suppliers do not usually have lien rights. I recently consulted with a client who usually furnishes directly to a contractor or subcontractor, but were now working on a project where the furnishing was to another supplier. While they usually have mechanics lien rights, they may not this time.
- State, County or Federal construction projects require a payment bond get posted whenever a project’s value reaches a certain threshold. When the threshold isn’t met, however, they may not be a bond in place. On Federal projects, the threshold is $100,000. This amount can be much higher, and an example of this is a new Virginia law that allows contracts of up to $350,000 to be un-bonded.
- You may be furnishing to a private developer, who is developing a project on public land. In this case, the project will not be bonded because it is not a public works project, but it may not be lienable because you’re on public land. In some states, you can file a lien against the lease interest in the property, but in others, like New York, it may be trickier.
Special Security Options: Joint Checks, Personal Guaranties, Letters of Credit
If you’re about to furnish to a construction project without bond claim or mechanics lien rights, you should consider additional security devices available to protect your rights to get paid.
Unlike mechanics lien and bond claim rights, special security devices do not arise by law, and therefore, you’ll need to negotiate these rights at the time of contracting.
Here are three popular security instruments you can contract into to protect your rights to payment.
Joint Check Agreements
What is a joint check agreement? It’s simply an agreement between two parties, whereby each agree that any payments to one will be made by issuing a check with both parties names on it.
In the construction industry, joint check agreements are popular. A typical scenario is when a material supplier and a subcontractor enter into a joint check agreement, and any payments from the prime contractor to the subcontractor will list the material supplier on the check. This ensures that the material supplier isn’t cut out of any payments, and that the subcontractor does not misappropriate any payment funds.
Joint check agreements should always be in writing. While they may be effective in some states if agreed to orally…good luck proving it! Also, while it’s best to enter into joint check agreements at the beginning of a project, these agreements can be entered into at anytime. They very commonly get executed when a material supplier begins to have credit concerns about a subcontractor, well after first furnishing.
To ensure compliance, it is best to get the paying party (i.e. the prime contractor) to sign on and agree to the joint check agreement. At the very least, make sure the paying party has a copy of your written agreement.
Personal Guaranty
Doing business with an organization is usually just fine. However, if you’re working with a small closely-held corporation or business entity, you should be cautious because that company can quickly shut down and leave its creditors hanging.
In these situations, you’ll want to consider requiring the company’s shareholders or members to sign a “personal guaranty,” which simply means that if the company doesn’t pay the debt, you can seek payment directly from the shareholder or member individually. This is not a guarantee for payment, but it can be very helpful when negotiating your debt if a company is tight on cash.
Letters of Credit
Finally, a letter of credit is a terrific security tool if you can get it. Wikipedia has a great definition:
A letter of credit is a document that a financial institution or similar party issues to a seller of goods or services which provides that the issuer will pay the seller for goods or services the seller delivers to a third-party buyer. The issuer then seeks reimbursement from the buyer or from the buyer’s bank. The document serves essentially as a guarantee to the seller that it will be paid by the issuer of the letter of credit regardless of whether the buyer ultimately fails to pay. In this way, the risk that the buyer will fail to pay is transferred from the seller to the letter of credit’s issuer.
You can furnish materials or labor without much concern if you can get a letter of credit from your customers bank or some other reputable and reliable company.