By: Frank Skelly

Why senior lenders might want to consider entering into inter-creditor agreements with commercial construction cash management & funds control companies.

We are frequently approached by sub-contractors who are in need of our services, however if they have an existing credit line, its often a deal killer. When banks and senior lenders provide borrowers with credit lines, they usually take a 1^st position security interest in the borrower’s assets, which includes their accounts receivables.

One of the best ways for a commercial sub-contractor to finance their construction projects is with a cash management & funds control company that uses their accounts receivable as collateral. But if the sub-contractor already has a line of credit they are usually out of luck. Senior lenders usually take a blanket security interest in all assets which prevents the sub-contractor/borrow from using their accounts receivables as collateral.

Typically banks and senior lenders are hesitant to give up their security interest in the borrower’s assets however banks should seriously consider inter-creditor agreements which, if drafted properly, can carve out the accounts receivable while providing all parties with the protection they need. A well-crafted inter-creditor agreement can actually provide the senior lender with an additional layer of security that they wouldn’t otherwise enjoy. Here are a few of the things a senior lender might want to consider;

• A project specific credit facility secured with accounts receivables would allow an existing borrower to capitalize on new opportunities and improve cash flow, without taking on additional debt.

• On financed projects a borrower’s receivables would be available much earlier in the billing cycle, usually within a couple of days instead of a couple of months.

• A senior lender could have the option of being notified each time the sub-contractor/borrower wanted to draw down on the project facility and the opportunity to approve (or deny) each funding.

• As is customary with construction cash management companies, a Notice of Assignment would be served upon the sub-contractor’s customers (account debtors). This would result in all funds being routed through a lockbox so in the unlikely event of a default the senior lender would be spared the arduous (and unrealistic) task of identifying (and intercepting) proceeds from the sub-contractor/borrowers’ receivables. Instead, they would only have to make one call to the cash management company.

• Provided the cash management company doesn’t have a performance clause in their agreement the inter-creditor agreement can actually reduce the senior lenders risk. Absent any performance clauses (such as monthly minimums, guaranteed fees and term period commitments) the cash management company would only be entitled to the funds advanced plus a small fee in the event the senior lender declares a default.

• As long as the cash management company is providing non-recourse financing and taking the credit risk, the borrower and the senior lender would be insulated from any loss related to account debtor insolvency.

• Finally, an inter-creditor agreement can be drafted to provide the senior lender with the ability to terminate the agreement at any time and for any reason.

The key is to find a cash management company that is bank and senior lender friendly!

By: Kim Slowey

Having enough cash on hand to pay the bills and fund new projects is always top of mind for contractors, especially labor- and material-heavy subcontractors that fund most of the activity on a construction project often months before the owner and general contractor pay their invoices.

Last October, construction finance platform Rabbet found that late payments cost general contractors and subcontractors about $64 billion a year, up $24 billion from a similar study Rabbet conducted the previous year.

More than 60% of contractors surveyed told Rabbet that they would not bid on projects if the general contractor was infamous for paying bills late, and only 39% said they had the available cash to cover operations until they were paid. The rest choose to take on the extra cost of various means of financing like credit cards or lines of credit.

The pain of having to scrape by until payday is so great for subcontractors that more than 70% said they would discount their invoices by 1% to 5% if it meant their invoices would see a quicker turnaround. That would create as much as $44 billion in project savings, according to Rabbet.

Add the COVID-19 pandemic into the mix, and cash-strapped contractors might be feeling the same type of pinch. Some say they are exploring as many ways as possible to get through to the next project.

The options for contractors that can’t secure traditional financing are limited, and this is where factoring enters the picture. Factoring is the term for when a contractor sells its invoices at a discount to a third party. This provides quick cash for the firm during the gap between when a contractor submits its invoice to a customer and when the customer pays the contractor.

In the early days of construction industry factoring decades ago, some operations were very aggressive, eager to make money by lending cash without being subject to the ever-expanding universe of bank regulations, said attorney Thomas Barber with law firm Munsch Hardt Kopf & Harr P.C. in Houston.

The typical factor scenario for subs, said Frank Skelly, managing director of FK Construction Funding, might see a subcontractor submit its pay application to both the general contractor and the factor. The factor would then verify the bill with the general contractor and then advance to the subcontractor the agreed-upon portion of the funds.

Of course, without enough oversight, Skelly said, the factor runs the risk that the general contractor is going to backcharge the subcontractor and not pay the bill in full. Or the subcontractor might not have been paying its suppliers and sub-subcontractors, and the general contractor has to withhold all or a portion of the subcontractor’s payment in order to remove mechanics liens or solve some other financial dispute.

There are many scenarios that could result in the factor not getting its money post-approval if there is not a holistic approach to the factoring relationship, he said.

“Factoring without funds control is like driving a race car without a seatbelt,” Skelly said. “It’s insanity.”

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The factoring companies take a fee starting at about 5%, Barber said, and then for every 10 days, for example, that the contractor went beyond the factoring commitment in terms of collection of the purchased invoice, the rate would increase possibly to 10%.

“Not many operations can sustain borrowing money at 10% a month and remain in business,” he said.

Other fees would appear as well to eat up the difference between what the factoring company advances on the invoice — usually about 85% — and any money the contractor still had coming after collection of the invoice.

Key benefits of factoring

Why would contractors agree to such terms?

Working capital and capacity go hand in hand, said Bill Fischer, partner at accounting and consulting firm Grassi, and contractors could exhaust or not qualify for more traditional means. A growing company, even one that has profitable projects, he said, might not be able to pay down a line of credit, for example, when it is always investing its cash into new projects.

But the good news is that the factoring industry has become “kinder and gentler” over the years, Barber said, with interest rates coming down and major banks getting into that market.

“Now that there’s competition … it’s not unusual to see a rate as low as 2% or 2.5%,” he said. “And the times for collection have extended a bit to 20 to 30 days.”

In fact, some factoring companies, like FK, have added value to their financing services, becoming as much of a partner as a lender.

Instead of writing a check and hoping for the best, FK manages the financial aspects of the project, ensuring that vendor, supplier, payroll and tax obligations incurred on the project are resolved before the subcontractor gets any excess funds.

“We don’t call it factoring,” Skelly said, “because it’s a very small component of what we do.”

On every project FK accepts — there is a screening process that rules out jobs that are likely to be under water — the company lets the general contractor, suppliers and vendors know how much of the client’s contract amount has been allocated to them.

Not every general contractor is on board at first, he said, because there is a fear sometimes that factoring can affect the contract agreement or that the factor will be a nuisance. Now, the company focuses on selling the concept of funds control to owners and general contractors in an attempt to get them to refer their subcontractors.

The perception of the company has evolved to the point that some general contractors have waived bonding requirements for subcontractors that participate in FK’s programs, Skelly said.

For those general contractors that still want to protect themselves, Barber said, they should:

• Keep lines of communications open with the subcontractor and verify they have a valid agreement with the factor.
• Notify the factor that the invoices are subject to the terms and conditions of the subcontract and that payment will be withheld if the subcontractor does not perform.
• Send notice to the factor that payment remitted to addresses outside of the jurisdiction listed in the subcontract does not constitute consent to change the jurisdiction.
• Notify the factor that the right to rescind or stop payment if the subcontractor is terminated or declared in default – and potentially also to offset payments to the subcontractor if they are in default on another project – is still in effect.

“I set all of these things out in a form letter, and I advise my clients, before they make any payments under the factoring arrangement that they’ve got to have that form letter signed and acknowledged by the factor,” Barber said.

Even under the best situation, Barber said, on an annualized basis, the lower interest rates that some factors offer can work out to be very high. Contractors, he said, might want to consider alternatives before they make the leap to factoring, like asking the customer for early or accelerated payments for a discounted rate.

“If you’re going to take on an enormous amount of work, and you don’t have the working capital to do that, then you better be very smart with the customer that you choose to work for and make sure those customers understand, ‘I need to be paid on a regular basis every 30 days,’” Fischer said. “No questions.”

At the end of the day, Skelly said, factoring is a tool, just like any other, and it has to be the right tool in order to get everyone paid.

“If you use it to get yourself out of debt or to bring money forward to [pay previous bills] … then, no, it’s not the right tool,” he said. “[When used] specifically to finance projects, we keep these jobs out of trouble.”

Subcontractors have the right to file a lien if they aren’t paid on time. From the GC’s side of things, I obviously want to do whatever we can to avoid a lien claim on the project. But if I were in a subcontractor’s shoes, I would want to do everything I could to ensure I had mechanics lien protection on every job.

By: Dawn Killough

As a construction accounts payable coordinator and contract administrator for a General Contractor, I’ve seen lots of invoices not get paid in my time. I’ve also received lots of calls and emails from subcontractors wondering where their check is. So I compiled some of the 10 most common reasons why the GC isn’t paying. (Five are the fault of the subcontractor, and five are on the GC.)

Below each ones, I included some possible solutions specific to that scenario. You probably also want to learn steps you can take to speed up payment on every construction project before, during, and after a project.

Subcontractor issues

Sometimes, an invoice doesn’t get paid because of a problem that the subcontractor could have solved. Here are 5 things subs do that delays their payments.

1. Missing documents

At the GCs I’ve worked for, subs were required to sign their construction contract and send in insurance certificates and a W-9 form before we would send the first payment on a project. It was my job to confirm that all of these documents had been completed, and if they hadn’t, to remind the sub to turn them in.

It’s a good idea to sign and return the contract as soon as possible, unless there is a dispute. Holding up this document could significantly slow the progress of the project, and your payments. If there is an issue that needs to be fixed on the contract, meet with the GC as soon as possible and get things worked out.

What you can do

I would suggest that you develop a checklist that includes all the documents that need to be returned when a contract comes through. These may include insurance certificates, W9 form, bonds (if necessary), and any other documents the GC is requiring. By having a checklist, you’ll ensure that the documents get sent before your first payment request.

2. Invoice was submitted late (or not at all)

Unfortunately, this one happens quite a bit. Most GCs have a cut-off date that you need to get your invoices in by (usually the 20th or 25th of the month). They do this because they have a certain date by which they need to invoice the property owner. If they have to wait until the 5th or 10th to get all the invoices in, then everybody has to wait that much longer to get paid.

The other mistake I see a lot is subs not sending an invoice at all. They think they sent it, but we never received it. (Trust me, I’m the one that keeps track of them.)

What you can do

Read your construction contract, and the documents that come with it, to see when the cut-off date is for each GC. If you don’t see it spelled out, contact the GC or their accounts payable (AP) department. If you have extenuating circumstances that prohibit you from meeting that deadline, talk to the GC about it. They may have some flexibility to accept a late invoice.

If you are emailing your invoices, either send them with a read receipt, or ask for a confirmation that they were received. Also, verify that you are sending it to the correct email address. For mailed invoices, make sure you have the correct address and be sure to send them out at least a week ahead of time so you make the deadline.

3. Missing attachments

Some contracts require additional documents with each payment application. These may be certified payroll reports, sworn statements, or conditional or unconditional lien waivers.

If you don’t include these documents with your invoice or pay app, then the GC has to track them down before submitting their own draw request to the owner. This costs everyone time, and delays payment.

What you can do

One way to address this is to create a billing checklist for each project, listing the added documents that need to be included with each invoice. The contract documents should spell out what these are, and sample forms may be provided. Ask the GC if you have any concerns or questions.

4. Billed for unapproved change orders

Change orders occur when there is a change to the scope of work on a project. They can happen at any time. Most contracts stipulate that change orders won’t be paid until they are approved.

The reality in the field is that many times the work needs to be done now, and no one stops for approval. Costs for the change are incurred, and subs want to bill for those costs. Of course, that makes sense.

What you can do

My suggestion here is that subs submit change order pricing for approval as soon as you are able, especially if it’s near the cut-off date for billing. Ask the project manager for approval so you can get the costs in your invoice. They may be willing to work with you if they have some flexibility in their budget.

Another idea, especially at the end of a project, is to bill the unapproved change orders in a separate invoice from the main contract. This way, if the change order billing is rejected because the change orders aren’t approved, only that payment will be delayed — for now.

If you lump all the unapproved change orders and the contract billing together, the whole amount could be held up waiting for approval.

5. Project is overbilled

If the GC isn’t paying your invoice, make sure your invoice isn’t overbilled. Overbilling is submitting an invoice for more of the contract than is complete. For example, if you are 50% done with your work, and you bill for 75% of the contract, that is overbilling. Some subs do it, especially early in a project, to help their cash flow position.

What you can do

If you are having cash flow problems and feel like you need to overbill a project, talk to the GC before you send the invoice. Surprising them with a “75% complete” invoice out of the blue — when you’re only 50% done — will probably mean your invoice will be rejected and you won’t get anything.

But if you talk to them ahead of time, you may be able to work something out. Often the GC’s payment application is scrutinized carefully, so they have to be sure that they are only billing for the work that is complete.

Cash flow issues could be a sign of a bigger problem in your business. Implement steps to collect faster on your invoices and improve your cash flow, so you don’t need to resort to overbilling to make up for a shortfall.

General contractor issues

A payment delay isn’t always caused by something you did (or didn’t do) as a subcontractor. Sometimes the GC isn’t paying because of an event on their side of things. Picking up where we left off above, here are 5 of the most common.

6. Waiting on documents from other subs

Often, the GC has to collect documents from their subcontractors and include them in their own pay application to the owner. These documents include sworn statements, copies of invoices, and lien waivers.

Some property owners or lenders won’t begin processing a draw until all the documents are turned in from all of the sub-tier parties. As a result, the GC has to wait until every single subcontractor and supplier gets their paperwork in before their own draw can be submitted.

What you can do

Unfortunately, you don’t have a lot of control over the actions of another subcontractor. If everyone included the required documents with their pay apps, and returned lien waivers promptly upon receipt, then the GC could submit their draw in a timely fashion and get everyone paid sooner.

Of course, if you are the sub holding up a GC’s draw, submit your paperwork as soon as it is requested.

7. The project owner is slow paying

Some customers take up to 45 days to process a payment, even when there isn’t a dispute or back-up documents that need to be turned in. Large companies and institutions, especially those that don’t do construction projects regularly, are notorious for slow payments.

What you can do

The best way to avoid this scenario is to be choosier about your projects, and avoid taking a job when you have concerns about the people in charge.

That might sound easier said than done. But just like you should be prequalifying the GC to check their payment history, it’s important to look closely at the property owner’s reputation before you get involved.

If the property owner is slowing down payments, take a look at the Prompt Payment laws in the project’s state. These laws set deadlines for payments on construction projects. For example, the Prompt Payment Act in California requires the property owner to pay the GC’s invoice within 30 days of receipt. In some states, the deadline is much shorter.

When the property owner is violating prompt payment requirements, you are within your right to file a prompt payment claim.

8. Financing problems

It can take a while for project financing to be put in place and get funded. If the project started before the loan was closed, it can take up to two months for the loan to be finalized.

What you can do

Subs aren’t really in control here, but you can ask the GC what the financing situation is before you start work, so you know when to expect payment on your first draw. Ask them to provide financial documents that demonstrate the project’s funding.

GCs don’t always ask their customers the hard questions, like about financing, so they honestly may not be aware of the customer’s financial position. By asking this question, you can help them find out for themselves and everyone on the project team.

9. GC cash flow issues

Most GCs won’t talk about this one, but they sometimes have cash flow problems themselves. They are often called on to “fund” projects by laying out money before they’ve been paid. That can hurt their financial position if they have to do it too often. GCs won’t tell you this is the reason they can’t pay you, but it does happen.

What you can do

Again, this comes back to prequalifying the GC and property owner before you take on a job. Look up the GC’s Payment Profile. If they have payment disputes pending on several projects at once, it could be a sign that their cash reserves are stretched thin.

10. Remote work due to COVID-19

Finally, the GC may be working with limited staff or their staff may be working from home due to the Coronavirus. This may limit their ability to cut and sign checks and process payments in a timely fashion.

What you can do

You can help by offering alternative ways to pay your invoice, such as by credit card or ACH transfer. Sometimes a project manager can make a payment that way much easier than getting the office involved.

Things to remember when the GC isn’t paying

Keep in mind that the people responsible for your payments are human, too. We all make mistakes. Sometimes, speeding up your check is as simple as sending an invoice reminder — send an email or make a phone call to jog the payment loose.

While I can’t speak from my own experience, I am aware that some GCs delay payments intentionally, make up back charges, or hold onto retainage and hope the sub just gives up on it. Remember that every state has mechanics lien laws for this reason.

Subcontractors have the right to file a lien if they aren’t paid on time. From the GC’s side of things, I obviously want to do whatever we can to avoid a lien claim on the project. But if I were in a subcontractor’s shoes, I would want to do everything I could to ensure I had mechanics lien protection on every job.

By: Frank Skelly

Construction projects require a lot of documentation: contracts, plans, notices, pay applications, supplier waivers, certified payroll, change orders, and more. One of those documents is the Schedule of Values (SOV). This document is particularly important, so it’s worthwhile to spend a few minutes discussing it.

What is a Schedule of Values?

Simply put, a schedule of values is a comprehensive documented list of work items on a particular project with corresponding values that, in total, represent the entire project from beginning to end including the entire contract price along with all approved change orders. According to the standard AIA documents, “The schedule of values shall allocate the entire contract sum among the various portions of the work.”

In practice, the level of detail on a schedule of values can vary dramatically. On some projects the owner or the bank might require that every item must be broken down in great detail, each on separate line items. On other projects the general categories might only be listed– there is no single, industry-wide accepted standard for the level of detail on an SOV. Generally speaking however on larger more complex projects the SOV will be more detailed then on smaller straight forward projects.

Why Is a Schedule of Values Important?

The SOV is essentially a project management instrument used in the monthly pay application process and is a valuable tool in evaluating a project’s progress as a completion percentage related to the scope of work. Since the SOV is used not only to determine the allocation of funds but also to determine the amount of money actually being released for any given month its accuracy is of crucial importance.

Another critical factor on any commercial construction project is cash flow and because it is in large part determined by the SOV, which in turn effects how the funds are allocated, its accuracy is critical. The percentage of a job that is deemed to be complete is of crucial importance to contractors to make sure the cash keeps flowing and their bills get paid.

Common Problems & Issues

Since the cash-flow on a project is in large part dictated by the SOV (as well as the length of time it takes the owner to release funds) there is a temptation for sub-contractors to “front-load” the SOV. Sub-contractors sometimes attempt to front load the SOV by artificially increasing the values of the early project activities which can leave shortages at the end of the job. This practice of “overbilling,” can put the general contractor, owner, surety or bank at tremendous risk.

Often cash flow can mean the difference between the success or failure of a sub-contractor on a given project. If the general contractor, owner, bank or surety doesn’t catch the overbilling it can put an entire project at risk. Unpaid subs, suppliers, vendors, union dues and payroll can further compound the problem. If a payment issue arises, there could also be a bunch of liens to deal with from unpaid subs, suppliers & vendors.

There are many other issues that can arise on a commercial construction project but since the SOV is one intrinsically tied to cash flow it is a document which all parties should be familiar.