Mitigating construction credit risks
While functioning as the General Manager and Chief Financial Officer of several commercial and residential construction contractors and subcontractors ranging in size from tens of millions to almost a billion in sales, I was surprised to discover the often lackadaisical approach of many owners and managers with respect to mitigating credit risk through strict adherence to Texas lien laws. Few seem to appreciate the magnitude of this remarkable deficiency in construction management circles, even subsequent to suffering multimillion dollar losses that could have been avoided were timely notices given to the requisite parties and proper Affidavits of Lien recorded as proscribed by the relatively complex Texas Property Code.
As a restructuring consultant, I have experienced firsthand many cases of defunct or bankrupt owners or general contractors where few if any subcontractors or suppliers of multimillion dollar projects managed to perfect a Mechanic’s Lien due to missing notice or filing deadlines, failing to notice the proper parties, or failing to use specific language required by statute. In such circumstances there was little or no recovery for these deficient subcontractors and suppliers when, had they strictly complied with the lien statutes, they would have likely avoided these significant financial losses and litigation time drains.
Case in point: A prominent regional commercial electrical contractor based in Houston was one of many large and sophisticated (they have a capable general counsel and an army of attorneys working for them) subcontractors supplying goods and services to a significant construction project in Austin. Although the electrical subcontractor was the most timely in filing its notices of all the vendors and suppliers on this particular project, it was one day late and missed the opportunity to lien the well funded project. Rather, the subcontractor was relegated to litigating the defunct general contractor, being awarded its full claim and fees in district court. Acting as receiver in this matter, we at Bridgepoint began the painstaking and messy task of gathering and investigating years of data of the general contractor, searching for fraudulent or preferential transfers, and hunting down assets. This matter is ongoing and could have easily been avoided had the subcontractor simply filed timely notices.
While the rules governing perfecting liens seem simple on the surface, there are a number of nuances here in Texas that can sneak up on an unwary vendor and spoil their best-laid plans and execution. Determining exactly what “tier” (hierarchy of lien claim status) one is and complying with statutory timelines is often a matter of confusion and misunderstanding. As has been shown in the foregoing examples, the slightest mistake can be very costly. More alarming, if the proper parties have not been noticed, all efforts will have been to no avail. This can be more difficult and complex than one might suppose as many owners spare no effort in convoluting their ownership structure and masking the proper parties for notice from any casual search of records. Subcontractors performing tenant finish services are subjected to above normal risk in this regard.
Case in point: A subcontractor supplied goods and services to remodel a convenience store. Through a search of property records, the owner was determined. Notices were timely made to the owner and general contractor. The general contractor filed bankruptcy and the subcontractor held a significant claim for their work on this project. It was discovered that the true owner of the property was not noticed! The tax records were convoluted and the ownership structure was complex. The subcontractor recovered nothing.
Many contractors do not have any mechanism for tracking when the work was performed on a particular project. All accounting and collection reporting is based upon the date goods or services were billed. Unfortunately, the statutory clock is based upon the date the services were performed. Frequently, the services billed lapsed a month-end, however, the statute requires notice based upon the month services were performed. Even the most sophisticated contractors frequently miss this nuance, at their financial peril.
Here are a few tips on how to mitigate credit risk on non-homestead construction projects:
- Utilize a standard form of request for critical project information to be returned with all relevant information for properly understanding the ownership structure and the respective contractor’s status on the specific project. As a matter of policy, do not perform any services prior to gaining a complete understanding of the status and assuring compliance with notice requirements.
- Track all billable activities based upon dates of service.
- Follow all notice and recording timelines – post an accurate timeline matrix where all that have need may utilize.
- Prepare and utilize standard notices that contain all required statutory language.
- Engage competent legal counsel and business advisors to assist in mitigating risks in advance of the myriad of potential issues that could cost millions.
While the examples and recommendations herein have been necessarily brief, it is our hope that construction contractors and suppliers will gain a deeper appreciation for the complexities and ramifications associated with Texas lien laws. Please note that additional lien requirements and limitations exist pertaining to homestead property.
About the Author:
Jeff Phipps is co-director of the business turnaround and restructuring practice at Bridgepoint Consulting. He has over 20 years of experience managing bankruptcy, turnaround, restructuring and litigation support services. He has been the CEO, COO, CFO and CRO for many small and middle market companies (up to $1 billion in revenues) across a wide range of industries and circumstances, although his mainstay has been commercial and residential construction. He also managed many projects on behalf of lenders and credit committees during his years culminating as Director in PricewaterhouseCoopers’ BTRS practice in Texas and Colorado. Jeff was a manager in Kenneth Leventhal Company’s audit and consulting practices based in Southern California, where he became a successful financial and operational business advisor for the firm’s prestigious construction and real estate development/management clients.