A few recent posts have briefly outlined the importance and basic content of a sound credit policy. Many of the posts have noted that, for parties in the construction industry, having a lien/bond claim policy can be a vital part of their credit policy. The mechanic’s lien (if the minutiae of the lien law is complied with) is an important part of a thorough credit policy for one main reason. A mechanic’s lien provides security.
What is Security in the Context of a Credit Policy?
Security, in this context, isn’t just a nice warm feeling that you’re going to get paid – although that feeling can be the result. What security means in this framework is that the customer’s debt to you (the amount of credit extended) is secured debt. That is you have a security interest in property that is tied to the repayment of the debt. If the debt is not paid, the creditor can take the property and sell it to satisfy the debt. Having a security in property basically means that the property is acting as collateral for the extension of credit.
Whether or not a security interest is a familiar term, many people are familiar with the concept. If you have a car loan, the lender has a security interest in the car: If you don’t pay, your car gets repossessed. A mortgage is a security interest, as well: If you don’t pay your home loan payments, the bank can foreclose on your house. This same concept is in place all over daily life – a gym may require you to leave your keys at the desk in order to receive a towel, for example.
What is the Benefit of Security in the Context of a Credit Policy
When viewed this way, the benefit of having a security interest in property to secure the debt is clear. Which party do you think is going to be more worried about getting paid: 1) A lender making a car loan that requires a security interest to be granted in the car; or 2) A lender making a car loan that is unsecured. While there are many variables, i.e. what the credit application looked like, the right answer is that lender 1 is less worried about getting paid, because their debt is secured.
The construction industry is in a unique position in that a huge majority of the credit extended can be secured by the property that is being improved via the mechanic’s lien instrument. It can be a complex process, which, unfortunately, is why most companies do not use the lien instrument to the full extent. But, when viewed through the lens of a total credit policy, the reason a comprehensive lien policy should be in place is clear.
It is not only the construction industry that can benefit from securing the debt owed to them. Conceivably, any party extending credit can contract with the party to whom they are extending credit for a security interest in some property, provided all necessary requirements are met.
Whatever industry your business is a part of, however, securing debt can be a very important part of the overall credit policy. By providing a much stronger likelihood of payment, and providing a mechanism to recover the money owed even if the payment is not forthcoming, securing the debt allows a credit policy to be a bit less restrictive – which in turn leads to more sales.
Using the mechanic’s lien process, or any other process, to make your company a secured creditor puts you in position to extend more credit if you want to, by providing a mechanism to recover the money owed, even if the customer is not providing payment.