Financial Risk, Credit Management, & Lien Law

In the world of news and content, it has become a late-December tradition to publish articles reviewing trends and news from the past year. We follow that great tradition here, reviewing the construction industry’s overall performance in 2013, trends that surfaced regarding financial risk shifting and lien law, and what the finance and credit professional must do to come out ahead in 2014.

2013: The Economy Is Recovering (Or Is It?) And Financial Risk Is High

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The fall and rise[?] of the US construction economy.
The construction industry entered 2013 with the promise of a recovering economy, and got almost that. For an industry that saw substantial economic downfall year-after-year from 2006 through 2011, the modest growth in 2013 was welcomed and embraced. Further, there was news that cause great excitement, such as the sudden and unexpected rise in home building. All in all, though, the sought-after recovery fell flatter than predicted.

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Along with the predictions of economic recovery came some warnings about recovery in the construction space, all sparked by an ENR Viewpoints article published by Thomas Schleifer:  Beware the Recovery: What History Teaches Contractors and Sureties.  Schleifer, a Ph.D. research professor at the Del E. Webb School of Construction, appropriately warned that recovering economies tax companies with limited cash reserves and are historically more dangerous to solvency than downturn periods.

According to Schleifer’s research, “the failure rate of construction enterprises is three times worse during recovery than during downturn.”

At The Lien & Credit Journal, we explored the dangers of a recovering economy in great detail, finding that companies failed in recoveries not only because of cash constraints, but because of difficulties scaling operations at all levels. This led to a number of publications about how to navigate through these new financial risks to come out on the other side.  See, for example, these articles:

We conducted a webinar mid-year on these questions, analyzing why recovering economies can be dangerous, and what CFOs, finance professionals, and companies can do to prepare for and succeed through the dangers. The recorded webinar and slide deck is available here:

Entering 2014, it feels like the same thing all over again. Hopes and news of a “recovery” in the construction economy continues to bubble, and one must wonder whether we’re reaching a boiling point of talk that must explode with either mind-blowing recovery numbers or a retaliatory recession.

In their annual press release on construction economic indicators, the AGC of America reported mostly good news about increases in construction employment throughout 2013, but cautioned that quarter 4 data is concerning, and that “progress remains fragile.”  The AIA’s annual “Consensus Construction Forecast” presents much of the same, acknowledging that “nonresidential construction activity has gotten off to a slow start [in 2013]”, but that next year looks brighter. According to forecasts, activity may be much brighter in 2014, with the consensus estimating a 7.6% increase in nonresidential construction, and at least one economist (Scott Hazelton of IHS-Global Insight) predicting an ambitious 9.7% increase.

Will 2014 finally be the year that the construction industry breaks through the near decade-long recession?  When it does, financial risk management will be more essential than ever.

Financial Risk Shifting:  Blame It On The Economy?

As 2013 passed by and the economy hadn’t grown as quickly as some hoped, project owners and lenders began to complain about cash and financial risk.

Financial risk shifting is more common than ever, and hits subcontractors first since they are furthest from the cash flow.
An October report from ENR.com, based on a consensus of presenters at the AGC/CFMA Construction Financial  Management Conference, indicated that “Owners Shift More Financial Risk as Recovery Remains Sluggish.” According to the report, the consequences for such risk maneuvers “[hit] the subcontractors first since ‘they are furthest from the cash flow.'”

This risk shifting report aligned with another from ENR in September 2013. Recapping the publication’s first Risk & Compliance Summit, the topic of interest was “payment abuses” or “risk shifting” — depending on your perspective — between the contracting chains:  Views Differ from Places on the Payment Flow Chart.

The financial risk shifting debate is hot and heating up in the construction industry, and that’s not likely to change as the economy recovers and cash only gets tighter. Those at the top of the chain are legitimately interested in avoiding subcontractor defaults, and those at the bottom are legitimately interested in avoiding payment abuses. The bottom line is that no one wants to bear the financial risk on a construction project, because it’s a heavy burden that may spell disaster.

While the conversation about financial risk shifting fits nicely with economic trends, the risk shifting battle in the construction industry has been engaged — nonstop —  for over 200 years.
While the conversation about financial risk shifting fits nicely with economic trends, the risk shifting battle in the construction industry has been engaged —  nonstop — for over 200 years. Perhaps the current economic climate has reasonably exasperated the dangers, but it’s more likely that both those at the top and bottom of the contracting chains are latching onto the economic situation to better leverage them in the risk shifting grab.

In The Lien & Credit Journal, we reviewed some of these discussions.

In “CFMA Says Owners Are Shifting Financial Risks Down The Contracting Chain — Here Are Your Options,” we reviewed the history of financial risk shifting in the construction industry as a means of exposing options. While owners and lenders are working hard to shift financial risk down the chain, it’s perfectly clear that United States policy is for this financial risk to sit at the top of the contracting chain. As explored in the history section of that article, that philosophy was first put forth by Thomas Jefferson in his 1791 invention of the mechanics lien device, and has expanded throughout state legislatures through lien laws, prompt payment laws, criminal misappropriation laws, and the like.

Again, we conducted a webinar on this important risk shifting topic: Shifting Financial Risk — Take Your Company’s Neck Off The Line.  You can review the webinar’s recording and the slides below.

In 2014, the trend of discussing financial risk shifting will continue, especially as the construction economy recovers and the burden of this risk will become larger.  While those at the bottom of the contracting chain have limited control over the construction contract’s terms, the law is layered with protections against the onerous contract terms that have become too popular in the industry. Protecting your company against financial peril will require better education on all of these competing theories, and to leverage of those in your favor.

The State of Mechanics Lien Law and Protection in 2013

In the construction industry, it’s an easy to make the argument that the financial risk shifting battle hinges completely on the mechanics lien instrument.

I make that argument all of the time. The mechanics lien document is easily the most effective weapon available to a subcontractor or supplier to get paid. The reasons why are explored in 17 Ways a Mechanics Lien Works To Get You Paid.  The success of lien filings is explored in our webinar and great article: Instantly Clean Up Your Aging Accounts Receivables: A Fool Proof Plan.  Recording of the webinar and slide deck is below:

In fact, when thinking about the financial risk battle, it is interesting for subcontractors and suppliers to look at what tools the owners and general contractors use to shift financial risk down the line. First, as reported by ENR, they use “onerous contract terms.”  But second, and more importantly, they manage their leverage and legal position using software to offset subcontractor and suppliers lien rights.  One such software is Textura, which we analyzed in GC Software Proof The Preliminary Notices Make A Difference.

There is a lot of promise for 2014 and beyond that the mechanics lien document will continue to get favorable treatment from the courts, arming parties with something to combat the onerous contract terms imposed by owners, developers, general contractors, and lenders.
Notwithstanding all of this, the mechanics lien instrument is an organic legal concept that seems subject to trends like just about everything else. While state legislatures only get around to amending the lien laws here and there, the courts are constantly confronting these complex rules and altering the level of protection afforded to contractors and suppliers.

For those at the bottom of the contracting chain (subcontractors and suppliers), 2013 was very friendly to the mechanics lien.  Better yet, there appears to be a lot of promise for 2014 and beyond that the mechanics lien document will continue to get favorable treatment from the courts, arming parties with something to combat the onerous contract terms imposed by owners, developers, general contractors, and lenders.

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Here is a summary of some of the biggest shifts in mechanics lien laws from 2013.

Statutory Changes

Statutory changes to the mechanics lien laws across the United States were largely in the claimant’s favor in 2013, all of which are discussed below.

Statutory changes to the mechanics lien laws across the United States were largely in the claimant’s favor in 2013
This is especially the case in Georgia and Oklahoma, where the legislature overruled case law that previously limited the amount of a claimant’s lien to exclude profits and overhead. Missouri and New Hampshire changed their laws to broaden who had lien rights.  Louisiana, Wyoming, North Carolina and Iowa all changed the manner or timing of sending notices. Virginia really stands alone as the only state to limit the rights of claimants, by requiring claimants to be licensed to file a lien (which, of course, isn’t a surprising limitation).

Pennsylvania seems to be in a downward and never-ending spiral of mechanics lien debate, which has yet to result in substantive legislation…but we’re watching (See Tag: Pennsylvania).

Here is a state-by-state review of some of the nation’s most important legislatively changed lien laws in 2013:

lien-law-statutory-casesIowa came right out of the gates with its mechanics lien law change in 2013, as new mechanics lien laws took effect on January 1st.  Iowa joined the ranks of states with a “State Construction Registry” website (other: North Carolina, Utah), and tweaked the notice requirements for general contractors and subcontractors.

New Hampshire also enacted new lien law legislation on  January 1, 2013, broadening the scope of those protected by lien laws to include architects, engineers, and other design professionals.

North Carolina can claim the most significant mechanics lien law amendments of 2013. The new statutory scheme created a website registry (like Iowa), and a complicated “Lien Agent” framework required on nearly all new construction projects.

Georgia enacted a mechanics lien law amendment that overruled a controversial court case and specifically allowed contractors to claim profits and other amounts “due and owing…under the terms of…its contract” within a lien claim.  (Also, see this discussions:  Georgia Amendments Signed by Governor.

Virginia made a number of changes to  its mechanics lien laws, most notably now prohibiting unlicensed contractors from filing a mechanics lien claim, and requiring contractors to disclose their contractors license number on the lien itself.  These changes, and the others, are outlined in Recent Lien Law Amendments in Virginia.

Louisiana had two legislative changes in 2013, one creating clarity in the lien laws, and the other injecting confusion.  The clarity comes with the statute changing how the lien foreclosure period is calculated, now requiring mechanic liens to be foreclosed upon within 1 year of filing, rather than the old convoluted method of calculating from the end of the possible lien period. The confusion, however, comes in a bizarre and under-the-radar amendment to the state’s notice requirements for equipment lessors, which now requires things that are both impractical and ambiguous.

Wyoming enacted a simple but heavily needed change to its lien laws. Previously, after filing a mechanics lien, claimants were required to deliver notice within just 5 days. This difficult period has been lengthened to a more reasonable 30 days. All discussed in Wyoming Mechanics Lien: More Flexibility to Claimants with Legislative Changes.

Missouri modified its mechanics lien laws for those who rent machinery and equipment in the state. Notice, previously required within 5 days, is now required within a longer 15 day period. And further, the statute previously only allowed lien rights for those who rent equipment “to others who use the rental machinery,” but that limiting language has been stricken.  See:  Missouri Makes It Easier For Equipment Renters to Protect Lien Rights.

Oklahoma, like Georgia, clarified in a law amendment that contractors can recover overhead and profits within a lien claim.

Court Interpretations Making Liens More Powerful

As above explored, legislators across the country have protected or expanded claimants rights through law amendments. This seems to be in line with trends across courts, which time-after-time in 2013 rejected attempts by owners, lenders, and general contractors to sidestep a party’s lien rights.

lien-law-changes-through-court-casesNew York had an interesting case come down in March 2013 that underscored the difficulty in challenging a lien claim in the state.  To get a lien removed as frivolous, the court ruled, the owners need to prove that the lienor wrongfully filed the lien intentionally.

Maryland addressed the friction between lien rights and mediation agreements, ruling that liens can be filed before mediation even when parties have agreed to mediate. The mediation will go on, but the lien can be claimed by a party parallel to seeking mediation, or arbitration.

Minnesota addressed an important question within mechanics lien law everywhere:  When does the lien deadline start to count, and can you include punch list or repair work as furnishing dates to extend the lien period?  The Minnesota case in question ruled that, in many circumstances, repair work can be used to extend the lien period, so long as it is not nominal and done for some purpose other than to simply extend the lien period.  See: Minnesota Mechanics Lien Case Holds Repair Work May Extend Lien Period.

Arizona provided one of the more recent cases which provided optimism to lien claimants everywhere, and especially in Arizona. It addressed a trend among lenders to challenge the priority of a lien claim based on “equitable subrogation” principles. This came up in 2012 with the huge Fontainebleau case in Nevada.  There the court rejected the lenders arguments, and again in December 2013, Arizona rejected lenders and ruled that mechanics liens have priority over equitable subrogation claims.

Court Interpretations That Make Liens More Difficult

It wasn’t all roses for lien claimants in 2013.

Declaring Mississippi’s “Stop Notice” statute as unconstitutional is not only a big deal for Mississippi subcontractors and suppliers, but also calls into question the constitutionality of stop notice statutes in places like Washington, Arizona, and other places.
The absolute biggest blow came in Mississippi, where the state’s Stop Notice statute was declared unconstitutional and completely unenforceable by the courts. This is not only a big deal for Mississippi subcontractors and suppliers (where the Stop Notice is the exclusive security remedy), but also calls into question the constitutionality of stop notice statutes in places like Washington, Arizona, and other places.   A great article addressing whether Mississippi’s opinion will wreck havoc in other states is published by Ahlers & Cressman out of Washington:  Stop Payment Notice — Is It Subject To A Constitutional Attack?

The other cases negative to lien claimants were quite limited in applicability.  California and Colorado both had cases negative to the claimant regarding the lien claim amount, but these related to situations where the claimants had exaggerated their lien claims (which claimants should not do!).  Another case came from New York that invalidated a lien claim based on a tiny, tiny typographical error with the claimants name.  This decision, however, has been strongly criticized and would not likely get followed.

Louisiana slipped in some controversy just before the end of the year about its notice requirement for material suppliers. Many in the construction law arena hope for a reversal at the supreme court level, or for legislative intervention to fix what is believed to be an incorrect decision.  See:  Is A Monthly Notice Required For Louisiana Material Suppliers? Legal Controversy Brewing in Bayou State.

New Technology and Tools Help Finance Professionals Tackle Credit and Financial Risk Challenges

What is the state of construction technology?  That is a very modern question. Unlike in years past, it seems that exciting innovations are really starting to take hold in the construction sector, and there is a clearer and clearer break with the past. This is especially true for technologies that impact CFOs, credit directors, credit managers, and other finance professionals.

Let’s start in-house with mechanics lien compliance, and leveraging cloud-based technologies to manage this compliance event. While the mechanic liens, bond claim, and other security devices are available to subcontractors and suppliers to offset the risk of onerous contract terms and financial risk shifting (see above), these remedies have been traditionally difficult to leverage.

A complex patchwork of statutory schemes have made complying with lien and bond claim laws as impossible as memorizing the federal tax code.  Cloud based ERP applications and cloud-based lien compliance technologies (like  levelset ) have enabled real-time communication between company data and lien compliance tools, which results in the automation of preliminary notices and dependable and affordable tracking of lien and bond claim compliance needs.  This, importantly, results in a better bottom line for companies.

We did a webinar on “Mechanics Lien Compliance” in the cloud, which is recorded and available (along with the slide deck) below:

All in all, many argue that managing the credit and financial risk of your organization is reaching a tipping point. Technologies are helping CFOs and finance professionals leverage data and automation to understand credit risk better, collect more often and faster, and turn to security and collateral when debts slip through the cracks.  This was discussed over the summer here in Is The Credit Risk Management Profession Changing…For The Better?

The Year Ahead: 2014 Is The Year For CFOs and Financial Professionals

2013, as you can see, has been an interesting year. The story of 2013 is a slower-than-expected recovering economy challenging cash flow at every tier of the construction industry, which in turn, has prompted an extra focus on the long-fought financial risk shifting battle. While owners, GCs, and lenders are winning with onerous contract terms, subcontractors and suppliers are winning in the legislatures, through courts, and through leveraging lien and bond claim rights.

construction-CFOs-financial-risk
Construction industry CFOs will be called upon to manage their organization’s financial risk, and this will require innovation and the leveraging of both tools (i.e. automations and data analysis) and remedies (i.e. security and lien devices).

What is to come in 2014?

We very well may be on the cusp of a fast paced economic recovery in the construction industry, and all of the “recovery risk” warnings of 2013 carry forward into the new year. Cash flow is going to be challenged, contractor default is going to increase, and the top of the contracting chain will be leveraging every opportunity to shift financial risk down the contracting chain. CFOs, credit professionals, and financial professionals are going to be more important than ever to the health of a construction-industry organization.

We’re not the only ones saying this, and it’s not even limited to the construction industry.  Deloitte, a global risk management and consulting firm, explains in “Four Faces of the CFO” that “today, the role of the CFO is under greater scrutiny, internally and externally…[with] never ending pressure to cut costs, grow revenue and ensure control.”  In this light, Deloitte’s 17th Annual CFO Vision Conference, as published in the Wall Street Journal, revealed that CFOs will be called upon to play a larger role in their company’s innovation process in order to achieve success through the challenges now confronted.

In the construction industry, the “innovation process” will require CFOs to tackle the financial risk shifting battle, and land their organization on-top.
What type of innovation does this refer to?

In the construction industry, the “innovation process” will require CFOs to tackle the financial risk shifting battle, and land their organization on-top.  This means truly understanding the nature of financial risk on a construction project, the means that general contractors and owners employ to shift the risk down the contracting chain, and what is available to subcontractors and suppliers to volley that risk back up the chain (where it belongs, I would argue).

CFOs will have to take the lead for their organizations to adopt technologies that can enable their company to take advantage of data, the cloud, and available automations, to deflect financial risks on projects and collect every time. Anything less could spell financial disaster.

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2013 Review: Financial Risk, Credit Management, & Lien Law
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2013 Review: Financial Risk, Credit Management, & Lien Law
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Reviewing 2013's trends in financial risk within the construction industry, and what it means for the financial professional and CFO in 2014.
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