This blog has been taken from a webinar presented by SunRay Construction Solutions and Alex Barthet. Alex is a board-certified construction lawyer who serves clients in Florida. In this blog, we will discuss whether or not and the reasons to demand cash versus extending credit. We will talk about personal guaranties, what they are, and how to use them to protect yourself.
Cash or Credit?
The first question you need to ask yourself is, are you willing to extend credit? The reason that people extend credit is pretty straightforward:
1. Customer loyalty
They want to increase customer loyalty by extending credit.
2. Financial position of customer (and you)
They have the financial ability themselves to extend credit and they want to increase the financial ability of their customer to do more work by extending credit.
Know more: How Much Credit Can I Extend to My customer Before I Get Screwed
3. Industry standard
In the construction industry, it is common for some to extend credit versus expecting cash on delivery (COD) or payments in advance.
4. Gain a competitive edge
It can provide a competitive advantage over the competition.
5. Increased sales
Extending credit can also help increase sales.
Remember that extending credit creates credit risk and that credit risk may need to be absorbed if things do not go well. Not everyone who extends credit will pay you on time or unfortunately sometimes, at all.
They may go into bankruptcy or maybe the job you extended credit and delivered materials to goes into bankruptcy or foreclosure. So, understand that when you extend credit, you are taking a risk yourself in providing credit to your customer.
In the construction industry, it is very common to extend credit to customers. The construction industry runs on credit, and not extending credit is very unusual.
Different Methods to Secure Payment
Now we will talk about the different ways to secure the right to be paid, expecting that you are going to have to extend credit in order to do business.
1. Personal guaranty
A personal guaranty is a written promise from a natural person to pay the debt of the business.
a) It should include the husband and wife
It can and should include the husband and wife. In Florida and some other states, but particularly Florida because it is what is known as a “debtor-friendly state, the liabilities of one spouse are not automatically the liabilities of another spouse.
For example, there is a supply house for windows and doors. They are a manufacturer, and they deliver products to a project. Unfortunately, they did not secure their lien rights, but they have a personal guaranty on their customer. They file a lawsuit, obtain a judgement, and garnish the personal guarantor’s bank account. There is ample money in that account to satisfy the debt.
Unfortunately, that account is held between the husband and the wife in what is known as “tenants by the entirety.” This is the most common designation that husbands and wives open accounts in. As a result, even though there is enough money in the account and the husband is a joint owner of the account, because it was titled the way it was when the couple opened the account, none of the money (not even a portion of the money, is available to satisfy the judgement.
So, a personal guaranty is good. It is better than not having one, but there are limitations on what you can do if you do not have the spouse on the guaranty as well. If you want to protect yourself, get a guaranty. But if you really want to protect yourself, then you need a guaranty of both the husband and the wife. Both spouses need to sign personally on the guaranty.
This is very hard to do. You probably already know that it is hard enough to get a guaranty and getting the guaranty of the husband and wife is even harder. What a lot of people do is, if their business is strong enough on its own credit, they may not require one at all. But if they believe that they need one, they get it from the principal that is involved in the business.
If they are not comfortable at all, they may say to the customer that they will not extend credit at all even with a guaranty. But if they secure their rights with a lien, and the customer and their spouse sign the personal guaranty, that they will extend credit.
So, note that there are limitations to a single party personal guaranty, and how you can make it better by getting both the husband and the wife to sign.
b) The guaranty does not need to be conditioned
The guaranty does not need to be conditioned on the business not paying. So, it is joint in several liabilities meaning that some people perceive that you can only go after the guarantor if the business does not pay the debt. This means that you have to exhaust your remedies against the business.
There are ways to write the personal guaranty to make it very clear that each of the parties – the company and all of the guarantors – are jointly and severally liable. You can look at the business and say that you are not even going to go after the business, but instead go after the guarantor on the debt, pursue them, and sue them directly.
c) You can include all debts without their consent
The other thing to know, is that you can include all of the debts even without the debtor’s consent on the debt.
An example of this is let us say there is another supply house, and they are a plumbing house. They have a personal guaranty against one of the partners of the business. He sells his interest in the business and left. But he did not remove himself from the guaranty. So, the business continues to accrue debt, they could not pay and then they filed a lawsuit against the business and the guarantor.
The guarantor (other partner) says that he has not been involved with the business for over a year. But the way the guarantee was drafted was done irrespective of him leaving the business.
d) Covers them after they leave or sell the business
So, as long as he did not cancel his guaranty from that point forward by giving the other partner notice, he is still on the hook even though there was no business involvement from his side. It does not automatically mean that they are off the guaranty.
2. Corporate Guaranty
A corporate guaranty is a lot like a personal guaranty, except it is from a business and not from a person.
Run credit on the guarantying business
If you are going to get a corporate guaranty, you should want it from a business that you believe to be ideally better off than the business that you are extending the credit to. So, remember that if the businesses are affiliated, like if a customer says that they need credit for Business A, says they also have Business B, and that they will guaranty the debt of Business A with Business B, it is better than not having anything at all.
But understand that if the two businesses are so intertwined that if one fails, both fail, you may not be getting much additional value. The ideal corporate guaranty is a separate entity. Again, it is not easy to get, but if you are not willing to extend credit as an option to them, then maybe they will come up with something that is willing to guaranty the debt.
3. Joint Check Agreement
The next way you can secure your right to be paid, is a joint check agreement. A joint check agreement is a written promise from the general contractor on a project to pay a sub-subcontractor or supplier directly.
a. You will be governed by the terms of the agreement
There is no such thing as a universal joint check agreement. Every one of these agreements is governed by its terms as it is written. This means that there are some agreements that are good for you and some of them that are bad for you. So, you have to read them and negotiate them like you would any other contract.
b. Many of these agreements provide little protection
Many joint check agreements provide very little protection for you. So, if you are a supplier or a sub-subcontractor, and your customer wants to buy or hire from you and you do not feel comfortable, you may feel more comfortable by securing your right to be paid by getting a joint check agreement. So, you ask for one from the contractor.
But just know that if the contractor gives you their form of joint check agreement, that it is probably not that great. If this is something that you do on a regular basis, or something that you wish to implement, you should take the time to have your own form of joint check agreement ready to go.
This will let you go directly to your customer and tell them that you will not sell to them unless you have a joint check agreement, and that yours is ready for them to sign. Start negotiating from your form of joint check agreement, rather than from the general contractor’s form.
c. What if the joint payee refuses to sign the check?
joint check is a dual payee check, so it will say something like subcontractor and supply house on the payee line of the check. Unless the counterparty to the joint check is willing to endorse the check, you still will not have the right to be paid. So you can address this issue in your joint check agreement, by requiring the subcontractor to sign the joint check.
But if there is a failure of the joint payee on the check to sign it, then you can add in the agreement that the contractor upon notice from you, will issue a single party check for the amount to you.
Because what sometimes happens is, the joint check payee as a means to exert leverage on the downstream sub-subcontractor or supply house, says that the joint check is ready, but that they do not agree that they owe you so much. For example, you may think that you are owed $10,000, but the other side may think that you are owed only $8,000. So, if you want them to sign the joint check, then you will need to cut them back another check for $2,000 or credit their account $2,000.
Because their signature is the trigger that releases the funds, sometimes they use it as leverage to effectively renegotiate the deal later. So be prepared for that in advance and address that in the joint check agreement.
4. Construction Liens and Bond Claims
A construction lien will encumber a property that you work on or provide materials to. A Notice of Nonpayment of a bond claim will encumber the contractor’s payment bond on the project.
The timelines for each document are follows:
a. Notice to Owner
The Notice to Owner (NTO) needs to be sent no later than 45 days after furnishing labor or materials to the project. The owner or contractor needs to receive this document by the 45th day, which means that you will need to send it much sooner than the 45th day.
If you use a Notice to Owner service like SunRay, we send out the notices with what is called a manifest. This means that we take it to the post office early, the post office stamps the manifest, and whether or not the owner or contractor ever receive the document, the fact that you have the manifest, under the lien law, means that your NTO is considered good and delivered.
Know more: Wait, What? I only have 40 days to send my Notice to Owner?
b. Claim of Lien/Notice of Nonpayment
Within 90 days of last work - and again this is the outside deadline – you need to record your Claim of Lien or serve your Notice of Nonpayment. This is the last day from your last work or last delivery of materials. It does not include warranty work or punch list work.
So, we advise that at Day 60 from your last work, is when you should seriously think about starting the lien or bond claim process. Do not wait until as late as Day 85, otherwise you will not have a lot of time to get the paperwork ready, sign the documents, and get them served.
Know more: How to Get Paid After Sending a Notice of Nonpayment
c. File lawsuit to foreclose on your lien
Finally, you need a lawsuit to foreclose on your lien within one year from the recording date of the claim, and for a bond claim within one year of your last work. This has a potential swing of as much as 90 days, so do not wait that long. There is a little less time to sue on a bond claim than on a lien claim.
d. Check for a subcontractor bond
If you are a supply house to a sub contractor, or you are a sub-subcontractor, make sure you check if the sub contractor has their own bond. Typically, this is seen on larger jobs.
If you are a supplier or a sub-subcontractor to a subcontractor, they have received the bond. And your rights on that bond are slightly different than the contractor’s bond, or if you have to assert a lien.
For example, a drywall supply house failed to timely serve their Notice to Owner on the project. They did not know that they missed the deadline and kept selling to their customer – the drywall subcontractor. The debt accumulated to almost $500,000, and the drywall subcontractor went out of business and disappeared.
Now there are no rights on the general contractor's bond because the Notice to Owner was not timely served. But it was found out that the subcontractor had a bond claim. So now a Notice to Owner does not need to be sent within 45 days or Notice of Nonpayment within 90 days. All of the timeframes go out the window because the drywall supply house now has a direct claim on the subcontractor’s bond, which is considered a common law bond.
e. Sub guard does not protect you
Remember that a Sub guard does not offer any protection for you as a sub-subcontractor or supply house. Sub guard is an insurance that protects only the owner and the contractor in case a subcontractor cannot finish a job. If you are working on a job with Sub guard, and the contractor does not have a bond, then your rights are on the lien that you may assert on the property.