eNews March 21, 2019

In the News

March 21, 2019


Creating a ‘Conduit Relationship’ to Avoid Construction Payment Mishaps

Brexit Delayed Again: What Does This Mean for Creditors?

US Trade Deficit Hits Record High

Recent Washington Court Decision Examines Lien Claim, Part 1

Creating a ‘Conduit Relationship’ to Avoid Construction Payment Mishaps

The business-to-business (B2B) credit process is fairly similar across various industries: A grantor provides credit to a debtor for business or commercial purposes. While this definition, found in NACM’s Principles of Business Credit, extends to the construction industry, project owners often encounter additional hurdles that, otherwise, aren’t as prevalent to borrowers in another sector. A prime example lies within the payment process between a lender and owner, as the borrowed cash flows from the owner to and from other parties such as general contractors (GCs), subcontractors (subs) and material suppliers. At the end of the day, the owner must pay back the lender, so it’s important to adopt an effective payment process further down the chain.

Let’s say an owner is seeking a significant amount of credit for an apartment complex. Although the owner is the initial debtor, the borrowed funds are used to pay the project’s GCs who need to pay their subs who then must pay the material suppliers. What if a sub has to delay payment to a material supplier because of a pay-if-paid clause in the general contract? According to professionals in the industry, there are a couple of methods material suppliers can adopt to ensure efficient and steady lending practices.

In the March PYMNTS article, “Why Construction Payments’ Friction Has Nothing to Do with Payments,” CEO Will Mitchell, of construction loan automation software company Rabbet, said owners must document a laundry list of information to keep the credit grantor informed on a project’s status and must do so in order to receive funds for the project. Invoices are a top priority because they track the involvement of specific parties as well as any payment, and legal and compliance documentation.

“Unfortunately, developers who need to send that information too often rely on email chains, PDFs and Excel spreadsheets to generate a document package each month to obtain funds,” PYMNTS states. “The process forces a developer to manually access information across multiple back-office systems, which Mitchell said creates massive inefficiencies and room for error.”

Attorney Jim Fullerton, of Fullerton & Knowles, P.C., in Clifton, Virginia, said the paperwork is the link in what he describes as “a conduit relationship” between all involved parties. Paperwork can easily “jam up payment” because most of owner-GC relationships and general contracts incorporate a pay-when-paid or pay-if-paid clause, meaning the GC is under no obligation to pay the sub unless or until they’ve been paid by the owner.

“That alone busts the 30-day payment cycle. The sub doesn’t have the money to pay the material supplier unless or until they’ve been paid by the GC,” Fullerton said. Conduit relationships are becoming unavoidable in the construction industry, with no “easy solution” in sight aside from refusing the general contract altogether.

However, Fullerton explained, many material suppliers accept they are going to be bound to the sub to the same extent the sub is bound to the GC and the GC to the owner in connection with the general contract. If this is the case, it’s important that material suppliers carefully document the paperwork, which includes having a copy of and reviewing the general contract. Some GCs have been known to “hide the ball,” providing material suppliers with the purchase order but no general contract.

“Nowadays, if you’re a vendor on a construction project, you can usually go on the general contractor’s website and they have it all there,” Fullerton added. “The material supplier has to develop the skill to look at the contract and find the parts that concern what they’re supplying.”

—Andrew Michaels, editorial associate

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Brexit Delayed Again: What Does This Mean for Creditors?

The U.K. will be asking the EU for yet another extension on the deadline for a Brexit referendum. As U.K. Prime Minister Theresa May and the U.K. Parliament fail to agree on a plan to leave the EU, creditors and financial markets continue to react to the fluctuating news, with several companies and creditors learning to adjust to the lack of certainty in the U.K.’s market.

Currently, the U.K. must exit the EU by March 29, and May is set to ask the EU for an extension. According to NACM Economist Chris Kuehl, Ph.D., “the betting is that they will” grant some form of an extension but not without scrutiny. This further development will likely make extending credit just as risky in the U.K., spanning several circumstances.

“Ask the right questions. When you’re dealing in areas where there is some turmoil, conflict or any significant business change, ask standard questions, then ask a lot more to go with it,” said David Bernardino, ICCE, director of customer credit solutions at McNichols Company. “Drill down and really understand where the money is coming from. Understand what can impact your ability to get paid, and along with that, what has changed since you last did business with this customer?”

Amid further Brexit delays, the British Chambers of Commerce (BCC) downgraded its growth expectation for the U.K. economy, according to a recent article by Supply Chain Dive. This new forecast—down 0.1% for 2019—also assumes the U.K. will leave the EU smoothly with a deal. Lowering the expectations comes after fewer business investments and lower trade with companies in the U.K., meaning creditors may be seeing less of their U.K. customers, or those customers may have more difficulties paying.

But larger companies, according to a recent article by Bloomberg, have been experiencing less trouble. Since companies like BP and Plc do not rely heavily on the local economy, they likely will not have issues paying back creditors. Small businesses in the U.K. have carried much of the economic burdens from Brexit, and these companies will likely continue to struggle paying creditors.

Despite the hazy future for the U.K., according to a recent article by CNN Business, “Companies in Britain and the European Union have spent months preparing for a chaotic Brexit.” Fears loom around trade barriers shifting, something many companies have been keeping in mind, especially given all the time the markets have with each extension.

But like all credit decisions, a creditor should practice due diligence when working with a creditor in the U.K. Each company and market will be affected differently, and creditors should keep that in mind moving forward.

“Know where the finances are coming from. For example, you may be doing business with someone in England for years, and you think you have nothing to worry about,” Bernardino said. “And then you find out maybe their financing is largely supported by an international bank that resides in the European Union. This particular bank may be pulling out its financing due to Brexit.”

—Christie Citranglo, editorial associate

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US Trade Deficit Hits Record High

The U.S. trade deficit is at a record high following dismantled trade deals and several rounds of tariffs. According to government data released earlier this month, the 2018 deficit continued to near a trillion dollars ($878.7 billion) after a $9.5 billion increase in December.

“Despite the drama and histrionics, President Donald Trump’s effort to reverse the U.S. trade deficit has been largely unsuccessful,” said NACM Economist Chris Kuehl, Ph.D. “This is not unusual as many presidents before him have tried to do the same thing in different ways. The reality is that changing trade patterns will always be slow and halting.”

However, trade deficits are not always a bad thing. “The U.S. is bound to have a trade deficit in goods with the rest of the world because we are growing much faster than they are growing and so we are buying more of their goods,” said National Economic Council Director Larry Kudlow in a Bloomberg article.

“A deficit can be an indication of a country’s prosperity,” states a USA Today article from the Editorial Board. “People with more money buy more imported goods, and the U.S. economy is the world’s strongest, fueled during the past year by the twin stimuli of reduced taxes and increased government spending.”

The last time the trade deficit decreased from year-to-year was in 2016. “The initial conclusion is that the trade deficit is continuing to widen despite the restrictions on trade with the Chinese,” added Kuehl. “It seems importers are finding other sources for those products that are getting hit with tariffs. At the same time, the U.S. has been affected by the tariffs and restrictions imposed on the U.S. in retaliation for the trade attacks initiated by the U.S.”

Meanwhile, the trade deficit with China also increased to $38.7 billion in December and $419.2 billion in 2018, up from $375.6 billion in 2017 and $347 billion in 2016. According to a new study by top U.S. universities, the protectionist trade approach by President Trump has cost the economy $7.8 billion, states Reuters.

Striking a trade deal with China is not a fix-all either, according to an article with Forbes. “Even if China promised to double its exports of U.S. agricultural commodities that would just cut $30 billion in a yawning $419 billion trade gap. It’s not even a 10% dent!” And the trade shortfall is not just with China. The U.S. also faces deficits with other large economies such as Japan and India.

—Michael Miller, managing editor

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Recent Washington Court Decision Examines Lien Claim, Part 1

On Feb. 11, 2019, Division One of the Washington Court of Appeals issued an opinion in the case of Woodley v. Style Corp. d/b/a Servpro of Shoreline/Woodinville, No. 77352-6-I (Wash. Ct. App. Feb. 11, 2019). The case highlights the care that should be exercised in filing a lien claim for services furnished to improve a condominium and the consequences that may befall a claimant under Washington’s frivolous lien claim statute, RCW 60.04.081.

The case arose from water intrusion at a unit in the Bellevue Park condominium complex. After discovery of the condition, the condominium’s property management company contacted Servpro and executed a work authorization for the contractor to clean up the water and perform restoration work. Servpro was not paid for its work and filed a claim of lien. The lien named the association as the indebted person, recited that it applied to the 20 specific units and a common storage area of the condominium, and named each owner of the 20 units, but did not allocate a specific portion of the total debt to each unit.

One of the unit owners, Denise Woodley, filed a motion to release the lien under RCW 60.04.081. The trial court granted the motion, finding the lien both frivolous and clearly excessive, and released the lien.

On appeal, Division One disagreed with the trial court’s ruling and found that the lien, although possibly invalid in a number of respects (e.g., whether (a) the work was authorized by the owner or its agent, (b) the lien was timely filed, and (c) the lien had factual inaccuracies) and subject to debatable legal and factual issues, was not frivolous.

The Court of Appeals next examined whether Servpro’s lien claim was “clearly excessive.” On appeal, Servpro argued that its lien was not clearly excessive because it was not filed in bad faith or with an intent to defraud, relying on Pacific Industries, Inc. v. Singh, 120 Wn. App. 1, 10, 86 P.3d 778 (2003) (where the court held that “[a] materialman’s lien will be declared invalid because it is excessive only if the amount is claimed with an intent to defraud or in bad faith”). The court in Woodley noted that the standard articulated in Singh “relies on cases that predate RCW 60.04.081 and consequently, fail to account for the statute.” Id. at 8.

Relying on the plain meaning of the statutory language to give effect to the legislative intent, the court interpreted RCW 60.04.081 to delineate between a frivolous lien (one made “without reasonable cause” and “beyond legitimate dispute”) and a clearly excessive lien (where “the face value of the lien is unquestionably far greater than the value of the goods or services provided”). Id. at 15 (emphasis in original). Under the limited summary proceeding authorized by the statute, the only remedy for a frivolous lien, according to the court in Woodley, is release, while the only remedy for a clearly excessive lien is reduction of the lien amount. Id. at 11.

Based on the facts of the case and the “plain meaning” of the statute, the Woodley court could not “read RCW 60.04.081 to allow release of a nonfrivolous, excessive lien even if made in bad faith or with intent to defraud because it would read additional terms into the statute and undermine the statute’s mandatory language limiting each remedy to a particular problem.” Id. at 12-13.

Reprinted with permission. Part II of this article will be published in next week’s eNews, Thursday, March 28.

Bart W. Reed is a partner in the Seattle office of Stoel Rives LLP. Bart focuses his practice on construction and design issues and disputes, representing public agencies, private owners/developers, contractors, design professionals and sureties in diverse matters on both public and private projects.

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