eNews April 4, 2019
In the News
April 4, 2019
When beginning the process of extending credit to a customer in construction, several caveats must be considered: Which state laws apply to the job, who are the people involved in the transactions, etc. In the process of obtaining job information and beginning to file a lien, oftentimes creditors forget a crucial element: whether the lien must be filed on a lease or a property, and whether the creditor is eligible to lien on a lease.
A leasehold interest, contrary to a standard project with just a general contractor and owner, involves creditors working with tenants who have bought materials for the property owner’s establishment. These customers perform enhancements to a building they do not own, and they are either forced to upgrade the premises at the request of a landlord, or in certain cases, upgrade without the permission of the property owner. Should a creditor file a lien involving a tenant, the lien will be placed on the lease the tenant has signed rather than on the property itself.
As a creditor considers filing a lien on a lease, National Sales Representative for NACM’s Secured Transaction Services Chris Ring said creditors should consider three core questions: Is the property truly a leasehold; was the landlord aware of the improvements and were the improvements commissioned; and can a creditor file a lien on a lease in the state? Since the lien will be on the lease, the project can be private or public.
“It all depends on how aggressive the liens on leasehold interest statutes are in that state. And basically, whatever a lien on a leasehold interest is, it’s not a lien on the property; it’s a lien on the lease,” Ring said. “What it doesn’t do is create security. It creates pressure on both the tenant and the landlord to get that lien released to allow those lease payments to flow smoothly. It’s really a psychological advantage at that point.”
As with any construction job, Ring said many of the issues around leasehold liens can be mitigated by diligently collecting information on the job. If a creditor relies on a third party to obtain job information, Ring said setting a threshold and certain expectations on this third party can alleviate any difficulties when filing. Once a creditor has determined a lien can be filed against a lease, the customer will likely feel pressured by the landlord to release the lien, meaning the likelihood of the creditor collecting increases.
While not immediately obvious on every project, a creditor may be doing business with a tenant of a property rather than the owner of the property. The most overt examples of a creditor needing to file on a lease rather than a piece of property emerge in projects such as chain stores in a mall or businesses in a strip mall.
“The big piece of the puzzle from a credit department perspective is setting a threshold on what questions to ask on certain jobs,” Ring said. “Questions such as all jobs over $50,000 or $100,000—large projects where the sticking point can really hurt—and train personnel to ask the right questions. … The devil’s in the details upfront. Set thresholds about when it’s appropriate to force somebody’s hand and ask that hard question, or whether to slow it down for a moment.”
—Christie Citranglo, editorial associate
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Regardless of the type of project, payments are always just around the corner in the construction industry and often driven by project deadlines. According to recent reports from Dodge Data & Analytics, construction’s struggles to maintain a solid labor force have created an increase in project delays, possibly marking the beginning of a domino effect that could soon topple over into credit departments.
In the USG Corporation and U.S. Chamber of Commerce’s quarterly Commercial Construction Index, the survey concluded 70% of the more than 200 contractors surveyed were “challenged to meet schedule requirements” in the first quarter of 2019—a 4% increase over 2018’s first quarter. Contractors attributed this challenge to labor shortages among other concerns, including the number of skilled workers as well as asking those workers to pick up the slack. Such sentiments reinforced concerns that the number of skilled workers will decrease in the next six months.
“[My single-most-important concern about my business in the next 12 months is] being able to bid jobs competitively and still turn a profit while paying much higher labor costs,” one survey respondent stated. The lack of sufficient labor also increased project costs for 63% of contractors, with 40% actually turning down offers. Project delays are ongoing.
So, what can construction credit managers do if they’re financing a project that gets delayed? NACM member Matt Abbate said they ought not fret because there are tools in place to ensure credit professionals still receive payment on time. Abbate, the manager of credit and collections at Construction Specialties in Muncy, Pennsylvania, said the company conducts business both domestically and internationally, so he has learned to try to address any payment concerns as soon as the company receives an order. Beyond conducting a credit investigation and/or pursuing cash in advance or a letter of credit, Construction Specialties also researches its lien filing rights in the state where it’s conducting business.
“We consider filing for every job over $25,000 depending on the state,” Abbate said. “We always protect ourselves that way because in a state that’s a notice state, if you don’t do that, then you lose your lien rights down the road and you can’t file a lien on the project. Staying on top of the lien rights is really important because that’s an eye-opener.”
Owners don’t want liens on their properties because liens can create problems if and when the owner wants to sell, Abbate explained, describing liens as “a cloud on the title.” If necessary, Abbate said, he will first inform the customer Construction Specialties has filed a notice on the property and that the customer has a set number of days to pay. Otherwise, Construction Specialties will move to file a lien. In response, owners often reach out to the general contractor (GC) who may contact the subcontractor (sub) to jumpstart the payment process. Abbate may also seek a personal guarantee from the owner to ensure they make payment or request a joint check agreement.
“We use a lot of joint check agreements. We might get a purchase order for $70,000 from a minority contractor who hasn’t been in business that long,” Abbate noted. “Financially, we’ll reach out to the GC and get a joint check agreement signed by me, the contractor and the GC. We get the GC to get the subcontractor to sign the check and then the GC mails it directly to us. That covers us too. We use every instrument allowed by law to make sure we get paid on time.”
—Andrew Michaels, editorial associate
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What traffic is to major metropolitan areas during rush hour disputes are to the construction industry. They’re more than likely always there, whether or not they’re wanted. While cars and other vehicles are at a standstill, it’s payments in construction that are logjammed. Traffic congestion happens for all sorts of reasons, such as accidents or slowing down to let a pedestrian cross. The same can be said for the construction industry. Disputes may arise for a number of reasons: wrong product delivered, shoddy work, etc. When this happens, the downflow of payments dries up and causes a stressful situation between the contractor, subcontractors, material suppliers and others involved on the construction project.
A project in Prairie du Chien, Wisconsin, is one of the latest construction sites to face difficulties of nonpayment. According to the Courier Press, at least 10 contractors are missing money, and mechanic’s liens were filed by at least four contractors late in 2018 and earlier this year. “There are different reasons why others have not been paid, but the short answer is that payment is not due,” said the general counsel for Commonwealth Development of Fond du Lac, part of Lawler School Lofts LLC, in the article. Lawler School Lofts is the nearly $9 million project facing the liens.
As with many states, where an entity sits within the construction supply chain determines what needs to be accomplished in order to have full lien protection under a state’s law. In the case of Wisconsin, prime contractors on private projects have 10 days after first furnishing to give the owner a copy of the written contract, but if no contract is entered into, prime contractors have 10 days to provide a separate notice to owner. A perfect notice example is laid out in Section 779.02(2)(a) of the Wisconsin statutes.
Nonprime contractors have 60 days from first furnishing to provide the notice, with some exceptions. One occurs when the lien claimant, who is not a prime contractor, has contracted directly with the owner. If lien claimants fail to give the required notice, they lose their lien rights. However, if the notice to owner is served late, rights are still available but for only labor, services, materials, etc. furnished after the late notice is received by the owner.
Another tricky portion of the statute for lien claimants to remember is that liens are valid unless waived by the claimant or if a payment bond is furnished by the prime contractor in accordance with the statute. Not all lien rights are eliminated, however. Prime contractors still have valid liens if the bond is furnished.
—Michael Miller, managing editor
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In a consignment distribution model, a third-party warehouse (the consignee) takes possession of goods on behalf of a vendor (the consignor) for sale to customers. Title passes directly from the vendor to the customer, and the customer pays the vendor directly (the vendor pays the warehouse a commission). Despite the direct relationship between vendor and customer, the Ninth Circuit recently clarified that if the warehouse files for bankruptcy, the vendor’s goods—and any proceeds from the sale of such goods—in the warehouse’s possession can be used to pay the warehouse’s creditors.
The case of IPC (USA), Inc. v. Ellis (In re Pettit Oil Co.) highlights pitfalls in a true consignment model: IPC delivered fuel to Pettit (the warehouse), a bulk petroleum products distributor, who then sold that fuel to customers. IPC retained ownership of the fuel, customers were instructed to pay IPC directly (rather than Pettit) and IPC would pay a monthly commission to Pettit. Some customers, however, mistakenly paid Pettit for the IPC fuel they purchased. When Pettit filed for bankruptcy, the trustee claimed that the IPC fuel still in Pettit’s possession—and all related money/funds customers paid Pettit instead of IPC (as proceeds from the consigned goods)—belonged to the bankruptcy estate and could be used to satisfy the claims of Pettit’s creditors.
The Ninth Circuit’s decision hinged on two related issues. First, the Uniform Commercial Code (UCC) “treats the consignee as having an ownership interest.” This ownership interest is sufficient to bring any consigned goods into the consignee’s/warehouse’s bankruptcy estate. Crucially, the Ninth Circuit explicitly held that within the UCC context, consigned goods include proceeds (such as cash and accounts receivable) from the sale of those goods as long as they are held by the consignee.
Second, once the goods and their proceeds were determined to be within the bankruptcy estate, the Ninth Circuit had to determine who had the superior right: the vendor/owner (IPC) or the creditors of the warehouse (Pettit).
Article 9 of the UCC governs the priority and perfection rules related to security interests in goods, and the UCC “treats a consignment as a security interest for all practical purposes.” Retention of title affects the types of remedies available to consignors (like IPC) in their efforts to recover goods after a default, but the Ninth Circuit explained: “Title is irrelevant to whether IPC or the trustee has a priority in the goods and proceeds.” Ultimately, because the UCC treats Pettit (the consignee) as having an “ownership interest” and IPC (the consignor) as having a “security interest”—and IPC (admittedly) never perfected that security interest—the trustee prevailed.
Consignors should take the necessary steps under the UCC to perfect their interests in consigned goods. Growers, manufacturers and other producers should work closely with their attorneys to identify the proper distribution model to use. If a consignment model is selected, then the consignor should take all necessary steps to protect its interests and avoid bankruptcy pitfalls.
Reprinted with permission.
Joseph M. Welch is a shareholder in Buchalter’s insolvency and financial law group and focuses primarily in the areas of bankruptcy, litigation and real estate. He is a licensed real estate broker in California and a certified bankruptcy specialist from the state bar of California Board of Legal Specialization.
Mirco J. Haag is an attorney in Buchalter’s Orange County office and a member of the firm’s insolvency and financial law group.
Credit Education Roadshow
Spend time with STS’s Chris Ring as he presents during the Credit Education Roadshow, a one-day event held at multiple locations, designed to provide educational and networking opportunities for the Credit Team. Bring your colleagues and join Chris for a fun filled day of education and networking!
Locations & Dates:
- Southern California - April 15, Anaheim Marriott Suites 12015, Harbor Blvd., Garden Grove, CA 92840
- Northern California - April 16, Courtyard Sacramento Cal Expo, 1782 Tribute Rd., Sacramento, CA 95815
- Las Vegas - April 17, Sierra Gold, 6515 S Jones Blvd., Las Vegas, NV 89118
To learn more, call Chris Ring at 410-302-0767 or visit nacmsts.com.