Positive cash flow is critical for construction contractors. If they don't get paid on time, they lose much of their ability to pay for the supplies, labor and subcontractors necessary for each job. Unfortunately, many contractors have problems obtaining the retainage (the money the contractee withholds until the end of the project) after a job is done.
Retainage is a standard practice in construction, but there are things you can do to ensure that you are paid during the work and once it's complete.
How to make contractor payment easier for your clients
You should take these steps before the project starts to make regular contractor payments easy for your client.
1. Set up and develop contracts.
Spell out all financial obligations, such as the schedule of payments or the milestones that trigger the next payment. List the expected amount (or percentage) as well as the trigger. Make clear provisions for add-ons: who can approve them and what that indicates for payment increase or schedule. Finally, spell out penalties for late payments, finance charges, a provision to collect attorney fees if you need to take legal action, and the right to suspend work until payment is given.
If you are using subcontractors, a pay-when-paid clause can protect you. This clause says you pay your subcontractors when the client pays you. Be sure your client understands this provision, as it can motivate them as well. When you set payments, particularly the down payment, consider client risk as well as materials and labor. If your new client is unknown to you, or the project itself is speculative (such as a new, untried restaurant), you may want to demand more upfront, with a small retainage. You can be more flexible when contracting with a trusted repeat client.
2. Make it easy to pay.
Be sure your invoices are clear, complete and correct. Far too often, late invoices are because of a problem with the invoice itself or inaccuracies in the paperwork. Clients should have not only a clear way to pay – such as a self-addressed envelope for a check or the information they need to make an online payment – but also a reminder of exactly what work that installment pays for.
Additionally, your invoices should contain all information that your clients need to pay you. If a check is your preferred form of payment, then include your mailing address and the name to which checks should be payable. If you prefer a wire transfer, include your banking information. For ACH payments, your client should already have your direct deposit information unless this invoice is your first for the client – the first invoice should include this information.
3. Use invoicing tools.
With invoice automation software, you can send complete, easy-to-understand invoices in just a few clicks. You can also easily email clients, track reminders and missed payments, set up online payments, and more. That said, no matter the invoicing platform you choose, you should always double-check your auto-generated invoices to minimize billing errors.
When you choose invoicing software, look for a platform that integrates with many of your other business programs. You may also want to choose a platform with expense tracking and mobile invoicing. [Looking for help with your invoices? Check out our picks for the best accounting and invoice-generating software.]
4. Establish a payment schedule and terms.
To ensure timely client payments, include a contractor payment schedule in your invoices. For example, listing "net 30" as your payment terms lets your client know that you expect payment within 30 days of invoice receipt.
5. Don't wait to send invoices.
An invoice sent in April for a project completed in February won't feel urgent for your client. That's why you should set up invoice workflows that ensure timely invoice creation and delivery.
Monthly client billing is common for contractors. However, other billing approaches exist. You can bill your clients after you complete each project, or you can send invoices every time you reach a certain number of work hours.
When a client doesn't pay
The most important thing to remember is to not wait. There are several steps you can take to get money from a non-paying client, the most drastic of which is a lawsuit or filing a mechanic's lien, which we discuss below. However, many states have a limit on how long you can wait after a project's completion before filing a lien. If you hesitate, you may lose your window. The longer you wait, the less likely you are to be paid. Here are several steps to take for the debt collection process:
1. Start with a reminder.
A past-due notice with a copy of the bill and a reminder of the contract, including the penalties, is a logical first step.
2. Follow up.
A simple call or visit can uncover issues that might impact your payment. For example, a customer might be withholding payment because of work undone or badly done. In that case, talk to the client to determine how to get the project and payments back on track. Sometimes, a subcontractor complains to the owner that they are not getting paid, and the owner holds back payment until they know the subcontractor is paid. In this case, the pay-when-paid clause is in your favor; otherwise, you should pay your people regardless of the payment you've received.
Occasionally, the client refuses to pay either out of dishonesty or because they are hoping to negotiate a lower project price. When this happens, you must decide what's in your best interest – taking legal action, or negotiating a discount and taking the financial hit.
3. Send a demand letter.
More than a simple past-due notice, the demand letter clearly states the payment that is needed, the deadline for making the payment, and the consequences for not paying by the deadline. Be specific, particularly on your next steps: "If we do not receive payment by (date), we will file a lien on the property for (amount) on (date)." However, do not threaten, disparage, or vent at the client, even if you are frustrated. Expressions of anger often make the reader ignore the message. It's best to display an attitude of calm control. After all, this is a business agreement; you are within your rights to enforce the terms of that agreement. Another thing you can do is suggest arbitration to resolve the issue, which can be cheaper than a lawsuit.
Editor's note: Looking for the right collections agency for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs.
The mechanic's lien
If a client still fails to pay after all these steps, you can file a mechanic's lien, sometimes called a construction lien, laborer's lien or artisan's lien. A lien states that you have a claim on the property because of the unpaid work you put into it. While a lien is on the property, it's difficult for a client to sell or refinance it, and it has an immediate negative impact on their credit score. A lien is a legal document, and each state and county has its own rules, including limits on how long after a project's completion you can file a lien, the information needed, even the kinds of forms necessary. Make sure you meet all the applicable requirements. Also, be very careful about the forms; there are stories of liens being rejected for something as simple as font issues and margins.
Finally, include the invoice for the unfinished work. You can file a lien in many ways, but if you do it in person with a clerk, they can check it on the spot for errors, saving you the time of correcting issues and potentially missing the deadline.
When the lien is successfully filed, the client often pays the bill, called satisfying the lien. If they do not, you can enforce the lien by lawsuit or wait for the property to go on sale, in which case you will be paid according to where you stand in the priority list of those who have a claim on the property because of the owner's debt.
You do not need a lien in order to file a lawsuit, of course. You have several options for this legal course of action. No matter what you choose, though, be sure to have all your legal documents ready:
- Copies of all correspondence, including any replies
- Before-and-after photos of the work when possible
- Subcontractor invoices
- Records of your payments for supplies, labor, etc.
1. Notify the client of your intent.
As with a lien, clients will often pay their bill rather than face court action once you alert them to your intentions.
2. Hire an arbiter.
If you are on fairly good terms with a client, or they are withholding payment for what they consider a valid reason (such as dissatisfaction with part of the job), then arbitration might be a less stressful way to resolve the issues and get your payment. Arbitration can cost as much as small claims court, and usually the parties split the cost. An arbiter's decision is legally binding.
3. Go to small claims court.
This court is a common method for debt collection, but it is restricted by the dollar amount of the claim. This varies by state, but it's usually for claims worth less than $10,000. You do not need a lawyer for small claims court, but you should have your documents ready to prove your case as if you were going to a superior court.
4. Go to superior court.
If your client owes you more than allowed in small claims court, you can sue for the maximum permitted in small claims and take a loss on the rest, or you can file in general superior court. While this is as straightforward as filing in small claims, you may want to hire a lawyer for this option.
Debt collection agencies
Some contractors prefer to avoid the hassle of debt collection by hiring an agency to handle it. Debt collection agencies have expertise and experience in collecting payments, and because they are not directly involved in the project and customer relations, they can put some pressure on your client as long as they comply with the laws for debtor treatment. This could be a cheaper option than legal action as well.
If you choose this route, select your debt collection company carefully. In addition to pricing, check its reputation through customer reviews and referrals. Find a company that specializes in the construction industry if you can.
Finances are as important to the job as the project itself. By taking some care in the contract and billing process, you can avoid late payments. However, if you do have trouble getting your payment, especially that retainage, you have options for getting the recompense you earned.
Max Freedman contributed to the writing and reporting in this article.