When economic times are tough, contractors find it much more difficult to collect from their clients. Clients watch the value of their stock investments decline as they are in the middle of a project; or they are concerned about the possibility of losing their job so they try to cut expenses, namely the remodel cost. Whatever the reason, you are not getting paid. What should you do?
Is a lawsuit worth it?
Lawyers are always standing by ready to file a lawsuit. The problem is that you usually need money up-front to pay the lawyer. Does your contract have a provision that the successful party in a lawsuit is entitled to recover their attorney fees? If yes, then moving forward might make sense. If not, a financial analysis is necessary to determine if it is in your best business interest to file suit. How much are you trying to collect and how much will it cost you to collect? Don’t file a lawsuit “on principle.”
Before you authorize your attorney to file suit, explore mediation. Mediation is a process whereby the two parties come together with the assistance of a neutral facilitator to work out a settlement. The facilitator will point out the extreme cost of litigation and the benefits of settlement. While you might not collect the entire amount owed to you, your net amount may be far larger than you would have received from a lawsuit. And the timing of the payment is usually much quicker. Lawsuits can take up to a year to conclude and then, if you win, you struggle to collect the judgment.
Cash flow planning is critical
You should ask yourself how much you can afford to walk away from and not be financially hurt. When you come up with that number, never let a scheduled payment amount exceed that number and never let a client owe you more than that amount before you stop work. If your maximum amount can be kept below the Small Claims Court amount, collection will be much cheaper, quicker and easier.
When you bid a contract, set up your payment schedule so that your “maximum” amount is never exceeded. The key here is to make the payment due upon presentation or within just a few days. If you give the client 30 days to pay, then you have done more work (for which you might not be paid) and thus you might exceed your maximum amount.
Time and material contracts
Put a provision in your contract that indicates you will bill the client “every two weeks or when the amount owing reaches $___________(your maximum amount).” This requires careful watch over your expenses attributable to the project plus your mark-up.
Many contractors charge in advance for change orders which obviously makes collection easier. Some states, however, have restrictions on charging for work in advance. If you are in one of those states, either bill the change order in increments or immediately upon completion.
Usually the final payment is connected to completion of a punch list. Your contract should allow only one punch list with final payment due upon completion.
If you are not getting paid, it is critical that you stop work. Usually if work stops the client is motivated to make payment, and if they are not, you can move on to another project and cut your losses. Keep in mind that if you choose this route, you must make sure that you are entitled to payment. Your accounting must be in order, your work must meet industry standards, and your payment schedule must meet legal requirements in order for you to be entitled to payment. If you have made a mistake in any of these areas, the client could hire someone else to complete the project and hold you responsible for any costs in excess of your contract amount.