Systems Can Provide Legal Protection

If you are planning to grow your business, it is imperative that you implement systems. Systems are critical in just the basic management of your business, but did you know that the use of systems can help avoid legal problems as well?

Establish maximum client debts

Growing your business usually means taking on larger projects, and this usually means having larger accounts receivable. What would be the effect on your business if a client did not pay you? That answer probably depends upon the amount the client owes you. Is it $10,000? $20,000? $100,000? You need to determine that limit — not your client. What is the maximum amount that your business could withstand to lose and still continue to operate comfortably? Whatever that number is, that should be the maximum amount you ever let your client owe you before you stop work. I frequently have contractors tell me that their client has not paid them for months and owes them a huge amount of money. When I ask why they kept working, they tell me they thought the client would eventually pay. In the meantime they are practically mortgaging their own home to keep the client’s project running. And then they usually do not have the funds to file a lawsuit to collect the amount owing!

The maximum limit you choose should also be a guide in setting your payment schedule. No single payment should ever exceed your maximum amount. Explain to your client in advance that you will have no choice but to stop work if the amount outstanding on the project ever reaches your preset amount.

This maximum amount outstanding now becomes your business system for payment schedules, invoicing, stopping work, etc. If the client declares bankruptcy or if the cost to collect the money is too high, it might hurt ,but at least your business will survive.

Establish office policies for collection of information

Growing your business usually means using more subcontractors. It is imperative that your subcontractors be properly licensed and insured. If they are not licensed, they may be considered your employee subject to payroll taxes. If they are not insured, you may end up paying for their mistakes or injuries.

Every time you hire a new subcontractor, check their license status, get a copy of the their general liability and workers’ compensation insurance certificates and have them name you as an additional insured on their policy. Many contractors will say they do this, but they only do it once when they first use the subcontractor.

Establish a system in your office to annually check the license status of your subcontractors and get an updated insurance certificate. Setting aside a particular day in the year to do this activity prevents it from falling through the cracks and prevents unwanted liability.

Conduct an annual business review

Growing your business usually means leasing more space, hiring more employees, purchasing more equipment and perhaps changing your overall business structure. An annual review with your accountant and attorney is critical. Bring to the meeting a copy of your current contracts, a financial statement (Quickbooks printout will do) and a list of the major things you expect to do in the following year (for example, lease new space, buy equipment, establish a retirement plan). Ask your advisers the following:

  • Is there anything I need to do before the end of the year to get a tax advantage?
  • Are there any changes to the law that require contract revisions?
  • Is there anything I need to consider before I proceed with my plans for the upcoming year?

Your advisers can help you plan in advance, but not in arrears. Don’t wait until it’s time to file a tax return to find out that you would have paid less in taxes if you had just done something a little differently at the end of the year. Putting this annual review system in place provides you with tax and legal protection.

Nancy A. Chillag is a construction attorney in Menlo Park, Calif., practicing for over 20 years. She is the author of Building by the Book: Legal Advice for Contractors. You can reach Nancy at or visit her website