If there's one piece of advice credit professionals in commercial construction should follow, it's knowing who you're getting into business with from the start. Material suppliers must not only assess any and all potential risks of conducting business with a subcontractor (sub) but also understand the consequences of little to no due diligence. Fortunately, there are some telltale signs material suppliers can use that shine the spotlight on risky business.
A recent article in Construction Dive highlighted five red flags for contractors to consider during their risk assessment process prior to accepting a job: Bad owner reputation, unorganized project, uncertain financing, unfavorable contract provisions, and taking over for another contractor. Although written from a contractor's point of view, Chris Ring, of NACM's Secured Transaction Services, said the reasons listed also apply to material suppliers and showcase why construction credit is "the hardest form of credit."
Uncertain financing is at the height of any credit professional's concern as their goal is to get paid. What contractors need to ask themselves is, "Is there money to pay for the project?" Mark Himmelstein, attorney and partner at Newmeyer & Dillion LLP, said in the article. In turn, material suppliers should do the same when working with subs because the latter may not get paid by the general contractor.
"As a general rule, material suppliers selling to subcontractors should secure lien and bond rights on large dollar job accounts because it's very likely that the subcontractor will not be able to pay the material supplier if the subcontractor is not paid. That's always a risk," Ring said.
A job account becomes more complicated when the construction project itself is risky. Ring said sales representatives working for material suppliers must be comfortable asking the tough questions when accepting job accounts from a sub, especially if it's a new sub. The sales representative can do so by rephrasing Construction Dive's five red flags into questions such as, "What is the owner's history with other projects, i.e., reputation?" or "How is the project organized, i.e., project documentation?"
Project documents that contain "too many inconsistencies or omissions" are a sign of a poorly organized project, Attorney Edward Seglias, partner at Cohen Seglias Pallas Greenhall & Furman PC, told Construction Dive. Just as contractors don't want to show the owner how to do their job, material suppliers don't want to hound down subs for payment.
Upon reviewing the article's red flags, Ring noted there is a possibility that a "desperate" sub may accept a project because many, if not all, other subs refused the project because of the associated risk. If a material supplier is selling to that "desperate" sub, then the risk of non-payment is quantifiably greater.