What an Economic Downturn Means for Your Construction Project
by Susan L. McGreevy
When bad things happen to the economy, eventually construction is affected. When housing is one of the primary causes of an economic downturn, the ripple effect on construction as a whole will be felt even sooner.
Because construction generally involves a lot of money, a lot of parties and a lot of risk, there are plenty of opportunities for people on all sides of the transaction to be hurt. With some additional care and forethought, however, it is possible to lessen the chances that someone else’s financial problem will turn into your financial loss. What you will want to do, of course, depends on whose shoes you are in.
The owner. Obviously, no owner intentionally hires a contractor who is financially shaky. Because many construction contracts take a long time to complete, a contractor who appears solid at the beginning can take a turn for the worse before your project is complete—and it could be for reasons that you know nothing about (a loss on another project, for example). The best way to protect against a contractor’s financial distress is to obtain performance and payment bonds from a reputable surety. Bonds cost money, but so do all of the alternatives to bonds, such as letters of credit. Making payments through an escrow company, which can be directed to obtain lien waivers from subcontractors and suppliers before disbursing funds, can also help avoid losses and claims, but comes at a price. Paying attention to tell-tale signs such as materials not showing up on time or in sufficient quantities or insufficient crews (signs of poor credit), can prompt an owner to do some investigating before releasing funds he’ll never see again.
The lender. Lenders want assurances that (1) the borrower will have enough funds to complete the project and (2) the bills are being paid. Protecting against the first risk takes quite a bit of due diligence, because even if all the right inquiries are made about the completeness of the construction design and budget before construction commences, inevitably changes and unforeseen conditions (such as weather, strikes/embargoes) will make the process cost more or take longer. Lenders are requiring more detailed information, more contingency funding, all of which stretches out the lending approval process and increases the cost of the project. Using escrow firms can help protect against the second risk.
The contractor. Contractors generally just want to be paid by their customers on time and have their subcontractors and suppliers perform as agreed. Contractors carry a significant amount of risk, since they are liable to all the subcontractors and suppliers (unless they persuade these firms to share the risk of non-payment), and they are liable to the owner for the defaults of the subs and suppliers. Given that most contractors are lucky to make 5% profit on their work these days, if one supplier can’t deliver, or an owner’s credit is turned off, the contractor becomes the de facto lender (if the problem is only short-term), and often end up absorbing the loss if the project “goes South.” And, since they tend to only get paid after their work is performed, they are at great risk if they only learn after-the-fact that their customers have run out of money. Contractors need to do their own due diligence to assure that the necessary funds are really available, and they need to watch cash-flow closely and act quickly if they see an owner developing financial problems. More than ever, contractors need to protect themselves by choosing the owners they work with carefully, making sure that they get paid on time, preserving their lien and bond rights, and saying their prayers every night. 
Susan McGreevy is Chair of the Construction Practice Group, Stinson Morrison Hecker LLP.
P | 816.691.3480
E | smcgreevy@stinson.com