Construction Credit


Construction credit is a unique and specialized form of mercantile credit. Although the field follows many of the same principles, practices and procedures as mercantile credit, there are a number of factors that make the practice unique. In order to be successful, the credit professional must have a working knowledge of these unique characteristics. The following is an outline of these factors with an explanation of their significance for the credit grantor, along with some observations that may be helpful.


The Construction Pyramid and Flow of Funds

The typical construction project is made up of a number of players. In general, a supplier of materials or services to a manufacturing company would expect to be paid according to its established terms of sale as set out when the parties agree to enter into a business relationship. Payment would be expected by the supplier according to the agreed terms of sale irrespective of whether the customer had made, sold, or had been paid for its product. In the case of the construction company, payment to the supplier depends upon the receipt of payment by the Contractor for the work it has performed on a project.


The credit professional must take into account where its customer is situated in the hierarchy of players, and have a working knowledge of the flow of funds that will ultimately pay its account. Progress payments may pass through a number of hands before reaching the customer. As one might expect, this process takes time. This often leads to the receipt of payment extending well beyond what would be considered normal as in the example of the supplier to the manufacturer, and, as one might imagine, a problem at any level of the hierarchy may delay or reduce the amount of the payment expected by the customer.


The Source of Financing

The funding for a construction project may come from varying sources, such as a mortgage, government grants or loans, a bank loan or line of credit, or consortiums of public or private corporations that often fund large projects.


The Owner

The owner of a construction project is the beneficiary of the work being performed. The owner may provide funding directly, such as in the case of government agencies or large corporations, or funding may be arranged through conventional sources.


 The Payment Certifier

In most cases, the payment certifier is retained by the owner to design the project, supervise construction, and make recommendations for progress payments throughout the construction process. The payment certifier may be an architect, project management firm, or consulting engineers. The payment certifier often substitutes for the owner in some matters during the construction project. Credit professionals should be aware that the owner retains the payment certifier, and, as such, represents the owner’s interests in a project.


The General Contractor

The General Contractor is hired by the owner, and is responsible for construction of the project. The owner is generally the approved low bidder on the project, and may or may not do most of the work. Funds flow from the owner to the General Contractor generally as work progresses and as approved by the payment certifier.



The sub-contractor is hired by the general contractor to do specific work on the project, and is generally a specialist. They might typically be hired for items of work such as excavation and site servicing, forming and concrete work, structural steel supply and installation, drywall installation, masonry construction, and so on. The sub-contractor will invoice the general contractor for work performed on a degree of completion basis; payment to the sub-contractor is the responsibility of the general contractor.



This group of trades may be hired by the sub-contractor to perform some of the sub-contractors work. For example, the excavation contractor may hire another contractor to provide operated equipment to the site, or they may hire an outside trucking firm to remove excavated materials.


The Supplier

This group may supply materials or services to any level of contractor or sub-contractor for the project. It is therefore incumbent upon the credit grantor to be aware of which rung of the ladder is being provided, since the rights and remedies for enforcement of terms are limited. This principle will be expanded upon later.


The Low Bidder Gets the Job

Generally speaking, most sellers of manufactured products know their costs prior to selling their product. In the construction industry, prices for work are based upon estimates. The actual cost of the work to be performed is, therefore, not known prior to the work starting. There are many potential problems that can (and do) arise out of this methodology. Factors such as weather, quantities differences, change orders, extra work, product failures, and labour difficulties all conspire to affect the eventual cost of the work. All of this provided the estimate was accurate in the first place.

The construction credit professional must be aware that it only takes one particularly bad job to ruin a contractor financially. The diligent credit manager will use all available resources to monitor the customer’s performance.


Holdbacks and Their Effects On Contractors and Creditors

Lien legislation is a provincial matter. The majority of provinces have enacted legislation that requires that a specified value of the work performed by a contractor is subject to a holdback for the benefit of potential lien claimants as well as workers. The amount of holdback required varies from province to province and generally ranges from 10% to 15% of the value of the contract or subcontract. The holdback is not due and payable until a specified period of time following substantial performance of the contract, usually 40 to 45 days, depending upon the province where the work is performed.


The requirement imposes a definite strain on the contractor’s cash flow. Often, a subcontractor’s contract terms do not allow for release of the holdback until the main contract is substantially complete. One could imagine the impact on cash flow of, say, an excavating contractor working on a major building that could potentially take two to three years to complete. Not only is the contractor’s profit tied up for an extended period of time, but, given that payroll, fixed monthly expenses, materials and other services such as equipment rentals require payment in full on a regular basis, and given the competitive nature of the bidding process, the contractor must also bear the burden of financing a substantial amount of cost. Furthermore, few if any lending institutions will accept holdbacks as valid receivables when asked for financing by the contractor.


Lien Legislation

As indicated previously, provincial lien legislation allows some protection for suppliers of work or materials to an improvement provided all requirements for preserving and perfecting the lien are met. This protection is limited to the total available holdback retained by the owner. In the case of suppliers to subcontractors, the maximum amount available would be the total holdback retained by the general contractor for work performed by the subcontractor. Lien claimants form a class of creditor, each with the same rights and entitlements. In the event that the total holdback available is less than the value of claims, beneficiaries share pro rata in any distribution eventually made.


Some observations

Liens are an expense that can be substantial, both in terms of costs and time delays with no guarantee of eventual payment. Experienced construction credit professionals are aware of the potential costs, and will generally only use the remedy as a last resort. The critical restrictions of time (usually 40 to 45 days maximum to claim) require decisions to be made quickly, often without adequate due diligence.

The complexities of lien legislation require a sound fundamental knowledge of the Act. It is recommended that credit managers work with skilled construction law specialists when contemplating the need to register a construction lien. Case law often determines the outcome of a particular argument in law, and decisions are ever evolving. For that reason, experienced construction lawyers can often guide the credit professional in the approach to a particular case so that the outcome is not only favourable, but at a minimum of cost.


Labour and Material Payment Bonds

Some but not all construction projects require the general contractor to post several bonds prior to the commencement of work on an improvement. The most common bonds required are bid bonds, performance bonds, and labour and material payment bonds. Without going into detail on the various types of surety bonds, the bond that is of interest to creditors of construction companies is the payment bond. These bonds are generally required on most government projects, federal, provincial, and municipal (with some exceptions), and provide a guarantee of payment to suppliers of services to the general contractor, who is called the “Principal” on the bond. The amount required varies, but typically would be a fixed dollar amount, 100% of the contract price, or 50% of the contract price. Suppliers have a fixed time period to file a claim for an unpaid debt, usually 90 or 120 days from the last date of supply. They have the right to sue the bonding company to recover an unpaid claim generally within one year.

Claimants must supply documentary evidence that their claim is timely and all invoices must be referenced to the bonded project. Suppliers can only claim against services provided to the Principal named on the Bond. Suppliers to subcontractors or sub subcontractors are not protected.


Lack of Capital Investment

Most businesses require some form of capital investment, often substantial, before startup. Many construction companies are started with a minimum of capital invested, some with a leased pickup truck and a cell phone. The lack of capital investment obviously increases the risk to the credit grantor, who may be asked to extend far more credit to a contractor than he has capital invested in the business. The character of the contractor, expertise, type and scope of work, bidding and performance capabilities are essential factors to be considered by the credit grantor. The failure rate for small contracting companies is extremely high in proportion to certain other businesses, and for that reason, the credit professional must use additional sources of information other than conventional sources prior to making the decision to extend credit.


Additional Sources of Information.

In addition to the sources of information typically used by credit grantors in the mercantile credit field, there are a number of additional sources of information that the credit professional in the construction industry can use to his or her advantage. Some of these are as follows:

  • Industry credit groups. Participation may be targeted to a specific type of construction activity, i.e. paving and sewer and water main work, electrical contracting, general contracting, landscape contracting, etc.
  • Credit reporting companies specializing in the construction field. A prime example would be Lumbermen’s Credit Bureau in Toronto. In addition to trade, banking, and legal information, cross-referencing is done on the principals of the company. Cross-referencing allows the credit grantor to learn about other related and prior companies with which the principals may have been involved previously, together with an indication of whether legal actions had been taken against those companies. They also provide a weekly bulletin of construction liens registered, often an early indicator of potential financial problems. The company also offers reports on specific projects that are updated regularly. It also sponsors
  • Subscriptions to industry trade publications such as the Daily Commercial News, Reed Construction Data and Dodge Reports;
  • Site visits; face-to-face meetings with prospective customers can serve to answer a number of questions that are not answered by normal credit reports. The construction industry is known for new businesses starting up on a continuous basis; it is also known for having a high failure rate. Face to face meetings can serve to assist in making the right call.
  • Tender results are generally available through sites on the Internet, particularly for government-sponsored projects. A review of tender results can often answer questions about bidding discrepancies (jobs underbid), as well as a description of the scope of work, contract number and bonding requirements.


Published under: Construction
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