Liquidity / Dispute Resolution

Factors that can have significant impact on a subcontractor are situations where an unanticipated event has developed resulting in extra costs, those costs are a matter of some dispute, and the work is directed to be performed pending resolution and issuance of a change order. These unfunded directives create a financial burden on the contractor, too much of a burden may trigger a default.

It is not uncommon for contractors to finance these costs until the end of the project. In meeting this need contractors generally have two choices, finance internally or utilize a credit facility. When they use a credit facility they are often constrained by the fact that a surety has a preferred interest in receivables on bonded work, so the lender must accept a secondary position. Not only can this have a restricting impact on the ability to secure adequate financing, the opposite is also true, by providing a priority interest in the future receivable to the lender the contractor can secure more favorable terms and possibly more credit. The surety is justified in giving up its priority position because the funds are applied directly to the project, thereby mitigating the surety risk by making the receivable “collection” timely for the contractor, but also because should the directive not turn into a change order the surety would have given up nothing. So the surety gets an advantage in either scenario, with no downside.

Another advantage is the request to the surety for their consent to waive their priority interest in the receivable will necessitate their review of the request. That review will prompt the engagement and communication that is at the heart of the surety based risk management program, and will provide the surety the opportunity to understand and subsequently mitigate their exposure.

When a directive is converted to a change order and subsequently paid, the loan will be paid off with the balance going to the contractor.

If the change order is ultimately denied, or is less than the loan, the lender is in the same position it would have been under their normal line of credit extension, so the bank has no downside with a considerable upside with respect to bank lending policies and priority interest in the AR.

Under certain circumstances a lender may provide better long term rates if there is a front loaded interest model as an incentive for early resolution. Under the typical scenario it is not uncommon for the legal system to be employed to resolve issues. The legal system has a financial incentive not to resolve things, and quite often a significant amount of dollars are redirected towards legal costs, time is wasted for even more financial loss, and untimely the only winners are the attorneys. Under a front loaded incentive the longer the directive remained unresolved the less income potential, the natural outcome being a sincere attempt by the lending group to bring about a resolution of the directive.

Having the liquidly to perform directives, the engagement of the surety, and the efforts of the resolution team to negotiate quickly all add up to better project for all participants, and less risk across the board.