Thursday, July 8, 2010

An Important Contingency

In the arcane world of receivables purchasing, there is a small corner of the industry that is even more arcane than the norm.

I’m referring to construction trades and to the various disciplines; such as architecture, engineering and other related fields that service or interact with the construction trades.

Often these professional services firms work for owners, including governmental entities, via subcontracts from firms that hold the primary contracts.

An example, for instance, is a client of mine: a cost-estimating firm that typically acts as a subcontractor to architecture or engineering firms. Sometimes the ultimate source of funds is the developer of a real estate project; sometimes it is a governmental or quasi-governmental entity contracting for public works projects.

I’m not going to attempt to describe the unusual problems raised in buying construction invoices. That is beyond the scope of a post like this. But suffice it to say that there are good reasons why construction invoice purchasing is a small and specialized sector of the factoring community.

The issue I want to address today is the frequently contingent nature of payment obligations in the construction or associated professional service businesses. Specifically, the impact of “pay when paid” or “pay if paid” clauses frequently found in contracts with those businesses.

These payment conditions are usually quite clearly stated and the substance of the language is enough to give any buyer pause.

In concept, they read, for example: “We’ll pay you WHEN we get paid” or “We’re only obligated to pay you IF we get paid.”

I am not an attorney and this is not to be understood in any way as legal advice, but those of us who do get involved in buying invoices from businesses like these are usually very quick to ask for a copy of the contract provisions dealing with payment, regardless of the apparent strength of either the Seller or the Account Debtor.

If either of these provisions is found in the contract, the first thing that a prospective Buyer can do is forget any stated due date on the invoices being reviewed for purchase. Those dates just don’t really matter.

The second thing that a Buyer might do is to request a full history of the invoices submitted and payments received under the contract in question.

The third thing might be to determine how the law in the applicable State treats “pay when paid” and “pay if paid” clauses. There has been a substantial amount of litigation on these clauses and there is not an answer that is universally applicable.

Some state courts; those of New York and California for instance; have ruled that a “pay IF paid” clause is against “public policy” and is unenforceable in those states. So a “pay IF paid” clause will be treated as a “pay WHEN paid” clause in those jurisdictions.

But what does that mean? In general, I understand that has been held to mean that payment will be made within some “reasonable” period. The effect of that, it seems to me, is to render the due date on an invoice essentially moot.

Other states have ruled that “pay IF paid” is an enforceable condition under certain circumstances. That’s scary.

When an invoice is posted by a TRE Seller whose business is like that of the client I mentioned above, for instance -- that might work for an architecture or engineering firm or for a construction manager – whose source of funds for the payment of subcontractors’ work is a third-party; it is very important to understand the payment provisions of the contract.

Currently, the Sellers on TRE do NOT post information that would allow a Buyer to determine whether the invoices being posted contain “pay when paid” or “pay if paid” provisions. If the Seller is in the type of business in which contracts often contain those clauses, the Buyer might be assuming an unknown and un-priced risk.

The point?

In some cases, regardless of the apparent strength of the Seller or the Account Debtor, or the validation of the invoice, or the satisfactory completion of the work required for payment, it is still possible to be exposed to either non-payment or very late payment.

Awareness of that possibility is the first line of defense.

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