Subs and Suppliers Pinched by Slowdown

As the Northwest Arkansas real estate market cools, several commercial developers, homebuilders and bankers are feeling the squeeze.

They are not alone.

As the pool of available jobs has receded, there is a rising tide of past due invoices for work already completed that threatens to wash out subcontractors who are often least able to weather the crippling effects of a broader financial crunch.

While building permits were off 56 percent in the second quarter of 2007 compared to 2006 according to the latest Skyline Report compiled by the University of Arkansas for Arvest Bank Group Inc., lien filings and civil suits to collect debts are up dramatically.

Washington County doesn’t track lien filings annually, but data from Benton County is revealing. Of the 670 materialman’s liens filed in 2006, more than half (362) were filed in the final four months of the year after several homebuilders filed for bankruptcy or were dealt foreclosures.

There have been 204 liens filed so far in 2007 compared with 308 during the first eight months of 2006.

During 2005, the last full boom year, only 143 were filed.

“My clients and many others have suffered tremendously financially as a result of the non-payment by many property owners/developers on many different projects,” said Fayetteville lawyer Lance Cox of Cox Cox & Estes PLLC, “causing an incredible cash-flow problem and consequential money damages, which are in addition to the principal and interest amounts owed.”

Cox was able to recover just more than $900,000 for four subcontractors with total claims of more than $1.5 million against Dixie Management and Investment Co. in July, but so far those payments are the exception rather than the rule.

The four contractors Cox represented (until he recently recused himself from the cases) were forced to re-file liens for the balance owed on Aug. 2 when Dixie failed to make good on the remaining amounts due in accordance with the lien release the company received for the initial partial payment.

Dixie, which wasn’t hit with a materialman’s lien during all of 2006, has been the target of at least 45 lien filings or lawsuits so far in 2007 (see story, p. 1).

Trying to collect debts is a delicate process for subcontractors, who often lack the legal background to properly file a lien according to the state law, the financial resources to see a collection through or the stomach to initiate litigation against a developer who may be a longtime business partner, a friend or a source for future work.

“It’s a Catch-22,” said EWI Inc. president Joe Whiteside, whose Fayetteville general contracting firm has been forced to file a few actions this year. “There may be pressure created from the people involved. They may have given you a significant amount of work and helped build your business.

“It can put a lot of pressure on a sub from that standpoint, the pressure of future work. It becomes a real dilemma.”

Whiteside said not getting paid can “put you out of business.”

“We know of a number in Northwest Arkansas who, because of late payments or non-payments have had to lay people off,” he said. “Some haven’t been able to make it. Without a doubt, companies have been impacted by not getting paid, from management to field workers.”

Lien on Me

The lien process is a complicated one.

Arkansas law requires a 10-day notice before any lien is filed and if the procedure is not followed the lien can be voided.

A contractor or supplier must file the pre-lien notice no later than 75 days after the last day on a job site or after a substantial completion of work, or the company loses its lien rights. It also must file the actual lien within 120 days to preserve its claim.

Cox recommends contractors and suppliers set up systems for sending out pre-lien notices no later than 60 days from the date of last work or for materials for which payment has not been received in full.

Many of the lien notices filed in both counties have been filled out by hand on standardized forms by subs and suppliers who may not want to incur the expense of legal fees while trying to collect a bill.

If the pre-lien notice does not result in payment, Cox said an attorney’s services are required.

He said the sub or supplier should wait no longer than 90 days to refer the matter to a lawyer.

Cox said it would likely cost at least $1,500 to review the case, prepare and make efforts to serve the pre-lien notice and, if necessary, file the actual lien. Costs increase exponentially if forced to follow through on foreclose.

Whiteside said part of the problem in Northwest Arkansas has been companies that began as real estate companies who branched out into general contracting and lacked experience managing expenses.

“If the site excavation, utilities or dirt work go over budget, you take those funds and apply them to the cost overruns but you’re not looking in the distance at the complete project,” Whiteside said. “By the time they get near the end, you’ve taken funds from one project, applied them to other projects and then it’s the last man trying to get into a chair.

“You see what we’re seeing, just insufficient funds at the end of a project.”

Homework Required

Whiteside said the trying times have strained the relationships between developers, contractors and suppliers.

“Adversarial roles start to develop,” he said. “It’s bad for the construction business.”

EWI has taken over completion of the shell of Nelson’s Crossing No. 3 at the corner of Joyce Boulevard and College Avenue in Fayetteville for Dixie.

Not surprisingly, Whiteside did some checking before taking on the job for one of the most delinquent developers in the market.

Dixie Construction was the contractor on the $902,130, 11,300-SF building No. 2, but cash flow problems and the divestiture of Dixie’s construction arm crippled the completion of the structure that now sits wrapped in Tyvek while EWI brings it up to the appearance of the rest of the commercial development.

EWI is only completing the shell. There is no contract for interior finish out.

“We were very concerned about coming in and helping out finalizing the project doing our due diligence,” Whiteside said. “We checked to see if there were existing liens. We made calls. We talked to the existing subs. We talked to the lending institution. Based upon our talking to all parties, we felt comfortable going in and performing.

“There is a sufficient amount of dollars [in the existing loan] to complete our scope of work. But there is a significant amount to be spent before it’s occupied.”

Whiteside said his company has tried to be thorough on the front end for the last few years, but even its own checks haven’t always kept issues from arising.

EWI filed a lien for more than $715,000 against the Spring Street Lofts project in downtown Fayetteville in June. At the time, John Nock, Brandon Barber and Mitchell Massey, a virtual who’s who of Fayetteville developers, owned the condominium project.

Nock and Hank Broyles bought out Barber and Massey on Aug. 10 for $13.1 million, settling the EWI lien and several other claims that together totaled more than $1 million before the title could transfer.

“We thought we’d done our homework in the past, but it’s bit us a couple times,” Whiteside said.

The fact liens must be settled before transferring title at least puts contractors near the front of the line to get paid should a property sell or be foreclosed upon.

Protecting Interests

Whiteside said good communication from the start is the best way to avoid problems getting paid.

“We’re all sitting down before it starts and knowing what written information we need and the assurance that we’ll be kept in the loop on timely payments and funds available at the end of a project,” he said.

Cox said there are a number of precautions subcontractors and suppliers can take to protect themselves before any deliveries or work takes place.

Cox recommends obtaining names and contact information on every partner of a development and having each sign personal guarantees of direct payment in full to the supplier or laborer hired by the general contractor. Cox said subs and suppliers should make sure their agreements with the general contractor should not include what are commonly known as “pay when paid” clauses.

Cox also said subcontractors and suppliers should demand proof the general contractor has served all property owners with any statutory notices required by law before any materials, equipment or labor are supplied.

“I haven’t yet seen a lot of change as to what subs and suppliers are doing to protect themselves,” Cox said,

“But I don’t believe that will be the case for long.”