This audio is automatically generated. Please let us know if you have any comments.
Dan Rosenberg is a construction attorney at the Much Shelist law firm, where he supports clients in construction, design, real estate and insurance. Prior to that, Rosenberg was the general counsel of Chicago-based construction company McHugh Enterprises. The opinions are the author’s own.
In recent months, high interest rates have caused concern delays and abandonment of projectsthough cuts expected this month could quell some of those concerns. However, we are currently seeing increasing signs of financial distress in certain sectors of the construction market, and this distress is affecting some construction project owners.
This distress appears to reflect a combination of factors, but appears to be particularly focused on two themes: relatively high interest rates and a slowdown in demand in certain sectors of the market. Sometimes, however, a delayed or canceled project can indicate more than a lack of funding or supply chain headaches, but that the owner is struggling financially.
Here are signs that building owners may be in trouble: red or yellow flags that should cause concern or at least raise awareness. These signs become increasingly worrisome, of course, when more than one sign appears in a project.
red flags
Project owners and promoters, or even government entities, may lose funding or have unforeseen problems in a project that the owner does not contemplate or include in a contingency in their budget. These problems can sometimes have aggravating effects on the project. Signs of this distress may include:
Headlines in the media. Obviously, if the media reports a loss of funding or other signs of distress, this is not positive for the project. Similarly, if you hear rumors or reports in the industry, you may want to follow up for additional information.
Do not make payments. It is one thing if there is a dispute that arises during a project and as a result a payment is not made. However, it is a sign of much greater distress if a landlord defaults on an otherwise undisputed payment.
Sudden slowdowns in payments. If the owner has been regularly meeting their payment obligations, but suddenly changes their payment pattern materially, this could be a sign of trouble.
Staff suddenly unresponsive. If the owner’s computer becomes slow to respond or suddenly becomes unresponsive, this is not a positive sign.
Significant staff turnover. If the owner’s staff suddenly starts leaving, and in particular if senior officers, such as the CFO, leave, this turnover is not a good sign. Senior staff often know about problems before others.
Things to think about
If you see signs that a party you are working with may be in financial difficulty, in addition to contacting capable legal counsel, there are steps you can take to put yourself in the best position to minimize the financial damage that could affect your business Here are some key considerations a business can take to protect itself when an owner or developer is struggling:
Understand your contractual right to stop working. If a homeowner doesn’t pay his general contractor (or a commercial contractor doesn’t get paid because the homeowner hasn’t paid his general contractor), it’s critical that the contractor understands when he has the right to stop work. Likewise, a contractor must understand the business implications of continuing to work when not being paid.
These considerations may vary depending on whether or not there are disputes over a project, as well as the language of the underlying contracts.
Understand consent and assignment agreement. On most private projects, a general contractor negotiates and signs a consent and assignment agreement at the start of a project that gives the owner’s lender the right to assume an assignment of the construction contract if the owner fails to meet the loan documents. When the owner is in financial difficulties, these agreements become critical.
Note that these documents often require the general contractor to notify the lender in writing of the owner’s default. This notification is essential to protect the interests of the contractor.
Understand the downstream payment obligation. Any contractor who has not been paid should carefully understand their own payment obligations. Pay-if-paid clauses become critical in these scenarios, but even if such provisions are in the subcontract, they may not override certain legal protections that downstream subcontractors may have.
Understand lien rights and the consequences of filing a lien. There are legal deadlines for recording mechanics liens on a project and business consequences for recording a lien. It is important for a contractor, at any level, to understand the legal and business issues involved.
Be prepared for bankruptcy. In development projects, it is somewhat rare for a single purpose entity that likely holds title to a property to file for bankruptcy, but it is not impossible.
As 2024 continues, keep an eye out for owners or projects that are faltering and use these tips to protect yourself if it happens.
Many Shelist directors Scott R. Fradin and Robert Glantz contributed to this story.