Creditor Lessons from the Homebuilding Downturn

Recent economic headlines resemble the most thrilling roller coaster ride. One week the outlook is dire; the next, things are on the upswing. What is certain is that employment rates are slowing, fuel and resource costs are increasing, and economists are debating the “R” word. The homebuilding industry downturn, already in its second year, provides important lessons in this challenging economic environment.

Business people and entrepreneurs are optimists and hard workers by nature. To be successful, you have already succeeded where many others failed. In the face of challenging economic times, many business owners emphasize increased sales and controlling costs. Those steps may not be enough. While an economic slowdown may never materialize or impact your business, being prepared to respond quickly if it does is crucial. As the homebuilding industry downturn demonstrates, recognizing the changing marketplace early and adjusting business models ensures viability and permits quick growth during a recovery, instead of struggling for survival when a business is slow to react.

The life blood of most businesses is sales and the generation of income. During sustained periods of growth, hard work can pay significant dividends. However, generating a sale is only half the equation. Equally important is obtaining payment. During boom times, payment is assumed. However, the loss of a major customer or revenue stream can be devastating. During an economic downturn, the risk of non-payment or loss of a major customer is significantly increased. Evaluating accounting, billing, credit and other policies and practices now, as part of an adjusted business model, may be the difference between lost opportunities or worse, bankruptcy.

While every industry or business is unique, the following overarching guidelines should be considered by businesses as part of a revised business model from the homebuilding industry downturn:

1. LOOK FOR THE WARNING SIGNS

Some examples include climbing write-offs, an increasing concentration within your own customer base, delayed payments, “negative industry gossip,” the departure of key management or personnel, and the conversion of outstanding accounts receivable into notes payable.

2. IMPLEMENT CONTROLS

Most businesses have not experienced a protracted economic slow down, or new personnel may not have experience in a downturn. Monitoring accounts receivable may be spotty and active collection activities may be negligible. Establishing clear credit policies and trade terms that are easily understood and implemented by everyone within a business is critical. Having a credit manual and written terms and conditions from a professional can eliminate confusion, ensure cohesive application of policies and permit greater success if litigation or claims in bankruptcy ensue.

3. A HANDSHAKE IS NOT ENOUGH

The business world is complex. Discussions over lunch followed by production and shipments are not enough. The person you have known for 20 years may not be the person who is required to pay you after a bankruptcy petition is filed no matter what is said. Clearly documenting all agreements is indispensable when it comes to getting paid.

4. EVALUATE CREDIT LINES

Some material suppliers in the housing industry extended hundreds of thousands or millions of dollars of credit to relatively new, but rapidly growing contractors. When the homebuilding downturn hit, many of those suppliers were left with large debts owing by insolvent entities. Evaluating existing and future use of credit can dramatically decrease losses in the event of an economic slow down.

5. KNOW YOUR CUSTOMERS

In modern business, it is common to form and use multiple entities to limit risk. While you may know that the individual behind a business is worth millions, that individual may not be obligated to pay you. Wherever possible, obtain a personal guaranty and where it is not possible, limit risk exposure by decreasing credit exposure.

6. KNOW THE LAW

Despite a number of important creditor protections in the home building industry, incredible amounts of money were lost because a lien right was not properly filed or perfected. Understanding what lien or other rights might apply to your business when dealing with a problem account can be the difference between payment and your own cash flow struggles.

7. STICK TO THE PLAN

It is tempting to “help out” a long time customer through an economic downturn. After all, your success may be linked to their prior success. However, the credit policy and terms an attorney creates for you are carefully designed to limit and identify assumed risks. Significant exceptions can erode any protection and once started, may cause other customers to ask for similar treatment.

8. EVALUATE ECONOMIES OF SCALE

A number of contractors avoided hiring professionals because of cost. After all, each account was only a few thousand dollars and profit margins are limited. However, when each account was with the same or related contractors, and the parent and related entities are insolvent, a few thousand dollars can translate into much larger losses. This happened time and time again in the home building industry. Often, a professional can assist you or direct you to cost effective resources to ensure preservation and protection of your rights before they are lost.

In a recent list serve discussion of credit and insolvency professionals, the unanimous opinion was that the single biggest thing a creditor can do to improve recovery success is to act early and respond quickly to problem accounts or customers. Delayed reaction makes the likelihood of successful recovery significantly less, and may compromise a professional’s ability to assist you.

As the economic headlines continue to point to rapid improvements or a downward spiral, contingency planning and updated policies are a wise and necessary business investment to head off problems before they materialize. If you have questions regarding this article, or would like assistance with these issues, please call a member of our Litigation and Creditors’ Rights Group.