Non-Payment and Extending Credit: Ten Considerations

Non-Payment and Extending Credit: Ten Considerations for Contractors and Suppliers

Your company is not a bank. You are not in the business of lending money over extended periods of time.

Just because the general contractor has not been paid does not mean that you should not be paid (see item #1).

Remember that you have other remedies besides a construction lien. Delivering a written notice of lien can be an effective way to stop the flow of funds on a project. Likewise, a breach of trust claim can be a powerful tool.

Agree upon credit terms in advance. Be consistent, clear and concise. Obtain information about your customer by way of a credit application, including the correct legal name of the business, and current banking information.

Do the Due! Conduct appropriate due diligence including: (a) credit searches; (b) reference checks; (c) property and corporate searches; (d) writ searches.

Identify problems early. Warning signs to watch for include: (a) slow or non-payment; (b) N.S.F. cheques or post-dated cheques; (c) cheques coming from someone other than the customer; (d) re-structuring or presence of outside people such as an accountant or “consultant”.

Get something in return. In exchange for revised credit terms, seek an acknowledgement and agreement on the amount of the outstanding debt, or additional security if necessary.

Lawsuits are inevitable. Good procedures and record keeping reduce the cost of lawsuits and increase the likelihood of recovery in collections. Consider whether your company has a clear mechanism for acknowledgement of receipt or pick-up of product.

Know when to cut your losses. $100 today is worth more than the possibility of $125 two years from now. Don’t be afraid to cut deals!

As hard as it is to believe, general contractors and customers do occasionally lie about the cheque having been mailed out!

Frequently Asked Questions

Should I incorporate my existing business?

I am the sole proprietor of a profitable construction business that I want to expand. I’m nervous about the risk associated with the business and its expansion. Should I incorporate?

We would strongly recommend incorporation. Incorporation provides you with limited liability to protect your personal assets from creditors, and tax advantages that will help you grow your business and your wealth.

‍Limited Liability

‍A corporation is a legal entity distinct from its shareholders. The obligations, debts and liabilities of the business are those of the corporation and not of its shareholders. The protection from creditors is a significant advantage, particularly for businesses that are inherently risky. As the sole proprietor you are currently liable for every debt, liability, obligation and claim against your business. In your construction business, an inadvertent error or mistake by a sub-contractor, or simply the failure of the project caused by others, could result in huge liabilities for which you are personally exposed to creditors, risking loss of your house, savings and other assets. Incorporation of your business creates a significant barrier of protection. (Note: there are statutory and other limited exceptions to the protection provided by a corporation)

‍Income Taxes

‍Active business income earned by a corporation is taxed at a much lower tax rate, approximately 15.5% in Ontario on income up to the small business limit of $500,000. This presents two wealth planning opportunities. Firstly, a growing business requires working capital. As a sole proprietorship, growing working capital is hard because profits are taxed at your personal marginal rate of taxation which may be in excess of 50%. By incorporating, you can grow your working capital, and thus expand your construction business, at a much faster rate because of the low rate of corporate tax. Secondly, by leaving profits in the Corporation in excess of your personal needs, you can grow your retirement savings in the corporation at a much faster rate. (In subsequent publications, we will talk about how to creditor-proof these savings).

‍Tax Splitting

‍A corporation provides for legal tax splitting with members of your family, if they are made shareholders of your corporation. The shares of your corporation may be structured so that you remain in control of the corporation notwithstanding shares issued to family members.

How do partnerships work and how are they setup?

My friend and I have an idea for a business and we are considering forming a partnership. How does a partnership work and how should one be setup?

Whether or not a partnership exists is a fundamentally a legal question. Ontario’s Partnerships Act says that a relationship between “persons carrying on a business in common with a view to profit” is a partnership within the meaning of the Act. This is important because it means that whether or not you declare yourself to be a partnership, legally speaking, you might be a partnership anyways, whether you intended to or not.

A partnership can exist between you and your friend personally, or even as between two corporations controlled by each of you. Unlike a corporation, however, a partnership has no separate legal existence from the partners themselves and each partner has the power to bind the partnership and each partner is jointly liable for any obligations incurred on behalf of the firm. This is why, when deciding to form a partnership, a partnership agreement can be very practical.

A partnership agreement sets out the rights and obligations for partners in the partnership and provides for what should happen in circumstances of partnership incapacity, retirement or death. Without one, the Partnerships Act will provide for what happens to the partnership in these circumstances, often with unintended results. A partnership agreement can also provide mechanisms for the distribution of partnership income and a process for bringing additional persons into the partnership. Creating a partnership agreement that meets your goals with the help of a commercial Lawyer ensures that your partnership will continue in a manner of your design.

Acquisition of a Business - Do such contracts affect the decision to acquire shares or assets?

I am considering the acquisition of a business. Long term contracts between the business and third parties are important to the business. Do such contracts affect the decision to acquire shares or assets of the business?

‍There are a number of factors to be taken into account when purchasing an existing business including tax, liability, due diligence and employee matters. Your question relates to the contracts between the business and third parties. These contracts may include rights obtained by the business necessary to carry on the business, such as licenses or franchises, or the benefit of sale or service agreements for the supply of products or services that generate revenue for the business.

A fundamental difference between an asset purchase and a share purchase is that in an asset sale the contracts must be assigned (along with the transfer of assets) while in a share sale the contracts remain intact (since only the shares of the business itself are transferred).A comprehensive review of all important contracts is advisable as early as possible during the due diligence process to determine rights and obligations. If third party consents are required, consideration must be given as to the risk that such consents may not be available in a timely manner, or at all, and whether the transaction may be better structured to avoid the necessity for assignment. In some less common circumstances there is an outright bar to assignment and consents cannot be obtained (this is the case in some government procurements). The acquisition of the business in such circumstances may only be achieved through a share sale to avoid termination of such contract(s). It should also be noted that some contracts contain provisions that deem a change of control from a sale of shares to be equivalent to assignment, and triggering the necessity for third party consent.