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
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.
“I’ve been told I need a Shareholder’s Agreement - do you have a standard agreement I can use” is something we hear with frequency. It reflects an understanding by the client that a Shareholder’s Agreement is a “good thing”, but without an understanding of what that good thing is. Generally the response of legal counsel to this question is that there is no such thing as a “standard” Shareholder’s Agreement, let’s meet and talk. So what is it about Shareholder’s Agreements that are so valuable and why isn’t there a standard form, like a real estate agreement?
At a high level of abstraction, a Shareholder’s Agreement is a document that expresses the expectations of shareholders in respect of a corporation through legal obligations and rights. The task of the Lawyer in preparing the Shareholder’s Agreement is threefold - discerning what the expectations are (and those expectations are often not fully formed) – providing counsel on the legal and tax implication on the various alternatives by which those expectations may be realized - and expressing those expectations in the form of contractual terms that bind the parties.
For example, shareholders in a narrowly held private corporation may have an expectation that on death the shares will be purchased. In the absence of a Shareholder’s Agreement, this expectation may not be realized. There is no statute or common law requiring or obligating a purchase. If the remaining shareholders are unwilling to agree to a purchase, the estate is left with the shares and a tax bill. Nothing of course prevents the parties from negotiating a purchase, but the relative bargaining power may have shifted in unpredictable ways, and planning opportunities, such as insurance funding, may have been missed. A Shareholder’s Agreement that addresses these expectations will reflect the parties prior expectations for fairness, and will create certainty. Legal counsel will discuss alternatives including the corporate purchase of the shares, purchase by the remaining shareholders, and hybrids including spousal rollovers, the tax implications under the alternatives to the estate and to the remaining shareholders, the use of insurance funding, payment terms, security and so forth.
In family held corporations, expectations for succession (how management is succeeded) and liquidation (how the shareholding interests are turned into cash) are particularly difficult and require unique and sometimes innovative solutions. A Shareholder’s Agreement is a valuable tool in estate planning for resolving how competing expectations for liquidation and succession are accommodated.
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.