Five Key Provisions Construction Material Suppliers Should Include in Customer Credit Agreements
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Material suppliers in the construction industry will often need to extend credit to their contractor and subcontractor customers due to the payment cycle on construction projects that can often run 30 days, 60 days or even longer. Due to this, suppliers of construction materials will often need to enter into a credit agreement with their customers to govern the terms on which credit is extend, including when payment is due and other important aspects of the credit relationship. The terms of the credit agreement can be critically important, particularly when the construction industry may be heading towards a downturn as the economy and housing market are cooling down. This blog provides an overview of five critical provisions that construction material suppliers should have in their credit agreements with customers. Suppliers should consult with an experienced attorney that understands the construction industry to address specific questions and issues related to these and other provisions in customer credit agreements.
- Extension of Credit and Payment Terms
Every credit agreement needs to set forth the terms on which the construction material supplier will extend credit to the customer to purchase materials and the payment requirements. For example, the credit agreement needs to address pricing, and should provide the supplier with the ability change the supplier’s prices as they may change from time to time and as in effect at the time of purchase. The credit agreement also needs to address whether payment will be due at the time of order, the time of delivery, or whether longer payment terms may be permitted. If longer terms will be permitted, the agreement should provide the interest rate, late fees and other charges that will apply. The agreement should also give the material supplier the ability to reject or cancel any order in the supplier’s discretion, as well as the ability to deny further credit to the customer for any reason at any time in the supplier’s discretion to protect to the supplier. It should also provide for a limited time period for the customer to inspect the materials and raise any concerns, and that the failure to do so shall be deemed to signify the customer’s acceptance of the materials, with no right to return the materials thereafter.
- Limitation of Liability and Disclaimer of Warranties
The credit agreement should include provisions addressing warranties. If the material supplier is distributing materials manufactured by others, as is typically the case, then the credit agreement should reference the manufacturer’s warranty as being the sole and exclusive warranty for the materials, that the customer acknowledges and agrees to look solely to the manufacturer’s warranty, and that the supplier excludes and disclaims all other warranties of any kind. The Uniform Commercial Code (UCC) includes requirements for such a disclaimer of warranties to be effective. While there are some variations, in almost every jurisdiction, to be effective under the UCC, the disclaimer of warranties must be conspicuous in the credit agreement, and to exclude the implied warranty of merchantability, it must expressly mention merchantability. Generally, to ensure that the provision is conspicuous in the credit agreement the disclaimer provision should be in all capital letters at least as large as the surrounding text. The material supplier should also include in the credit agreement a mutual waiver of consequential damages, and a limitation on the total amount of damages that the supplier can be liable for under any theory, whether contract, warranty, tort or other legal or equitable claim. These types of disclaimers and limitations on damages are critical to try to minimize liability exposure for the construction material supplier.
The credit agreement should address the term of the agreement, and how it can be terminated. Often, credit agreements will have an initial term of one year, with automatic annual renewal unless earlier terminated by the supplier or customer. The credit agreement needs to provide the construction material supplier with robust termination rights that give the supplier the right to terminate the agreement immediately upon written notice if the customer fails to pay any amount due under the agreement, breaches any provision or the agreement, becomes insolvent, unable to pay its debts when due or files bankruptcy. This is important to allow the construction material supplier the ability to mitigate against potential further losses when a customer becomes financially troubled.
- Jurisdiction, Venue and Attorney’s Fees
Construction material suppliers should try to avoid litigation, when possible, but there are times when litigation is necessary to collect payment or otherwise enforce the supplier’s rights under the credit agreement. In those situations, it is important for the credit agreement to include provisions governing where a lawsuit may be brought, and recovery of the costs of suit, including attorney’s fees. The credit agreement should include a provision that mandates that the exclusive venue for litigation arising out of relating to the credit agreement is in the state and county in which the supplier maintains its principal place of business. The credit agreement should also include a provision that the customer agrees that the law of the supplier’s home state applies, and that the customer consents to the jurisdiction of such court and waives all objections to jurisdiction or that the venue is not a convenient forum. That way, the supplier can bring suit or defend suit on its “home court” rather than potentially being dragged into a far-flung court in another state. While arbitration can be an option in lieu of litigation because construction material suppliers may often be the one filing suit to collect payment or enforce lien rights, litigation will likely be preferrable since it avoids the additional step required after arbitration to convert an arbitration award into a court judgment on which collection actions such as garnishment, levy, etc., can be taken.
In addition to jurisdiction and venue, the credit agreement should also include a provision that the construction material supplier shall be entitled to recover attorney’s fees from the customer in any litigation arising out of relating to the credit agreement. That way, if the supplier is forced to sue its customer to collect, the attorney’s fees incurred in that process can also be awarded as part of the damages. Without a provision providing for the recovery of attorney’s fees in the credit agreement, the standard rule of law in almost all jurisdictions, known as the “American Rule,” is that each party in litigation pays its own attorney’s fees with no opportunity for the prevailing party to recover attorney’s fees from the non-prevailing party. It is important that the prevailing party attorney’s fee provision in the credit agreement provide that the supplier is entitled to recover all attorney’s fees incurred in connection with litigation, including in any appeals, bankruptcy proceedings and in post-judgment collection proceedings, as well as proceedings to determine entitlement to attorney’s fees and the reasonableness of attorney’s fees. Including explicit language like that in the attorney’s fee provision will make it more likely that the supplier will be able to recover all attorney’s fees incurred in connection with the potential various directions in which the litigation might proceed.
- Personal Guaranty
It is also important for the credit agreement to include a separate personal guaranty from the principal or owner of the customer, particularly where the customer is a small business that may not have sufficient assets in the business to pay a judgment that the supplier might obtain for breach of the credit agreement. The personal guaranty will allow the supplier the ability to pursue claims for payment against not only the customer’s company, but also the personal assets of the principal or owner of the customer that signs the personal guaranty. Oftentimes, those personal assets may be greater than the assets of the corporation or business entity, particularly where the business entity is shutting down or facing bankruptcy. The customer may also be more motivated to ensure that the supplier is paid in situations where the customer’s principal has personal liability for payment under the personal guaranty than in situations where the only assets at risk after a default are the corporate assets.
These are just five of the key provisions that construction material suppliers should include in their credit agreements with customers. In addition to these, there are many other provisions that will also help protect the supplier and that should also be included in credit agreements. Also, the terms of all such provisions will need to be adjusted based on the specific laws of the jurisdiction where the construction material supplier is located, as well as based on the specific circumstances of the supplier’s business and customer base. For these reasons, construction material suppliers should consult with an attorney knowledgeable regarding the construction industry about their specific situation to help ensure that the customer credit agreement is best suited to properly protect the supplier’s rights and business interests.