Running a home improvement or remodeling business is never without risks. But you can mitigate those risks with the right strategies, says D. S. Berenson, legal counsel at the Washington, D.C., law firm Berenson LLP. His firm focuses on home improvement and remodeling law, and represents the majority of the top 500 remodelers in the U.S. In a recent Houzz webinar, Berenson sat down with Liza Hausman, vice president of industry marketing at Houzz, to share the latest top liabilities for remodelers and ways they can protect their businesses.
Watch the webinar below:
1. Nonpayment Concerns
While any business can run the risk of not being paid for services rendered, “this issue has been rearing its head a little more since post-COVID started,” Berenson says. “And it’s a little more complicated than most people in our industry give it credit for.” Luckily, there are ways to solve any issues that arise as well as ways to avoid having the issue crop up in the first place.
Fee and cost recovery. Make sure you include language in your contract that entitles you to recover legal fees. “Lawsuits are expensive and time-consuming, so you need this,” Berenson says. “Even if you don’t file a lawsuit, the threat of one can often prompt a client to pay.”
Interest. Put a clause in the contract that allows you to charge interest on any amount not paid. Don’t specify a percentage; instead, say you’ll be allowed to recover the maximum amount allowable by law.
Substantial completion. This contract clause says the final balance due will be paid by the client when the work is substantially completed. But you must define “substantial completion,” Berenson says, because otherwise the client can use even the smallest item to claim that the work hasn’t been substantially completed.
“We’re generally talking about the windows being installed and functioning, the roof being installed,” Berenson says. Sometimes we’re talking about a certificate of occupancy or a permit, but we’re basically trying to define ’substantial completion’ as the products’ being usable as intended, and once that occurs, we want to get paid in full.” You’re aiming to avoid that never-ending job, because some customers will argue that the job is never fully completed.
Punch list. It’s good to have a contract clause related to a punch list even for smaller home improvement projects versus just big remodeling projects. How does it work? “You say, ’Let’s make a list of the items that you think are not completed, and we’re going to value those. And you can hold back that value, but you’re gonna have to pay us the rest of the balance,’” Berenson says, adding that it’s very effective in dealing with clients who say the job isn’t completed.
It’s a very simple type of clause, he says, and it should say something along the lines of, “In the event at time of substantial completion you believe there are items that have yet to be done, even though the product is usable, we will walk through the job site with you. We’ll make a list, we’ll value that at cost or at fair market value, and we’ll hold that back off of the amount due, which you agree otherwise to pay us. And then we will address those outstanding items promptly.”
Collection “cookies.” These are a series of one to four template letters that go out at set times post-installation when you haven’t received your funds. “The idea is that you’re homogenizing your collection protocols on a job,” Berenson says. If you don’t get paid at the time of substantial completion, you’d send the first letter out. It says the job has been completed and you’re owed the money, and you don’t want to issue a mechanic’s lien. (This is a security interest in the title to property for the benefit of those who have supplied labor or materials that have improved the property.) Give the person five days to pay, then send the second letter, increasing the severity of the tone, and so on. The idea is to convey the potential for legal action.
Make sure to lay a paper trail with these. You can send them by certified mail, regular mail, and email (consider requesting a read receipt if using email).
Mechanic’s liens. These are designed to protect the labor for installers and contractors, but can be a bit “unwieldy,” Berenson says. The paperwork requirements can be difficult; for instance, depending on the state you live in, you might have to file preliminary notices with the client as to your mechanic’s lien’s rights before the job even begins. You also have to renew the paperwork periodically, in some cases as soon as six months.
Nevertheless, liens are worth the effort, says California based construction project manager Matt Panella. "Liens should be done by every vendor or trade on a construction project," he says. "They give us a sturdy ground to stand on and are a great tool to have if we encounter payment issues." But understanding how liens work is important, he adds. Before starting the work, contractors must notify the parties involved that a lien is in place, Panella says. "If you don’t give proper notice, your lien will not be valid."
ACH discount. The ACH (automatic clearing house) discount allows you to automatically withdraw from the client’s bank account the funds that are owed to you when they become due. It has to be built into the contract, and the reason the word “discount” is in there is because you can’t require a client to provide you with ACH authorization. You’ll offer a discount off the job cost or a little something extra to get him or her to agree to the ACH option.
This strategy “can alleviate a great number of collection issues,” Berenson says. “And a lot of folks are using ACH…. It’s much more commonplace these days.”
UCC-1. Berenson’s firm has been using the UCC-1 option (a filing under the Uniform Commercial Code) for many years with some of its more advanced clients. While state regulations differ, it’s basically a filing you can do online for a relatively small fee, and it essentially places a security interest on the assets of the property being installed for the client’s house (such as a deck or a kitchen).
“It’s substantially faster and easier than a mechanic’s lien, and it doesn’t go away,” Berenson says.
2. Independent Contractor Issues
Berenson often refers to “the brick wall of protection” when it comes to independent contractors. You can hire them as W2 employees or as 1099 independent contractors, but the “bricks” listed below should be in place either way.
The repercussions of not having a brick wall of protection can be severe. Attorneys for the contractor can argue that he or she should have been classified as an employee. And if a judge agrees, you’re looking at potentially disastrous payments in the form of owed state and federal income taxes, interest penalties, worker’s compensation costs, retirement benefits and the like.
“With one person, you can be looking at six figures right off the bat, let alone if they try to turn it into a class action,” Berenson says. “So it’s a dangerous issue.”
Written agreement. You should have a written agreement with all contractors saying that you’re hiring them as an independent business entity (IBE). But that alone isn’t enough to fully protect you. You’ll also want to have the other “bricks” below.
Tax ID number. “You don’t want to hire Johnny,” Berenson says. “You want to hire Johnny’s Window Installations or whatever company.” Their business should have a tax identification number (TIN) or employer identification number (EIN), not just a personal social security number. And if the contractor is not a W2 employee, you’ll have to issue a 1009-NEC at tax time.
License. A contractor should be fully licensed. This is not negotiable, and certain states are likely to actually check licenses more frequently than others.
Pay per job. You can group job payments in one paycheck, but the jobs and payment for each should be clearly specified.
Ability to work for others. It’s not essential that the contractors actually do work for anyone else; the important thing is that it’s clear they could. They can show this by having a business website, business cards, advertising and more.
Checking tax returns. “You want to get a copy of a tax return — a cover page or two — from the independent contractor’s tax return to show that they’re filing their taxes with the IRS or with the State Department of Taxation, and they’re taking deductions as an independent business entity,” Berenson says.
3. Recession-Related Risks
While experts disagree on when and even whether the economy might be heading into a recession, it’s good to be prepared for one.
Homeowner default. Regardless of the reason, if the homeowner defaults on payments, you can utilize the strategies listed above under “Nonpayment Concerns.”
Rescission. This refers to when the client cancels or revokes the contract after the standard three-day period. A cancel rehash savings clause will help you here. It says that canceling after three days will trigger a payment of 15 to 20 percent of the contract’s project price as damages. The purpose of this clause isn’t necessarily to get that percentage; rather, it’s to enforce the idea of adhering to the contract.
Financing turn-downs. With interest rates spiking, these might increase. And while you can shop around for a lender with the lowest rates, it’s good to avoid selling projects based on 100% financing. “The more you obtain a deposit and the larger deposit you obtain on any job,” Berenson says, “the more psychological commitment you have from the customer and the lower your rescission rate — hands down.”
Ski control. This refers to not “getting out over your skis.” Given that we might be heading into a recession, it’s a good idea to “hoard your cash,” Berenson says. “You want to pay off your debts. You want to watch the inflationary impact with your vendors… Hunker down for the long haul a little bit” versus growing your business.
Eyeing opportunities. Some companies inevitably can’t sail smoothly through the waters of a recession. So when the recession is over, be on the lookout for ways to expand into former competitors’ territories or just new neighborhoods. If you’ve hoarded cash and hunkered down previously, you should be in a better position to do this than if you had tried expanding under unfavorable economic conditions.
4. Class Action Lawsuits
Berenson calls class action suits “a nuclear issue” due to legal fees and more, adding that “every month or two, we get clients in the industry that are forced out of business because of lack-of-arbitration issues.”
The solution: a class action waiver accompanied by an arbitration provision in the contract. An arbitration is not necessarily less expensive or faster than the court system, Berenson says, but you can still keep the proceedings confidential and avoid “jackpot juries,” which award high amounts.
“And you can, with a little luck, avoid the class action entirely, because in an arbitration you generally cannot have a class action,” he adds.
Addressing these four risk areas will go a long way toward protecting your business. But it’s still important to consult a local legal professional specializing in the remodeling industry when you’re building a contract, as laws vary from state to state.
DISCLAIMER: The information provided does not, and is not intended to, constitute legal advice; instead, all information, content and materials in this article are for general informational purposes only. Readers of this article should contact their attorney to obtain advice with respect to any particular legal matter. No reader, user, or browser of this site should act or refrain from acting on the basis of information on this site without first seeking legal advice from counsel in the relevant jurisdiction. Only your individual attorney can provide assurances that the information contained herein — and your interpretation of it — is applicable or appropriate to your particular situation. Use of, and access to, this website or any of the links or resources contained within this article do not create an attorney-client relationship between the reader, user, or website authors, contributors, contributing law firms, or committee members and their respective employers. All liability with respect to actions taken or not taken based on the contents of this site is hereby expressly disclaimed.
Want advice delivered to your inbox?
Unlock industry insights and updates for contractors and design pros
By signing up, I agree to the Houzz Terms of Use and Privacy Policy and that Houzz may use my information to contact me about relevant content, products, and services.
