Invoice Factoring for Natural Disaster Clean-Up Work

This article was originally published in the ABJ Journal and written by Paragon Financial’s President, Chris Curtin.

When disaster strikes, many need contractors to clean up the aftermath. Chris Curtin explores the process of providing invoice factoring to FEMA contractors and outlines potential pitfalls for factors.

Over the last decade, the estimated cost of natural disasters to the U.S. government was an astronomical 350 billion dollars.

Natural disasters can leave catastrophic destruction in their wake. The repair costs following significant hurricanes can be incredibly high. High price causes businesses and local communities to starve for resources when they need them the most to rebuild fast and effectively. Recent months have seen Category 4 hurricanes Florence and Michael strike the Carolinas and Florida respectively. Both incidents are causing severe damage and necessitating extensive local disaster relief efforts.

In these unfortunate situations, many rely on contracting companies to provide critical clean-up and repair services. Such contractors operate between localities and federal government during a time when communities ravaged by natural disasters seek to rebuild damaged businesses, housing, government property, and infrastructure as quickly and effectively as possible, mostly regardless of other considerations such as the speed of payment for services rendered. When there is a delay in the payment from disaster relief contracting, the onus is on the contractor to have the financial means to fund their operations for the duration of the relief effort until the government or prime contractor eventually provides payment.

Notable Industries that Benefit from FEMA Contract Financing

Industries that benefit from invoice factoring following a natural disaster include construction, transportation, and telecommunications repair businesses. Construction companies enter a damaged area to provide repair services ranging from demolition to landscaping, taking on significant upfront capital and labor costs in the process. Transportation companies are often called to bring supplies to a ravished area and to supply trucks to remove trees and debris left behind plus damaged vehicles and machinery. Telecommunications companies must get voice and data up fast to serve both locals and first responders. Utility companies and their contractors must repair power and resolve dangerous situations such as live wires putting property and people in harm’s way.

Staffing agencies commonly see a significant uptick in demand following natural disasters, supplying personnel on the ground for clean-up, relief, and security. Invoice factoring has long been a valuable tool for staffing agencies to fund payroll and smooth cash flow consistently over time while simultaneously meeting short-term financial obligations that enable the business to take on more contracts and meet ongoing expenses.

Contracting Through the Federal Emergency Management Agency (FEMA)

While the Federal Emergency Management Agency (FEMA) provides support when there is significant damage, the extensive paperwork requirements and typical delays resulting from multiple bureaucracies can cause substantial gaps of time between completion of disaster relief work and receipt of payment from the federal agency. The first payment can take many months creating a situation in which companies are already working on the ground lack the working capital to fund payroll, lodging, travel, and food for workers and other ongoing expenses. These complications may dissuade small business from taking on government contracts altogether. However, such contracts are often invaluable opportunities to expand the business.

Many criticize FEMA for the delay in payments to contractors for their work in assisting recovery efforts. But FEMA does not pay contractors directly. Instead, local governments hire and ultimately pay contractors for their work. Local governments that hire contractors and seek federal funds must follow all federal, state, and local procurement practices. FEMA typically obligates funding to a state’s Governor’s Office of Homeland Security and Emergency Preparedness (GOHSEP). In turn, local cities and counties must work with GOHSEP to ensure that documentation meets the state’s requirements to draw down the available funds or receive advancements of already obligated funds from GOHSEP.

News articles will quote local officials saying a big reason for payment delay is FEMA underestimating cleanup costs. FEMA’s policy is to fund all fair and reasonable costs associated with public assistance projects, which include debris and demolition removal activities. The project worksheets that capture the scope of work are living documents. These documents regularly undergo revision to reflect all actual and eligible costs.

Slow payments often stem from incomplete documentation of work submitted by local governments to GOHSEP. Whenever possible, FEMA coordinates with local and state officials to ensure proper documentation is maintained to expedite the reimbursement process. Administrative fees obligated by FEMA are available to local government agencies to hire staff to ensure documentation requirements are met.

Potential Natural Disaster Factoring Problems:

Invoice factoring can be a fast solution for a contractor doing disaster work for FEMA, government entities, or the downstream sub-contractors. Factoring government contracts in general and factoring FEMA grants and contracts specifically have their nuances and rules that make it different than other types of factoring. Some areas to be mindful of include:

  • FEMA doesn’t want time & material contracts. When a natural disaster strikes, all stakeholders wish for fast and efficient cleanups and repairs. Government at all levels want to pay the bill when a cleanup project is done, or a milestone is met. A factoring company wants the exact opposite — a fundable, verifiable invoice created based on time and material deliverables. Milestones in written contracts can be problematic and increase the risk of future deductions and non-payments.
  • Prime contractors who are not creditworthy or not sufficiently creditworthy. Many times, a prospect will call looking for a large FEMA contract for funding. During due diligence, the factor discovers that the prospect is,
    1. a sub-contractor to a small or relatively new prime contractor that is not creditworthy; or
    2. asking for an amount 100 times its normal credit.

    The problem of pay when paid clauses are also discovered during initial due diligence. One solution to this problem is to turn the prime contractor into a factoring client, and direct pay their subs.

  • Milestone Billing. Milestone billing was briefly mentioned above, but it is worth noting other potential problems. The prime contractor, FEMA, or other government agency can find hidden defects or develop a case of buyer’s remorse after the fact. Milestone billing sounds like a panacea versus progress billing, but deductions and dilution can still be problematic. Cleanup projects can also run out of money leaving contractors (and their factoring company) holding the bag.
  • Hastily and poorly written contracts and purchase orders. Natural disasters come with public pressure to get “boots on the ground” as fast as possible. This increases the chance of making mistakes while creating, issuing, and awarding contracts. As a factoring company, we often scratch our heads at contract verbiage and the qualifications of the winning bidders in sizable contracts.
  • Mobilization Draws. Prospects want their mobilization draws sooner, and factoring companies are called upon to advance against them.

You must meet the following conditions to get comfortable funding mobilization:

    1. Must be a separate line on the schedule of values, broken down to show what is specifically included
    2. Cannot exceed 10% of the amount of the project
    3. The contractor must invoice for the mobilization expense, specifying on the invoice what the expense covers
    4. The invoice must have approval for payment by the owner (if factoring a GC) or GC (if factoring a subcontractor) via signed estoppel.
    5. The factor must fund the advance by paying mobilization expenses directly to critical vendors and payroll company.
  • Is this a spot deal above a prospect’s skill set? One of the hardest variables to quantify is the potential client’s capacity to perform. Sales and working capital needs can increase 100-fold during a natural disaster and then flex right back down to historical levels. Most factoring companies don’t want to fund a one-time event.
  • Bonding Issues. One may need a performance bond on clean-up or restoration work. Surety companies have a de facto lien on a company’s assets including their accounts receivable. Unless other substantial assets exist, it may be difficult to persuade the surety company to subordinate their collateral position to a factoring company.
  • Client licensing and insurance requirements. State, county, and city levels may require a prospect licensing. Unless the factor has experience or legal representation in each licensing jurisdiction, its claim to payment could be at risk for licensing reasons. Workman’s compensation and other insurance requirements must be in place according to the contract’s language so as not to put payments to the factoring company at risk.
  • Lien rights and notice to owner law differences. Just like licensing requirements, lien rights and notice to owner laws vary across every state in the U.S. Unless you are comfortable acting as a construction factoring company, stay away from situations where they require lien rights, pay when paid contracts, tri-party payments, and progress payments.
  • (And sadly) Fraud. Massive dollar amounts, many parties involved and deals happening too fast. These are the variables for a factor to be hit by fraud. Factoring companies are also in the client performance monitoring and fraud detection business. At Paragon, we seldom lose money because of credit issues. We also keep our antennas up for clients that do not meet their customer’s needs and the occasional fraud.

While invoice factoring is an excellent solution for any business desiring a more stable cash flow or requires immediate working capital, it can also serve as an essential form of financing when natural disasters strike. Since factors are primarily concerned with the creditworthiness of the customers comprising the outstanding invoices and not the business seeking the invoice factoring, it is possible to receive funding through invoice factoring without having a strong credit rating.

In the case of non-recourse factoring, the factor assumes the limited credit risk of a client’s customer (account debtor) non-payment. Non-recourse releases business owners from the inherent liability of potential non-payment of some part of their accounts receivable. However, as few as 20% of accounts receivable factoring companies have the requisite size, balance sheet, and loss history to qualify for credit insurance.

Why Credit Ensure Government Receivables?

There have been many bankruptcies and near-bankruptcies among government entities in the U.S. With much-unfunded retirement liabilities; many expect government bankruptcies to increase in the future.

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