How to Get Paid Promptly — Generally Speaking

On November 15, 2007  By Scott Wolfe Jr

Efficient payment is critical in construction. Without timely, dependable payments to those who are actually doing the work and providing the materials, construction projects of any size become vulnerable.

Non-payment or slow payment can cause abandonment of the job, sub-standard work, and decreased productivity — as well as an increase in claims and liens. Reputations in the community can also be tainted by slow and unreliable payment procedures, resulting in harm which can take years to repair.

Still, slow payment and non-payment remains one of the biggest risks facing a contractor. Owners withhold payment for many reasons: they are dissatisfied with the work; they want to push a project that is behind schedule; or they may just be strapped for cash. Regardless of who is at fault, payment controversies can destroy a project.

Prompt Payment Acts – When They Apply & How They Help

Every state in the union has passed legislation that is similar in character to federal law requiring the prompt payment of government receivables. Prompt Payment Acts cover a variety of industries, but they are particularly important when construction is involved.

In any work performed for a governmental entity, payment of the invoices will be covered by the Prompt Pay law regardless of whether or not a contract exists to support the work. Invoices submitted to the government legally must be paid within a relatively short period of time or interest will be assessed, which the governmental entity will be required to pay, as well. The time limits vary from state to state and may or may not mirror the federal time limit of 30 days.

These statutes also set requirements for the invoices that are presented: if the invoice does not conform to the statutory requirements, then it will not be honored. The Acts will not force a timely payment on an improper invoice. Therefore, the preparation of applications for payment becomes very important in governmental work and many companies use automated software designed especially for this task.

Automated Payment Systems

A simple web search reveals a cornucopia of software packages available for the construction payment process. Pricing and product features run the gamut. However, good quality automation need not be expensive: QuickBooks offers a highly regarded system for under $200 which should be well within range for most subcontractors and craftsmen.

What if it’s Not a Government Project?

Projects that do not involve a public entity usually will not be covered by prompt pay legislation. However, those statutes can be used as a guide on how fast payments should be made, as well as how detailed payment applications should be. More importantly, however, will be the basic written contracts that the parties have signed: what the contract language relates — or fails to address — will control the project’s payment process.

For example, in Louisiana, payment is not legally due in private contracts until the project is completed — unless the contract language provides otherwise. (For more information here, see Wolfe Law’s May 2007 article on Pay When Paid clauses, link shown below.)

Without a written contract, state law will control. Which state’s law? The state where the construction is located controls. Thus, the importance of a strong contract in the construction payment process cannot be underestimated.

Securing Payment and Performance: Bonds Versus Liens

There are various methods of securing payment and performance of a construction contract that are recognized across the industry, in every state. These usually involve bonds or liens.

Owner’s Security

One common method that owners use to insure that there will be performance under the contract is a performance bond. Here, a bonding company (“surety”) issues a bond which documents that the bonding company is guaranteeing payment of a set amount (“face value”) to the owner should the contractor fail to finish the job. The surety agrees to pay this sum to the owner if the contractor fails to perform all the required services and deliver all the required materials and equipment. Usually, the bonding company reserves the right to take action before paying on the bond, such as having the general contractor remedy any outstanding claims, or hiring another contractor to finish the work.

Contractors’ Security

Mechanics’ liens are used by contractors to secure payment. These are writings filed with the public real property records pertaining to the property involved in the construction, giving public notice of the contractor’s priority interest.

Overall, there are two forms of mechanics’ liens: general and particular. General mechanic’s liens allow the owner’s property to be held, and sometimes sold, to pay the unpaid amount that is due and owing to the contractor. Particular liens are those filed by contractors claiming a right to retain certain, identified property because of money or labor they have invested in that specific property. A security system company, for example, may have a particular mechanics’ lien on all alarms and related equipment.

Contractors can create liens in a variety of ways. Mechanic’s liens can be created by an express contract, in a standardized document that the parties sign. These liens can also be created under the law by “implied contract,” which usually occurs as part of a particular usage of trade or from the dealings between the parties. When goods are delivered to a subcontractor that he needs in order to complete his part of the project, for example, that subcontractor has a legal right to hold those goods until he gets paid for his work.

Payment Under The Contract

Today, most construction projects will see the use of one of two American Association of Architects (“AIA”) contracts: either AIA Form 201 (most popular) or AIA Form 200. However, these forms both have problems when issues of slow payment or non-payment arise if they are signed without revision. For example, while AIA Form 200 does include language regarding the creation of a lien in the event of non-payment, it fails to include any specific time period for making payments to subcontractors. Similarly, AIA Form 201 does not prevent the commingling of funds, and fails to address possible delays in disbursements.

Both of these popular forms of written construction contracts have been criticized for their inadequacies in dealing with payment controversies. In response to this, in part, 2007 saw the introduction of an industry alternative to the AIA contract forms, the Associated Owners & Developers Standard Form of Contract Between Owner & Contractor (“AOD Form”).

The AOD Form simplifies matters by requiring owners to pay general contractors within an agreed-upon time (e.g., 30 days) and requiring general contractors to hold monies due to their subcontractors and suppliers in trust, paying them within 7 days from the time that they receive payment.

The AIA has responded to the criticisms of the AOD by upgrading its own set of construction contract forms. Experienced contractors as well as owners using either set of forms, however, are careful to work with experienced construction attorneys to insert clear contractual provisions at the outset.

No contract form (AIA or AOD) should be signed without first obtaining the advice of legal counsel. Experienced construction attorneys may see holes in the forms that fail to address payment issues, as well as other concerns, that are particular to the project. Particular contractual provisions, or clauses, may be needed that the attorney will know are appropriate.

Clauses which owners should consider
regarding payment include those addressing:

description of the work; contractor’s cost of the work plus fee; separate contractors; subcontractors and subcontracts; applications for payment; retainage; conditions for final payment; insurance; warranties; changes; no damages for delays; defaults and remedies to default; right to terminate without cause; alternative dispute resolution; concealed conditions; and unknown conditions.

Clauses which general contractors should consider regarding payment include those addressing:

incomplete or deficient plans and specifications; architect’s right to withhold funds; changes in taxation; architect’s approval or disapproval of payments, or final payment; warranty; concealed conditions; weather delays; separate contractors; change orders; schedule of values; stored materials; substantial completion inspections; retainage; and right to terminate for convenience.

Subcontractors: Contingent Payment Clauses and Liquidating Agreements

To buffer themselves against a slow-paying or non-paying owner, general contractors have developed several methods of sharing this burden with their subcontractors and suppliers. Two of the most common are contingent payment clauses and liquidating agreements.

Contingent payment (“pay when paid” or “pay if paid”) clauses are inserted into agreements by the general contractor, making the sub-contractor or supplier wait along with the general contractor for the owner to make payment. These provisions are not legally recognized in all states. (For their use in Louisiana, see the May 2007 Wolfe Law Article on Pay When Paid Clauses.)

Liquidating (“pass through”) agreements are contracts entered into between a general contractor and a subcontractor, where the subcontractor agrees to be paid only when, and if, the general contractor is paid by the owner. The agreements may not, however, provide for the subcontractor to have any remedy against the general contractor should the owner decline to ever make payment. Accordingly, pass through agreements are not recognized as valid contracts in every state.

Suppliers: The Joint Check Rule

Joint checks are commonly issued to pay both a subcontractor and a supplier at the same time. Since these are often accompanied with a number of legal issues (endorsement, allocation of proceeds, etc.), many states have enacted a “joint check rule” which requires any supplier endorsing a joint check to collect its proceeds from that check or be legally barred from later asserting a lien or bond claim on that amount.

State law bases this rule upon a variety of doctrines (release, waiver, estoppel), but all share the perspective that a joint check is intended to protect the issuer from the supplier’s claim, as well as protecting the supplier by ensuring payment, and the owner from any lien.

Tools developed by the construction industry, as well as protections created in the law, to deal with the issues of payment during the construction process are numerous, and they are constantly evolving. While standardization across the county has removed many of the payment pitfalls, the best protections for smooth payment remains strong, written contracts entered into by all the construction participants.

For more information:

Federal Prompt Payment Act
39 USC 3901 et seq
http://caselaw.lp.findlaw.com/casecode/uscodes/31/subtitles/iii/chapters/39/toc.html

Louisiana Prompt Payment Act
La. Rev. Stat. Section 38:2191; 9:2784
http://www.legis.state.la.us/

Washington Prompt Payment Act
RCW Sections 39.04.250; 39.76.010-39.76.040
http://apps.leg.wa.gov/RCW/default.aspx

QuickBooks Construction Application for Payment Solution
http://marketplace.intuit.com/AppID-859-Reviews.aspx

Wolfe Law Article: Payment Provisions and “Pay When Paid” Clauses
http://www.wolfelaw.com/main/news/index.php?atype