Common Contract Provisions to Avoid and Prepare for CollectionsOn April 20, 2010 By Scott Wolfe Jr
Preparing and signing a comprehensive construction contract is your construction company’s best way to take a proactive approach to collections.
A good contract can help your company avoid collection scenarios by:
- Clarifying the scope of work and its costs, to avoid disputes;
- Stipulating that one party can recover attorneys fees from the other in the case of non-payment, to give your company some leverage against the non-paying party (as above-discussed, the general rule in America is that attorney fees are not collectible);
- Providing for monetary penalties in the case of non-payment to give non-paying parties an incentive to pay on time;
- Providing for the recovery of interest on overdue accounts, to avoid losing interest on money owed to you and to offer non-paying parties an incentive to pay on time;
- Providing for Alternative Dispute Resolution to ensure that disputes over payment are resolved as quickly and inexpensively as possible.
There are many “form” construction contracts out in the market, with the most common form contracts being the contract documents periodically updated by the American Institute of Architects. The Association of General Contractors and ConsensusDocs produce other form contracts.
These sets of contract documents are equal in quality.
They are prepared by and for their respective trades with input from members of the industry and construction attorneys. In general, the documents are comprehensive and completely adequate to meet the goals discussed in this section.
The parties can also alter the contract documents to include extra language establishing an
agreement on issues such as non-payment penalties and alternative dispute resolution mechanisms.
While the industry-standard form contracts are good in many cases, the documents are also long, complex and expensive, and it’s quite clear that they do not meet the needs of every project. The documents might not be affordable to some generals or subcontractors, and the scope of the documents may be too complex for smaller projects. In these situations, contractors, generals and material suppliers will turn to less complex and more custom documents.
The following contract provisions may be incorporated into a construction contract in attempt to avoid collection situations. Contract provisions are indented.
Attorneys Fees Provisions
Recovery of Attorneys Fees
The Parties hereby agree and stipulate that in the event of a dispute, and regardless of whether or not the dispute matures into formal litigation or any alternative dispute procedure, and further regardless of whether or not a judgment is rendered or the matter is settled, the non-prevailing party will pay the attorneys fees and legal costs of the prevailing party.
As previously mentioned, the general rule in America is that each party in a legal dispute is to bear the burden of its own attorney’s fees. In other words, whether you win or not, and whether you’re completely right or not, you’ll likely have to pay your own way through litigation unless you either fall into a small category of cases where attorneys fees are recoverable by law or you stipulate in your contract that attorneys fees are recoverable.
When added to your contract the above provision will do the latter. It’s language aims to accomplish two things: First, to contractually stipulate that attorneys fees are recoverable in the event of a dispute; and Second, to allow recovery of attorneys fees regardless of whether your dispute matures to a lawsuit.
In certain situations, a court may find that attorneys’ fees are not recoverable because the matter did not mature into a lawsuit, or because it was settled instead of fully litigated. This provision makes it clear that the parties intend to pay the other’s attorneys fees regardless of whether or not the matter escalates to any particular level. In other words, you’ll have the legal right to collect attorneys’ fees from your adversary even when you only hire an attorney to send a single collections letter.
Attorneys fees can add up very quickly, and without a provision like this, it will be hard to justify employing an attorney to collect a $5,000 – $10,000.00 account. However, with the ability to recoup some of these costs, the proceeding might be worth it.
Another common dispute over attorneys’ fees concerns the cost of the attorney employed. Did you agree to a $400 per hour attorney, or a $150 per hour attorney? Did you agree to pay an attorney working on a contingency, whereby he or she would receive 33% or more of the debt?
The courts normally resolve this type of dispute by awarding a “reasonable” attorneys fee to the other party. The judge or jury arbitrarily decides what is “reasonable”.
You can seek to limit this uncertainly through contract as well, and perhaps add the following language to your “Attorneys Fees Provision:”
The amount of attorneys fees shall be equal to the amount actually paid or to be paid to the attorney(s) employed by the prevailing party, and shall specifically include compensating that attorney(s) under an hourly fee agreement, a fixed fee agreement, a contingency fee agreement, and/or any mixture of these agreements.
Do remember, of course, that these types of provisions can backfire. If you’re not the prevailing party, for example, you will foot the hefty bill.
Penalties For Non-Payment & Interest
Unlike the Attorneys Fees Provisions, this is a component of the contract that will not likely backfire on you. This provision will only apply to the party who has the duty of making payments to the other party.
These types of provisions can work wonders for your collection practices if employed correctly.
Many construction companies will include them in their contracts, and offer non-paying customers a “last chance” opportunity to pay the bill without the penalties to entice prompt payment. If the non-paying party continues its failure to pay, it increases the amount owed giving your company more reasons to continue its attempts to collect.
One caution in using these types of provisions is that courts will strike them down if they find the provision to be “unjust,” or above a certain legal threshold. For example, if you have a $10,000.00 contract, you cannot make a $1,000,000.00 non-payment penalty. You also cannot charge an absurd amount of interest on an account (such as 50%). There are federal laws that restrict the amount of interest you may charge on an overdue account, and drafting a contract charging more than this amount will be stricken down and read out of the contract by a court.
The following suggested language might be used in your construction contract to provide for a “penalty” for non-payment of an invoice:
The Parties agree that if the [Owner | Contractor | Subcontractor | etc.] fails to make any payments when due, a late payment penalty of ___% of the unpaid amount will be immediately accessed against the non-paying party. Furthermore, the Parties agree that interest will be charged on the unpaid amount in the amount of ___% per annum or the maximum rate allowed under state and federal law, whichever is greater.
Alternative Dispute Resolution Provisions
Perhaps more than any other industry, the construction industry can benefit greatly from the use of Alternative Dispute Resolution programs. Construction projects both big and small are very prone to dispute, and they are usually complex in nature.
The traditional litigation of these claims is lengthy, costly, and heard before a judge or jury with little to no technical knowledge to aid them in understanding the merits of the case.
Accordingly, an ADR option – although still at an expense – will result in a resolution procedure that is faster, less expensive and tried before someone who has construction experience and/or
For these reasons, it’s normally quite beneficial to you to enter into a contract electing to resolve disputes through ADR.
Making this election is quite simple. Generally speaking, to subject the parties to ADR you can simply add a one-line sentence at the end of your contract that provides “the parties will resolve any disputes through arbitration.” The provision, of course, can also get more detailed. It can go into the type of arbitration, the number of arbitrators, the rules governing evidence and discovery, the location of the arbitration, the name of the arbitrator, etc., etc.
One simple, yet complete arbitration provision is as follows:
The Parties hereby agree to resolve all claims and disputes through binding arbitration. The arbitration shall be governed by the Construction Industry Rules of the American Arbitration Association. The parties agree to hold the arbitration in the city where the project job-site is located.
It is also common to require mediation (an informal process whereby the parties attempt to reconcile their differences without the threat of a binding judgment) prior to arbitration (a more formal proceeding that ends in a binding judgment). This is usually more beneficial to those involved in a larger construction project than those in a smaller project, as the extra procedure would come at extra expense. Nevertheless, you would simply add the following sentence before your arbitration provision:
The Parties hereby agree that as a condition precedent to arbitration, they will mediate all claims and disputes through the American Arbitration Association.
Note that you can choose any arbitration provider, but that for the purposes of this Toolkit we have used the AAA, a popular national outfit.
One of your most successful collection practices – smart contracting – requires work before the construction project even begins, and doesn’t seem at all like a “collection practice.”
In reality, however, strong construction provisions can properly position you against your adversaries in the event of a dispute over payment. The better your position, the more leverage you have, and the more leverage you have the easier it is to find success recovering on non-paying accounts.
This article originally published in the Louisiana Contractor’s Collections Toolkit.