Payment

• Author: Carol J. Patterson - Ross J. Altman - Stephen A. Hess - Allen Overcash
• Pages: 361-392

12.01 IntroductIon

Payment and cash ow issues are often the most negotiated and litigated issues

on construction projects. Construction is all about the ow of funds from the

lender to the owner to the contractor to the subcontractors to the suppliers.

A contractor typically has to advance certain costs before receiving payment

from the owner. For example, a contractor typically will perform work for 30

days before sending its rst invoice to the owner. The owner then has 30 days

to make payment, and the owner is often entitled to withhold a portion of the

payment as retainage. As a result, a contractor may have to wait 60 days or

longer before receiving its rst payment, which may only represent 90 percent

of its billing (where the owner withholds 10 percent retainage). During that

60-day period, however, the contractor must make payment to its employees,

subcontractors, and material suppliers. Contractors and subcontractors cannot

“be expected to nance the operation to completion without receiving the stip-

ulated payments on account as the work [progresses]. . . . Advance payment is

a condition precedent to the contractor’s obligation to proceed.”1

1. Guerini Stone Co. v. P.J. Carlin Constr. Co., 248 U.S. 334, 345, 39 S. Ct. 102, 106 (1919).

12

Payment

DAVID A. SENTER

CHAPTER

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CONSTRUCTION LAW

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Subcontractors tend to be smaller, less well capitalized entities than gen-

eral contractors. Although not always the case, subcontractors may not be as

nancially strong as either the general contractors for whom they work or the

suppliers on whom the they rely for materials. Although subcontractors will

not receive payment from the general contractor until a specied portion of

the work is completed, subcontractors usually pay their eld personnel and

tradespeople on a weekly basis and often must pay suppliers in advance for

materials received. Placed in this nancial squeeze, subcontractors not uncom-

monly “rob Peter to pay Paul,” that is, use payments on one project to pay bills

on another.

If payment is delayed at any point in the construction chain, the contractor

or subcontractor may run out of money and/or be unable to pay its subcon-

tractors, suppliers, or tradespeople to continue working.2 The likely result is

delayed performance or nonperformance. Thus, a project’s success or failure

may depend on whether the project participants are paid promptly for their

work.

12.02 basIs For paYment

The parties’ contract should clearly describe the basis and timing for payment.

Many ways exist to structure payment in a construction contract, including

stipulated sum (lump sum or xed price), unit price, “cost plus” (cost of the

work, plus the contractor’s fee), and others.3 The traditional pricing mecha-

nism is xed price. This mechanism arises out of the Design-Bid-Build method

of project delivery. Under this method, an owner presents its plans and spec-

ications, prepared by the owner’s design professional, either to a contractor

to price, or to a group of contractors to bid. Based on those plans and speci-

cations, the owner and the contractor enter into a contract to construct the

project for a xed price, also referred to as a lump sum or stipulated sum.

A unit price contract may be used where the type of work is well dened

but the quantity is only estimated. If a contractor must bid a xed price for an

unknown quantity, its price will likely be high so as to include the quantity

risk contingency. On the other hand, with a unit-price contract, the quantity

contingency is not a signicant issue because the contractor receives a speci-

ed unit price for each of the units it installs on the project, and the contrac-

tor’s price likely will be lower.

2. Subcontractors, as a whole, le more bankruptcies than any other entity in the construc-

tion process. See Carina Y. Enhada, Cheri Turnage Gatlin & Fred D. Wilshusen, Fundamentals of

Construction Law,

aBa cOnstructiOn fOruM

2001 [hereinafter Fundamentals].

3. See id. at ch. 9 (discussing pricing mechanisms in more detail).

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Payment 363

A cost-plus or cost-reimbursement contract provides that the owner will

pay or reimburse the contractor for its costs (labor, material, and equipment)

and also will pay the contractor a fee, which is usually a percentage of the

costs (e.g., cost plus 15 percent). Such contracts should contain a clear deni-

tion of “costs,” especially as the term relates to the contractor’s own person-

nel, equipment, management, and overhead. The AIA contract documents, for

example, deal with “cost” by dening the term to include labor costs; subcon-

tract costs; costs of material and equipment incorporated in the completion

of construction; costs of other materials and equipment, temporary facilities,

and related items; and miscellaneous costs.4 Obviously, such an open-ended

contract leaves the owner exposed to uncertainties and increased costs. This

exposure is often managed by using a cost-plus contract coupled with a Guar-

anteed Maximum Price, or a GMP. Such a contract involves a typical cost-plus

arrangement up to the dollar amount of the GMP. The contractor bears the risk

of any costs over the GMP, thereby reducing the owner’s risk.

Given the risks involved in cost-plus contracts, AIA Contract Document

A102–2017 provides that

The Contractor accepts the relationship of trust and condence established by

this Agreement and covenants with the Owner to cooperate with the Architect

and exercise the Contractor’s skill and judgment in furthering the interests of

the Owner; to furnish efcient business administration and supervision; to

furnish at all times an adequate supply of workers and materials; and to per-

form the Work in an expeditious and economical manner consistent with the

Owner’s interests.5

Some courts have held that such language creates a duciary relationship

between the owner and the contractor, thereby increasing the level of the con-

tractor’s duty to the owner and providing the basis for a constructive fraud

claim.6 Other courts have held that such language alone does not necessarily

create a duciary duty.7

4. AIA Contract Document A102–2017, articles 7 and 8.

5. Id. at art. 3.

6. See Jones v. J.H. Hiser Constr. Co., 60 Md. App. 671, 484 A.2d 302 (1984). Compare Di

Sciullo v. Griggs & Co. Homes, Inc., 2015 WL 6393813, at *6 (E.D.N.C. 2015) (contractor did not

have duciary duty to homeowners with respect to application of deposit toward construction

costs).

7. See Eastover Ridge, LLC v. Metric Constructors, Inc., 138 N.C. App. 360, 533 S.E.2d 827

(2000) (stating that, notwithstanding Article 3 of the contract, the “architect’s constant, close

involvement in the project belies any claim that a ‘relation of trust and condence’ existed

between” owner and contractor); see generally

PhiliP l. Bruner & Patrick J. O’cOnnOr, Jr., cOn

-

structiOn law

§ 6:81 (2002).

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