Payment

• Pages: 369-400

Payment369

14.01 introDuction

Payment and cash  ow issues are often the most negotiated and litigated is-

sues 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 suppli-

ers. Contractors typically have to advance certain costs before payments are

received from the owner. For example, contractors will typically perform work

for 30 days before their  rst invoice is sent to the owner. The owner then has

30 days to make payment, and the owner is often entitled to withhold a por-

tion 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. 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 stipulated payments on account as the work

14

Payment

DAVID A. SEN TER

C H A P T E R

369

370CO N S T RU C T I O N L A W

[progresses]. . . . Advance payment is a condition precedent to the contractor’s

obligation to proceed.”1

Subcontractors tend to be smaller, more undercapitalized entities. While

this is not always the case, they may not be as nancially strong as either the

general contractors for whom they work or the suppliers upon whom they rely

for materials. Although they will not receive payment from the general contrac-

tor until a specied portion of the work is completed, subcontractors usually

pay their eld personnel and tradesmen on a weekly basis and often must pay

suppliers in advance for materials received. Placed in this nancial squeeze,

subcontractors not uncommonly “rob Peter to pay Paul” (i.e., use payments on

one project to pay bills on another).

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

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

contractors, suppliers, or tradesmen to continue working.2The likely result is

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

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

work.

14.02 Basis for Payment

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

There are many ways to structure payment in a construction contract—stipu-

lated sum (lump sum or xed price), unit price, cost-plus (cost of the work

plus the contractor’s fee), and others.3The traditional pricing mechanism is

xed price. This mechanism arises out of the Design-Bid-Build method of proj-

ect delivery. Under this method, an owner presents its drawings and specica-

tions, prepared by the owner’s design professional, to a contractor to price or

to a group of contractors to bid. Based upon those drawings and specications,

the owner and the contractor enter into a contract to construct the project for a

xed price or a lump 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, and the contractor’s price likely will be

lower.

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

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, EDS. FUNDAMENTALSOF

CONSTRUCTION LAW, ABA CONSTRUCTION FORUM 2001, at 112 [hereinafterFUNDAMENTALS].

3. See generally id., Chapter 9 (discussing pricing mechanisms in more detail).

Payment371

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 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nition of

“costs,” especially as the term relates to the contractor’s own personnel, equip-

ment, management, and overhead. The AIA Contract Documents, for example,

deal with “cost” by dening it to include labor costs; subcontract 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 guaranteed 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 Document A102–2007

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 be-

tween 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

Once the price is agreed upon, the parties must also agree on how that

price is to be paid. A structure is not built overnight, and the contractor is not

4. American Institute of Architects, AIA Document A102–2007, Standard Form of Agreement

Between Owner and Contractor Where the Basis of Payment is the Cost of the Work Plus a Fee with

a Negotiated Guaranteed Maximum Price §§ 7 and 8.

5. Id. at § 6.

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

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 2 PHILIP L. BRUNER & PATRICK J. O’CONNOR, BRUNER &

O’CONNORON CONSTRUCTION LAW § 6:81 (West Group 2002) [hereinafter BRUNER & O’CONNOR].