Payment

AuthorDavid A. Senter
Pages369-400
Payme nt 369
14.01  in troD uc tion
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
370 CO 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.2 The 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  Ba sis  fo r 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.3 The 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. FUNDAMENTALS OF
CONSTRUCTION LAW, ABA CONSTRUCTION FORUM 2001, at 112 [hereinafter FUNDAMENTALS].
3. See generally id., Chapter 9 (discussing pricing mechanisms in more detail).
Payme nt 371
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’CONNOR ON CONSTRUCTION LAW § 6:81 (West Group 2002) [hereinafter BRUNER & O’CONNOR].

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