Elizabeth Charnowski and Carl Pebworth | Faegre Drinker Biddle & Reath
Construction project partners considering new projects in the post-COVID-19 market face some unfamiliar challenges, including challenges related to prompt payment. Escalating material costs, a still-constricted labor market and little clarity about the pandemic’s long-term impact on certain market segments (including hospitality and retail) all contribute to what may be the greatest challenge in today’s market: uncertainty. In an uncertain marketplace, payment practices should be a top consideration for construction partners.
In a recent poll of commercial trade contractors, nearly half reported difficulties in sustaining adequate cash flow to support normal operations and fuel future growth.1 This issue for subcontractors is compounded by other factors due to the COVID-19 pandemic. Those include irregular payment cycles, time constraints on paying suppliers not aligned with delayed upstream payments, and difficulty in accessing capital to navigate these challenges.
Developing sound payment practices is important for all construction partners to consider, for several reasons:
- Without timely payment, trade contractors critical to upcoming projects may not be available because of cash flow issues.
- Faced with shortages of their own, suppliers may not be able to — or may choose not to — provide materials needed for project progress to cash-strapped subcontractors.
- Suppliers are often much stricter in requiring payment within a particular time period than the ultimate consumer is in paying for these materials.
What does this mean for other construction partners?
According to some commentators, slow payments in the construction industry cost general contractors and subcontractors approximately $64 billion annually nationwide. These slow payments can seriously impact owners’ ability to construct projects in timely fashion and at the lowest price. In a recent poll, nearly two-thirds of subcontractors (many of whom must pay directly for most of the labor and materials used on construction projects, and then have to wait on reimbursement from their clients) reported that they will not bid on projects if the owner or general contractor has a reputation for late payments to their vendors.
What should construction partners do to manage this uncertainty?
In this challenging marketplace, the following considerations can help offer some peace of mind — and keep your projects and business running smoothly.
Careful consideration and drafting of contract payment terms is particularly important today. An owner or construction manager who does not consider the timing of payments or alignment of payments in relation to downstream contractor obligations risks unexpected delays on the current project. Pay-when-paid provisions tend to be common in downstream contracts, and owners and construction managers need to be conscious that, if they are delayed in paying their subcontractors, their subcontractors may not pay their sub-subcontractors and suppliers, which can not only cause delays but expose the owner or construction manager to potential liability or even termination. Worse still, irresponsible or oblivious payment practices can create long-term damage to the owner or manager’s ability to effectively and efficiently build and construct in the future.
In a time of uncertainty, flexibility is key. Subcontractors may be willing to accept discounted payments if timely to ensure steady project and business cashflow. Increasingly, construction project partners share each other’s business challenges. Recognizing and embracing that approach is one key to success in 2021.
Uncertain business and market conditions also call for greater transparency and collaboration where possible in construction projects. In a time of unprecedented challenges, communication is imperative, and alerting project partners to these challenges as soon as they arise can go a long way to mitigating future payment issues. It may be a cliché, but it’s true that an ounce of anticipated cure is much less costly in time and dollars than a pound of after-the-fact cure.
The key for owners is determining when to pay and in what amount. For contractors and suppliers, when to demand payment, threaten to stop work or stop work altogether should be top of mind. One thing appears true — working to avoid confrontation and conflict should be vigorously explored before an issue arises. It is ideal to engage counsel when dealing with payment issues prior to the point of stopped work or potential litigation. Simply put, conflict and project slowdowns should be an option of last resort.
- See, “Report: Construction contractors eager for business growth in 2021 despite unique industry cash-flow challenges”, Billd, May 17, 2021.