January 02, 2014

At the time of contracting, the manner in which payments are to be made and the limitations regarding payment obligations need to be clearly defined. On an overall basis, payment scheduling on a construction project is typically included within a milestone payment provision or a schedule of values/progress payment provision. Under the former, fractions of the overall payment responsibility are to be made upon completion of certain milestones. This may include an initial payment at contract signing with follow up payments at milestones such as completion of footings and foundations, completion of framing, completion of roofing, substantial completion and final completion. This method is most typically used in residential and private renovation work.

On most public projects, the schedule of values/progress payment process is used. Under this process, primary work functions are identified on a schedule of values with a particular value associated with each component. The cumulative values of each of these scheduled value items add up to the total contract price. The schedule of values is prepared by the contractor and submitted to the owner for its approval. As the project progresses, on typically a monthly basis, a payment application is issued whereby it is represented by the contractor that it has performed a certain percentage of one or more of the identified work components. It is then paid after approval of the application for the percentage of completion of those components. A percentage of retainage is typically withheld on each payment so that at the time of substantial completion the owner will be holding not only the value of remaining line items on the schedule of values, but also the stated percentage. This is for purposes of assuring that the work will be completed and that any corrections will be made.

Variations to these two primary payment methods may exist including unit price payments, allowances and time and materials billing. In all instances, the contract should include timing provisions for the submission of invoices or applications, timing for when payment is required, provisions that would allow the owner or contractor to withhold downstream payments and submission of supporting documentation that may include material invoices, storage invoices, certified payrolls, delivery tickets and the like. This has become more crucial with the amendments to the New Jersey Prompt Payment Act (N.J.S.A. 2A:30A-1 et seq.).  Regardless of the payment method selected, certain common problems arise with regard to payment obligations. A subcontractor or supplier may execute an agreement that calls for a “pay when paid” clause or worse, a “pay if paid” clause. Under these clauses, regardless of the timing provisions that may exist in the subcontractor/contractor agreement, if the contractor has not been paid by the owner (regardless whether it was due to the subcontractor’s acts or omissions), the subcontractor may not have an immediate entitlement to payment. The courts in New Jersey have typically sided with the subcontractors on “pay when paid” clauses to the extent that the courts have agreed that this is not an infinite ability of the contractor to withhold payment. There have been no cases decided in New Jersey on enforcing “pay if paid” clauses although that has occurred in other states where the clause is comprehensively drafted. More general contractors are including “pay-if-paid” clauses into their subcontracts, including language that has been successful elsewhere in enforcing such clauses. They have coupled this clause with a lien waiver clause, which is enforceable on public contracts. This combination of provisions can leave a subcontractor with little recourse if payments are not timely made. Even a bond claim (discussed infra) can be affected on the basis that the pay-if-paid clause precludes the accrual of a bond claim.

Another frequent problem that arises with regard to payment provisions deals with the upstream party’s ability to withhold payments. AIA and other form contracts identify those instances where payments may be withheld and require for written notice of the withholding.

Private contracts and/or subcontractors may or may not include limits on the ability to withhold. Contractors and subcontractors who enter into these contracts need to carefully review them to ascertain the upstream party’s ability to withhold payments and the circumstances under which and procedures by which withholding can occur.

Subcontractors and suppliers need to be alert to the contractor’s ability to ignore payment obligations for “extra work.” Many subcontracts and purchase orders issued by contractors will include provisions that effectively state that the subcontractor or suppliers ability to receive funds for extra work is limited to instances where the contractor has the ability to receive such funds. If the subcontractor’s work is outside of its personal scope of work, it should not matter whether or not the contractor is able to obtain an overall change order from the owner since it is not uncommon for a scope of work item to exist in the owner/contractor overall scope but in some fashion have been excluded from the subcontractor’s obligations.

Finally, although outside of the basic payment terms, the contract should identify mechanisms under which change orders or claims for additional or deducted work should be priced. Often problems arise during the course of construction where there may be agreement that particular work is outside of the scope of work but disagreement arises with respect to valuing that extra or changed work. Mechanisms must exist in addition to the standard issuance of a quotation, acceptance of the quotation and then issuance of a change order that handle disputed cost functions. This may be addressed by work directives followed by time and material provisions, use of dispute resolution boards or other neutrals to value the work, unit price development or similar mechanisms.