Types of financing
What types of financing are used for construction projects in your jurisdiction? Which are the most common? Are there any restrictions on available financing methods?
The different types of financing used for construction projects depend in large part on the size of the project. For smaller projects, such as residential or commercial construction, the contractor or bank will finance the company or the project itself. Public construction projects often rely on bonds (e.g., a municipal bond may raise funds for a sewer project), and the federal government will finance larger infrastructure projects (e.g., interstate highways). Many parties to large-scale projects use non-recourse project financing, where the lender provides financing based on the contract commitments and the equity in the project, and without a guarantee from the project owner or its affiliates or parent companies. Parties may also use balance sheet financing, where the company finances the project out of its own cash reserves.
What forms of security are used in construction project financing?
It depends. Owners often require performance and payment bonds, letters of credit, parent company guarantees, and hold retainage to guaranty performance. Public-private partnerships will use surety bonds with a liquid element that is similar to a letter of credit. Bank guarantees are more common abroad, and less common in the United States.
Methods and timing
What are the typical methods and timing of payment for construction work? Are there any restrictions on ‘pay when paid’ and ‘pay if paid’ provisions? Do any other rules, restrictions or procedures apply?
The timing of the owner’s payment to the prime contractor is typically 30 days, although the payment term may be longer or shorter. The prime contractor’s payment to subcontractors is often less than 30 days.
Contract language is often unclear as to whether the parties intend to create a ‘pay when paid’ or ‘pay if paid’ arrangement. Conflicting interpretations of these clauses can mean the difference between subcontractors receiving payment within a reasonable time after the prime contractor is paid, or the subcontractors remaining unpaid until the prime contractor resolves disputes with the owner. These clauses are commonly litigated in state court, and many courts interpret ambiguities as creating a ‘pay when paid’ arrangement. Common grounds for challenging a ‘pay if paid’ arrangement includes arguing the clause is contrary to the parties’ intent, the clause is unconscionable, or the party has waived its right to enforce the clause by making partial payments.
The most common restriction to these clauses is that the prime contractor is not permitted to enforce an otherwise valid contingent payment clause if the reason for the owner’s non-payment is the prime contractor’s own failure to comply with the contractual requirement.
How can the contractor secure itself against non-payment by the employer? Under what circumstances can the contractor suspend work for non-payment?
The most common way for a contractor to secure itself against non-payment by the owner is by filing a lien against the project. Each state has its own rules describing the necessary steps to secure a lien, and many of these rules have very specific requirements. However, where project financing is used, the contractor should recognize that it will be required to subordinate its liens to the lenders.
The contractor may also terminate the contract for default, usually after a contractually defined grace period. The parties can include other remedies in the contract to protect the contractor in the event of non-payment, including circumstances that expressly authorize suspension of the work.
How can subcontractors secure themselves against non-payment by the contractor? Under what circumstances can subcontractors suspend work for non-payment?
In the event of non-payment, subcontractors may lien the project, then require the owner and prime contractor to resolve the issue of non-payment. The availability of this relief, and the directions for how to file such a lien, are state-specific. The subcontractor should put the owner on written notice immediately if payments are past due. In many jurisdictions, such a ‘fund trapping’ notice may require the owner to hold certain funds for the subcontractor or place them in a trust account until the subcontractor’s dispute with the general contractor is resolved. The subcontractor may also begin the dispute resolution process based on the contractor’s breach of contract.
Generally, a subcontractor should be very careful about suspending work for non-payment as doing so may result in the subcontractor’s own breach of contract. In the instance of the prime contractor’s non-payment, it is important for the subcontractor to understand its rights and responsibilities under the contract before taking any action. This may be affected by the existence of a ‘pay when paid’ or ‘pay if paid’ clause in the subcontractor’s contract.
On what grounds can payments be withheld?
Payment can be withheld if the contract permits withholding and if the withholding does not run afoul of the respective state’s prompt payment act.
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