Non-Payment and Risk-Shifting in the Construction Sector
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Non-Payment and Risk-Shifting in the Construction Sector

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Getting paid can be hard for any business, but getting paid in the construction industry is especially difficult. Learning how to implement a strong receivables management program is crucial when it comes to getting paid, and getting paid on time. In the construction world, this means being aware of potential risk-shifting mechanisms in contracts, and knowing the ins and outs of the security rights that are available.

Non-Payment & The Foundation of Risk-Shifting

Many factors contribute to the difficulty of getting paid, and paid on time, in the construction industry. Scope of work issues, inspection problems, change order dispute, pay when paid or pay if paid clauses in contracts, and some of the highest failure rates of any market all play a part.

Long-standing American public policy is that trade contractors and suppliers should be paid for their work. This deeply held belief that people should be paid what they are owed is not specific to the construction industry, but the construction industry does have specific safeguards and tools to ensure that it happens. The mechanics lien instrument was developed for just this reason. This concept that subs and suppliers should be protected from bearing the burden of non-payment on construction projects has a long history.

Mechanics liens work to protect parties on a construction project in many ways: by obligating more parties to pay, by demanding the attention of the owner and lender, by causing a breach of contract, by prioritizing certain invoices, and potentially most importantly, by encumbering the property itself. An unpaid mechanics lien claimant is able to initiate a lawsuit to foreclose on the property itself, and have the property sold to satisfy the debt. Because of this protection, and the public policy idea that subs and suppliers should not be forced to bear the risk of nonpayment – that risk was pushed up the payment chain to the property owners and general contractors. Property owners and GCs don’t want to shoulder financial risk any more than sub and suppliers do, so they fought back with contract provisions specifically designed to force risk back down the payment chain.

Policy & Contract – Opposing Forces

Contractual language forms the basis for payment in any industry. In construction, contracts have historically been used as a tool of the parties higher up on the payment chain to force a project’s financial risk downward. However, these risk-shifting attempts and practices sometimes bump up against a state’s public policy and must be very specific to accomplish their purpose.

On one side there is the public policy that subs and suppliers should have the protection of the mechanics lien instrument, and that property owners and GCs are the parties in the best position to bear the financial risk of construction projects, and on the other side the property owners and GCs have come up with a bevy of contract provisions designed to eliminate or complicate this protection. These contract provisions include “no-lien” clauses, pay if paid clauses, pay when paid clauses, and strict noticing provisions.

No-lien clauses have routinely been thrown out by courts, and as a result, there is a general prohibition on this type of clause, and they are no longer considered an effective risk-shifting mechanism. The other contract provisions mentioned, however, may be effective in shifting the risk of nonpayment down the payment chain and onto a project’s subs and suppliers.

Pay if paid clauses are generally looked upon with disfavor, and are banned outright in some states. However, this is not universally true, and a pay if paid clause may work as a risk shifting mechanism in multiple states, provided the specific wording requirements are met. The generally held view that these type of clauses are disfavored, does result in strict scrutiny in these clauses by courts, and routinely leads to the decision that the clause is either ineffective totally, or functions as a pay when paid clause, rather than the more restrictive pay if paid clause.

Pay when paid clauses have generally been interpreted as timing mechanisms rather than risk-shifting mechanisms. This means that while a valid pay when paid clause may delay the time by which payment must be made, it does not excuse the payment forever (even if the GC is never paid). For this reason, the trend has been toward containing strict notice provisions in contracts in an attempt to complicate the claim process.

These opposing forces of policy and contract provide an interesting backdrop for payment issues in the construction industry. As the landscape stands currently, the mechanics lien instrument is the best way for subs and suppliers to protect their right to get paid on every project, but there remain some contract clauses that can weaken, or even potentially extinguish this right.

About the author:

Nate Budde is the Editorial Director of The Lien & Credit Journal and Chief Legal Officer at zlien, a resource platform that reduces credit risk and default receivables for contractors and suppliers by giving them control over mechanics lien and bond claim compliance. Nate is a licensed attorney in Louisiana, a graduate of Stanford University (B.A.) and Tulane Law School (J.D.). You can connect with him via LinkedIn, Google+.

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