This feature is a part of "The Dotted Line" series, which takes an in-depth look at the complex legal landscape of the construction industry. To view the entire series, click here.
Contractors know that prompt payment of their pay applications is critical to a construction project’s success. Timely and accurate payments allow them to pay their employees, lower-tier contractors, material suppliers and other vendors as agreed, which not only helps make sure there are no disruptions to the project schedule, but builds loyalty. High-demand specialty contractors, for example, choose to work on projects that pay on time and avoid ones that don’t.
Sometimes late payments from the owner are procedural in nature — perhaps staff members that handle pay applications are inundated with work and just have trouble getting organized enough to process the paperwork on time. In other instances, the owner might have not secured adequate construction financing or may have run into other money troubles.
There are ways, however, to learn if an owner has the financial and organizational capacity to support the project.
Typically, contractors and subcontractors must submit credit references and other proof that they can provide a quality product, as well as adequately staff their scope of work, before they can even bid on a project — or at least before the contract is executed. The requests for background information also can include bank and other financial data.
What some contractors might not realize, though, is that their contracts, including one of the most commonly used forms, might give them the right to ask for proof that the owner has enough financing in place to pay its bills.
When and how should contractors make information requests?
In the American Institute of Architects’ A201-2017 General Conditions of the Contract for Construction, there are two circumstances under which contractors can verify an owner’s financial resources — before starting the project or if certain circumstances arise during a contractor’s performance of the work.
In Section 2.2 of A201, upon written request from the contractor, the owner must provide “reasonable evidence” that it has the ability to finance the project. If the owner doesn’t provide that information, the contractor doesn’t have to start work and is eligible for an extension of the project schedule based on how long it takes the owner to respond to the request.
After work begins, the contractor can ask for proof of the owner’s financial wherewithal if the owner has been late in making progress payments according to the agreed-upon terms of the contract. The contractor can also ask for verification of financing if there is a “reasonable concern” on the part of the contractor that the owner might not be able to meet its financial obligations or if there is a change to the contractor’s scope of work, one that “materially changes” the contract amount.
If the owner doesn’t provide the contractor with the requested information within 14 days under this scenario, the contractor could stop work and bill the owner for demobilization and remobilization costs plus interest. In the case of significant changes, contractors must proceed with the portion of their work that is unaffected by the change.
Additionally, said attorney J. Gregory Cahill of Dickinson Wright in Phoenix, after the owner provides the requested financial information, it cannot materially change loan or other financial arrangements related to the project without notifying the contractor. “The general contractor is allowed to rely on the information that they are provided,” he said.
What constitutes proof?
“Here's one area where the AIA stops short of specifying exactly what is considered reasonable evidence of financing,” said Joshua Atlas, in West Palm Beach, Florida.
“If there's a bonding requirement from either the contractor or their general contractor as part of the issuance of the bond, the contractor's surety is usually going to want to see some kind of evidence of financing before assuming the risk and issuing the bond.”
Partner, Saul Ewing Arnstein & Lehr
Depending on the type of project, he said, proof could be anything from a commitment letter from a lender, financial statements, bank statements or a bond commitment. “Anything that's got … information that can be verified will probably fall under the category of reasonable evidence,” he said.
Contractors also have to be aware, Cahill said, that the owner can designate the financial information it turns over as confidential, although contractors can share that information with individuals and companies connected to the project like employees, consultants, sureties, subcontractors and their employees, lower-tier contractors and others who have a vested interest in knowing the owner’s financial position. Under those conditions, he said, the information can only be passed along to those who are willing to maintain confidentiality.
What about subcontractors?
Subcontractors must rely primarily on the general contractor’s willingness to ask for financial information, Cahill said, because, even if A201 is incorporated into their contracts, that doesn’t establish the necessary contractual relationship between the owner and subcontractor.
“It does not create an independent right for a subcontractor to demand owner verification of a project's financing,” Cahill said.
However, barring the general contractor’s willingness to ask for the information, subcontractors that must provide performance and payment bonds for the project in question could gain access to the information through that process, Atlas said.
“If there's a bonding requirement from either the contractor or their general contractor as part of the issuance of the bond,” he said, “the contractor's surety is usually going to want to see some kind of evidence of financing before assuming the risk and issuing the bond.”
This is particularly important for contracts with pay-when-paid clauses, he said. These clauses typically mean that the subcontractor will not look to the general contractor for payment until the owner has paid the general contractor. “[Those contracts] expressly shift the risk of payment from the GC to the owner, so, as a subcontractor, you have an interest in making sure the owner can make those payments,” he said.
Should contractors ask for financial details?
“I have seen [the requests for verification of financing] more often as the project is proceeding, especially where disputes arise between owner and contractor,” said attorney John-Patrick Curran, a partner at Sive Paget & Riesel in New York. In one instance, he said, he saw that clause used in an attempt to declare a default when the owner did not respond to the contractor’s request in the specified time.
In general, Curran said, some contractors might be hesitant to ask for the information for fear of creating tension in its relationship with the owner. On the owner side, some try to strike that clause from the contract altogether, asserting that the terms of its project financing are not the contractor’s business.
Curran said he suspects questions around financing in many cases might be resolved more on an informal basis than as a result of an official written request.
Contractors, Atlas said, must make sure that their interests are protected. Depending on the relationship with the owner or developer, a request for financials should be like exercising any other rights under the contract, such asking for sworn affidavits or a list of subcontractors, which contractors in some states are entitled to under mechanic’s lien laws.
Atlas said he looks at it as just doing business — an enforcement of a right. And if a contractor presents it properly in a way that's not adversarial, he said, then the owner should take it that way.
Of course, contractors doing business with long-time customers or ones that always pay on time might not need to ask for this kind of information, but they shouldn’t let the fear of losing a project for an untested customer or one with a negative payment reputation stop them from enforcing their rights.
“It’s one of those buyer-beware [situations],” Cahill said. “If you have an ability to [make the request], and the owner's unwilling to provide the information, why is the owner unwilling to provide the information? That would concern me.”
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