Protect Your Company's Investment With Payment Assurances
ASA

A construction subcontractor can do everything right in terms of negotiating a good contract and running a project smoothly, but still lose out if project funds run out without warning. The situation is not unlike a bank that issues a credit card and manages a cardholder account well, only to find out that it won't receive payments because the cardholder unexpectedly goes into bankruptcy. The financial risks of under-funded projects cannot be eliminated on private construction, but there are steps subcontractors can take to limit their losses in case they find themselves working for clients that cannot pay.

Early knowledge of project funding arrangements is critical, because once a subcontractor has performed work, the subcontractor has incurred the costs of providing labor, materials and equipment. A white paper published by the American Subcontractors Association, Inc. (ASA), "Payment Terms: Adequate Assurances of Payment," describes how subcontractors can avoid being taken by surprise by lack of project funding. Inadequate project funding most impacts subcontractors by reducing or stopping progress payments or payments for extra work. By having the earliest possible knowledge that progress payments or extra work payments will not be made, subcontractors can choose to save themselves from the grief of performing work and then trying to collect from a client that doesn't have any money.

Under the contract law of most states, a subcontractor has the right to demand assurance that a client will be able to pay, and if such assurance is not provided, can suspend work. The protections provided by contract law are, however, limited by prevailing practices in the construction industry. In particular, ASA's white paper notes, the use of pay-when-paid and pay-if-paid clauses creates uncertainty about what kind of assurances of payment subcontractors can obtain if they are not entitled to payment at a particular time (pay-when-paid), or at all (pay-if-paid) : "Even subcontractors who do agree to pay-if-paid contract language must still have some right to demand adequate assurances and concurrently suspend performance, because the purpose of progress payments is to enable continued performance. Clearly, however, a subcontractor could not pursue such a course without tremendous risk."

Another approach outlined in ASA's white paper circumvents this problem by contractually ensuring a subcontractor can get project financing information and has the right to demand payment assurance. The white paper notes that industry model prime contract forms increasingly contain terms allowing prime contractors to obtain project financing information, and, ASA argues, subcontractors should expect no less. ASA has developed model subcontract language in its "Addendum to Subcontract" (2005 ed.) at Paragraph A.2.2.6 to this end:

"Subcontractor shall be provided, upon written request, with the legal description of the property, the name, address and representative of the Owner, and evidence of adequate owner project financing. The Contractor shall promptly notify Subcontractor of material changes in the Owner's identity or financial arrangements. Subcontractor shall not be obligated to commence or continue Subcontract Work unless adequate assurance of payment is received."

Learn more about payment assurance. Visit ASA's Web site at www.asaonline.com and click on "Stand Up! for Subcontractors" or call ASA at (703) 684-3450.