If You're Going To Be a Banker, Be a Smart One
American Subcontractors Association, Inc.

In a real-life example, a construction subcontractor that worked on a very high-profile project in Ohio won recognition as the outstanding subcontractor on the project, only to wait two years before receiving the funds retained from its progress payments. How about that? Would you rather have the money for two years or the recognition for one day? Most subcontractors would choose the former.

The scenario is far from unique. Construction owners' contractual payment terms and practices routinely shift the financial burden and financial risk of construction projects to contractors and subcontractors. For example, extended progress payment terms give owners leeway to rely for greater periods on contractors' and subcontractors' ability to keep labor, materials and equipment dedicated to the project. As project work is performed, the owner does not finance the work directly with project funds, but rather through the credit of contractors and subcontractors that expect payment for their investments in the project. Practices such as retainage and slow payment can also function to the same effect, providing project funds. Indeed, it is not uncommon to hear contractors and subcontractors lament that they are "the bank" for the project.

The nature of the construction industry is that subcontractors cannot choose whether or not to be bankers for others. Since subcontractors work on a promise of future payment, they already are creditors, just as banks are. What banks do differently from many subcontractors when they extend credit is that banks make borrowers pay exorbitantly when they "break the rules." Their credit comes with conditions. The choice for subcontractors is, then, whether to be smart bankers by creating conditions that preserve their investment.

Take mechanics' liens, which are supposed to provide subcontractors with bedrock security for the credit they extend in the form of labor, materials and equipment. The wrong subcontract terms can compromise that security, however, so savvy subcontractors pore over terms that affect lien rights.

The most common threat to subcontractor mechanics' lien rights is the contractual lien waiver. Such waivers, where state law permits them, potentially have devastating effects for subcontractors, often erasing more rights than subcontractors intend. When examining lien waiver language, subcontractors should consider how well the language protects their rights to assert lien claims in the future. The proposed subcontract may contain weak protections or no protections at all, requiring the subcontractor to "release" or "waive" rights to "all liens" or "all claims." Or, the subcontract document may contain stronger protections, not allowing lien waivers or limiting waivers to only "previous payments" to the subcontractor for materials, labor, etc., as paid through "the last invoice." Think like a banker: A bank would never give up its rights to foreclose on a home or garnish wages to collect a debt without receiving something in return! In case of trouble, stronger protections for lien rights will allow the subcontractor to seek the intended security provided by lien laws.

Another example of where it pays to think smart is with payment bonds. At least for the purposes of analogy, the payment surety is the like the co-signer on a bank loan. Like the co-signer on a loan who doesn't want to cover for the primary signer, the surety hopes that it will never have to cover for the general contractor. Think like a banker: Banks fully intend to protect themselves from losses, and so they carefully examine the co-signer's credit history and assets. Likewise, smart subcontractors will negotiate contractual rights to a copy of the payment bond. Review the bond for caps, restrictions on claims and claimants, the notice period, and any suit limitations period. This is tantamount to the bank understanding when and how it can "foreclose" on the co-signer's assets. Also, to limit the general contractor's ability to invalidate the legitimate payment protections that are set forth in a payment bond, remove pay-if-paid clauses and limit the scope of any waivers to work for which the subcontractor has already received full payment. (Imagine how quickly a bank that accepted pay-if-paid terms on loans would go out of business!)

To judge whether to make a loan, naturally banks look especially hard at the primary signer's financial health, and calculate how healthy his or her finances are likely to be during the loan period. Similarly, the subcontractor should try to establish the right to obtain project financing information. On private work, subcontractors may not have the right to this information unless they obtain a written commitment. ASA's generic "Addendum to Subcontract" (2004) uses the following language:

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. 

If the subcontractor encounters resistance to the idea of accessing project financing information, it may remind the customer that many industry model contract documents include "project financing right to know" clauses. If the subcontractor cannot receive assurance that it will receive timely project financing disclosure, it may wish to adjust its bid price to account for the increased risk it will bear.

Retainage is a special issue. For a bank, the practice of retainage would be like the borrower saying that it would partially retain loan repayments. The analogy between smart bankers and smart subcontractors breaks down here, because no banker engages in such a practice. Nevertheless, there are steps that smart subcontractors can take to protect funds retained by the higher tier of construction:

1. Ask for reduced or zero retainage.

2. Negotiate for retainage to end at 50 percent completion of the work.

3. Ensure that the level of retainage is no more than the level the owner retains from the general contractor.

4. Seek payment of retainage when your work is "complete" (i.e., line-item release); avoid language releasing retainage only once the project is "complete." 

5. Negotiate the release of funds for work that is substantially complete.

6. Require that retained funds be held in trust or otherwise segregated from other project funds.

These strategies will increase a subcontractor's chances of being paid all retained funds it is owed for properly performed work.

Thinking like a smart banker is an unfortunate necessity for subcontractors that want to succeed. However, every smart move that a subcontractor makes to protect its investment of labor, materials and equipment will help it stay a step ahead of the competition. So review your options and consult with your professional advisors to develop a strategy that works for you. And above all, keep your eye on the money. You earned it!

Learn more about empowering your company to advocate the best possible subcontract terms through ASA's Stand Up! Web page. Click on the Stand Up! image on the ASA home page (www.asaonline.com).

© 2005 Naylor Publications, Inc., and the Foundation of the American Subcontractors Association, Inc. All other rights are reserved.