Trigger words are terms and phrases in construction contracts that heighten risk during a B2B transaction. Credit professionals must pay close attention to these trigger words to avoid additional costs, payment delays or nonpayment on a project.
#1 Mandatory Arbitration Clause
Litigation is a lengthy process that often delays payment, which is how mandatory arbitration clauses came to be. Mandatory arbitration declares that the parties will not litigate if a dispute occurs, such as a breach of contract or business dispute. Instead, the parties agree to arbitration to resolve the dispute but can be costly to creditors.
"You have to abide by the arbitrator's hourly rate and hours of operation," said Emory Potter, partner at Hays & Potter, LLP (Peachtree Corners, GA). "If the arbitration isn't taking place at one of the lawyer's offices, you have to pay for the other location and hourly by room."
To save time and money, creditors should include a mandatory mediation clause, where both parties agree to mediate a dispute before resorting to litigation. Mediation does not require counsel, court fees or enforce strict deadlines. Or, they can add a voluntary arbitration clause, where both parties agree to go to arbitration, and creditors can set their own terms and hire their own arbitrators.
#2 Pay-if-Paid (PIP) and Pay-When-Paid Clauses
A term that is well known in construction, pay-if-paid clauses, state that the general or prime contractor's payment obligation to pay downstream subcontractor claims are triggered only, if and after the receipt of payment in full from a higher-tiered contractor or owner for the lower-tiered subcontractor's work. This means if the debtor is not paid, the creditor isn't either. This can cause payment delays and lead to litigation, which is costly in itself.
Similarly, pay-when-paid clauses allow a general contractor or a subcontractor to pay lower-tier subcontractors and suppliers only after payment is received from the party with whom they are contracting. "Pay-when-paid clauses can impede prompt payment through no fault of a subcontractor or supplier," said Steven Hopkins, CCE, CCRA, regional credit manager at North Coast Electric Company (Seattle, WA). "It can be viewed favorably by the general contractor, but lower-tier contractors may find this clause to be a hindrance to prompt payment."
#3 Reasonable Time for Payment
Reasonable time for payment (RTP) is the timeframe for when a debtor is obligated to pay the creditor in the absence of agreed payment terms. For example, pay-if-paid is allowed under the Texas Contingent Payment Law, but can be voided under certain circumstances. In this case, the contractual terms of pay-if-paid are no longer enforceable and the general contractor (GC) is obligated to pay the subcontractor within a reasonable time (default new payment terms).
But the problem arises because a specific timeframe is not identified in the statute. In many contracts, RTP is defined as when the GC has exhausted all remedy in pursuing payment with the project owner, which could take years.
#4 Damages to Work
The costs of consequential damages and liquidated damages could be excessive through no fault of the creditor. Consequential damages result from performance or completion delays on a construction project, which eventually lead to a breach of contract. This means that if a project is not completed on time, the property owner can lose revenue. In this case, the property owner could file a lawsuit against the construction company in an attempt to recoup their losses.
Liquidated damages are a type of consequential damage that refers to the sum of cash that a party must pay if they breach a contract. The owner can include a provision that lets them obtain a specific amount of money if the construction company violates the contract and bails on them.
These damages impede on what is called the critical path in a construction contract, "the longest path (in time) from start to finish; it indicates the minimum time necessary to complete the entire project," per Harvard Business Review. If the critical path is disrupted, creditors are left recouping what's been lost through those damages. Thus, creditors should limit consequential and liquidated damage clauses to the value of the contract to save money.
#5 Lien Rights/Unconditional Lien Waivers Prior to Payment
A mechanic's lien is a guarantee of payment to builders, contractors and construction firms that build or repair structures. Lien rights also extend to material suppliers and subcontractors and cover building repairs. The lien ensures that workers are paid before anyone else in the event of a liquidation. But many states don't allow creditors to waive their lien rights before a construction job.
Lien waivers are documents that waive or release the right to lien, usually in exchange for payment. They are legally enforceable, so it is important that creditors know what they mean before they sign them. Unconditional lien waivers are provided by contractors or suppliers after they've been paid, so signing one prior to payment heightens risk of nonpayment.
"A lot of times, you'll have a contract that says you waive your lien rights and you want to fight about it," Potter said. "My recommendation is to talk to a lawyer in the state to find out if that's applicable at all because why fight over something that is utterly unenforceable?"
#6 Back Charges
A back charge occurs when a general contractor or project owner identifies certain deficiencies in the work or costly damage attributable to a subcontractor or supplier. The cost of the error or neglect is calculated to a dollar amount and then subtracted from payment to the party at fault.
In a federal project, like a highway, mandatory back charges are put in place if the project gets delayed. "They don't want the road closed any longer than it has to be," said Ty Knox, ICCE, director of credit and risk at EFCO Corp (Des Moines, IA). "The responsible party can be back charged as much as thousands of dollars each day they're running behind." It's important contractors keep an eye on this trigger word to avoid costliness.
#7 Indemnity for Active or Gross Negligence
The purpose of indemnity clauses is to protect a party from third-party claims where the indemnified party is required to pay. Indemnity can protect active or gross negligence, an act showing a severe and reckless disregard for the lives or safety of another person. "It doesn't matter if you agreed to it or indemnified them," Potter said. "It's an intentional tort and you can't consent to it."
#8 Extended Warranty
An extended warranty extends beyond completion of the project where the owner makes a claim against the surety for a latent defect, constituting a breach of warranty surviving completion of the project. "You want to make sure that in any contract you sign, the warranty does not give more rights than usual," Potter said. "If a contract seeks to extend warranty, this may increase risk."
#9 One-Sided Attorney Fees
One sided-attorney fees are just as they sound, one-sided. One party recovers attorney's fees in the event of litigation but the disadvantaged party is unable to recover them. "These are viewed as a valuable legal resource by some in the construction industry," Hopkins said. "But an equal number may find it completely non-beneficial or an actual impediment to projects."
One-sided attorney fees are disallowed in many courts but can be enforced "if only the other party can sue for fees," Potter said. "It is not a fair contract."
#10 Design Responsibility
Design responsibility in construction contracts should be discussed between employers to minimize the potential for disputes. If not, contractors run the risk of being uninsured for the design responsibility where the standard for assessing their performance under the contract is in excess of reasonable skill and care.
Creditors must make an explicit reference to the plans in the beginning of the documentation. "I look at the first three pages of the blue prints," Potter said. "You want to make sure you're relying on the general representations and not the specific representations." The general requirements an architect imposes in the beginning can be very different from what they draw later in specific areas of the plan.
Are you a construction credit expert looking to network with others in your industry? Sign up for NACM's virtual Construction Thought Leaders Discussion groups. The next meeting is scheduled for April 18.
-Jamilex Gotay, editorial associate