Jordan ... payment obligations are often ignored.
How to address a payment issue
Delayed or non-payments is an issue that has serious repercussions in the construction industry. STUART JORDAN* outlines measures that can be taken to safeguard against this problem.
01 July 2018
Cashflow is the lifeblood of the construction industry” – so said a famous judge. That sounds a bit obvious but his point was that there is a real cost to the whole industry when payments fail to flow.
Good businesses fail, quality falls and prices increase both because of a smaller and less competitive contractor market, and because the risk of not getting paid is priced into tenders. Ultimately, if the cost of construction goes up, fewer things get built.
For many contractors in the Gulf region, not getting paid – on time or (sometimes) not at all – is a real problem. Most of us don’t even notice the problem. Industry commentators discuss endlessly the details of contract terms and disputes (I am as guilty as anyone!) and yet we largely ignore the more straightforward fact that payment obligations are often ignored, especially post-completion, with no reason given and no (genuine) allegation of failure by the contractor.
This problem afflicts the industry everywhere but we have to admit that it is widespread in this region and can include every type of project. This is not to say that all, or even most, project owners (and main contractors) exhibit bad paying practice. In my observation, most developers (if only to protect their own commercial interests) understand the need to deal with their supply chains in a way which will maintain relationships and their own reputation. Still, the problem of denied payment is a big one.
For perfectly sensible reasons, contractors are almost always cash-negative: they do work before they can even apply for payment and those payments are partly retained. Nobody is arguing with that as reasonable security for owners. The problem arises when legitimate payment entitlements are not met, including retentions not released. The means of legal recourse are lengthy, expensive, uncertain in outcome and damaging to relationships.
Subcontractors experience the same payment problems as above but they are multiplied due to the subcontractors’ position further down the chain. This is commonly reflected in tough subcontract terms which include “pay-when-paid” and more general “equivalent project relief” provisions which add up to “pay-if-paid”, leaving the subcontractor exposed to main contract payment delays and disputes about failure which may have nothing to do with the subcontractor’s work. Also, there is, of course, added insolvency risk, when relying on both the owner and main contractor to pay.
What can be done? Some steps are simple and aim only to achieve clarity in contracts:
• Firstly, the right to get paid is often complicated by process and subject to arbitrary tests such as “satisfaction” of the owner’s representative. Works valuation, works completion and defects rectification should be drafted as matters of objective fact; and the process (certificates or whatever) should simply be used to confirm that factual position.
• Contracts can require the owner (and not just the contractor) to make its claims within a certain time period or lose the right to claim. That can prevent owners raising spurious allegations of contractor failure only at the point of payment or retention release.
• To reduce the risk to subcontractors of “pay-if-paid”, the main contract terms can be exhibited to the subcontract, with main contractor obligations to present and enforce its payment entitlements in the main contract – and to report on those efforts.
• Retentions can be removed completely, although owners will often require a retention bond instead.
• An escrow account – a holding account into which the owner makes advance payments – can be used as the vehicle for making payments. Contractors can be sure that, once the contractual payment triggers are met, the money will be released.
• A payment bond or letter of credit can be obtained from a financial institution. There are various types: letters of credit can operate as the normal vehicle for payment (similar to an escrow account) or function only as a backstop guarantee in case payment obligations are not met. Of course, any kind of external security will add to overall cost.
• Project bank accounts can be used in a similar way to escrow accounts, with the added feature of allowing for payments direct to named subcontractors.
Of course, simply pointing to “payee-friendly” solutions like these is not going to solve anything if payees generally do not have the bargaining position to negotiate them. Some paying parties will want to keep the ability to avoid paying, if that is their habit.
There is, however, real damage done if supply chain relationships are sacrificed as soon as projects run into difficulties – or sometimes just because a payer can get away with not paying! This, ultimately, is self-defeating for the industry and we should have a culture of intolerance to it. n
* Stuart Jordan is a partner in the Global Projects group of Baker Botts, a leading international law firm. Jordan’s practice focuses on the oil, gas, power, transport, petrochemical, nuclear and construction industries. He has extensive experience in the Middle East, Russia and the UK.
