Civil Engineering Chapter 17 One Way Approach The Payment Process Postulate Two Hypotheticals The First

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Chapter 17

One way to approach the payment process is to postulate two hypotheticals.

The first is a home owner building a garage and the second, a large commercial

structure. Ask the students when the home owner would have to pay if there

were no provision in the contract dealing with payments and then postulate a

contractor who cannot accept this and wishes to be paid as it works. Then ask

them to structure a payment schedule which would take into account the needs

of both owner and contractor. Move then to a large project and the need for a

complex payment process.

While the exercise may be boring to many students, it is useful to introduce

this topic by reading AIA language or any other sophisticated contract dealing

with the topic. The payment process expressed in A201–2007, Article 9 is

complex. Will students appreciate the importance of going though what appears

to be boring language? Yet the language in such an agreement is the culmination

of a host of problems that have come up and gives a good indication of the types

of issues that arise in construction.

Joint checks (Section 17.4) will need class explanation. While the owner

clearly benefits from the rule, does it unfairly deprive a subcontractor (who may

have little economic power over a prime contractor) of a statutory remedy in the

form of a mechanics’ lien?

Section 17.5 (payment certifications) re–plays the issues discussed in Section

10.3B, dealing with design professional inspection of the contractor’s work and

the concomitant duty to protect the owner. In the case of payment certifications,

liability may extend as well to a claim by the payment bond surety.

The role of the lender (Section 17.6) provides an opportunity to review the

financing of a large construction project. (A re–reading of Section 7.6 is merited.)

Where the project involves a homeowner who does not employ an independent

design professional, to what extent may the owner look to the bank for

protection?

As noted in Section 17.8, increasingly statutes deal with delayed payments. In

March 1982, the Congress enacted the Prompt Payment Act (31 U.S.C.A. § 3901

et. seq.) which requires the federal government to pay its bills on time or face

interest penalties and attorneys’ fee charges.

After an enactment of that legislation a coalition of contractors and suppliers

undertook a major job to encourage state legislatures to pass similar measures.

A clear majority of the states have such laws on their books. Most of these laws

deal with public agencies and public contracts. Some, however, regulate private

agreements.

Common law regulation of delayed payment or nonpayment reprises the

concept of a material breach, introduced in Section 3.7B. A class discussion

directing the students’ attention to Section 3.7B should help bridge the gap

between an abstract, legal concept (material breach) and a concrete,

construction dispute (owner non–payment for one day, one week, two weeks,

etc.).

Beginning with Section 17.9, the second half of Chapter 19 deals with project

completion, including payment issues.

Section 17.10 deals with the substantial performance doctrine. The facts of

Jacob & Youngs, Inc. v. Kent case illustrates well the underlying rationale for this

doctrine. The contractor is clearly in breach of contract, but what is the proper

remedy?

The doctrine is subject to abuse: used by contractors to more or less complete

a job and then walk away from it and be able to recover under this doctrine. Ask

the students what they think of the substantial performance doctrine. Some may

believe it is absolutely essential in the construction process for reasons that have

been noted in the book. Others may insist that overuse of the substantial

performance doctrine even if it is accompanied by proper price reductions can

encourage the contractor to walk away when a job has not been completed. (A

hidden cost to the owner not recognized by the doctrine: The administrative cost

of finding a contractor willing to come in and wrap up another’s work. Not only

may the new contractor not be interested in such a small project, but it may fear

liability arising out of latent defects in the first contractor’s work.)

An instructor who wants to develop this topic should read the Tolstoy case

cited in note 21 and give the facts of that case to the students. It will be a good

illustration of how a contractor in a contract which involves an unsophisticated

consumer may seek to use the doctrine to recover when there is a host of minor

defects he refuses to fix.

As to the Plante case, ask students whether the owners should be able to

recover some amount for the misplaced wall if they can show that the living room

will no longer be able to take furniture because of it being a foot narrower than

specified. Also ask whether this case really involves, at least as far as the wall is

concerned, damages which can be considered more aesthetic than economic. If

so, how should claims be measured?

Answers to Chapter Questions

1.) How does the progress payment system work in the construction industry?

a. In the progress payment system the contractor is paid incrementally

commensurate with the percentage of work completed. The common law’s

“work first and then be paid” rule is divided into units of the work: as each

unit is completed, payment is due for that work. The units can be either

stages of completion or time elapsed.

2.) What are the purposes for retainage?

a. One purpose of retainage is to provide money of which claims that the

owner has against the contractor can be collected without the necessity of a

lawsuit. If a project is nearly complete, but small defects remain and the

contractor fails to correct the problem, the owner may use the retainage to

effectuate these repairs, and then refund the remainder to the contractor.

Another purpose of the retainage is to provide the owner with money with

which to pay any subcontractor or supplier liens.

3.) What are two tactics that seek to protect the owner against future claims by unpaid

subcontractors or suppliers?

a. Some contracts require the contractor to give the owner assurance or proof

that the prime has paid its subcontractors and suppliers when payment

applications are made. Alternatively, contracts may require the prime

contractor to demand lien waivers from the subcontractors as a condition

for payment, in which the subcontractor gives up its right to a mechanic’s

lien for the work covered in the progress payment.

4.) What are the implications if a design professional undercertifies or overcertifies a

payment application?

a. Undercertification impairs the contractor’s cash flow, and overcertification

diminishes the retainage.

5.) If a contractor obtains a loan from a lender to finance construction, how might the

lender use an assignment to secure pay–back of the loan?

a. An assignment transfers the right to receive payment and effectuates a

change of ownership in the rights transferred. It is a more substantial

security than a promise. As the contractor performs and becomes entitled to

progress payments, those payments are made either directly to the lender or

by joint check to the contractor and lender.

6.) What are the differences in rules of the courts in the GEM Industrial, Inc. v. Sun Trust

Bank and White v. AAMG Construction Lender Center on one hand, and Alpine Bank v.

Hubbell on the other?

a. In GEM and White, both courts found the construction lender liable to the

owner when the lender’s inspector had discovered defective or incomplete

construction, yet still made the payments to the contractor. In Hubbell, the

court enforced a Limitation of Responsibility provision in the loan

agreement and found the lender not liable to the owner/borrower. The

owner could not rely upon the bank to protect the owner from the

contractor’s improper performance.

7.) What is the Prompt Payment Act and what are the penalties if a contractor is found

to break this act?

a. Under the federal Prompt Payment Act, a contractor must pay its

subcontractors for satisfactory performance within seven days of receiving

payment from the federal agency. Failure to pay on time subjects the

contractor to an interest penalty owed to the subcontractor. Subcontractors

have the same obligation to pay sub–subcontractors.

8.) What is substantial completion and what are the ramifications to the owner and

contractor of the contractor achieving substantial completion?

a. Substantial completion is the point at which the project may be occupied

and used for its intended purpose. It may entitle the contractor to payment

of the retainage, less adjustments for incomplete or defective work.

Warranties generally begin to run at the time of substantial completion, as

does the statute of repose. Achieving substantial completion is also a

prerequisite to the contractor’s use of statutory remedies, such as filing a

mechanic’s lien. Liquidated damages may begin to run from the date of

substantial completion or final completion, depending on the wording of the

contract.

9.) What is the substantial performance doctrine and how does it function?

a. The substantial performance doctrine provides the contractor with a means

of achieving at least partial payment notwithstanding its contract breach. In

its simplest form, it requires the owner to pay the balance of the

construction contract price if the contractor has substantially performed,

leaving the owner a claim for damages based on failure of the contractor to

perform strictly in accordance with the contract requirements.

10.) What is restitution, what is its purpose, and when might a contractor use the

doctrine in the project completion process?

a. Restitution may enable the contractor to recover for any net benefit that its

performance has conferred on the owner. One purpose of restitution is to

avoid unjust enrichment to the owner. A contractor may invoke use of

restitution if it has not performed sufficiently to achieve the benefits of the

substantial performance doctrine, yet is otherwise done working on the

project.