A frustrating recent trend in the construction industry is the improper withholding of the final construction payment by the owner. In a number of recent discussions with contractors, we have been informed that owners have been waiting until the final invoice to dispute changes, allege project deficiencies and costing issues in most cases raising issues significantly smaller than the final draw, essentially holding the contractor hostage to either conduct repairs or absorb some additional costs.
Although it can be impossible to protect against every possible way that an owner might attempt to withhold payments, this article aims to inform contractors of some potential safeguards that can be embedded in their contracts to protect the final payment.
On larger projects it may be viable to have an independent third party involved to act as a payment certifier. This role can be filled by a consultant such as an architect, engineer, or other experienced professional. A payment certifier is generally put in place to determine if a project reaches milestones that trigger payments, such as foundation, drywall, or occupancy. As an independent third party, the payment certifier should not be interested in taking sides but merely determining if the level of completion accords with the release of an associated payment. A properly worded contract with reference to the powers of the payment certifier should take the power out of the hands of the owner and allow the contractor to rely on their work to trigger payments. If after certification an owner continued to withhold payment, the contractor would be in a much clearer position to lien or terminate. Although it would be convenient to have a payment certifier on every project, the cost of hiring an independent consultant can be prohibitive on many projects.
Other Contractual Terms
Additional contractual terms can also be used to clearly protect against the owner’s retention of the final payment, however such terms must be negotiated in advance to be effective. One way contractors can protect themselves is to modify the language surrounding the deposit or retainer for the project. In the normal course, the parties will often agree that these amounts are to be used during the construction process to account for costs incurred by paying portions of invoices as they are issued. This type of provision puts the contractor in a position of weakness at the end of the project as they no longer have the leverage of stopping work on the project in order to pressure the owner into providing payment.
Instead of following this practice, the terms can be amended to allow the contractor to hold those deposits/retainers as security until after the issuance of the final project invoice. Once the final invoice is issued the contractor can use the deposit/retainer amount required to cover that final invoice and return any remaining funds to the owner. These changes can put the contractor in a position of strength at the end of the project instead of the normal position of weakness. This can also be achieved by having a minimum amount held as a deposit/retainer throughout the course of the project, still allowing for payments to be made from those funds while requiring the owner to top them up throughout the project.
Another strategy that can be used, in conjunction with modifying the deposit/retainer terms or on their own, is to amend the payment terms to have more funds due earlier in the project. This can limit the contractor’s exposure to the risk of larger outstanding amounts having a significant impact on their business. This can also be achieved by using invoicing and project management strategies that leave minimal meaningful work near the end of the project (meaning the expensive work would have to be paid earlier to keep the job going) to again limit the amounts outstanding at the end to potentially be withheld by the owner.
Limiting occupancy or possession within the terms of the contract can also help to manage the contractor’s risk. Terms can be added to an agreement to allow the contractor to withhold occupancy or possession of the property until all accounts have been settled between itself and the owner. This however may only be a short-sighted strategy, as the owner will have rights in the property as the owner that can be difficult to limit. The owner can potentially go around the contractor to obtain any necessary approvals, or simply take possession of the unit when the contractor is not in possession.
One further level of protection that the contractor can use to protect the final payment (and any other potential disputes) is to document everything. Although this can be cumbersome in some circumstances it may mean the difference between prompt payment and a drawn-out process to obtain funds owing. Having the corresponding documentation to support amounts invoiced, project changes and cost discussions can be invaluable in compelling the owner to provide prompt payment. If a dispute arises, the party with the most complete documentation will often come out on top.
Although having signed confirmations is the best practice, it can often be impractical during the day-to-day operation on site. The use of simple follow up emails or text messages regarding discussions, changes or instructions can go a long way to avoid potential disputes in the future.
The protections afforded by the practices outlined above are by no means the only options when it comes to protecting the final payment on projects. They are also not perfect solutions, however they can provide peace of mind to the contractor when undertaking a new project.
Nathan MacDermott is an associate at Pihl Law Corporation in Kelowna, practicing in commercial litigation and construction law.