Aiming to do better
In a two-part article, Shourav Lahiri, a partner in Pinsent Masons LLP looks at the measures that can be taken by both employers and contractors to shepherd projects through the credit crunch. The first part published in Vol 4 [Jan5-18, 2008] dealt with five strategies available to employers. This part deals with five strategies available to contractors.
My earlier article focussed on options available to employers to ameliorate the impact of the credit crunch and keep projects on-track. I now focus on the options available to contractors.
If the employer is in financial difficulties, there might be an inclination not to pay. In deciding whether or not to pay, an employer will have to assess the risk of the contractor exercising its contractual right to suspend work.
This risk will be small if the employer can contractually justify of not paying or making a low payment.
This makes the role of certification critical. If the employer’s payment obligation is conditional upon certification, a low certification gives the employer a legitimate ground to pay less. Short of notifying a dispute under the contract and taking the matter to arbitration, a contractor has little recourse in such circumstances.
While many contracts give the contractor the right to suspend work for non-payment of assured amounts, none of the contracts (at least the ones I have seen) give the contractor a right to suspend upon an under-valuation of its works in a certificate.
In contracts where the certifier is not truly independent of the employer, contractors are now finding that their works are increasingly being subject to low valuations in payment certificates. Even independent certifiers are under pressure from employers to scrutinise payment applications so as to minimise the amount certified for payment.
To maximise valuations in interim certificates, contractors need to ensure that they are complying with the necessary preconditions to their payment applications and are providing adequate substantiation to support their applications. This minimises the risk of payment applications being rejected as non-compliant, which increases the time lag between work done and the payment, and reduces the likelihood of the certification not accurately reflecting the value of the work carried out. Proper certification enhances the prospects of getting paid.
Contractors should put in more effort in the present market to minimise defects in their work. It is moot whether certain inadequacies in the work are merely snagging-list type items that can be rectified during the liability period, or are an indication of the work not being complete. In good times, when completion of projects was a priority, certifiers and employers were prepared to overlook inadequacies, characterising them as defects to be rectified later. That enabled contractors to obtain payment early.
But the reverse is happening in this market. Accordingly, contractors need to pay more attention to the quality and finish of the works to make an application for payment. This will reduce the prospect of under-valuation in the certificates that follow.
Where stage payments are released upon attaining milestones, reaching those milestones early is key to a contractor’s cashflow. Contracts do not require contractors to follow a submitted programme slavishly. Accordingly, re-jigging the order of works to enable the earlier attaining of milestones would be permissible under the contract.
Most contractors are reluctant to accelerate progress or re-programme their works at their own cost unless compensating for their own inefficiencies. Insolvency of employers is a real risk. Hence, contractors may find it worthwhile spending more in the short term and accelerating works it their own cost to attain milestones earlier.
On major projects, where interim payments are of significant value, the 5% or 10% retention that is withheld from each interim payment can be expensive for a contractor. Unless the contractor has managed to pass that charge down-the-line to its subcontractors and suppliers, the contractor essentially ends up financing that portion of the works until substantial completion, and the end of the defects liability period, when retention sums are released.
An alternative to enable the release of retention sums at the interim payment stage is for contractors to offer a retention bond to the employer in exchange. As the only purpose of withholding retention from interim payments is to provide the employer with security for the proper completion of the works, an on-demand retention bond should suffice. Combined with a small discount in the interim valuation of the works, this approach may be a win-win for both the contractor and the employer. However, given the cost of obtaining such bonds (usually 1% to 2% of the sum secured by the bond) this mechanism will need to be commercially viable for the contractor to be attractive.
With specialist suppliers and subcontractors, contractors are often unable to pass down a pay-when-paid mechanism.
To reduce exposure in having to pay out to such suppliers before it has been paid by the employer, contractors can request employers to enter into direct contracts with the suppliers and supply the materials to the contractors as ‘free issue’ materials.
Employers are unlikely to want to take on this obligation without some quid pro quo. One concession for the contractor would be to forgo its overheads and profit on these materials in return for the materials being procured by the employer. The employer therefore gets a reduction in the price of the works. However, any such arrangement will need to be carefully structured so as to ensure that the warranty and liability chains for non-performance are properly arranged.