Some contractors can afford to finance multiple projects at a time and weather the impacts of payment delays during claims resolution. However, for those contractors that do not have the same margin for error, all it takes is one problem project to set into motion a series of unfortunate events that ultimately leads to financial distress.
Traps for the Unwary: Changes & Delays
While contractors assume that there will be changes and potential delays during the course of any construction project, these possible changes can vary based on the complexity of the project, whether it’s new construction or rehabilitation of existing work, the project’s coordination needs, etc.
Since there are few ways to effectively mitigate against this uncertainty, and with contractors reluctant to build too many contingencies into their bids to account for such risk, the next best option is for contractors to diligently comply with the contract terms to preserve the right to be paid. Two of the most common “surprises” are changed or extra work and delays and disruption to the progress of work. The impact of claims made under these clauses are a frequent source of cash flow problems.
Changes Clause
When a contractor encounters changes on a construction project, the first step is to identify whether additional compensation is available for the extra work associated with the change or if it is covered by the scope of work under the original base contract.
An owner will have the right to unilaterally identify additions and changes that will increase the scope of a contractor’s work in exchange for additional compensation according to Article 7 and §15.1.3.1 of American Institute of Architects (AIA) Document A201TM – 2017. However, most contracts place the onus on the contractor to notify the owner within a short timeframe as to the existence of the changed condition that the contractor believes to be out of its base contract scope and request compensation for such work.
The relevant contract may also require the contractor to maintain specific time and materials and other cost records in connection with the performance of such changed/extra work as noted in §7.3.4 of AIA Document A201TM – 2017. Both the notice and recordkeeping requirements are strictly construed, and a failure to comply can be fatal to a contractor’s ability to recover its costs.1
At best, a change order is negotiated, a fair price is agreed upon between the contractor and owner, and the change order is approved before the contractor performs any extra work so that the contractor can perform and bill for the additional work in the normal course of contract administration.
At worst, a contractor performs the extra work before it has been formally approved as an amendment to the contract and risks being denied a request for compensation for such work. If the contractor does not pause to make sure that it is complying with the contractual notice and recordkeeping requirements for extra or changed work, then it risks waiving its right to recover the cost of that work.
However, the best-case scenario is less common. Even where the contractor is fairly compensated for the cost of the extra work, there is frequently a delay in approval and payment such that the contractor winds up financing the cost of the work for some period of time. If the request for a change is denied after the work has been performed and the contractor has financed the work with its own funds, then the contractor is left with the claims procedures within the contract to dispute the decision to deny compensation.
This often involves multiple levels of administrative review and can ultimately result in the commencement of a legal proceeding to recover the value of the work performed. While changes on a construction project can manifest in a variety of ways, the common thread is that extra contractual changes often lead to financial impacts to a contractor.
Delay Claims
When a contractor encounters conditions causing delay on a project, it is also required to provide notice of the condition causing delay and potential costs stemming from such delay within a short period of time, with recurring updates regarding ongoing costs as presented in §15.1.3.1 and §15.1.6.1 of AIA Document A201TM – 2017. Failure to do so will bar a contractor’s right to recovery absent a favorable court ruling. However, even strict compliance will not expedite recovery for delay costs as substantial project completion is often required to quantify the full impact from, and seek compensation for, delay claims.
As a result, the contractor is forced to finance its time-related damages throughout the course of the project. For a contractor with subcontractors and suppliers that are unwilling or unable to do the same, the financial impacts are exacerbated; contractors may seek to close out with their subcontractors and suppliers to maintain those relationships and can be left to pursue the recovery of delay costs from the owner.
Moreover, many contracts have no damages for delay exculpatory clauses, which either provide for a blanket prohibition on delay damages or limit the recovery to specifically enumerated causes of delay and cost categories.
While there are common legal exceptions to blanket prohibitions on delay damages in many states, these hurdles typically require a contractor to incur additional costs for consultants and lawyers to prepare a delay claim for the owner before they can be compensated for their time-related damages. Whether resolved through litigation, alternative dispute resolution, or on an informal basis, the contractor will likely be required to expend additional time and resources to prove its entitlement, quantify its claims, and overcome the owner’s contractual defenses to payment.
Given the strict contractual requirements, contractors must be diligent in providing timely notice and monitoring their costs. Best practices at project inception include having in-house or outside counsel review the contract and prepare a “cheat sheet” for the field personnel that identifies the:
- events requiring notice under the contract,
- time for providing such notice, and
- required contents of the notice, including whether there is a requirement to maintain specific types of cost records.
Impact of Delayed Payment on Credit Relationships
When work is performed outside of the normal monthly requisition process, there will be inevitable payment delays — even where a contractor diligently complies with all contractual notice and recordkeeping requirements. Depending on the size of the construction operations and the magnitude of the delayed payments, the contractor may experience liquidity constraints that impact credit relationships with its key credit providers, such as the bank and surety.