Masonry Magazine February 1982 Page. 37
New Methods for Construction Disbursements
By Thomas J. Barfield and Robert L. Wilkinson
The problems associated with the disbursement of construction funds are accurately and perceptively described by the authors of the following article. They suggest that the use of title companies in the payment process is a viable alternative to the conventional payment system. However, while they represent one point of view, readers should be aware that there are other solutions to the construction disbursements dilemma than going the route of the title company.
It has become increasingly evident that subcontractors and suppliers have much in common with construction lenders. Both have major concerns about the diversion or slowness in the movement of construction funds, but each of the groups has difficulty in dealing effectively with this problem. Their shared frustrations have led to reevaluation of conventional disbursement procedures and development of new construction payment systems.
Problems of Conventional Payment System
On most present construction projects, the funds advanced by lending institutions for job progress payments go through many hands before reaching trade contractors and suppliers who performed the job-site work or supplied the material for which the money was advanced. The parties in between may include owners, developers, construction managers, general contractors, prime specialty trade contractors, and upper tier subcontractors. At each point along the way, there is jeopardy that the funds will be used for purposes other than for compensation to the firms entitled to payments. The temptation for diversion or for slow payment has been increased by spiraling interest rates and the far greater use by general contractors of specialty trade subcontractors to perform work previously accomplished by the contractors' own work forces.
The conventional payment system has other weaknesses. Subcontractors and suppliers have only limited opportunities for determining the amount of money advanced to cover each of their payment requisitions. The specialty trade firms have no contractual relationship with the owner or lending institution for a construction project. As a result, subcontractors and suppliers can obtain payment flow information from the source of funding only by going over the heads of their customers and thereby risking serious animosity. Even then, there is no assurance that such information would be furnished. Thus, contracts between trade firms and lending institutions are few and far between. In fact, subcontract language often prohibits or discourages such contacts.
Similarly, banks and other construction lenders are generally reluctant to contact the construction trades. Few lenders verify directly the payment flow and in many instances do not even know which firms to contact. There is also a problem in knowing what questions to ask since many lenders are not familiar with the day-to-day details of construction. Lenders are also reluctant to make such inquiries because their questions may be viewed as expressions of distrust by the owners and general contractors involved.
Factors Contributing to Pressure on the System
Accordingly, the conventional payment system inhibits communication and places a heavy reliance on the integrity of the parties in the construction process. Further pressure is placed on the system by such factors as:
* General and other prime contractors may elect to use different values for the various portions of the work in their requisitions than those represented by the amounts of individual subcontracts or orders for those trades.
* Project-wide retainage may be reduced by the owner in payments to the general contractor and others having direct contracts. However, those contractors may feel no legal or moral obligation to pass the retainage money along to their subcontractors or suppliers.
* Many subcontract agreements have "pay-when-paid" provisions. Unscrupulous contractors use these provisions as an excuse for not paying subcontractors' requisitions promptly even in those cases where money was received by the prime contractor. Also many contractors do not pay subcontractors for work that has been satisfactorily performed when contractors have not been paid for reasons totally unrelated to the unpaid subcontractors' performance. These improper failures to make timely payments are possible because of the communication difficulties mentioned earlier.
The net result is that construction subcontractors and suppliers are often paid at a slower pace than the rate at which lending institutions advance funds for a project. This, in turn, causes unnecessary job delays, disruptions, and liens. The lender may even have to pay twice for the same work.