Brookline, MA – A depression in the real estate market and the failure of several financial institutions has led to tighter lending practices and greater interest on the part of banks with regard to the security that they hold. While this economic situation has made the financing of construction projects more cumbersome, it has, perhaps, brought about a return to what is good standard construction practice regarding payment control. The purpose of this article is to highlight those payment control practices and illustrate how they can lead to a successful construction project.
Assuming that proper financing has already been put into place, the construction of the project is, in essence, a continuing exchange of money for additional collateral. The financial institution is lending to the project based on the addition of new value from the contractor and subcontractors in the form of work in place. As the contractor and subcontractors put this work in place it is transformed from goods and services into real property over which the lender generally has a security interest. Given that this rather simple exchange is the basis of construction financing, we can avoid problems by recognizing potential stumbling blocks in the exchange. This article classifies those stumbling blocks into two general categories; valuation and flow.
Valuation
As an initial matter, it is important to place a proper value on the aforementioned money for collateral exchange. This is true from the viewpoint of any of the four standard players in a construction project; lender, owner, contractor, or subcontractor. Each of these parties has an interest in making sure that the value of work in place is equal to the amount paid or lent. The best construction practice to ensure this proper valuation is to obtain detailed cost estimates and schedules of values prior to the commencement of construction activity. Without an accurate schedule of values the parties have a limited ability to make sure that the work in place requisitioned for each month is equal to the value of money distributed pursuant to that requisition. Diligently adhering to an established schedule of values, which is backed by cost estimates, is critical in avoiding overpayment and/or underpayment for the services rendered by contractors and subcontractors.
it is critical that proper documentation of valuation be obtained and that the lender, owner, architect, or an independent construction manager check those documents against requisitions and the work actually put in place on the project. Where construction projects are continuously changing in size and scope, these valuation checks need to be done with respect to both the original contract and any subsequent revisions to the work. Keeping an accurate eye on the value of the work put in place will go a long way in avoiding other problems with the flow of money on the project.
Flow
If valuation is performed incorrectly, the flow of construction financing can be easily disrupted. One of the most common problems occurs when insufficient funds are released based on the valuation of work put in place or changes to that scope of work.
A complete stop in the flow of financing, at any level, usually results in snowballing and a potential for catastrophe. When the flow of financing to a subcontractor completely stops that subcontractor typically takes actions in the form of a mechanic’s lien to protect its interests. These mechanics’ liens then further restrict the flow of construction funds where they are an encumbrance to the lender’s security interest and the owner’s property interest. Thus, one interruption in flow farther down the contractual chain can result in the entire flow of construction funding for the project being cut off.
The most basic and standard construction industry tools that should be utilized to monitor the flow of funds are the “payment affidavit” and the “lien waiver.” They provide documentation of what has been received and paid by the various parties to the construction contracting chain.. Contract documents should provide for the monthly submission of amount specific payment affidavits and lien waivers for each party that is receiving and distributing funds according to its requisitions and schedule of values. These documents must be completed on approved forms tailored to the project that are dated, executed, and notarized by persons authorized to act in that capacity. This is particularly true where times in the construction industry are tight and the temptation to take funds from one project for use on another can be overwhelming. It is only through the use of these types of payment controls that one can make sure the funds being released on a project are being spent on that project and that they are flowing to the party that deserves them.
The payment controls mentioned in this article are just a sample of the basic tools available for monitoring the funding of a construction project. However, if used diligently and in the correct way, even these simple tools will go a long way in avoiding problems on your next construction project.
Mel Nash and Ross Wecker are attorneys engaged in the practice of Construction Law. They are partners in the firm of Nash & Wecker LLC located at 1330 Beacon St., Brookline, MA 02446. Phone: (617) 264-9998. Web address: www.nashandwecker.com
