Cash Flow Crunches: How to effectively address disputes and claim issues efficiently and amicably
What do I do when I’m not getting paid on my project? Or, depending on your perspective: what do I do when my contractor or subcontractor is demanding payment and is threatening to walk? Our discussions of recent court cases illustrate the strict, theoretical legal rights and obligations of contracting parties. However, being “right” or having a “right” does not address the cost, time, frustration and inefficient use of other resources the owner, general contractor and subcontractors suffer when a dispute or claim, large or small, arises on a project; by the time one party is proven “right”, cash flow will have dried up, cost exposure will have escalated and the project (or at least work) schedule will be behind. While a retrospective commentary on commercial construction and site practices might be interesting, it does not solve or even really address the issue. So, what can you do? Below we discuss two options, one being the more traditional approach of stopping payments and filing liens, the second being what we view as an alternative approach that is more cost effective and project-completion oriented for all parties. Using the example, our contractor and owner could have collectively saved $48,000 on a claimed change order of $500,000 and prevented an escalation to trial. We also propose another project operation approach that would have saved them even more, around $53,000 and less schedule disruption. The Example Facts: The general contractor (“GC”) has engaged a subcontractor (“Sub”) for steel work on a power-generating station and a total subcontract cost of $5 million. The scope of work was set out in a standard form contract (e.g.: CCDC, CCA, ACA, owner custom form) and set out the major portions of the work. During early construction, GC is drilling a piling and strikes an underground boulder that requires the piling to be moved and necessitates a few design changes. The change requires Sub to wait eight weeks beyond his originally expected mobilization date (also pushing some work into cold winter months) and requires it to use about 15% more material than was originally included in its fixed-price agreement and its labour costs will also increase. The major portions of the work as set out in the contract and to be performed by Sub have not changed. Sub indicates to GC that it can still do the work, but it is going to cost GC more and submits a change order request to GC for approximately $500,000. GC has a turn-key, fixed price agreement with the owner and the owner has refused to pay any more for the project. If Sub was to walk now, the project schedule would be pushed back another four to eight weeks and the schedule is already behind. Communications between Sub and GC break down. A couple of letters go back and forth between them. And then what? The Traditional Approach: Withholding Payment and Liens Generally, the traditional approach is for GC to deny any further payment is owed, which results in:
Sub engages legal counsel, who then drafts a demand letter and files a lien on the project (say external cost of $2,500);
The Owner and, in turn, GC, have their respective financing placed in jeopardy and scramble to have the lien removed, engaging their own legal counsel.
The two lawyers go to court to get the lien taken off and, either, money is paid into court indefinitely or a lien bond that exists as a liability on the principal’s balance sheet sits open indefinitely.
The two lawyers might argue about the amount of the lien, requiring more legal work and a contested court application (say external cost of $6,000-$10,000);
Now, Sub and GC aren’t communicating well and are hostile, or maybe Sub is no longer even on the project. Their respective counsel go to work using various procedural court rules and rules under the Builder’s Lien Act to prove the lien and produce and review documents. A lot of documents are reviewed: each party’s entire project record to the extent it relates to the subcontract work is reviewed (say collective external costs of between $70,000-$100,000 if an Application to Declare Lien Valid is brought or the parties have produced documents and attended questioning on those documents). At this point, Sub and GC now have a fairly good idea of the other party’s position. Both lawyers have each looked at the same documents, both have researched the same legal databases and both have drafted long, expensive legal memorandums that provide an assessment of their respective client’s position. The Sub and the GC have submitted their “buy-in” amount of between $78,000-$113,000 (we will generously call it $78,000 for this example) so that they can start negotiating on an informed, reasoned basis. Note that $500,000 was the potential pot and 15% of that is now gone. Finally, Sub and GC do not reach an agreement and go to trial, with a cost of two or more years of distractions, resources, legal fees (through trial could double or triple the above costs), expert fees and any potential of salvaging a relationship in a small construction world. And the result? Considering that each party is confident of its position and had a massive buy-in to escalate the claim, one would think the potential upside is huge (in this case $500,000). Sadly, the claim and the dispute were not clean cut and there were problems with each side’s claim and defence. GC “won”, but was subject to a set off for additional work actually performed and required of approximately $300,000 in favour of Sub. Since a party normally only receives reimbursement for about a third to a half of its legal costs, GC “won” and had a net victory of $15,000 or 3% of the actual amount at issue (calculated as: $500,000 +$43,000 in costs award, less $300,000 set off, less $75,000 in initial legal fees and $150,000 in ongoing legal fees). This is one option. Below is another option, an option we strongly advocate for the vast majority of disputes. A New Approach: Focus on Your Business and Project First, we are not suggesting that it makes sense for either side to “just pay” when there is a legitimate disagreement between the parties. We do, however, suggest that there is a more efficient and better way. Apart from lowering each party’s costs and the goal of substantially faster resolutions, our approach could also be preventative for future issues, set the expectations of both parties and keep communication open at the outset of the project, avoid one party feeling like they have been “taken for a ride” or “scammed”, maintain a level of trust between the parties and preserve their relationship for the current and future projects, as well as an ongoing development and increased knowledge base for the project personnel on commercial matters. Engage an independent project dispute counsel: The starting point of the parties’ rights and obligations is a contract and the legal right to payment will be defined by contract law, the Builder’s Lien Act and evidence. In our above example, the GC and Sub crystallized their disagreement on their respective rights and obligations around the time when the Sub indicated that the cost and time to do the work was going to increase. Instead of each having gone and started their $78,000 investment into a crap-shoot and becoming entrenched in doing so, we suggest each party spend substantially less upfront and receive a comprehensive assessment of their positions, along with direction and identification of the crux of the issues between them. Remember: GC and Sub don’t agree with one another, but their legal entitlements are determined in contract law, the Builder’s Lien Act and evidence. An Independent project dispute counsel (IPD Counsel) will work with both GC and Sub. IPD Counsel are not mediators or arbitrators. They will make a legal assessment and quantum of the claim being made, then point out the issues that each side faces. They will review both sides' relevant documents, but can then also ask both sides questions about the documents. IPD Counsel will engage, in a meaningful way, each party on their strengths and weaknesses and make a recommendation as to settlement based on their application of the contract, the law and the evidence that exists. In this example, the amount of work that goes into the traditional approach to get to the same fact-sharing and discussion points was $78,000. With IPD Counsel, GC and Sub only have one collective cost, which immediately cuts their respective costs in half. In addition, Sandquist Law & Construction Project Consulting has generally lower rates than many full-service law firms and can offer both a lower cost and fixed costs on this type of service. GC and Sub in this instance could have expected to each pay around $13,000-$18,000 instead and would be keenly aware of the issues and strengths each party faces, something each would have had to spend a considerable amount in cost and resources to get anyway. They now also have a very strong foundation for determining reasonable settlement numbers and discussions if they chose to take the IPD Counsel’s recommendations and continue negotiations on their own. During the resolution process, Sub and GC can continue their project with the knowledge that their dispute is being addressed expediently and as a business issue, not a personal one. Engage a project consultant or independent project consultant: There are intervening steps along the way to a dispute that, if taken, would have prevented a disruption to the project and work entirely. We recognize that in a world of tight margins and impossible schedules there is reluctance and caution to something that is “not in the budget” or is perceived as possibly adding “more work” or too many processes. We do not suggest simply implementing policies or adding unnecessary costs. Rather, we suggest a dedicated resource that takes the commercial aspects of a construction project and lays them out in a simple, easy to understand manner for all parties involved at the front-end of the project to prevent excessive costs on the tail-end. An independent project consultant acts for both parties, answering questions, providing clarity on rights and obligations and identifying where the parties do not seem to be aligned; it can prevent both a legal and operational dispute before it occurs. A project consultant could also be engaged by one party only and act only for that party. Either method means a relatively minuscule additional project cost included at the front end that will provide a readily available resource to identify, prevent and assist with issues from project commencement onward. Good project counsel is also expected to take an active and pro-active role in the project, doing more than providing templates and making “policies". To name just a few areas in which project counsel or independent project counsel can assist:
At bid or request for proposal stage, define the work to be performed in a way that minimizes language and descriptions that are often the beginning of a major dispute at a later project stage;
Clearly set out any excluded work or costs;
On-site or in office training for project personnel that relate to commercial matters, understanding and reviewing the project contract and identification of key contractual requirements at the outset of the project;
At or before work commencement, create an easy reference list of everything that will be required for payment, including the owner (or general contractor) invoicing procedures, coding etc.;
In developing and using a standard, agreed form for change orders, payments and other administrative functions;
At work commencement, determine whether the status of the project as a whole and site conditions are the same as what is reflected in the provided schedule for that specific work scope – if it is not, start addressing that at work commencement, not in a claim months later;
At work commencement, make a list of everything that could require notice to the owner (or general contractor) - discuss that list collaboratively. A subcontractor may not know that the general contractor needs to meet notice obligations or will face a denial of payment from the owner, possibly supported by the law;
If a dispute, claim or slow payment does come up, keep communication open and give written notices in writing that something has occurred. These notices do not need to be vindictive or mean-spirited; the notices are simply letting the other party that something has happened or could be happening that will have consequences; and,
On an ongoing basis, in reviewing the commercial aspects of the project with the project team and identifying potential issues early before they become major issues.
Looking at our unfortunate GC and Sub above, the independent project counsel could have been engaged at the moment the Sub knew he was going to be delayed. Better yet, if the Independent Project Counsel was engaged on a fully retained basis for the project, he could have assisted GC in identifying, working through and minimizing the effects that striking the boulder was about to have on the GC’s work directly, as well as all of its subcontractors including Sub. The cost? In this example we would expect a fully retained Independent Project Counsel to cost the project as a whole around $25,000, which can be anticipated at the early project stages and add a preventative, cost-saving and schedule protection resource throughout the project lifecycle.
We at Sandquist Law pride ourselves in our pragmatic and value-driven alternatives to our clints' business and would welcome the opportunity to discuss with you how we can help.