Security of payment in Canadian construction projects It has been said that money is the blood of the construction industry. There are four basic elements of a contract to be enforceable by the courts: an offer, acceptance, intention, and consideration. Consideration is ‘either some right, interest, profit, or benefit accruing to the one party, or some forbearance, detriment, loss, or responsibility, given, suffered, or undertaken by the other’ (Currie v. Misa (1875), L.R. 10 Ex. 153, at p. 162). Each party to the contract must receive consideration. In a building construction contract, the owner gives the primary consideration, which is the promise to pay the contract price in exchange for constructing the building (Samuels B. & Sanders D., 2011). This article highlights common types of contracts and reviews the payment application process and available options for the security of payment in the Canadian construction industry. Types of contracts: Contractors and other partners in the supply chain in the construction industry naturally would like to be treated fairly and receive agreed-upon prices. As payment is the prime mover in any business, the contract drafting and reviewing processes are essential. Contracts allocate risks to each contracting party; these risks are managed differently depending upon the contract type. Building construction contracts can be stipulated contract price, unit price, cost plus, or standard forms of contracts. Under the stipulated contract price, the contractor agrees to execute the construction work for a fixed, lump sum price. If a contractor underestimates some work items, it will not be entitled to any extra money. As a result, in the absence of contract changes approved by the owner, the contractor will eventually receive only the stipulated contract price. Changes during construction are a significant source of cost overruns. Hence, for this type of contract it is important that the scope of work is clearly defined; the specification is well detailed and free from contradictions; the agreement and contract clauses incorporate lessons learned in the industry; and a cost breakdown is well detailed to show the inclusions and exclusions. Although it is good practice to use a standard form of contract, every project has its own special requirements, meaning that special conditions have to be well written. Under the stipulated contract price, progress is measured on the basis of percentage of completed activities and/or quantities of work completed and materials delivered to the site. Under the unit price contract, the contractor performs the work for pre-determined unit rates for each work activity/ item. Because of uncertainties in the total quantities of work, the final contract sum usually is finalized at the end of the project based on field measurement of the actual work CLICK HERE to return to Table of Contents
performed. The owner bears the risk of the project cost being higher than its budget, whereas the contractor bears the risk of the accuracy of its fixed unit prices. A significant source of cost overruns for unit price contracts is errors in the estimated quantities. The cost-plus contract approach is subdivided into two types of contracts: cost-plus/percentage fee, and cost-plus/ fixed fee. Under the cost-plus/percentage fee contract, the parties agree that the contractor will be reimbursed the actual direct costs of doing the work, as well as a specific percentage of that cost for overhead and profit. This is one of the types of contract that requires an increased amount of bookkeeping. The cost-plus/fixed fee contract also is paid on a direct cost basis, but the overhead and profit is paid as a pre-agreed, fixed fee. The contracting parties can use standard forms of contracts or ad-hoc (bespoke) contracts. The main advantages of using standard form of contracts are: – The contract is developed by a wide range of industry experts, which ensures fair allocation of risks among the contracting parties. – Stakeholders are familiar with the contract’s general conditions, which can save time during the project phases, especially initiation phase. – Courts have tested standard contract clauses, so it is easy to find comparative case laws that allow the parties to understand the courts’ interpretations. The types of contracts discussed above display the requirement for a contract team to carefully consider the appropriate type of contract for a given project. Contracts are not to be one-size-fits-all; rather they must be tailored to the specific needs and requirements of each client and their project. Payment administration and process One of the main features of a construction project is that it is of a temporary endeavor; duration depends on the complexity and nature of the project. Some projects may take a few days while other projects may take years. Contractors, subcontractors, suppliers and others who are involved in the supply chain cannot survive without consistent cash flow. A construction corporation could go out of business due to lack of cash flow. Therefore, it is not unusual for those who are included in the construction industry supply chain to have their work progress payments on a monthly basis. Conditions of the contract stipulate the payment application process. For Instance, part five of the Canadian Construction Document Committee CCDC-2 Stipulated Price Contract, stipulates the procedure for contractor payment application. Clause 5.2.4 Winter 2018 | www.ciqs.org | CONSTRUCTION ECONOMIST | 21
