Security of payment in Canadian construction projects

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 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

directs the contractor to prepare a schedule of values that is to be approved by the Architect in advance: “The Contractor shall submit to the Consultant, at least 15 calendar days before the first application for payment, a schedule of values for the parts of the Work, aggregating the total amount of the Contract Price, to facilitate evaluation of applications for payment . ”

Likewise, Clause 5 .1 .2 of stipulated price subcontract – Canadian Construction Association states that: “The Subcontractor shall submit to the Contractor, at least 20 calendar days before the first application for payment, a schedule of values for the parts of the Subcontract Work, aggregating the total amount of the Subcontract Price, so as to facilitate evaluation of applications for payment”

Schedule of values

Unbalanced schedules of values/Front-loading schedule of values A schedule of values is a breakdown of the work components with an estimated value assigned to each element . The contractor is required to coordinate with subcontractors to secure their work schedule of values . Subject to the consultant’s approval, this document is the basis for the contractor’s payment applications .

The key base document for the payment is the schedule of values . It is good practice that the consultant spells out the format, supporting documents and level of details required, before the contractor’s first application for payment .

To reduce the risk of overpaying the contractor and subcontractors, the schedule of values must be as accurate as possible, and it is subject to the scrutiny, challenge, and finally the approval of the consultant . If this schedule were frontloaded, the contractor and subcontractors would receive their payments in advance, which would be unfair to the owner . A contractor who front loads a schedule of values (for contract work) may attempt to convince the consultant approving such schedule that the monthly payments are interim by nature and that the contract sum cannot exceed the stipulated price at the end of the project . This is a biggest risk of a front-loaded payment schedule . Although it is interim, it increases the potential for disputes . It is important to highlight that as long as the project goes well, all parties are happy . However, if for whatever reasons a dispute arises in the project, all parties will refer to the contract . It is essential that the monthlycertified payments are in accord with the actual progress of work on site because, if for any reason the work is suspended or the contract is terminated, the owner should not be found to have overpaid the contractor . Ultimately, the owner will be reimbursed for the overpayment from the performance bond .

It is worthwhile mentioning that the payment application includes the value of the work performed to-date, the material procured and delivered to the site, and any agreed percentages, change orders, and change directives . There is a distinct difference, however, between payment application and contract-adjusted price, which does not include change directives . Disputes on these items definitely affect the amount of payment certified . The skills and knowledge of the consultant reviewing the schedules of values are essential to ensure the integrity of the payment certification process .

Current Security of payment under the contract and the law

The success of a construction project depends on the timely flow of money from the owner to the general contractor and subsequent parties involved in the project . The time frame for the payment process is usually provided in the general conditions of contract, and particularly in the payment provisions . It starts with payment application to the consultant, where the consultant has a specific time set to review and certify the payment to the owner . The owner thereafter will release the payment to the general contractor, within a contractual set timeframe . To ensure the payment flow between the parties involved in the construction industry, there is a combination of legal and contractual requirements, which, if satisfied, will reduce payment problems in the construction industry . They are as follows: – A Builders’ Lien provides protections for the general contractor, subcontractors, and suppliers performing work on the land .

Delayed payments to any of the aforesaid, provide the right to hold the land until payment is received . It is not a direct process to register a Lien, and it doesn’t guarantee payment (Ross McLennan, 2012) . In compliance with the construction lien, the owner is usually required to retain 10% of the total value of work performed and materials delivered to the site as a holdback; this is not a penalty . The holdback can be released after the issue of a certificate of completion by the consultant and receipt of a statutory declaration, usually within 90 days of publishing the project’s completion in a newspaper . – A further provision in some standard forms of contract is a requirement for the owner to provide evidence to the contractor that it has the financial capability to fulfill its payment obligations under the contract . – A contractor may transfer the risk of delay in the payment process to the subcontractors by incorporating a pay-whenpaid provision . If the payment clause is worded clearly, it means that the owner’s payment to the general contractor is a condition precedent to payment to the subcontractor i .e . the subcontractor has no right to be paid until the contractor receives the corresponding payment from the owner .

Canadian courts have been inconsistent with their judgments concerning this clause (Cardinal Contracting Ltd. v. Seko

Construction (Vancouver) Ltd., 2017 YKSC 51) . Furthermore, the contract usually stipulates that the contractor is obligated to submit a statutory declaration to confirm that all payment obligations incurred by the contractor and subcontractors have been satisfied . The primary purpose of the statutory declaration document is to ensure that all due payments to the entities involved in the execution of the project are paid .

It is worth mentioning that is not always required by the contract to submit the statutory declaration with the progress payment . For example, in CCDC Conditions of Contract, it is required to submit the declaration form with the progress or final payment application .

The main principles of the new Act are a prompt payment regimen together with a mandatory adjudication process. The aim is to establish an efficient mechanism to ensure that money flows down the contracting chain.

– A security provision in the contract is the contractor’s right to suspend the work or terminate the contract if the owner fails to pay the contractor (conditions and precautions apply) . – A Labour and Material Bond, which is a guarantee that the prime contractor will pay the subcontractors if Bond conditions are fulfilled . The Bond conditions include an allowance for the claim to start 90 days after the date a subcontractor or supplier supplied or performed material or labor to the project in addition to notice requirements .

The main challenge is the process and proving the claim is time consumer . – A Performance Bond is another protection tool, which protects an owner financially if the main contractor failed to complete the work, by financing the value of the remaining works up to the bond value . It is common for an owner to request the Performance Bond, and Labour and Material

Bond on a project . Despite the above-mentioned measures, we still face problems when it comes to payment flow . Therefore, as available in other parts of the world, Ontario has introduced its new Construction Act, which received Royal Assent in December 2017 . The main principles of the new Act are a prompt payment regimen

About the author

Mahmoud Bader, MSc ., P .Eng .,PQS, LEED G A, PMP, is an Engineer and Quantity Surveyor with more than 15 years of experience in design/ construction management of sustainable built environments . He has worked on variety of complex and innovative projects, focusing on commercial, residential, and water pipelines . Moh is registered with APEGA as Professional Engineer and registered with Canadian Institute of Quantity Surveyors as PQS, certified as Project Management Professional and LEED G A . He works at NAIT as an Instructor in Bachelor of Technology in Construction Management . He also recently incorporated a company in Alberta: Beam Engineering & Construction Management Consulting Services Ltd .

together with a mandatory adjudication process . The aim is to establish an efficient mechanism to ensure that money flows down the contracting chain .

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