Why are construction payments so unique? The truth is that there is more uniqueness driven by tradition and habit than by necessity. Construction payments are fundamentally similar to many other industries. What they share is mode of progress payment and the need for validation and compliance documents that accompany them. With that in mind, the process and forms that have become the “norm” do work – just not efficiently.
AIA G702 and G703
By far the most common form for applying for construction payments is the AIA G702 and G703. Trademarked in 1992, the AIA Document G702, Application and Certificate for Payment, and G703, Continuation Sheet, provide forms on which the contractor can apply for payment and the architect can certify that payment is due.
In its foundation, the G703 lays out a detailed list of items with their respective contractual values. More commonly known as the schedule of values, this detailed list allows for progress updates on a periodic basis. The G702 is a summary of the G703 that incorporates information regarding previous payments. Not only does the G702 provide a payment summary, it also defines the total amount due for the period being invoices.
What is the Purpose of AIA?
The AIA templates were designed for contractors to update progress and submit for review by the developer or developer representative. After the reviewing progress and approval, a submission to the mortgaging bank is submitted to process their draw. In other words, release the next tranche of funds to the project. Today, the overwhelming number of AIA G702 and G703 forms exchanging hands are not between GCs and developers, but between GCs and their subcontractors. This increase is driven by the fact that you normally have 10x+ subcontractors for every one general contractor. Moreover, the GC’s role is more one of a consolidator. This means first validating that the subcontractor’s progress is accurately represented. Next it’s time to translate and include amounts due for their work, and value add for owner and bank submission.
Why Change?
Adding to the pain, AIA documents today are predominantly managed as excel spreadsheets that get emailed between subcontractors. With multiple updates, saves and varying degrees of computer literacy and GCs from all collaborators, organization gets a little messy. Couple that with the fact that you can easily have 10+ items in each subcontractor’s schedule of values – and in an environment that requires a GC to request, receive, review and approve updates on hundreds of items every month.
The subjective nature of the progress being reported results in frequent rejections and resubmissions, again via excel spreadsheet and email. You don’t need to be a mathematician to quickly realize that you have multiple dozens of spreadsheets. Each spreadsheet with hundreds of items. All exchanging hands and being consolidated in an effort to get accurate dollar numbers to be drawn from the bank.
Version Control
If you have ever consolidated spreadsheets, you are likely reading on in horror at this point. Version control becomes a fundamental risk. It very quickly becomes challenging to align on the final version that was agreed on in that draw period. Especially because balancing the risk of including the incorrect version is prominent and frequent. Furthermore, the process of updating these spreadsheets is manual and the formulas embedded are easily editable. Incidentally, values within the document are at risk of miscalculation or misrepresentation due to data input or faulty formula errors. In case my point is not blatantly clear, progress invoicing in excel is extremely prone to errors and misrepresentations.
With all that said, the AIA invoice and method is a great way of driving detail and transparency in the invoicing and payment process. As I alluded earlier in this document, it works, just not always well and never efficiently. Thankfully there are tools in the marketplace that have started to address this issue.
Relating to MX Build
Take our MX Build tool for example. The goal of these tools is not, and should not be to recreate and reimagine the output. We can all agree that the output, an itemized representation of the construction project with detailed progress by period, provides the required details to get the job done. By addressing the main shortfalls of this process via excel and email, efficiency and effectiveness of the process can be improved. An added bonus to this solution is that it will be more compliant, less risky and significantly cheaper. Sounds like a great deal to me!
Organizations will ultimately save time by reducing efforts of the finance or admin teams in charge of this process. In tandem, project managers and field teams that are working to approve progress reap the benefits as well. This allows the team to focus on more value add activities like ensuring schedules and quality standards are being met.
Progress Updates
Another key point to discuss is the process and method of updating progress in pay applications. It doesn’t matter if you’re using AIA templates or simple verse invoices, it’s often still challenging to define and agree with what’s owed in the terms required (i.e. dollars and cents).
Subcontractors and contractors will always want to get paid as much as possible, as quickly as possible. Unfortunately, the exact opposite is normally the case with the developer and bank on the other side. This creates a general tug of war. Contractors tend to overestimate completion, and developers push back in the opposition before finally arriving at a number.
Payment applications are frequently requested and created in advance of the stated completion date for that progress. In other words, lag created by the administrative process which goes into payments first by the GC. By then the developer and bank GCs often request progress updates as early as the 10th each month (possibly sooner). Progress updates are expected to be completed by the end of the billing period. This forces GCs and subcontractors to talk about progress, not in terms of what is complete, but in terms of what will be completed by month’s end – a mark which is frequently missed. Furthermore, it is often more practical to talk about progress as a percentage completion rather than a tangible completion milestone.
Let’s Take a Look in Real Life
How can you define partial completion of an electrician, for example? You can start with the lineal foot of cable laid. Then by looking at the installed equipment put in place. With the stage of completion, or even by segments in the construction, and so on. Point being, unless explicitly defined in contracts (which is excessive and impractical) one person’s 50% can easily be mistaken for a different number in someone else’s eyes. Coming to an agreement is subjective and a fundamental friction point in the whole process.
Finally, none of this takes into account the contractual terms that have been agreed upon for payment. Often they aren’t aligned with the actual progress or a value loaded schedule or payment terms. Take payment terms with subs that include a deposit and predefined payments depending on completion of milestones for example. Tasks with more and more demanding specificities are more challenging to overcome. In my business, our default bid was: 50% upfront, 25% upon completion of fabrication before shipping and 25% after installation. To state the obvious, this very frequently did not match the actual project completion that is sought from progress payments. It requires a level of normalization by the general contractor to maintain alignment with developer and bank, and at the same time the funds flow.
Compliance Documents
The core invoice document (AIA etc.) isn’t the only document that should be tracked. Tracking documents, benefits processing and minimizing the risk associated with the invoicing and payment processes.
For starters, let’s discuss the Certificate of Insurance and the W9. Everyone in the supply chain has an inherent interest in ensuring the completeness and adequacy of these two documents. Since these documents are gathered in advance, they’re essential before any payment can be made. Once payments are made, the incentive of the payee to observe compliance requirements is basically willful. Thus leaving the GC and the Developers exposed to unnecessary risk.
Ensuring the validity of these documents is an ongoing process, particularly with the certificate of insurance. This is due to the fact that coverage levels might decrease or even expire during the project. If and when this were to occur, it requires a refresh in documentation in order to ensure compliance.
Take it from us,
In my experience, the vast majority of general contractors don’t proactively review certificates of insurance. Often they themselves request an updated copy months after the expiration date. In the event of an accident, those periods could potentially result in the GC or the developer being held liable for damages that should have been covered by someone else.
The first worker’s compensation claim I was forced to file involved an installer that we hired for short term support at a job site. Within the first couple hours of working, he misstepped on a ladder and fell and landed on his elbow. The fall was short, he wasn’t even two feet above the concrete. Yet his fracture resulted in a whirlwind of damages. A trip to the emergency room, his inability to work for over two months and multiple subsequent doctors visits. Between lost wages and medical bills, the otherwise minimal accident resulted in a claim that approached $100,000, thank god for The Hartford!
Had it not been for our workers compensation insurance, that would have been initially our responsibility. In the event we were unable to cover the expense, the GC would have been responsible. In the event of the GC’s inability or lack of insurance coverage, the burden would fall on the property owner. This was all for a two foot fall. Imagine if, god forbid, someone died. All moral and emotional impacts aside, this could become a claim in millions of dollars exposing GCs and owners to real financial risk.
Lien Waiver
Likely the most unique contract to construction compliance documents is the lien waiver. For those not familiar with lien waivers or mechanics liens in general, here is the 1000 foot overview:
Mechanics liens rights are given to builders during the construction process- be it trades people or general contractors as a protection against default in payment. Like other liens filed against real property, mechanics liens are registered with local jurisdiction as a claim against that property. Consider practical terms, a plumber cannot go back to a house and dig up their plumbing if the owner of the property fails to pay once the work is complete.
This is an exceptionally powerful right given to builders that helps them collect payment. Mechanics lien laws vary from state to state and even from county to county. Through and through the fundamentals are largely the same.
Lien Waiver Operations
In most cases, the lien rights are granted all the way down to the second tier subcontractors. That is to say, even the contractors hired by your subcontractors are granted lien rights. For example consider the following situation: A plumber hiring a company for assistance in the job the plumber’s hired for. The plumber directly pays for this company to take care of concrete work required before they can step in. This concrete contractor would have a contract with a contractor hired by the general contractor.
Just to tie up loose ends, the general contractor is hired by the developer/owner. However, all parties illustrated are eligible to potentially file a lien on a property and have a claim against its title. Understanding the weight of its importance is its essential knowledge to have especially as a property owner. Despite being potentially 4 levels removed from the second tier contractor, the property owner can ultimately end up liable for this bill in order to clean up the title to their property.
Furthermore, mortgaging banks that hold the primary lien on a property have a significant interest in title remaining clean. Often they won’t accept real property collateral if the title contains any other liens, hence they will potentially stop funding a project in case of a lien, even if the lien is insignificant in terms of value against the property.
As such, there are three typical types of lien waivers that could be required for each project:
Conditional Lien Waivers
At the beginning of the process, lien waivers are submitted along with invoice submissions. These essentially state that if contractors are paid the amount in the pay application (also stated in the lien waiver) then they waive the right to file a lien for that amount due. Conditional lien waivers are then effective for a property owner to remove a lien. However they are only eligible if they are accompanied by proof of payment like a canceled check.
Unconditional Lien Waivers
Each unconditional lien waiver is normally collected after each payment. Each waver states that a certain amount has been paid and the respective pay application has been satisfied. In turn, the contractor waives their right to file a lien for that amount due.
Final and Unconditional Lien Waiver:
Lastly the final and unconditional lien waiver is requested at the end of the project. Normally, final and unconditional lien is accompanied by the payment for retainage. This waiver confirms that the project’s labor and material payments have been fully satisfied. The then contractor agrees they have no additional claims on the property from the work performed in that particular project.
Though fundamentals of lien waivers are consistent, the detailed requirements may vary from contractor to contractor and project to project. Slight variations are mainly driven by legal language required by local law and often dictated by banks or developers. Some projects require all three waivers, some only require only the unconditional and sometimes just the final. Some projects require notarized original signatures. Other projects are satisfied with a simple signature, or even an electronic one. Whatever the permutation might be, getting lien waivers correct is of utmost importance.
Sworn Statement
The last item I would like to discuss as it pertains to lien waivers is the sworn statement. This is a document that is often required by contractors, and sometimes subcontractors. This document outlines every party involved with the project within their contract, e.g. sub tier contractors, material providers etc.
As previously mentioned, subcontractor’s contractor often retain the right to file a mechanics lien in the event of non-payment. Remember, the lien may go on the real property. If so, the property owner could end up paying these bills to maintain their title clean. With this in mind, sworn statements are for property owners. It ensures that they have a proper list of everyone that could potentially file a lien against their property. When this accurate and complete set of lien waivers is received, and mitigates their risk of a lien.
Errors or inconsistencies can often result in rejected pay applications, in turn can delay payments for the entire project. Most general contractors attempt to follow a paid when paid practice (see below). An error or a missing lien waiver, for a small subcontractor, can imply the withholding of the entire project draw and result in delayed payments for everyone. In turn, errors that go unnoticed can potentially lead to owners taking unnecessary, and unwarranted risk that could prove costly.
All of this turns into a somewhat mundane task of collecting amounts to a glorified signed receipt. Then formatting them into a challenging logistical exercise that is required to be orchestrated on each monthly draw. Given the uniqueness in this process to construction, many contractors continue to manage lien waivers manually in spreadsheets.
Time for Change
As is thematic in construction payments. Spreadsheets are effective yet reactive and inefficient. Furthermore, spreadsheet trackers do not ensure the accuracy of submitted lien waivers. Tools that allow automation, both on the creation of the lien waiver, the signature and the tracking of completion are extremely helpful in waiver management. Companies often rely on eSignature platforms that can be extremely expensive. Oftentimes paying $5+ per document, which isn’t truly integrated into the invoicing process. We took a more holistic approach to lien waivers in our MX Build tool. MX Build has made this step native in the invoicing process. It allows subcontractors to fully execute a lien waiver document systematically, at the time of creating a pay application. Not only is MX Build removing the burden from the subcontractor, but also ensuring they get done properly.
Once the projects have been completed, and prior to releasing the final retainage payment, contractors often collect close out documents. These often differ depending on the project. Most often they include a final lien waiver, a sworn statement and a limited warranty. So, all documents that are normally required in the owner contract and thus normally feed into the subcontract.
Retainage
In order to ensure financial coverage, owners often retain a percentage of every payment that’s paid to the contractors and subcontractors. This cycle repeats until the very end of the project when everything has been satisfactorily completed. This is called retainage. Though retainage varies from contract to contract, the most common that I have seen has been 10%. This in turn means that only 90% of every payment request submitted will be paid. This also means that subcontractors who perform their work at the beginning of a project could be waiting on that last 10% for months or even years. In some trades, the retainage could signify the entire profit margin of a project and could be significantly delayed by no fault of the contractor.
Though this is often not a very flexible clause in a contract, it is important to understand the effects that this can have on a company’s cash flow. Therefore emphasizing that open conversations at the time of contract negotiations can be very beneficial in the long run. For example, I was successful on a few occasions. Based on the project schedule, I showed that before the due date we would be 100% complete with our work. Along with this I illustrated that withholding our retainage would mean that we wouldn’t see our final payment for months after our work was completed.
Instead, the contractor and owner decided we would agree to a 10% retainage, as was consistent with the other subcontractors. But, once our work was complete the general contractor and/or the owner representative had 30 days to highlight any issues. At this time is when our final payment would be due. Then there were other times where we simply had to wait.
Where to Take Note
One lesson to emphasize is the importance for detailed documentation and sign off of work at the time of completion. While providing finished carpentry, our furniture often sustained damage due to prolonged exposure to an active construction site for several months after completion. During the final walk-through inspection by the owner, all of this damage would come to light, leading to challenging discussions with the general contractor and owner due to the lack of proper CYA (covering your assets). More times than not, we were required to travel back to the project site and make costly repairs – that was not ours to begin with.
With that in mind, we became very proactive about advising general contractors to protect our furniture soon after installation. We even advised ram board and other protective materials and taking as many pictures and sign offs as possible.
Retainage is often where all the disputes in payments happen. It’s important to be proactive, transparent and over communicative to minimize surprises. Following these procedures will ensure that final payments will be performed in their entirety.
Paid when Paid
The concept of paid when paid can be fairly counter intuitive at first and has big implications to a subcontractor’s recourse in the event of non payment. Paid when paid is a common clause in general contractor contracts with their subcontractors that stipulates that the general contractor will pay the subcontractors within a predefined period of receiving payment from the developer. This means that if a GC does not get paid for work performed, they do not have a contractual obligation to pay the subcontractor for the work. It also implies that payment terms commonly found in vendor contracts can prove ineffective in construction, as the timing of payments often relies on the general contractor receiving payment, and delays are frequent occurrences that subcontractors have no control over.
Variation
The legality and enforceability of paid when paid clauses varies from state to state, some states like California simply do not allow them and others make it a timing clause whereas, even if the GC does not get paid, they are still contractually obligated to pay the subcontractor in a reasonable time frame. As such, I would advise contractors to consult their attorneys before agreeing to this clause if they are not clear as to the potential implications.
Finally, regardless of the paid when paid terms and enforceability, these are independent of a contractor’s mechanic lien rights which are the ultimate collateral for non payment. As I had a general contractor tell me the first time I was fighting a paid when paid clause, if we don’t get paid we will be marching side by side to the county office to file our liens which felt like fool’s comfort at the time but in reality is technically and practically accurate.
In addition to the basic timing of payments, subcontractor contracts often make reference to the owner contracts for multiple clauses and requirements, for example acceptance criteria. This said, subcontractors should request the language that’s being referenced that they’re agreeing to again, and speak to an attorney if they need clarification. Payment, and work acceptance are the most frequent sources of disputes. Contractors are best served ensuring clarity and alignment with all their trade partners.
Payment Management tools and enablers
In the context of this document, payment management encompases the entire life cycle of the construction payment, from the progress reporting by the sub, to the consolidation of the GC to request payment from the developer through the submission to the primary bank that will approve the funds and distribute them back down the chain.
The complexity of this process varies from project to project and between sub industries (residential, commercial and industrial). For example, residential work can be more simple when working directly with a homeowner. The reason is that shorter cycle subcontracts allow for a simple payment, while large infrastructure projects often come with complex compliance requirements imposed by the governmental agency funding the project. Whatever the requirements may be, there is a need to track pay applications, compliance documents and payments in order to continue moving the project forward while not taking on any unnecessary risk.
Tools with different levels of sophistication and connectivity help general contractors, developers and banks work through this process effectively. By far, the most widely used tool is a simple spreadsheet. As a finance nerd, I am a huge proponent of spreadsheets for many uses as it can be a very effective tool that is easy to configure and implement, however they are not effective for this use case. Spreadsheets are not great collaboration tools. Not only do spreadsheets not store documents, but the automation is limited. This said, most of the input will be manual and prone to errors.
Think about payment management tools in three main dimensions and core requirements:
- The single source of truth. Meaning to say, having a single information source that everyone works from.Version control was a fundamental challenge. This was my biggest challenge with the current process of excel, pdf and email. Ultimately we agreed to a pay app that was different to the one that the GC had agreed to. Finding documents for reference or dispute was messy and time consuming – Too many versions of a pay app with their lien waivers, without real clarity as to which one was the final one.
- Automation and proactive data validation. Independent documents, such as quotes, budgets, pay apps, lien waivers, and payments (including checks, ACH, etc.), frequently lack linkage between them. Though at the same time they contain substantially the same information. Variances between these documents happen frequently. This is a common source of disputes and misalignments amongst stakeholders. Therefore, companies must invest valuable time in reconciling and comprehending discrepancies on multiple levels to determine necessary corrections. A recent benchmark study by PricewaterhouseCoopers indicates that automation and behavioral change have potential to reduce finance efforts by 30-40%. Interconnected tools that allow GCs, Subcontractors and Developers to ensure consistency from bid to payment with tracked modifications.
- Compliance and document management. Last but not least, tracking and managing compliance documents is a tremendous challenge, and one that forced me to be very reactive. At any moment of dispute or misalignment, I found myself going through many emails just to validate and document my point. Having a proactive approach to managing documents saves companies time and effort – More importantly it ensures the right documents are available at the right time.This prevents them from taking on additional expenses from the document gathering process and more importantly can prevent them ending up on the losing end of a legal dispute.
One Last Look
Evaluation should be first and foremost a function of finding a tool that has features which allow your process to improve and make your employees’ lives easier. Next, yet probably the most important factor, should be tool sizing. The issue that companies often run into is that they take tools that are too big and complicated to give them value.
For example, taking on a project that is too big, companies struggle with end to end tool implementation. This goes well beyond setting up a tool and into the actual behavioral changes of their team that will allow them to get the full benefit. A common issue companies run into is struggling to get all stakeholders on board using the tool. As a result they struggle receiving any benefits. Larger companies with the appropriate IT infrastructure and implementation budget to experience the right change management protocols don’t experience this challenge. By far the biggest struggle I’ve heard of has been getting subcontractors to play ball.
Oftentimes, despite contractual agreements, subcontractors refuse to spend time using new tools. In practicality, learning a new tool and process potentially for single use and often to achieve a process that they already do successfully, be it in a more manual way requires more time and energy. Yet, the impact of the entire supply chain ecosystem should be top of mind to ensure robust adoption and long term success.
Features and Adoption
I’m a big proponent of the 80/20 rule with features and adoption. Think about your current processes in terms of ‘why?’ and modifications in terms of ‘why not?’ Most software developers endure robust market assessments, process design protocols and strive for the best in class processes and practices with their tool.
From my experience with system implementations, even fortune 500 companies often find that there’s no hard requirement to keep a process instead of modifying it to fit the tool. Let’s face it, we all receive subcontractor invoices and pay bills, the rest of it is more times than not a product of how our team has organized themselves.
In terms of adoption, find a tool that will allow you to automate and improve on the majority and deal with the exceptions, particularly when it comes to subcontractors. Remember you hired them for the value they bring to your construction project, so finding a way to work with them is imperative to your long term success.
