In contracts between owners and contractors or between prime contractors and subcontractors delays in payment are frequently a concern. In some jurisdictions, and for specific industries such as construction,a contractor or subcontractor may want to include the right by statute to stop or suspend work if they have not been paid. In jurisdictions where those types of statutes do not exist, the right to stop work for non-payment needs to be included within the agreement. Not paying on time may be a breach of the contract, but in most cases it would be considered a minor breach where only money damages could be claimed unless the delay is unreasonable. As a result a contractor or subcontractor could wind up continuing to invest more in the work and risk having to sue the breaching party to collect the money and damages. Many prime contractors have tried to implement “pay when paid” provisions so they don’t have to pay a subcontractor until the prime contractor receives payment from the buyer (see separate post on “Pay when paid”). That doesn’t do much to protect the subcontractor.
If I were the subcontractor I would want several things to protect me against the unethical owner or prime contractor. First, I would want to be paid interest on late payments so I’m not providing free financing to either the owner or prime contractor. Second, to deal with the issue of disputed amounts invoiced, I would want language in the agreement that in the event of a dispute in the amount of the payment, the other party may withhold only the reasonable value of the actual amount under dispute. That way they cannot withhold payment of an entire invoice. Third, I would want the right to stop work if any undisputed payment was more than thirty days late. Fourth if the work is stopped I would want to be paid any additional costs to start up the work and have the work be extended day for day for each day it was stopped for non-payment. Last, I would want the right to be able to terminate the agreement for cause if payment was more than sixty days late.
From a procedural standpoint I would add a concept that is frequently used in governmental contracts but seldom used in commercial contracts which is a show cause notice. No one likes to be surprised, and simply stopping the work without any advance notice would be just that. A show cause notice is similar to a cure notice and would provide the facts, remind them of your contract rights, and ask them to provide you with a reason why you shouldn’t exercise your rights. For example,
Invoice number 1234 was submitted for payment on October 1, 2012. In accordance with the terms of the contract EXCO was required to make payment on November 1, 2012. That payment was not received. Invoice 1234 remains unpaid as of the date of this notice. In accordance with Section 9.1.5 of the contract, in the event of payment is more than thirty days late (December 1,2012, SUBCO has the right to stop work for non-payment. This notice is to remind you of your payment obligation and put you on notice of our right to stop work if payment is not made by December 1, 2012. Please show cause why work should not be stopped if payment is not made by that date.
If you were not paid you could both stop the work and send a cure notice that they have breach the agreement for non-payment and the other party would have the cure period in which to correct the breach or be terminated and be subject to damages.
The unethical owner or prime contractor may not want to agree to this as it would take away their ability make money at the expense of their contractor or subcontractors. If an owner or prime contractor is ethical, agreeing to this language places no additional burden on them. They would already pay when they are obligated to pay.
Tuesday, October 2, 2012
Show Cause Notices and Cure Notices
One of the problems with contracting is the same terminology can be used in different settings and have a different meaning. For example a court issued show cause notice requires the recipient to appear before the court and explain why a certain action should not be taken. In business companies may use a form of show cause notice to place employees or other parties on notice that there has been a performance problem or misconduct that needs to be corrected. In government contracting a show cause notice may be a precursor to terminating the agreement where they want the supplier to explain why they should not be terminated.
In most commercial contracts companies seldom use the concept of show cause notices. Instead if a party is in breach of the obligations under the agreement they will issue what’s called a cure notice. Most commercial contract termination for cause provisions requires several things prior to being able to terminate. First there must be a material breach of the agreement. In drafting this clause to avoid any misunderstanding, the parties may agree what specific terms, which breached, would constitute a material breach of the agreement. Second, the non-breaching party needs to provide notice to the breaching of the circumstances of the breach. That notice is called a “cure notice”, Third, the breaching party will have the right to remedy or “cure” the breach within the period of time specified in the termination for cause
section. If the breaching party cures the breach, the non-breaching party cannot terminate the agreement as the breach has been cured. If the breaching party fails to cure the breach, the non-breaching party has the right, but not the obligation, to terminate the agreement for cause.
That doesn’t mean that a show cause notice cannot be used in commercial contracting. In fact is could be a preliminary notice that could be used to notify the other party that is something isn’t corrected within a specific period, that you would take a certain action or exercise a specific right. An example of that will be in my next post called “Stopping Work for Non-Payment”.
In most commercial contracts companies seldom use the concept of show cause notices. Instead if a party is in breach of the obligations under the agreement they will issue what’s called a cure notice. Most commercial contract termination for cause provisions requires several things prior to being able to terminate. First there must be a material breach of the agreement. In drafting this clause to avoid any misunderstanding, the parties may agree what specific terms, which breached, would constitute a material breach of the agreement. Second, the non-breaching party needs to provide notice to the breaching of the circumstances of the breach. That notice is called a “cure notice”, Third, the breaching party will have the right to remedy or “cure” the breach within the period of time specified in the termination for cause
section. If the breaching party cures the breach, the non-breaching party cannot terminate the agreement as the breach has been cured. If the breaching party fails to cure the breach, the non-breaching party has the right, but not the obligation, to terminate the agreement for cause.
That doesn’t mean that a show cause notice cannot be used in commercial contracting. In fact is could be a preliminary notice that could be used to notify the other party that is something isn’t corrected within a specific period, that you would take a certain action or exercise a specific right. An example of that will be in my next post called “Stopping Work for Non-Payment”.
Completion Types in Construction Contracts.
In construction contracting you may define and refer to three types of completion: substantial completion, final completion, and completion of the defects liability period. In many construction contracts to owner will retain a portion of each payment as a form of making sure that the contractor completes the work, or having those funds available it they need someone else to complete the work.
Contractors don’t like to have those funds, which may be substantial, to be retained any longer than absolutely necessary. From that the concept of substantial completion was created is used to allow the release of a significant portion of those retained funds. A common definition of substantial completion is the work is complete with the exception of a small “punch list” or “snag list” of items that still need to be corrected or finished. When substantial completion is certified by a third party such as an architect or engineer or agreed, the contractor will invoice for payment of the amount of funds or percentage to be released at substantial completion. The owner retains the remaining amounts as protection that the contractor will complete the remaining work.
Once all the defects have been corrected and all work is completed, if there is an architect or engineer involved they will issue a certificate of final completion. The final completion does two things. First, it allows the contractor to invoice the remaining amounts withheld, except for any amounts withheld for the defects liability period. The second thing it does is serve as the start of the defects liability or warranty period on the work.
The completion of defect liability period ends the buyer ability to make future defect claims. It does not end the contractors responsibility to correct defects that were identified during the defects liability period. If the buyer was retaining monies during the defects liability period, most agreement do not include anything similar to substantial completion for the defect liability period. The owner would have the right to withhold the remaining amount until the correction of all defects listed defects are complete. Depending upon the relationship, amount withheld, and the value of the defects remaining to be corrected, a Buyer may agree to release further funds and still withhold enough to correct the work if the contractor failed to complete the correction of the remaining defects.
The primary alternative to retaining funds is the requirement that the supplier provide bonds or guarantees given by a third party that guarantee performance by the contractor.
Contractors don’t like to have those funds, which may be substantial, to be retained any longer than absolutely necessary. From that the concept of substantial completion was created is used to allow the release of a significant portion of those retained funds. A common definition of substantial completion is the work is complete with the exception of a small “punch list” or “snag list” of items that still need to be corrected or finished. When substantial completion is certified by a third party such as an architect or engineer or agreed, the contractor will invoice for payment of the amount of funds or percentage to be released at substantial completion. The owner retains the remaining amounts as protection that the contractor will complete the remaining work.
Once all the defects have been corrected and all work is completed, if there is an architect or engineer involved they will issue a certificate of final completion. The final completion does two things. First, it allows the contractor to invoice the remaining amounts withheld, except for any amounts withheld for the defects liability period. The second thing it does is serve as the start of the defects liability or warranty period on the work.
The completion of defect liability period ends the buyer ability to make future defect claims. It does not end the contractors responsibility to correct defects that were identified during the defects liability period. If the buyer was retaining monies during the defects liability period, most agreement do not include anything similar to substantial completion for the defect liability period. The owner would have the right to withhold the remaining amount until the correction of all defects listed defects are complete. Depending upon the relationship, amount withheld, and the value of the defects remaining to be corrected, a Buyer may agree to release further funds and still withhold enough to correct the work if the contractor failed to complete the correction of the remaining defects.
The primary alternative to retaining funds is the requirement that the supplier provide bonds or guarantees given by a third party that guarantee performance by the contractor.
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