Managing Payment Delays on International Construction Projects






                  Practical Steps
                  How to Avoid Delays and Delay Claims on Wind Power Projects

                  Renewed Commitment
                  Energy Policy Act of 2005: How It Affects Hydrogen Production, 
                  Technology and Use

                  But Must Apply Now
                  6-Month Grace Period Granted to Some for Californias New 
                  Mandatory Electrician Certification Program

                  No Exception to Contract
                  Liability Limitation Held Enforceable Despite Owners Breach 
                  of Duty of Good Faith

                  Contract Omission
                  Montana School District Faces Liability to Workers for Failing 
                  to Require Contractors to Comply with Prevailing Wage Laws

                  Mechanics Lien Fails
                  Design-Build Contractors Lien Rights Under California Law 
                  Left in Doubt When Construction Does Not Begin

                  Contractor Options
                  Managing Payment Delays on International Construction Projects

                  Attempt Is Enough
                  Misleading Report by Engineer Held to Be Professional 
                  Misconduct

                  Insufficient Evidence
                  Federal Contractor Cleared of False Claims Act Charges Based 
                  on Allegations of Intentional Underbid

                  Previous Issues

                  Construction Industry News



                  Managing Payment Delays on International Construction Projects 


                  November 21, 2005 

                  Back to Industry Newsletters


                  (The following outline was used in a presentation to the 
                  Overseas Construction Association of Japan, Inc. (OCAJI) on 
                  July 29, 2004.)


                  By Gregory R. Shaughnessy 
                  Masons Thelen Reid LLP 


                  The Dynamics of Payment

                  As a construction project moves toward completion, the 
                  Contractor loses leverage, and the Employer gains leverage. 

                  This is based on the reality that the Contractor builds the 
                  project, and the Employer simply pays money. As the project 
                  nears completion, the Contractor has less leverage because the 
                  Employer is close to obtaining what he bargained for  a 
                  completed project. This is the time when the Employer will be 
                  inclined to suspend or reduce payments to the Contractor, not 
                  early in the Project. 


                  The Wrong Response to Non-Payment

                  The natural inclination of the Contractor near completion is 
                  to continue working, regardless of the non-payment, and 
                  complete the Project. This can be the wrong step for the 
                  Contractor to take. With the Project complete, the Contractor 
                  has lost all commercial leverage  the Employer has what he 
                  needs. The unpaid Contractor must give notice of intent to 
                  suspend work in the event of non-payment. 


                  Standard Contract Language Regarding Suspension of Work

                  Many standard contract forms in use is Asia do not give the 
                  Contractor the right to suspend work in the event of 
                  non-payment. 

                  But, all of the standard contract forms give the Employer the 
                  right to suspend work for cause or for the Employers 
                  convenience. 

                  The Contractor must include language in every prime contract 
                  that allows the Contractor to suspend work in the event of 
                  non-payment. An Employer that refuses to agree to Contract 
                  terms allowing the Contractor to suspend work for non-payment 
                  probably is an Employer for which the Contractor should not 
                  work. 


                  The Law When There Is No Express Right to Suspend Work for 
                  Non-Payment

                  Without the express right to suspend work in the event of 
                  non-payment, the issue is whether the non-payment constitutes 
                  a material breach of contract. 

                  Although the law varies from country to country, in general it 
                  is fair to say that the issue of when non-payment becomes a 
                  material breach of contract, justifying suspension or 
                  termination, is a grey area. 

                  As a matter of policy, Contractors with Contracts that do not 
                  include an express right to suspend work should wait a minimum 
                  of two months without receiving any payment before suspending 
                  work. 

                  Depending on the payment terms of the Contract, this can leave 
                  the Contractor exposed for the value of four to five months of 
                  work. 


                  Payment Clauses from FIDIC Red Book, 4th Edition


                  Monthly Statements

                        60.1The Contractor shall submit to the Engineer after 
                        the end of each month six copies, of a statement, 
                        showing the amounts to which the Contractor considers 
                        himself to be entitled up to the end of the month.


                  Monthly Payments

                        60.2The Engineer shall, within 28 days of receiving such 
                        statement, certify to the Employer the amount of payment 
                        to the Contractor which he considers due and payable in 
                        respect thereof.


                  Time for Payment

                        60.10The amount due to the Contractor under any interim 
                        certificate issued by the Engineer pursuant to this 
                        Clause, shall, subject to Clause 47, be paid by the 
                        Employer to the Contractor within 28 days after such 
                        interim certificate as been delivered to the Employer.




                  Termination and Suspension of Work Clauses from FIDIC Red 
                  Book, 4th Edition


                  Default of Employer

                        69.1In the event of the Employer:


                        (a)failing to pay to the Contractor the amount due under 
                        any certificate of the Engineer within 28 days after the 
                        expiry of the time stated in Sub-Clause 60.10 within 
                        which payment is to be made, subject to any deduction 
                        that the Employer is entitled to make under the 
                        Contract;

                        the Contractor shall be entitled to terminate his 
                        employment under the Contract by giving notice to the 
                        Employer, with a copy to the Engineer. Such termination 
                        shall take effect 14 days after the giving of the 
notice.


                  Contractors Entitlement to Suspend Work

                        69.4Without prejudice to the Contractors entitlement to 
                        interest under Sub-Clause 60.10 and to terminate under 
                        Sub-Clause 69.1, the Contractor may, if the Employer 
                        fails to pay the Contractor the amount due under any 
                        certificate of the Engineer within 28 days after the 
                        expiry of the time stated in Sub-Clause 60.10 within 
                        which payment is to be made, subject to any deduction 
                        that the Employer is entitled to make under the 
                        Contract, after giving 28 days prior notice to the 
                        Employer, with a copy to the Engineer, suspend work or 
                        reduce the rate of work.




                  Illustration of FIDIC Red Book Payment Delay

                  Month 1

                  Work is performed


                  Month 2

                  Work is performed

                  Contractor submits payment application for Month 1

                  Certificate issued for Month 1 (28 days after submission)


                  Month 3

                  Work is performed

                  Contractor submits payment application for Month 2

                  Payment due for Month 1 (28 days after Certificate)

                  Certificate issued for Month 2 (28 days after submission)


                  Month 4

                  Work is performed

                  Contractor submits payment application for Month 3

                  Payment due for Month 2 (28 days after Certificate)

                  Notice of intent to suspend work (28 days after non-payment 
                  for Month 1)

                  Certificate issued for Month 3 (28 days after submission)


                  Month 5

                  Work is performed

                  Contractor submits payment application for Month 4

                  Payment due Month 3 (28 days after Certificate)

                  Work suspended at beginning Month 5 on the basis of 
                  non-payment for Month 1

                  Certificate issued for Month 4 (28 days after submission)


                  Managing the FIDIC Red Book Payment Delay

                  Even when the Contract gives the Contractor the right to 
                  suspend work for non-payment, the Contractor still can be 
                  exposed to working for four months without receiving any 
                  payment until the Contractor can give notice of its intent to 
                  suspend work. 

                  And, if the Contractor is not paid the first progress payment 
                  at the end of Month 3 and does not promptly give notice of its 
                  intent to suspend work, the Contractor will quickly find that 
                  five months of work have been performed without receiving 
                  payment. 

                  This underscores the importance of giving notice of the intent 
                  to suspend promptly upon the expiration of the payment due 
                  date. 


                  Three Suggestions for Managing Payment Delays

                        1.In negotiating the payment terms of the contract, 
                        reduce the certification and payment 28-day periods to 
                        14 days apiece. This is commercially reasonable and will 
                        reduce the time delay for payment by at least one month. 
                        These changes would be made in Clauses 60.2 and 60.10 of 
                        the FIDIC Red Book, 4th Edition.


                        2.Include in the Contract a suspension of work clause 
                        with a short notice period, 14 instead of 28 days, 
                        saving another half month. This change would be made to 
                        Clauses 69.1 and 69.4 of the FIDIC Red Book.


                        3.Include in the Contract the right to suspend work in 
                        the event of the Employers failure to provide evidence 
                        of its ability to finance the balance of the work. The 
                        following language could be added to Clause 69.1 of the 
                        FIDIC Red Book:


                        (e)Failing to provide reasonable written evidence to the 
                        Contractor of the Employers ability to finance the 
                        remaining outstanding unpaid Contract Amount within 14 
                        days after written request therefore.



                  Illustration of Modified FIDIC Red Book Payment Delay

                  Month 1

                  Work is performed


                  Month 2

                  Work is performed

                  Contractor submits payment application for Month 1

                  Certificate issued for Month 1 (14 days after submission)

                  Payment due for Month 1 (14 days after Certificate)


                  Month 3

                  Work is performed

                  Contractor submits payment application for Month 2

                  Certificate issued for Month 2 (14 days after submission)

                  Notice of intent to suspend work (14 days after non-payment 
                  for Month 1)

                  Work is suspended in the middle of Month 3 (instead of at 
                  beginning of Month 5)

                  Payment due for Month 2 (14 days after Certificate)


                  Suspension or Termination In Response to Non-Payment

                  The FIDIC Red Book gives the Contractor the right to terminate 
                  the contract or suspend or reduce the rate of work in the 
                  event of non-payment. The choice of which path to take is a 
                  critical one. Generally, suspension of the work will be the 
                  preferred alternative, as it is the less drastic remedy. But, 
                  there may be cases when the non-payment provides an 
                  opportunity for the Contractor to escape from an unprofitable 
                  contract by terminating the contract.


                  Reducing the Rate of Work In Response to Non-Payment

                  FIDIC gives the Contractor the option of reducing the rate of 
                  work in response to non-payment. This must be considered as a 
                  first option. It shows the Employer that the Contractor is 
                  serious about taking action in response to the non-payment. 

                  While reducing the rate of work does cause the negative cash 
                  flow to continue (although at a reduced rate), suspending work 
                  also has financial consequences (de-mobilization and 
                  mobilization costs), assuming that the Contractor re-commences 
                  work, as usually will be the case. 

                  Slowing down the work as an initial response to non-payment, 
                  followed by a suspension and, ultimately, termination if 
                  necessary is a reasonable sequence of actions to take in 
                  response to non-payment. 


                  Notice

                  The key to suspending or reducing the rate of work for 
                  non-payment is providing notice of the intent to reduce or 
                  suspend. 

                  FIDIC Clauses 69.1 and 69.4 require advance notice of the 
                  intent to reduce the rate of or suspend work. The purpose of 
                  this advance notice is to give the Employer an opportunity to 
                  cure the breach of contract by issuing payment to the 
                  Contractor. In the notice, the Contractor should advise that 
                  it reserves the right to reduce the rate of work, suspend the 
                  work or terminate the Contract, citing the relevant provisions 
                  of the Contract. 

                  Extreme care must be taken to ensure that the notice strictly 
                  conforms to the terms of the Contract, as the notice will be a 
                  key document in any subsequent litigation. 

                  Frequently, the notice works, and the Employer pays the 
                  Contractor. So, giving notice does not mean that the 
                  Contractor will need to suspend or terminate the Contract. It 
                  simply gives the Contractor that right. 

                  Legal advice should be obtained before suspending or reducing 
                  the rate of the work or terminating a Contract for 
                  non-payment. 


                  Different Non-Payment Scenarios

                  Non-payment or failure of payment can mean many different 
                  things on a construction project. 

                  Non-payment scenarios include: 

                        Non-payment by the Employer after certification.


                        Reduced payment after certification.


                        Non-payment of change orders.


                  Each of these scenarios presents substantially different 
                  challenges. 


                  Non-Payment After Certification

                  This is the purest form of non-payment and the strongest basis 
                  for suspending work or terminating the contract. 

                  Under this scenario, payment is certified but not made. 
                  Although this is rare, it does occur. This scenario presents 
                  the most serious and compelling case for the Contractor to 
                  suspend work, as it suggests that the Employer may be having 
                  severe financial difficulties. 


                  Reduced Payment After Certification

                  The reduced payment scenario is far more common than pure 
                  non-payment. 

                  This scenario presents much greater risks for the Contractor 
                  that is considering suspending work. The basis for the reduced 
                  payment may be a legitimate difference of opinion as to the 
                  percentage of completion or the validity of some Employer 
                  backcharges. 

                  If the Contractor guesses wrong and suspends work for 
                  non-payment and if a court later finds that the reduction was 
                  justified, the suspension of work may justify the Employer in 
                  terminating the Contractor, which can have dire financial 
                  results. 

                  The reduced payment scenario, particularly late in the 
                  Project, may suggest that the Employer is attempting to 
                  generate a large pot of disputed money to leverage a 
                  favorable settlement with the Contractor after completion of 
                  the Project. 


                  Non-Payment of Change Orders

                  The scenario of an Employer not processing and issuing payment 
                  for a substantial amount of change orders is common to the 
                  international Contractor. 

                  It will be a rare case when counsel will advise the Contractor 
                  to suspend work based on non-payment of disputed change 
                  orders. None of the standard forms of contract in use in South 
                  Asia give the Contractor the right to suspend work or 
                  terminate based on non-payment of change orders. Indeed, most 
                  standard forms of contract state that in the event of a 
                  dispute over whether an instruction from the Engineer is in 
                  fact a change order, the Contractor must perform the work and 
                  pursue a claim for the change order and may not suspend work. 


                  Refusing Further Change Order Work as an Alternative Strategy 
                  for Non-Payment of Change Orders

                  A better option for the Contractor that is not being paid for 
                  a substantial amount of change orders is to refuse to perform 
                  any additional change order work until the Employer processes 
                  a significant portion of the outstanding change orders. 

                  This may constitute a breach of the contract by the 
                  Contractor. But, if the Employer was in breach of contract 
                  because it was obvious that a substantial number of the change 
                  orders being requested by the Contractor were valid, then a 
                  court could find that the Employer was in breach of contract, 
                  justifying the contractor is refusing to perform further 
                  change order work. 

                  While it must be conceded that a strategy of refusing to 
                  perform additional change order work is quite risky, it may 
                  give the contractor commercial leverage. 

                  The Employer has two choices: process the change orders or 
                  terminate the Contractor. The third option, hiring another 
                  Contractor to perform the change order work, will not be 
                  practical in most cases. For example, the Employer would never 
                  want to hire a separate contractor to perform change order 
                  work on an electrical or plumbing system, where a sole source 
                  of responsibility is critical. 

                  Termination also is not a very plausible option for the 
                  Employer. 

                  If the Employer wants to terminate the Contractor, the 
                  Employer faces the risk that a court will find the 
                  Contractors refusal to perform further change order work was 
                  justified and, therefore, the Employer committed a material 
                  breach of contract when it terminated the Contractor. 

                  Termination of the Contractor, justified or not, also will 
                  cause a substantial delay to the completion of the Project. 

                  So, the Employer faces tremendous pressure, in response to a 
                  refusal to perform additional change order work, to simply 
                  process at least a portion of the outstanding change orders. 

                  The international contractor with a long list of change orders 
                  to negotiate at the end of a project faces risks. The employer 
                  may try and obtain a steep discount on the change orders. 

                  The Contractor should consider refusing to perform additional 
                  change order work as a method of pressuring the Employer into 
                  processing and paying what should be undisputed change orders 
                  before the completion of the project. After the project is 
                  completed, the Contractor has lost all leverage. Disputed or 
                  gray area change orders can await completion of the project. 



                  Payments to Subcontractors

                  It is common for subcontracts to provide that the Contractor 
                  will pay the Subcontractor within a certain number of days 
                  after the Contractor receives payment from the Employer. So, 
                  the impact of non-payment by the Employer to the Contractor is 
                  reduced, in theory, as the Contractor also is not required to 
                  issue payments to the Subcontractors. 

                  In reality, in developing countries, particularly in South 
                  Asia, the subcontractors are not financially strong, so the 
                  unpaid Contractor issues payment to the Subcontractors to keep 
                  them working. This negative cash flow situation makes it even 
                  more important for the unpaid Contractor to quickly use the 
                  available tools in the event of non-payment. 


                  The Importance of Being Able to Request Evidence of Financing

                  A clause in the prime contract allowing the Contractor to 
                  request evidence of the Employers ability to finance the 
                  balance of the costs of the work provides an important 
                  alternative to the Contractor. 

                  Employers may reduce the amount of progress payments because 
                  the project is in financial difficulty. 

                  Being able to ask for evidence of the ability to finance the 
                  costs of the work and then being able to suspend work if such 
                  evidence is not provided provides a strong alternative basis 
                  for suspending work. 

                  If you would like to receive legal reports and updates more 
                  quickly, by e-mail, click here and fill out the mailing list 
                  form.

                  For more information about the issues covered in this report, 
                  please contact Gregory R. Shaughnessy in San Francisco at 
                  415-369-7235 or at gshaughnessy@thelenreid.com or contact your 
                  Thelen Reid & Priest LLP attorney. For more information about 
                  Thelen Reid & Priest's Construction and Government Contracts 
                  Department, click here. 










       


       2006 Thelen Reid & Priest LLP
      All rights reserved.
      Legal notices, and terms and conditions. 

