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Why Are Payment Issues Persistent in the Construction Industry?

Why Are Payment Issues Persistent in the Construction Industry?

May 24, 2019

The construction industry is known to be one of the most difficult industries to partake in, especially for contractors, subcontractors, and other industry players that need to get paid in full and on time. Construction delays and payment disputes have become quite the norm in the industry, and if you’re a constructional professional — chances are you know fully well how common these disputes are.

Construction payment issues are prevalent in the construction industry all across the globe. Many industry experts, lawyers, and government authorities have tried to weigh in on why payment concerns have become such a systemic issue in an industry that is arguably one of the most important vessels in any country’s economy.

Understanding the reasons behind the persistence of payment issues in the construction sector may not be enough to completely avoid having to deal with them. However, it may be a good start to have a deeper understanding of the construction industry.

Why Are Payment Issues Persistent in the Construction Industry?

Here are some of the reasons.

1. Multiple contracts are signed by multiple parties.

The construction industry runs on contracts. In a single construction project, there are multiple contracts that are being agreed and negotiated upon by multiple stakeholders. During payment disputes, contracts are often the most commonly cited documentation to prove one’s claim.

Not only are these contracts interrelated, but they are also hierarchical. The construction industry follows a tiered framework, which implies that payment accountabilities start from a top stakeholder (like a property owner or a general contractor) and they go down to the subcontractor, supplier, sub-subcontractor, and so on.

These web of contracts can cause payment disputes to arise in many ways.

I. It causes communication issues.

Contracts often do not have provisions to address specific concerns that are encountered only after the construction has begun. The lack of clear provisions often result in communication issues regarding payment claims, and this dispute may occur between any two or more parties in a project.

Let’s look at a contract-related communication issue between a property owner and a contractor.

Say, for example, that a contractor discovers a construction site to have too much underground water that needs to be pumped out. In order for their team to construct the building, they first have to dewater the site, which will of course incur additional costs. They might also potentially have to build drainage systems and waterproof the structure, even if these were not stated in the original plan.

Because these are all additional tasks, the contractor may assume that the owner will pay them a higher amount and will shoulder the added cost for the extra work. The property owner, on the other hand, might think that it is part of the contractor’s job to deal with unexpected issues like this since they are obligated to deliver the finished project whatever it takes.

Since their contract does not state which party will be accountable for shouldering the dewatering costs, this scenario will likely lead to a payment dispute.

II.  It causes delays in schedule.

Contracts often contain the specific deliverables that the contractors must fulfill, but sometimes the scope of a project or other design concerns are not clearly stated. When a project’s scope changes or when a design mistake is discovered during the construction, the project may be delayed which will in turn delay the payments to the project participants.

Let’s look at another example of a design-related issue. Say a designer for a building states that the doors in the said building do not have to be fire-rated. The contractor then asks a sub-supplier for non-fire rated doors, as required by the designer.

However the fire department notices these doors during inspection and issues a notice for the building to use fire rated doors instead. Since the doors have already been installed, the contractor now has to uninstall them and buy the approved door, all because of a lapse in design.

In this scenario, it is clear that it was the designer who made the wrong call and he or she is therefore accountable for the mistake. However, regardless of who’s to blame for the mistake, the issue will still delay the schedule of the construction since more work has to be done. A delay in the schedule consequently means a delay in payment.

III. It triggers a “domino effect” of non-payment.

Since the contracts are hierarchical in nature, payment disputes among the top parties will usually be felt by the other project participants down the contracting chain.

So if, for example, that an owner is not satisfied with the prime contractor’s work and refuses to pay them, the prime contractor will also hold off the payment for the subcontractors, suppliers, sub-subcontractors and so on.

This domino effect is quite a common scenario in the industry, that’s why almost all project participants are guaranteed to have legal rights to claim payment, whatever their role in the project is.

2. The construction market is very competitive.

Construction projects are typically secured by a contractor through a competitive bidding process. This process is arguably unique to the construction industry since the client wants to know the exact cost of the project before giving the winning contractor the go-signal.

Contracts are usually won by the bidder who promises the best quality of work for the lowest price. This in turn encourages contractors to promise the cheapest cost for the highest quality of work.

However, once construction begins, the winning contractor might end up negotiating with the owner to avoid overspending. Contractors trying to convince the owners to allow them to use cheaper materials is considered to be one of the most common causes of construction payment disputes.

A contractor for a residential remodeling project may, for example, haggle with the owner to let them use a type hardwood flooring that is different from what they promised in the contract. The contractor may have struck a deal with a hardwood supplier, therefore they want to insist on using this cheaper hardwood material.

The owner, of course, may balk at this idea and hence a payment dispute ensues.

3. The construction sector is greatly affected by economic downturns.

When the country’s economy is doing well, the construction sector also does incredibly well. Plenty of infrastructure projects start opening opportunities for various construction industry players. However, it also goes the other way — when the economy crashes, the construction sector becomes one of the first casualties.

Most contractors get their money from construction loans, and they end up not paying the loan according to the agreed terms because of a crash in the market. It may also be hard to acquire new loans because lending requirements become more strict during an economic crisis. Furthermore, contractors may be forced to lower their prices just because there is very little demand for projects.

All of these result in payment issues. Not having enough capital results in people not getting paid, and projects may even be terminated mid-construction when cash flow for all parties is clearly constrained.

Moreover, the construction industry is also subjected to other forces that may not be within anyone’s control. Weather conditions, for example, affect the productivity of labor and may cause a project to be delayed.

Workforce management problems may also arise especially due to the rotating and shifting nature of work schedules. If this is the case, scheduling software will be able to help. Quality of laborers is also another consideration, as sometimes the hired personnel may not fulfill the amount of work expected of them, which can be due to inexperience.

4. The construction industry players do not always have the best business skills.

This may be a hard pill to swallow but contractors can be very skilled builders, but they are not always necessarily the best at running a business.

Multiple studies have traced payment delays and disputes to cash flow mismanagement.

A contractor may for example bid on a project that is significantly bigger in scope than what they usually work on. Once they win this project, they realize that they do not have enough capital to handle such big a job, and this can potentially result in poor quality of work, project delays, or just overall financial failure for the contractor’s company.

The contractor may have initially counted on a projected growth for the company that did not materialize, or the decision may have relied on the approval of a construction loan that eventually got rejected. In any case, poor business decisions like this typically trigger payment issues down the road.

HOT TIP: Financial mismanagement does not only constitute making poor business calls and not having a good understanding of how the construction industry works. Sometimes it can also mean failure to pay keen attention in keeping tabs of your records.

Paperwork in the construction business is not negligible. Payment disputes often come up from the lack of proper records of invoices, of services rendered, or of legal documents that need to be copied and sent to the right parties. Clerical work is undeniably part of running a business, and often it can spell the difference between getting paid or not getting any money for the services that you have furnished.

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