Once upon a time, we lived in a commercial construction
environment where contractors could bid jobs which included a
profit margin of greater than 2 percent, where subcontractors could
make successful careers based on a single relationship with the
right general contractor, where owners could obtain financing based
on a good set of plans and a solid track record, and where payment
squabbles got resolved by agreeing to make it up on a future
Times certainly have changed. Over the past few years, the
commercial construction industry has become clogged with
contractors bidding jobs with flat margins just to maintain cash
flow, subcontractors watching their longstanding work-supply
sources dry up, and banks tightening the reins on lending to a
point where the private construction market is suffocating.
Relationships are fractured. Nerves are frayed. People are
anxious about the future, and rightly so.
The present construction landscape is a minefield of risks,
particularly for general contractors. Perhaps no risk is greater
than winding up on the wrong side of an expensive and drawn-out
lawsuit. As a general contractor's profit margin decreases, so does
its margin for error. One step in the wrong direction can spell
significant legal exposure or worse. While there is no guaranteed
formula to eliminate these risks, there are some practical ways for
general contractors to minimize their legal exposure and protect
themselves from potential problems.
1. Obtain lien waivers from all downstream subs and
suppliers. At this stage of the game, it is simply too
risky for a general contractor not to require every subcontractor
and supplier - regardless of tier or contract amount - to provide a
lien waiver as a condition of payment. Sure, such a requirement
poses an added layer of administrative hassle for a project
manager, but it protects a general contractor from having to chase
a subcontractor who decided to make a car payment with the
disbursement that should have gone to his material supplier.
A GC should be sure that its subcontracts require lien waivers
from all subcontractors and suppliers, and provide for an absolute
right of setoff against a subcontractor's balance for all payments
made directly to lower-tier subs or suppliers and/or attorneys'
fees incurred in addressing any related matters.
Receipt of a Notice of Identification should trigger an
automatic procedure whereby a joint-check is issued for all future
payments made to that supplier. Finally, failure to provide proof
of payment for all labor, equipment and materials should be
expressly set forth as grounds for immediate termination.
2. Prequalify owners. These days, general
contractors can be so relieved to be awarded a job that they fail
to do their due diligence to ensure that the owner has the means
and intentions to meet its financial obligations of the project.
Such a blind faith approach is an invitation for problems.
With increasing regularity, owners are defaulting on their
payment obligations, usually after much of the construction is in
place, leaving the general contractor in the impossible position of
either taking a sizable financial hit on the project, or putting
dollars into an expensive lawsuit against a potentially bankrupted
owner. No matter how responsible, efficient and effective a general
contractor is, it is only as solvent as the owner on which it
relies to fund the project.
It is critical to know as much as possible about the financial
wherewithal of the owner prior to commencement of construction and
at all necessary times throughout the project. The 2007 iteration
of the American Institute of Architects A201 General Conditions
contract document greatly restricted a contractor's right to obtain
financing information from the owner after commencement of
construction. A general contractor therefore should consider making
the owner's provision of financial information a condition
precedent to beginning (or continuing) work.
In addition, the general contractor must be careful that the
entity that is acting as the owner is an entity with assets. A
single-purpose LLC that was established specifically for a project
likely has no real assets to which a general contractor can look to
secure payment. A prudent general contractor asks for a corporate
guaranty or some other security so that if the worst case becomes a
reality, its chances of reaching assets to satisfy a judgment
3. Go public. While the private construction
market has yet to make a serious rebound from this recession, the
public construction market has remained steady. Many contractors
are weathering the current economic storm by adapting their
operation to compete for public work. Although the potential profit
is generally lower than private jobs and the
administrative requirements more burdensome, public projects
usually spawn less payment dispute litigation since the risks of a
non-paying owner are nearly non-existent (in light of the bond
requirements and other statutory safeguards related to public
Of course, general contractors who pursue this work must become
familiar with the public bidding procedures, prequalification
requirements, and laws related to payments (such as the False
4. Train decision makers. Nearly every
construction lawsuit can be traced back to a bad decision. Whether
it was to bid a project in the first place, or to sign the contract
without negotiation, or to proceed with extra work without a signed
change order, often these decisions are made against a contractor's
better instincts. Many of these decisions are made by people who
are unqualified or unequipped to make them.
A general contractor should take special care to ensure that
there is a clear chain of decision-making command on a project.
Project managers and superintendents need to be trained so that
they can (1) identify potential legal risks and (2) act quickly and
appropriately to minimize the potential negative impact on the
project and on the bottom line. They should understand mechanics'
liens and bond claims. They should know what to do if a project is
picketed. They should read the contract and be aware of key
provisions, such as change order procedures, inspection
requirements and liquidated damages. The more information and
training a project manager has, the more likely he/she will be to
make the right decisions.
Although most construction lawyers are keen to try cases, the
good ones recognize litigation as a last resort, especially when
legal fees can often subsume the amounts in dispute. Advising
general contractors to take preventative actions such as those
outlined above can help them minimize their legal exposure, which
may well be the key to surviving these turbulent economic
Bradley L. Croft is a shareholder at Ruberto,
Israel & Weiner in Boston. He focuses his practice on
construction law and is the co-chair of the Construction Law
Committee of the Boston Bar Association.