Other People’s Money
Project Manager Thom Molloy thinks he did a good job installing insulated steel panels on the interior of the lobby of the graceful new masonry buildings at the Horace Mann School, a private institution in The Bronx in New York City. His work was hardly mentioned, he says, when the building's final punchlist was issued last December.
One day soon, Molloy hopes his company, All Season's Siding Inc., Hicksville, N.Y., will see some of the $15,000 to $20,000 he claims is still unpaid on the $60,000 contract. The project's construction manager has been stalling for months, Molloy claims, and he's tired of lip service about how everything possible is being done. "This is a perfect example of how the industry in general treats subcontractors", says Molloy.
The current construction boom contains a perplexing irony for many contractors and in particular subcontractors. Work volumes are growing but so are the piles of unpaid invoices. That has exposed contractors to more risk than they took on during the slow years. Although prompt-pay rules have been adopted in many states, the timeliness of payment for work not in dispute appears to be eroding. It now takes specialty contractors 66 days to collect on average, more than seven days longer than in 1996, according to the newest survey of the Construction Financial Management Association, Princeton, N.J. "Our best general contractors average 69 days" says Michael Boyd, president of mkb Construction, a wall, plaster and paint contractor in Phoenix, Ariz. Closeouts on projects with big change orders are stretching past a year and in many cases longer. Not surprisingly, subcontractors feel the most abused and say they are being manipulated into providing a large portion of a project's working capital. And to a greater degree than in the past, subcontractors say they are standing up to pay abuses by taking a more hard-nosed approach to parsimonious owners and prime contractors and refusing to submit bids to companies that have burned them. Some general contractors who are sensitive to pay abuses and who depend on quality relationships to smooth their own projects are going out of their way to treat subs respectfully and pay them promptly. One general contractor, Hitt Contracting Inc., Fairfax, Va., has a fulltime subcontractor relations coordinator. But many general contractors say the subs complain too much and that primes are themselves skirmishing with owners on payment in ways they never would have a few years ago.
The American Subcontractors Association, Alexandria, Va., has set its sights on the abolition of retainage, the common practice in which an owner or prime contractor withholds generally 10% of the value of the work performed and decreases the amount to 5% in the later stages of the job. Where abolition isn't possible, asa wants all retained funds placed in interest-bearing, escrow accounts and asa wants funds released early for work completed early in the project. Federal agencies no longer routinely hold retention during on-time projects, subs point out, citing that as further evidence of obsolescence. "Typically, we are long gone by the time the job finishes," says David H. Bradbury, president of Precision Concrete Construction Co., Alpharetta, Ga. "Why shouldn't retainage be released?" he asks. In Bradbury's view the practice amounts to institutionalized usury and a shifting of risk that has nothing to do with the way responsibilities are outlined in contracts.
Bradbury's company generally performs $35 million worth of work each year, and it is owed $2.2 million year-round, $900,000 of it in retainage. At 6.3%, that is actually a very good collection record, bankers say. Nevertheless, it irks Bradbury. Other subs say they are continuously owed 30% of their total annual revenue. A medium-sized mechanical contractor that has a yearly volume of $20 million says its receivables rarely dip below $6 million, or 30% of revenue, with retainage comprising $1.4 million of that total. Smaller companies sometimes are owed even more. Subcontractors constantly are lugging around these bloated receivables. "If you want to do $30 million worth of work, you better have $3 million in the bank," says Jim Davis, president of United Masonry Inc. of Virginia, Alexandria.
The injustice, complains Bradbury, is that subcontractors must pay their suppliers and labor crisply within 30 days or less but must wait months often for the final 10% that represents the profit on a job. Withheld funds undermine the spirit of cooperation on a project and duplicate the guarantees provided by bonds. "We are professionals and have longevity. We have payment performance bonds and have no problem with funds withheld for noncomforming work and performance," Bradbury says. "Oh, bull," replies Rick Grebel, a veteran general contractor who is president of kci Construction Co., St. Louis. The subs want to penalize the whole general contracting community for the few that give them trouble, he says. "Our policy is to pay them whatever we are paid" says Grebel. He says he has seen subs hold back payment unfairly from their own suppliers."Then if a lien is filed, I'm stuck paying twice. It's happened a few times."
Retainage is an important method of guaranteeing performance and is not abused, at least not in western Michigan, says David H. Gibbs, treasurer of Owen-Ames-Kimball Co., a Grand Rapids, Mich.-based general contractor. "I can't imagine operations without retention" says Gibbs. "It's part of what we do, and it's accepted and included and important to us." Other general contractors say the subs know the payment risks and the costs of money and factor that into their bids. "They aren’t stupid," says one general contractor.
"Why reform something that is not followed anyway," adds Jeff Mertz, a project manager with Russell Construction, a general contractor in Bettendorf, IA. Mertz says his company lives and dies by the policy that it pays only when it receives pay from the owner and Russell?s core subcontractors know they will be paid by the company's reputation. That means subs just have to wait. And Russell Construction itself sometimes has to skirmish with owners who lag in payments, even shutting down a job. It also tries to hold the line on owners who want aggressive payment terms in their favor. On one project last year an owner made a last-minute effort to stick in 90-day payments and 15% retainage. But Russell held out for 45 days and 5%. "We also raised the price of the project to compensate ourselves and the subcontractors for the time value of the money," says Mertz.
Even many prime contractors who say they try to be fair in dealing with their subcontractors expect those subs to take the payment risk with them. "I know some Primes hold retention on subs, even early ones, till the end of very long contracts," acknowledges Phil George, a senior engineer with Stimpel-Wiebelhuas Associates, a highway and heavy contractor based in Redding, Calif. Nevertheless, "I do not favor limiting sub retention by the percentage held on the Prime." Why? A prime contractor may be 95% done with a large project, which may reduce retention to 1 or 2%. To George, that means he can only withold 1 or 2% on the seeder even though the seeder could be behind schedule or performing work that proves to be faulty. "I wish they would adopt the reduction based upon the percentage complete of the subcontracted work. the owner feels justified holding 10% until we are half done. What is wrong with holding subs to the same standard?"
Nothing, say some subcontractors. In fact, one of the most important requests that a subcontactor can make of a prime contractor is to review the prime contractors agreement with the owner. By knowing the terms of payment between owner and prime, a subcontractor can request the same terms from the prime contractor. Yet many smaller subcontractors are too timid and feel that is a bad business practice. Such reluctance can be a fatal oversight giving the prime contractor the right to sit on money it has already collected.
The new determination to stand up to pay abuses registers in other ways. Some small specialty contractors had made a practice of granting discounts to prime contractors for timely payment, but no more. Bigger, more sophisticated contractors treat those kinds of offers as jokes. "We were asked once, and we just laughed," says Don W. Hiatt, comptroller of Tri-State Drywall Inc., Rockville, Md.
In addition to the campaign against retention, subcontractors have an array of defensive tactics. The best one is to withhold bids from poorly paying owners and primes. One New York City area subcontractor was invited to bid by a large building contractor. When the subcontractor told the general contractor's chief estimator that the sub wasn't going to bid because the sub hadn't been paid for the last work it had done for that company, the estimator told others at his company. A check was issued to that subcontractor the next day. That kind of action--quick payment to extract a new bid--hardens the cynicism of subcontractors.
Once a subcontactor is on a job where the payments are slow, the focus often shifts to documenting work rather than performing it. "When someone holds more than is due, we want to make sure we put our efforts on documenting and getting liens ready," says one subcontractor. "We tell them we're too busy protecting our rights on the money you owe us to worry about your problems. The work slows down." If foremen are spending time on documentation because they're afraid of not getting paid, quality often is overlooked.
Word travels fast if an owner or prime contractor stops paying. a concrete subcontractor may show up but with half a crew--it doesn't want to invest a lot unitl it's sure of payment.
The pay outrages continue to mount, sewing seeds of discontent--in one case, literally. William J. Olmos, III, general manager of Salinas Reinforcing, Inc., Livermore, Calif., says that buried in the contract for work on a new overpass was a six-month gestational period for the surrounding shrubbery. The bridge was opened and put into use, but not in the season when shrubs bloom in California. Months went by as a landscape contractor waited to plant, and months more passed waiting for the shrubs to bloom. "In retrospect, it seems like a great tool to screw the contractors that performed the 99.99% of the useful portion of the construction project, making all wait for pay because of cosmetic fluff," says Olmos, apologizing for his anger.
Cavalier attitudes toward payment sometimes are barely disguised by the flimsy execuses put forward--and financial staff at contractors hear plenty of it. Papershuffling is often attributed a mystical power. Webster Gravel and Asphalt, Minden, La., has been waiting to collect retainage for a job finished back in October. "I have been told that the paperwork has been misplaced," says Elizabeth White, the company's bookkeeper. "Tell me that's not a crock." Keith A. Donmoyer, the treasurer for HMS Interiors, Inc., Devault, Pa., says an owner has been sitting on more than a million dollars owed to contractors on a new office building, most of the invoices dating from July, 1999. Out of that total HMS is owed $275,000. The worst part is that the owner is a construction-related company. "They should know better and it is inexcusable that they do not," Donmoyer says.
Sometimes subcontractors can gum up the process by failing to send in invoices, file lien releases on time. When that happens it provides a convenient excuse for a contractor to wait to pay off another, later round of invoices until the current paperwork has been cleared away. "We've had our payments held up because another sub didn't get their requisition in on time, so the owner didn't get the requisition on time, didn't get their lien release filed, therefore the owner won't release the current month's payments," says Susan P. Griffee, an accountant in the Washington, D.C. area who has also worked as a utility contractor. In at least one instance the delay was because a subcontractor hadn't come to pick up a check already issued by a prime contractor.
A presumption that subs are front-loading their invoices lies behind some of the slow-paying primes. Chris Doyle, vice president of Tyler Mechanical Contracting Inc., Ijamsville, Md., says the impression is wrong. He has to prepare a schedule of values that will stand up to scrutiny by an owner or prime contractor and he has to use the schedule as an internal control tool during a project. Get the schedule of values approved by the prime contractor at the beginning of the project, he says. "Ours are fair and accurate and have to be for our own use," says Doyle. "It has to reflect an honest conception of the job."
The real wildcard in the payment game--and an odious form of risk shifting--are the change orders that represent a large portion of the value of many projects. Subs are compelled by their contracts to do the work, but after that many of the rules of civilized business behavior go out the window.Months pass as construction managers and general contractors haggle with owners--or team up to criticize subs. And then the prime contractor may propose a closeout payment at a fraction of the value of the work. While subcontractors' paperwork is often examined over and over for flaws, general contractors and construction managers concoct back-charges without documentation, subs say. The process is a rotten one that brings out the worst in everyone. "The tendency is to drag out decisions on change order pay until the end and then try to resolve it," says Chip Swab, president of Ennis Electric Co., Manassa, Va.. But by then many of the players have moved on and memories change.
Complexity often leads to trouble. That is partly what made the change orders and project closeout difficult on the Hayden Planetarium project for A.J. McNulty, New York City. The planetarium had an usual spherical structure and a several levels of pay review in a construction manager, a museum and a private funding source. McNulty held contracts for the structural steel and the curtainwall and both contracts expanded significantly with change orders during work in 1998. The owner and prime contractor retained 10% thoughout the job and reduced the retainage somewhat as work was completed. The company completed its work in early 1999, according to sources familiar with the project, but more than a half million dollars remained unpaid for 18 months.
At the root of the change order plague are cultural problems that have bedeviled the industry for years, including poor plans and drawings and inexperienced managers. But because the general contractor can issue directives for changes or order forced account work from a sub, a convenient short-term fix is always available. "We have this year alone over $700,000 in retainage and change order directives due from three jobs performed almost a year ago," says Tanya Sims, executive vice president of B&S Diversified Inc., general and electrical contractors based in Orlando, Fla.
Like other subs, Sims believes the owner or general contractor is using disputes with a few subcontractors as an excuse to withhold money from a large number. It isn't fair, but eventually another kind of justice may prevail. "And then the owner wonders why no one wants to continue working for them and the labor market is even tighter?"
That feeling of we don't have to take it from them may only last as long as the good times, but for now subcontractors have options. Michael Markham, a paving and grading and sewer contractor in Arizona, remembers when work was slow a few year ago and he wrestled with retention problems on two-thirds of his work. Now he only has it on 30% of his work. And he feels armed and capable of dealing with prime contractors that want to hold onto his money.
"It forces us to pay smaller subcontractors ourselves, although we haven't been paid. It makes us get much firmer in our position on extras. It doesn't make us more willing to be negotiable, it makes us more hard-nose on what we deserve."
About the Authors
Richard Korman is the managing senior editor of ENR at McGraw-Hill Construction.