Problematic Construction Contract Clauses: Compensation and Payment

This is the ninth blog post in a series that discusses clauses in construction contracts with the goal of providing awareness of contract terms that often cause difficulties and give rise to claims.

Previous blog posts have addressed problematic contract clauses involving differing site conditions, no damages for delay, changes, coordination, suspension of work, warranty and defects liability, variation in quantity, inspection, force majeure, and flow down. This post discusses compensation and payment clauses, and other posts will discuss weather, escalation, and oral modifications clauses.

Compensation and Payment Clauses
Typical payment clauses give the owner the right to withhold payments due to defective work, claims, backcharges, or other reasons that justify such action. Contractors may also use these clauses with subcontractors.

An example private contract states the following:

5.0    Payments Withheld.
5.1    Owner may withhold payment on an invoice or a portion thereof in an amount and to such extent as may be reasonably necessary, subject to the dispute resolution provision of Article 22, because of:

(a)    Defective Work or other non-conforming Work not remedied pursuant to the warranty provisions of Article 12;
(b)    Liens, claims or other encumbrances for which Contractor is liable under this Agreement being placed or filed against the Work, the Plant Site or Owner to the extent not paid, bonded or otherwise discharged to the satisfaction of the Owner;
(c)    Any other third party claims against the Work, the Plant or the Owner for which Contractor is liable;
(d)    Damage to Owner or the Plant or any subcontractor which results from Contractor’s or any subcontractor’s failure to obtain or maintain insurance as required by the provisions of Article 14;
(e)    A default by Contractor in any of its material obligations under this Agreement; or
(f)    An incomplete milestone.

If the owner determines that the performance of the contractor is unsatisfactory, the owner must notify the contractor of the deficiency and the timeframe required for its correction. The contractor often must provide the owner with a corrective action plan, within a stated number of days after notice, describing how the contractor will address all issues of contract nonperformance, unacceptable performance, failure to meet the minimum performance levels, deliverable deficiencies, or contract noncompliance. The owner may not accept the corrective action plan and may assess the contractor a nonperformance retainage based on a percentage of the total invoice amount, applied to the invoice for the then-current billing period and withheld until the contractor resolves the deficiency.

Disputes can also occur when there are disagreements about the quality of work performed, adherence to specifications, or the need for rework to rectify defects. The first line of defense against payment disputes is a well-drafted construction contract that includes clear and detailed payment terms, including schedules, milestones, methods of calculation, and dispute resolution procedures. Contractors and subcontractors may make a mechanic’s lien to secure a claim against the property if payment is not made. This encourages payment and can be an effective tool for resolving disputes. It is essential for all parties involved in construction projects to be well informed about the payment terms of their contracts and the available mechanisms for resolving disputes to ensure the success and timely completion of projects.

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