How Should Progress Payments Be Structured and Calculated?

On a complex construction project involving millions of dollars of work, it is not reasonable to expect the constructor to finance the effort to completion. Consequently, construction contracts typically call for the project owner to make periodic progress payments to the contractor. The manner in which these payments are calculated or structured is a matter of contractual consent between the parties.

There is no single method of calculating progress payments, but the most common formula is the percentage of completion applied to the total contract price, less retainage which is held by the project owner until final acceptance of the project. On simpler projects, progress payments are frequently tied to achievement of certain milestones in the work.

In a recent case, the parties structured progress payments under a fixed-price subcontract in a most unusual way. The subcontract called for payment of stipulated amounts on set calendar dates, apparently unrelated to the actual work in place. When the prime contractor felt the sub was not making adequate progress, a payment dispute was the inevitable result.

What is the best and fairest way to structure progress payments? How much retainage is appropriate? Is the “front loading” of progress payments permissible under some circumstances?

As always, I welcome all comments below.

In next Monday's issue of Construction Claims Advisor:

• Teaming Relationship Did Not Violate Anti-Assignment Act
• Contractor Liable to Sub for Owner’s Rejection of Compliant Work
• Terminated T&M Contractor Failed to Prove Lost Profit

Bruce Jervis, Esq., Senior Editor
Construction Claims Advisor

Comments

[George Watts]

This is long... sorry...
Your recent case study poses an interesting situation. The sub and prime evidently agreed on the progress payment arrangement before work began. But you didn't say whether the subcontract established some important standards and duties. Two of those would be: 1) performance by the sub, and; 2) responsibility of the prime to provide timely access to the area of work by the sub. If the subcontract did not establish such, then both parties committed rookie mistakes.

As to your questions about progress payments, the "fairest" way to establish payment arrangements is not always the most customary way (% completion x contract price - retainage). Fort example an unusual scope of work for a given subcontractor might include include a disproportionate down payment for exotic raw materials or custom fabrication. Or the owner and architect might have standards of performance that are over the top compared to industry standards, or they could even be unreasonable. Those issues could influence what payment arrangements are determined to be "fair".

[Modular Solutions]

with AIA documents the owners will always hold retainage, so getting the subs to buy into this process is the fairest method, however with LONG term contracts, a sub that completes at the beginning of the contract will not ususally wait for project completion for thier final %. Add a point to bid cost for carrying the balance if this is the case.

[Bruce Jervis, Editor, Construction Claims Advisor]

In response to the first comment, the contract in question did not establish those standards or address those duties. I agree it was a very poorly drafted agreement.
With regard to retainage on subcontracts completed early in the project, this is a matter of contract. I agree that a prudent subcontractor will price accordingly if it will be forced to wait until final project completion for its retainage.

[BC]

Using the customary way (contract amount x % of completion - retained funds) usually fits most projects. For projects with special materials, it's been customary that the prime or subcontractor will request for "MOH" materials on hand and submit invoices for payment ahead of time. Then on future progress billings, the assigned costs for MOH will be adjusted off of the original contact amount. Typically the only requirement is that the materials are stored in a safe area which is insured and that the product meets the requirements of the project. The downfall of this is that, the prime or subcontractor are now solely responsbile for the pre-purchased materials until they are installed for the project.

As for subcontracts, the subcontractor should carefully read and understand the subcontract and its requirements.. (time, retained funds, close out docs and most especially the scope of work).

Subcontractors do have ways of getting retained funds released after completion. In the State of Washington, the WSDOT Standard Specifications Section 1-08 stipulates that if a subcontractor completed their assigned scope of work and have submitted all required compliance documents that they are entitled to the retained funds even if the project has not reached final acceptance. Generally most subcontractors only know that they will get their retained funds when the prime has received theirs.

[J. Ngunjiri]

I'd say okay for someone wanting to be paid on specific dates, but I'd add to the contract penalty clause for unachieved work at date of progress payment, based on agreed progress schedule. So, if by June 30th subcontractor was to receive 2nd of 4 payments with agreed 50% completion but has only achieved 40% due to their own performance issues, they loose 10% of fee (or something akin to that). This was the risk is shared.

[JOSE TOLEDO]

THE OWNER NEVER CAN ACEPT THE FRONT LOADING UNLESS HE HAS A WRITEN ACEPTANCE OF THE SURETY TO DO SO , BECOUSE THIS CONDUCT WILL BE A DEFENSE OF THE SURETY IN A FUTERE CLAIM OF THE OWNER AGAINST THE SURETY.

[Makkimane Venkataramu]

It rather strange that the contract has such faulty clause.. The payment should have been for completion in stages along with dates of completion such stages. In the event the subcontractor failure complete the stated stage on set date in the contract, he should be liable to pay a penalty for not completing.

If the contract is front end loaded, he should be asked additional security either in the form of “Bond or Bank guarantee” acceptable to Employer