However, for major projects, where banks are injecting money on a limited-recourse or project-finance basis, the form of the construction contract is usually radically different. The most extreme example of this approach is in connection with PFI/PPP projects, where the emphasis is on "risk transfer" and passing down to the contractor all the responsibilities and liabilities in relation to time, cost and quality.
Here the demands of the project and, in particular, the requirements of the financing arrangements, result in contracts under which the contractor takes full responsibility for all design and construction risks for a "fixed" price, with its entitlement to additional monies and extensions of time being severely limited.
In the USA, most projects are procured on a construction management basis, which is usually low risk for the contractor and high risk for the employer. The emphasis is on the construction manager being part of the employer's team and on its ability to manage the many individual trade contractors who will carry out the works.
Whether the trade contracts are entered into directly by the employer or by the construction manager, the construction manager's ultimate responsibility for the performance of the trade contractors will usually be limited. The construction manager will usually be paid a fee plus reimbursable costs and the employer will be responsible, directly or indirectly, for all payments due to the trade contractor.
Since this form of contracting allows a substantial degree of overlap between the design and construction phases of a project, it lends itself to so-called "fast track" construction, whereby construction for a particular aspect of a project may begin as soon as that part of the design is finished, whether or not the design for the overall project has been completed. This procedure permits an early start on site and an earlier completion date.
Although many US financiers view construction management as a viable option, some US lenders require a guaranteed maximum price to limit the risk to the employer; the degree of risk a US lender is willing to undertake is dependent in part on the lender and in part on the interest rate and underwriting for the project.
In most US states, "pay when paid" clauses are enforceable. This enables the main contractor, typically a construction manager, to enter into the trade contracts in the knowledge that ultimately it will not have to make payments to trade contractors unless and until it is first put in funds by the employer.
For trade contractors this is commercially no different than if they had entered into trade contracts directly with the employer. The result is that, either way, trade contractors are necessarily concerned with the financial strength of the employer, the success of the project and the funding arrangements.
In the UK, pay when paid clauses in subcontracts never became part of the accepted culture and were generally seen as unfair.
Now as a result of the Construction Act 1996, if a provision in a construction contract to which the act applies makes payment conditional on the payer receiving payment from a third person, that provision is ineffective unless the third person is insolvent.
This causes a problem in relation to PFI/PPP projects. However, various ingenious devices have been developed to ensure that the employer or project company will not be left financially exposed to the contractor in the event of non-payment under the project agreement.
A combination of land law and the typical payment terms of construction contracts in the UK leave contractors with a high degree of exposure in respect of materials and equipment supplied by them.
Once materials and equipment have been physically incorporated into the project and become part of the fabric or a fixture, legal ownership passes to the landowner, irrespective of the terms of any contract under which they are supplied and whether or not the materials or equipment have been paid for. Owing to the normal length of the valuation and payment cycle under construction contracts, most materials and equipment will become the property of the landowner well in advance of payment for them.
There is no right at common law or under statute for a contractor or subcontractor who has not been paid to remove any materials or equipment once they have been so incorporated, nor does it have any charge over such items or any part of the land to which they become affixed. As a result, it is in the position of an unsecured creditor, while the landowner has the full ownership and use of his product.
By contrast, in most US states, unpaid contractors and subcontractors are in a much more favourable position and are able to register statutory "mechanics' liens" to secure the amount they are owed in respect of the supply of labour, materials and equipment. This usually involves registering the liens in the local court.
A mechanic's lien takes the form of first-ranking security against the property and takes priority over existing legal charges, except for tax liens and properly recorded construction loans with respect to advances made prior to the date of filing of the mechanic's lien.
- Contractors take much of the risk for big projects
- Contractors have to pay subcontractors even if the employer fails to pay
- Contractors and subcontractors can easily end up as unsecured creditors USA
- Employers take most of the risk
- “Pay when paid” clauses mean subcontractors depend on the employer for payment
- “Mechanic’s liens” can put contractors near the top of the creditors’ list in insolvency
Alan Elias is a partner in the London office of Clifford Chance. This article was co-written with Stephen Poltrack, a partner in the New York office.