We’ve all heard the expression “God is in the details”, which basically means that details are really important. But when it comes to contracts, God is in the Payment Schedule.
What is the payment schedule? It’s the agreement as to how the total sum owed to the contractor will be distributed over the course of the project. The most basic form of that would be: ½ up front, ½ at completion. What’s wrong with that? At the beginning of the project, the client is assuming all the risk- what if you pay ½ of the cost up front and the contractor disappears? At the end of the job, the contractor is assuming all the risk- what if they finish the job and the client just decides not to pay?
You could sue
In each case, one of the parties could sue. However, unless very large sums of money are involved (at least $80,000), it’s almost never worth it to litigate. There is no guarantee of an outright victory (each party will have their own story, and the judge or jury will not want to get in to the weeds to really understand the facts). More importantly, the legal fees will eat up whatever money you are awarded. Not to mention that it will take a few years for the process to play out, during which time your house will be unfinished (if you are the client and the contractor has vanished), or you will be broke (if you are the contactor and the client has decided not to pay).
The way to avoid these unpleasant situations is to have a detailed, accurate payment schedule. The overall intent is to pay the contactor for the work they have done, but not more. That way, if they disappear, you will have enough funds left to hire someone else to finish the job. From the contractor’s standpoint, they will have been paid for the work as it progresses, so there will not be a huge balance due at the end.
How often should I make payments?
The most accurate payment schedule would be if they contractor were paid at the end of each day, but this is obviously too cumbersome. A reasonable schedule is a payment every two weeks. But how do we know how much to pay? To determine that, we need a Schedule of Values.
A Schedule of Values is a list of the work items that need to be completed, and their relative value. On a typical addition project, the schedule of values might look like this:
Every two weeks, the percentage completion in each of the categories is determined. On larger projects, these categories can be further broken down, for example, framing could be divided into three separate line items of floor, walls, and roof. A more granular breakdown of tasks results in a more accurate assessment of work completed.
Sounds Good, but There’s a Problem
Who is making the assessment of what work has been completed in each period? What if the Contractor says the electrical work is 80% done but you don’t think so? If you are very construction-savvy, you can negotiate that with the Contractor. However, most Clients don’t have the knowledge or experience to make that assessment, which is why the Architect is often in charge of approving payments. They will typically make a site visit after each payment request to visually assess the state of completion, and either approve the payment request or negotiate changes to it.
Bi-monthly (or fortnightly for you Anglophiles) payments, coupled to an accurate Schedule of Values, ensure that the Contractor is being paid fairly for work completed, and that the Client is not paying for work that has not yet been completed. Note I said “accurate Schedule of Values”. If the Schedule of Values is “front loaded” (the Contractor has put a higher value on those items that will be completed first), it is of little value. It is therefore critical to have a knowledgeable person (presumably the architect, if they have real-world construction cost knowledge) review and negotiate the Schedule of Values as part of the contract signing phase.
Boring, but Important
I agree that this is technical and boring. However, it’s important to keep in mind that the Schedule of Values is the most important part of the contract, and the only thing that really protects both Client and Contractor from each other. The words of the contract may seem important, but money talks.
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