Written by Eamonn Ryan

On 5 June, Timothy G. Wentz, PE, HBDP | Fellow / Presidential Member ASHRAE, gave the second of a series of three presentations over three weeks to the South African Chapter of ASHRAE.

… continued from part 1.

Timothy G. Wentz, PE, HBDP | Fellow / Presidential Member ASHRAE. Image supplied by ASHRAE

Timothy G. Wentz, PE, HBDP | Fellow / Presidential Member ASHRAE. Image supplied by ASHRAE

The second was on the topic of Money and ethics: exploring the ethical standpoint of the HVAC industry hosted by the ASHRAE Society Chapter Technology Transfer Committee (CTTC). The following is a relatively complete review of that presentation edited by Eamonn Ryan, with lecture three being covered in subsequent issues of RACA Journal. Due to the importance of this lecture and its length, it is split into parts 1 and 2, with part 1 having been published in RACA August issue.

To navigate scope games effectively, creative contract negotiation plays a vital role. Do not sign away your rights or overlook the issues at hand. When faced with an owner who refuses to pay for unforeseen conditions, engaging in a constructive dialogue becomes crucial. Explain the potential consequences, such as contractors and engineers factoring in additional costs to account for these uncertainties. Most owners would prefer to pay for actual unforeseen conditions rather than paying for potential ones that may never materialise. By clarifying and refining the scope in meticulous detail, engineers, contractors, and manufacturers’ representatives can minimise disputes and ensure a clear understanding on both sides.

However, if all else fails, and the situation calls for it, one must consider adjusting the price or margin accordingly. It is important to approach this decision with careful analysis and consideration, as relying on a barrage of change orders can strain relationships and have negative consequences throughout the industry.

Navigating scope games requires diligence, transparency, and a commitment to ethical conduct. By actively engaging in clear communication, thorough contract review, and fair negotiations, we can mitigate scope-related challenges and foster a healthier industry environment for all parties involved.

In the world of construction contracts, there are often decisions to be made that can have significant consequences for all parties involved. It’s like having a devil on one shoulder and an angel on the other, each whispering their own advice. One strategy that is often overlooked, but can be crucial, is the concept of ‘run like hell’. Sometimes, the risks associated with a particular job are so high that it’s better to run away and not bid on or enter into a contract with that owner.

Cutting corners is another approach that some may consider, but it rarely benefits anyone, including ourselves. A study conducted by Lawrence Berkeley National Laboratory revealed that out of 60 buildings examined, 15% had missing equipment that was never included in the plans and specifications. Some individuals may view this as a margin, but it ultimately tarnishes the reputation of everyone involved, causing harm to owners, engineers, contractors, and the industry as a whole. It’s clear that such strategies lack a strong ethical foundation.

Payment games are a prevalent issue in the construction industry. The standard practice is to work for 30 days and submit an invoice, with a 30-day window for payment. This means that before engaging in a project, it’s crucial to ensure there is 60 days’ worth of cash flow available. However, two critical questions remain:

  • Will I get paid in full when I submit the invoice?
  • When will I receive payment?

These questions weigh heavily, particularly for small family-owned businesses, where cash flow is essential for meeting regular obligations. Payment in full can sometimes be compromised by factors such as retainage or holdback, additional bonds for defective work, or general contractors withholding money due to incomplete or faulty work. These deductions can significantly impact the amount received, reducing it from the expected 95% to as low as 70% or 75%. Furthermore, the timing of payment is an ongoing problem worldwide. Some contractors may experience delays of 60 or even 90 days before receiving payment. Addressing these payment-related issues requires careful examination of the contract, particularly the clauses related to payments.

One concerning clause that frequently appears in contracts is the ‘pay-if-paid’ provision. This clause essentially states that a contractor will only be paid if the party responsible for payment has itself received payment. It’s essentially a red flag clause that raises ethical concerns. Accountability should apply when one’s own actions result in mistakes, but it is unfair to withhold payment when the fault lies with someone else. Negotiating around this clause becomes imperative to protect one’s rights and ensure fair treatment.

To gain more insights into the impact of delayed payments, an informal study was conducted on a USD5.7-million project with monthly payment requests from the electrical contractor. Analysing the data it became evident that a 60-day delay in payment led to significant financial gains for the general contractor. They earned an additional USD27 000 in interest while the contractor had to cover the gap with a line of credit loan, costing them approximately USD47 000. Moreover, the contractor’s ability to secure new work or engage in productivity-enhancing measures was compromised, resulting in a potential loss of USD57 000 in profits. This example highlights the substantial financial repercussions that can arise from payment games.

Contracts should specify a specific time for payment, and if the agreed-upon timeframe is not met, the contractor should be entitled to interest at the prevailing market rate. This negotiating strategy ensures that cash flow remains robust, supporting the financial stability of the business.

Prompt payment laws : Ensuring fairness in construction

The standard practice is to work for 30 days and submit an invoice, with a 30-day window for payment.Image supplied by ASHRAE

The standard practice is to work for 30 days and submit an invoice, with a 30-day window for payment.Image supplied by ASHRAE

In the construction industry, prompt payment laws have proven to be effective tools in promoting timely and fair payment practices. These laws establish specific timeframes within which payments must be made, with penalties imposed for non-compliance. Such legislation can positively impact cash flow and discourage deliberate withholding of payments.

As a recent adopter of such legislation, Nebraska has experienced positive outcomes, demonstrating the value of implementing similar laws in other communities. Prompt payment laws push stakeholders to honour their financial obligations promptly, benefiting contractors and subcontractors who rely on timely payments to maintain healthy cash flow.

One significant advantage of prompt payment laws is the reduction of extended retainage periods. These laws aim to limit the amount of retainage that can be withheld, preventing excessive deductions from contractors’ payments. Retainage should serve its intended purpose without becoming a mechanism for undue financial strain. By setting clear guidelines, prompt payment laws establish a standard for retainage that safeguards the interests of all parties involved.

While filing a lien against a property is an option, it is generally considered a last resort due to its potential strain on professional relationships. Creative negotiating techniques should be explored first to remove unfavourable clauses from contracts and establish transparent expectations regarding payment terms and amounts. Trust and ethics are paramount in the construction industry, making it crucial to collaborate with individuals and organisations that uphold high ethical standards. Aligning with reputable professionals ensures smoother operations and minimises the risk of conflicts arising from payment disputes.

Another area of concern in construction projects is front-end loading, a practice where contractors submit payment requests that exceed the actual work completed. Front end loading can be justified when it serves as a means to maintain adequate cash flow. However, caution must be exercised to avoid excessive front-end loading that may strain project finances and hinder progress. The line between reasonable front-end loading and fraudulent practices can be blurred, as illustrated by a case involving an engineer in New York. This incident highlights the importance of maintaining transparency and reasonableness in financial transactions to uphold professional integrity.

Change orders are an aspect of construction projects that often evoke negative sentiments from all parties involved. Architects, engineers, and contractors alike have reservations about change orders due to the perceived impact on project quality and the challenges associated with payment. Change orders disrupt established workflows, strain relationships, and complicate payment processes, leading to delays and frustrations. Contractors, in particular, find it challenging to receive prompt and full payment for the additional work required by change orders.

The detrimental effects of change orders can be attributed to several factors. Slow payment processes, the possibility of payment rejection, and increased scope of work are among the reasons why change orders are perceived negatively. These issues contribute to strained relationships, impede productivity, and disrupt project schedules. It is essential to address these challenges and find ways to streamline the change order process to foster a more collaborative and efficient construction environment.

Contrary to popular belief, contractors and engineers do not relish change orders. These requests are often viewed as reflections of quality issues, and contractors, in particular, find it challenging to secure full payment promptly. To illustrate the impact of change orders, consider a scenario where a crew encounters an unforeseen problem at a job site. They call upon their field managers, superintendent, and eventually, the engineer to address the issue. Meanwhile, work halts, and productivity declines as the highest paid personnel shift their focus to troubleshooting rather than their designated roles. Only after the engineer resolves the problem can the crew resume their original tasks. This situation begs the question: What does the owner intend to pay for?

Typically, owners expect to pay for the fixed scope of work outlined in the original contract. However, when change orders arise due to unforeseen or unknown conditions, accurately valuing these changes becomes challenging. Contractors prefer resolving issues through means other than change orders due to the difficulty in receiving fair compensation. Therefore, alternative mechanisms such as shared contingency funds, bonds, and warranty reserves can help account for unforeseen circumstances. By considering potential change orders in project planning, engineers, contractors, and manufacturers can better prepare themselves and negotiate for full recovery.

Creative negotiations can resolve 

Creative negotiation strategies can play a crucial role in ensuring favourable outcomes. For instance, on a massive wastewater treatment plant project worth USD700-million, an unforeseen issue arose when Native American remains were discovered, halting progress and triggering potential disputes. One contractor proposed a solution: forward pricing the additional labour required for resolving such issues. In exchange for waiving all claims, both parties agreed to include this forward-priced labour in change
orders. This innovative approach allowed the project to proceed, resulting in successful completion ahead of schedule and under budget. Negotiation strategies like this can greatly contribute to resolving disputes effectively.

These issues are prevalent in the construction industry, not just in the United States but also in South Africa. It’s unfortunate to hear that contractors are requesting upfront payments of such high percentages, ranging from 50-70%. This practice puts an unnecessary burden on clients and disrupts their cash flow, forcing them to seek additional funding or take out loans to cover project costs. It’s crucial for contractors to understand that it’s their responsibility to manage their own cash flow and not rely on clients to finance their operations.

Lack of contract knowledge and poor estimating abilities are also concerning trends. Contractors should have a thorough understanding of the contracts they enter into, including payment clauses and change control provisions. Estimating should involve detailed breakdowns and clear explanations, allowing clients to assess the project’s cost structure. Effective change control management is essential to address variations and ensure fair compensation for additional work. The concept of ranking clients based on their adherence to ethical standards, can be an effective strategy. Focusing on ‘gold’ and ‘silver’ clients who demonstrate a commitment to long-term relationships, meeting expectations, and shared ethics, can minimise ethical problems and enhance the success of one’s company. It’s also recommended to establish key performance indicators (KPIs) for clients, enabling one to measure their performance and identify areas for improvement.

WRD serves as a platform to educate the public. Image credit: ASHRAE