Escrow and arbitration

[Coppersmith]

Since the process of collecting on disputed payments is so flawed and expensive, I was wondering if there is a way to specify in a contract the use of an escrow account to hold the largest projected progress payment with release only if (1) both parties sign off; or (2) a neutral arbiter orders it.

Normal payments could be made directly as usual and the escrowed amount could just sit there until the end of the project and act as the final payment plus a refund of the overage. Alternately overfunds could be released as soon as the largest payment is successfully received.

A binding arbitration clause would protect both parties and avoid filing liens, hiring lawyers, and going to court. I don't think asking for this would anger an honest client.

Anybody have any experience with doing this. I haven't researched the subject yet. Obviously, there would be a cost involved and if reasonable, would be well worth it.

 

[bkludecke]

Probably be best to talk with a fiduciary at your bank along with an attorney to get the answers. It does sound like a reasonable approach for larger projects.

 

[bwat]

Another thing to consider for doing this would be when does the client actually place the the money into the escrow account? If they have to place it in there at the very beginning of the project and the large payment milestone in question isn't for a couple years down the road, I'd imagine there are clients who wouldn't like the money being out of their hands for years, even if it could come back to them at the end. Perhaps the payments into the escrow account could be segmented and made in smaller chunks at points of the smaller milestones. Similar to a retainage.

 

[Coppersmith]

Usually the longer the job, the more progress payments there are. If the payments were arranged to be relatively level, then keeping one progress payment in escrow wouldn't be a big deal. It's like paying first and last months rent on an apartment.

 

[RumRunner]

Coppersmith says:

Since the process of collecting on disputed payments is so flawed and expensive, I was wondering if there is a way to specify in a contract the use of an escrow account to hold the largest projected progress payment with release only if (1) both parties sign off; or (2) a neutral arbiter orders it.
Normal payments could be made directly as usual and the escrowed amount could just sit there until the end of the project and act as the final payment plus a refund of the overage. Alternately overfunds could be released as soon as the largest payment is successfully received.
A binding arbitration clause would protect both parties and avoid filing liens, hiring lawyers, and going to court. I don't think asking for this would anger an honest client.
Anybody have any experience with doing this. I haven't researched the subject yet. Obviously, there would be a cost involved and if reasonable, would be well worth it.
……………….
My response:

The general term for this transaction is escrow. Mostly applied to real estate.
The term used in construction is: Performance Bond.

This is an insurance to cover uncertainties.
Performance Bond is for protection of owners.
On the contractor's side of the deal there is called "Good Faith Money". As with Bonds this is often held by insurance company or a bank .
This law of security has been around since 2700 BC when the Romans developed it.

This is a questionnaire asked when applying for a contracting business license in CA.
In preparing for an (FE) Fundamentals of Engineering exam, this is also included in Business Finance section.
As a legitimate company doing business lawfully, you as the contractor can demand this guarantee from the owner. An amount of say $5000 or a certain percentage of the contract is required of the owner to secure this insurance coverage.
It is beneficial to the owner or even peace of mind if assured that his investment is safe.
Besides, if he is really interested in something to be built, he wouldn't have any qualms.

There are so many uncertainties that can not be foretold. Either party (contractor or owner) can go bankrupt. A single proprietor contractor can die unexpectedly or disappear, and the owner would be left holding the bag.
One or the other would be left high and dry if catastrophic event arise.

This insurance cost is often added to the bid price that will usually be under Indirect Cost. Cost of burden is shouldered by the contractor .

A billion dollar contracting company can be self-insured if the company can afford the operating expense to do so.
If you are just small fry it is best to buy insurance.
In a small (puny ) contracts less than $10 K , the owner or contractor can take the offending party to a Small Claims Court for breach of contract.
Here in CA., you can take your case to Small Claims Court without the services of a lawyer or a jury.

In fact, it is a requirement of the court. Each party would have to make his case in front of the judge.
When settled, neither party can make any further claim. Meaning you can’t take your case to an appellate court.
There is an exception:
If the judge rules that no one is liable, the judge can declare “without prejudice” rule. . . meaning no opinion or judgment was given and it is up to either party to pursue using another venue. The case is not permanently dismissed.

But then, you can argue: "why can't we just put it in escrow to avoid the hassle".
Well. . . escrow will charge you for the services. So the parties will simply forego with the trouble hoping to save a few bucks. It does make sense for them to take the risk, if the contract is only worth a few hundred dollars.

I have not had the chance to go that route though.

 

[brantmacga]

You can hold retention payments in escrow; there is an alternative term for it also and the word escapes me right now.

Furthermore, if there was a progress payment dispute, we are putting the brakes on this project. I can see where this wouldn’t always work, but at my level, it does.

I’ve had one job in recent memory with a dispute where retention payments went to escrow. From what I remember, the engineer sent an addendum to delete some RGS pipe work, which I wrote the credit for, but then something with the site conditions required it to basically be put back. The GC signed my $10k+ change order, but didn’t actually have the architect review and sign; just assumed since it was absolutely required to complete the project that it would get approved.

Their next mistake was telling the owner the work was complete; stopping for approval would’ve stopped everyone on what was already a tight schedule.

So, owner disputes the payment. Retention gets held up, GC and owner go to arbitration, GC has to eat it. So it took about 120 days to get the change order PLUS retention as GC was holding out change order also during arbitration, but they did pay it. I felt bad for them, but I was also an idiot to accept only the GC signature on the change order. Because it absolutely requires the architects signature, and thankfully they were an honest company.


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[RumRunner]

You can hold retention payments in escrow; there is an alternative term for it also and the word escapes me right now.

Furthermore, if there was a progress payment dispute, we are putting the brakes on this project. I can see where this wouldn’t always work, but at my level, it does.

I’ve had one job in recent memory with a dispute where retention payments went to escrow. From what I remember, the engineer sent an addendum to delete some RGS pipe work, which I wrote the credit for, but then something with the site conditions required it to basically be put back. The GC signed my $10k+ change order, but didn’t actually have the architect review and sign; just assumed since it was absolutely required to complete the project that it would get approved.

Their next mistake was telling the owner the work was complete; stopping for approval would’ve stopped everyone on what was already a tight schedule.

So, owner disputes the payment. Retention gets held up, GC and owner go to arbitration, GC has to eat it. So it took about 120 days to get the change order PLUS retention as GC was holding out change order also during arbitration, but they did pay it. I felt bad for them, but I was also an idiot to accept only the GC signature on the change order. Because it absolutely requires the architects signature, and thankfully they were an honest company.


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GCs are not authorized to make addenda or any modification to what the architect had sealed and approved for construction.

If the GC thinks that some details can not be applied to the actual construction, say unavailability of material, fabrication problems, etc., he ought to generate a SUBMITTAL FORM and forwarded to the architect.

The architect would then call a conference with the owner or his representative, the GC and the material supplier and all engineers involved.
They will decide if recommended substitutes would meet safety standard, aesthetics, time lag etc are acceptable.
Architects usually are open to any ideas to anyone that he thinks are worth considering.

Barring all these protocols, you run the risk of eating unforeseen expense.

In the case you mentioned, the GC dropped the ball that probably cost him a few bucks.
Important lesson he won't attempt to do twice.

 

[brantmacga]

GCs are not authorized to make addenda or any modification to what the architect had sealed and approved for construction.

I knew that, as it’s something that would also be spelled out in the specs with a sample change-order format, I let myself get rushed through it. That particular project was a couple of years ago in the middle of me having to take a medical leave where I would be out for what was then an undetermined amount of time, and I let it get pushed through on my way out. Again, they paid, but it was a lesson learned.


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