All of the standard and model forms of building and engineering contracts contain provisions for advance payments, and for many years they have been little used, but with the continuing materials price rises developers and contractors alike are both turning to advance payments to protect themselves.
Most advance payments are for goods and materials, and that makes sense for both parties. Contractors can give a definite contract price without worrying that their profit will be eaten up by increases they can’t control; developers can be sure that the feasibility of the project will not be called into question half-way through. But what should be parties to do protect themselves?
Developers have a couple of options. For goods and materials paid for and stored off-site, vesting certificates are essential, as is the requirement that the items are stored separately to the contractor’s other materials, and marked as the property of the developer. This means that, in the event of the contractor becoming insolvent, the developer will be able to prove the administrator or liquidator what they own, and remove it. It is essential, of course, that title to the items is passed upon payment, rather than delivery to site.
The second thing that should be considered is ad advance payment bond. This is more appropriate if the advance payment is for labour or services, rather than tangible items that can be recovered in the event of a problem. An advance payment bond is, like any other bond, basically a form of insurance policy issues by a bank or insurer guaranteeing payment if the specified problem arises. So if the contractor defaults or becomes insolvent, the developer can recover the advance payment from the bondsman. It is possible to get a parent company guarantee for this instead, but there is of course the risk that if the subsidiary company goes under, so might the parent company.
Contractors are generally in the better position, as they are the ones holding the money, but they need to consider their position when it comes to “repayment” of the advance payment. How exactly the payment is going to be accounted for in the interim payments needs to be carefully defined, and it is likely to need amendments to the published base form of contract. It needs to be agreed with the developer, of course, but the payback regime needs to be sufficiently slow as to not affect the contractor’s cashflow and, ultimately, their ability to complete the project. If the advance payment is just for goods and materials it is worth getting those split out from the interim payments for design and labour so that those are paid on the usual basis and repayment of goods and materials are dealt with separately.
If, however, advance payments are not an option (perhaps because of funding requirements) then the parties can look to allowing for price fluctuations due to inflation to deal with rising costs.
If you have any questions on advance payments on construction contracts our Construction and Engineering team will be happy to help. Please get in touch for further information.