Legal and Regulatory

Best Practices for Avoiding Payment Disputes in Commercial Tenant Improvement Contracts

Following essential business practices when drafting commercial tenant improvement contracts can help contractors stay on schedule and manage the client’s expectations.
By Renee S. Diaz
July 13, 2020
Topics
Legal and Regulatory

Contracts to remodel commercial space for tenant improvements are often on AIA A101-2017 Standard Form of Agreement and incorporate the AIA A201-2017 General Conditions for the Contract for Construction. These documents, along with the project plans, govern the tenant improvement work.

What many general contractors forget is how timing requirements may impact the plans and contract documents, and that oversight can lead to some unintended and particularly ugly consequences.

Following essential business practices when drafting commercial tenant improvement contracts can help contractors establish a realistic schedule based on the contract terms and manage the client’s expectations around timing.

Pay Attention to What Needs to be Ordered Before Establishing the Construction Schedule

Most AIA A101-2017 contracts have a construction schedule included in the contract. Since the general contractor typically prepares this schedule, it is important to carefully think through what the tenant improvement entails before creating the construction schedule. Build enough time into the construction schedule for suppliers to deliver their products and materials and thoughtfully sequence the subcontractors’ work. While no one can predict the future, it’s always wise to allow time for delivery delays in production, shipping, customs and even possible pandemics.

How this plays out in real time: In a tenant build out for a yogurt franchise, the project documents anticipate completion in 35 working days. The project documents also call for installation of custom-made millwork so that all stores have a uniform look. This millwork must be custom ordered from a specific manufacturer designated by the franchisor; delivery typically takes one month. If the general contractor does not contact the manufacturer as soon as the contract is signed, there won’t be enough time for the millwork to be fabricated, delivered and installed. If the millwork is not installed in the sequence laid out by the general contractor’s schedule, the rest of the construction project is delayed. Worse, if there is a liquidated damage clause in the contract, these delays can rapidly eat up the general contractor’s profit and may result in the work being done at a loss.

Pay Attention to the Payment Application Provisions of the Contract

In the general conditions, there is typically a provision that requires payment applications be supported by all data substantiating the general contractor’s right to payment, such as copies of statutory releases and waivers from the general contractor, subcontractors and suppliers.

How this plays out in real time: If the general contractor fails to attach to each of its payment applications, signed releases and waivers from any of the subcontractors or suppliers of any tier of the project, then the tenant may not pay the general contractor for the work performed by the subcontractors or for materials and supplies.

Pay Subcontractors and Suppliers

The general conditions typically require that by submitting a final pay application, a general contractor certifies that it will timely pay its subcontractors and suppliers all monies owed for their services on the project, so title to all of the tenant improvement work will pass to the tenant, free of any claims or liens.

How this plays out in real time: If the general contractor signs this certification, he is agreeing to pay suppliers of any tier for the project for most of their work, and, upon this final payment, will have paid the final progress payment and the remaining retention. If the general contractor fails to pay subcontractors and suppliers when paid by the tenant, then the general contractor might be sued by both the tenant and subcontractors and suppliers, each of whom might allege that the general contractor misappropriated or diverted the funds from the project for another use.

Bond Off Mechanics' LEins

If a general contractor fails to pay its subcontractors and suppliers after receiving payment in full from the tenant, the tenant may demand an accounting of payments to subcontractors and suppliers. The tenant may also demand that the general contractor comply with the typical requirements of general conditions, and defend and indemnify the tenant for all losses, including reasonable attorney’s fees and litigation expenses, due to any lien claim or other claim for payment by any subcontractor or supplier. If the property owner demands that the tenant remove any mechanic’s lien recorded by subcontractors or suppliers, the tenant will look to the contract to require the general contractor to post a surety bond to replace the value of all liens or claims.

How this plays out in real time: The general contractor will incur the cost of providing the tenant with a full accounting of payments to subcontractors and suppliers. In the unlikely event the general contractor’s insurance company determines it will defend the tenant against subcontractor or supplier mechanic’s liens or claims, and has to pay out to resolve the claims against the tenant, the general contractor’s insurance rates will likely increase. Generally, the general contractor pays to bond off the mechanic’s liens.

Be Sure to Complete the Project on Time

Include a clause in the contract addressing how construction schedule overruns will be handled. If the tenant is a franchisee, its contract with the franchisor will typically contain a time limit, such as 10 calendar days from completion of construction, for the franchisor to inspect the franchise store for compliance with the franchise requirement before the store can open for business. The tenant may look to the general contractor to pay its rent for the period between the intended construction completion date for delays in opening and securing the franchise’s green light to start generating income.

Keep Good Records

One of the best ways a contractor can prepare for future claims is to keep good records, including contracts, change orders, invoice payments and proof of completion. Take date-stamped photographs of work in progress. Keep all emails, texts and client communications. While emails and texts are a convenient way to communicate, think before sending an email or text that might contain language that can be used against the company in a claims situation.

Provide Frequent Client Updates

Staying in frequent contact with the client and giving them weekly progress updates is a good business practice and can help create a solid relationship with the client. Address problems immediately to preserve the client relationship.

If There Are Unanticipated Delays, Tell the Client

Remember that not all construction delays are the contractor’s fault, and even when there is a seeming cascade of scheduling delays and construction errors, the client may be understanding, provided they are told right away so that decisions can be made. To avoid escalation and having the situation become personal, keep the client informed of construction developments, take pictures of progress and stick to the construction schedule. When problems arise, contact a construction attorney for assistance in navigating the ups and downs of negotiating a resolution with the client.

by Renee S. Diaz
Renee Diaz, Clark Hill’s Construction Practice Group, has represented design professionals and subcontractors in residential and commercial construction litigation, including first chair bench and jury trials. She is experienced in handing all aspects of case management and evaluating and devising case strategy.

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