I was working for a general contractor on several fast-track student housing projects in the late 1990s to fill a need in the Boston area, especially on smaller campuses that had limited space. One fast-tracked campus apartment project I remember started with a lot of positive energy because everyone was excited to be part of what at the time was a new process. Most of the individuals involved saw it as a challenge.
But then the trouble started. The amount of work put in place outpaced the owner’s ability to draw funds and pay on time. The late payment and the problems it triggered deprived us of a “clean” project—one that meets all client expectations by getting done on budget and on time, safely and without stress and litigation.
About three weeks after the first pay application was submitted, the owner had not yet paid us and the unpaid subs began showing up understaffed—or not at all. For those that did show up, there was a marked transition in project energy, from passionate and enthusiastic to negative and lethargic. All the little favors that used to be answered as, “Sure, no problem, Adam,” were now answered as, “I will need you to call my office; we will need a change order for that.” Work quality sank; material deliveries were delayed.
That’s why I’m a big fan of construction escrow services to separate, store and disburse funds needed for the work. Had the college whose student housing we were building used such a service, the funds would have been readily available and released after the ordinary due diligence process. Instead, the first progress payment was delayed 60 days due to a 30-day draw request process to the owner and another 30 days to receive and process payment to the vendors.
Many of us already know how the approval process for a payment can drag out on a typical building project. A pay requisition package prepared for formal submittal takes a minimum of three to five days. It begins with an onsite pay requisition meeting and the arduous process of pinning the percentage of work completed to the work in place—plus some horse trading for favors—and work in process that “should” be complete at the time of payment.
Once the pay requisition is submitted, the waiting begins. An individual from accounts payable will put together a file, including a copy of the pay requisition and invoices, T&M slips, approved change orders and all pertinent supporting documents for that invoicing period.
The file then needs to go through the final review and approval process by the superintendent, general superintendent, project manager, senior project manager, accounting, legal, chief financial officer and others. There is usually at least a two- to three-week delay because of mistakes, missing lien waivers and other things that must be fixed before the pay package can be sent to the lender for payment.
Rarely are net 30-day checks received at 30 days, especially when high dollar requisitions are involved, and the flow-down of funds is further delayed by bank holds. Funds involved have likely already been spent by the general contractor, with the GC either out-of-pocket for labor and material or on account with suppliers to the contractor and subcontractors.
For a general contractor with net 30-day payment terms, there is already a cash outlay and outstanding debt 60 to 90 days before the GC is made whole. That immediately introduces stress for all the contractors and vendors. When payment is late, people start pointing fingers. When payment is very late, subcontractors pack up and leave.
Using an escrow agent makes the process clearer and more transparent, eliminating blame. It saves working capital for unplanned events and seasonal changes.
Using the escrow agent as a neutral third party with a dual fiduciary duty is the fairest and most timely method. It helps contractors plan their finances and keep track of their cash flows. Using the value of the escrow funds as collateral, a contractor may get additional front-end funding against part of the contract’s value.
The owner’s administrative recordkeeping is minimized and the cost is a fee determined in different ways but which amounts to only a percentage of the total project costs. The owner enjoys peace of mind knowing funds are fairly distributed on time. If there was ever a time for taking the payment headaches out of a project, this is it.
Adam Post, a senior-level project manager who has studied at Boston University, Northeastern University and Wentworth Institute of Technology, can be reached at firstname.lastname@example.org.