Nobody thinks about construction project funding until it’s time to get paid. Even then, most contractors don’t worry about it until payment is late. By being proactive and finding out how a project is going to be funded ahead of time, you can save yourself some payment headaches down the line.
But what kind of proof of funding should you be asking for? How do you ensure that any funds the owner has are going to be used for the project, and not other expenses? We’ve got some suggestions.
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When project funding is through a private construction loan
When you know that the project is being funded by a construction loan from a bank, it can be easier to get project funding proof, because banks are used to providing this information.
One helpful document is known as a commitment letter.
The letter will contain general information about the loan, including the amount, and can help reassure you that the project has adequate funding.
(As an example, take a look at this commitment letter from Wells Fargo bank for the construction of a Colorado casino.)
One thing the bank’s commitment letter may not tell you is if the loan has closed and the project is fully funded. Before beginning work, it is best to confirm that the loan has closed, and funds are ready to be disbursed.
Confirm that the loan has closed
If it has not closed yet, it may take one or two months before you can submit a draw request and get payment. You don’t want to start work and order materials then have to wait two months for payment.
Make sure everything is ready to go before you get on site.
If you have any concerns about the project financing or aren’t getting answers from the owner, ask them if you can talk directly to the bank. This is often the easiest way to find out where the funding is in the process and assure yourself that you will get paid promptly after submitting a pay application.
When there are multiple funding sources
If a project is drawing funding from several sources, such as government grants or loans and private loans, you may request or receive a disbursement agreement.
A disbursement agreement is a statement provided by the bank or institution providing the funding that shows who is providing how much funding and for what work. It may come in the form of a simple commitment letter or may be a more involved agreement.
(As an example of a more involved document, take a look at this disbursement agreement for another casino development project in Nevada.)
Look the agreement over carefully to see if there are any specific instructions regarding fund disbursement so you know what to expect.
When the owner is financing the project
Things get a little more complicated when the owner is funding the project themselves. You may feel awkward asking them directly about their financial situation. You want to assume that they wouldn’t be undertaking the project unless they had the money. Unfortunately, that may not be the case.
To protect the financial interests of your company, you have a right to ask the owner if funds have been set aside for the project, and if so, how much.
You can even request a copy of their bank statement to show proof that the funds are available. The owner may request that you keep their information confidential, which is understandable.
A GC may, however, share the information with their lower-tier subcontractors and suppliers so they are aware that funding is available and adequate for the project.
When discussing the contract amount for the project, make sure the owner includes extra funds for a contingency in case additional work comes up.
If they request it, you can carry this amount in your budget and credit the owner for any unused portion at the end of the project. Otherwise, they just need to be aware of the fact that there may be additional costs that come up throughout the project.
Putting funds in escrow
If you have concerns about the availability of the funds the owner has set aside for their project, you can request that funds for the project be placed in an escrow account.
An escrow account is held by a neutral third party, such as a bank or title company, for the express purpose of funding the project. Once your payment requests are approved by the owner, the account holder issues a check.
The third party ensures that the funds won’t be spent on other expenses unrelated to the project, which protects your interests.
How to ask for proof of funding
How do you politely ask a project owner if they have adequate funding for a project? There is no perfect answer to that question.
Make it a habit
One suggestion is to add it as part of your regular procedure for vetting a project. Subcontractors prequalify the GC, and the GC prequalifies their subcontractors. To ensure that everyone gets paid on time, it’s also important to prequalify the property owner, too.
When you are gathering the information you need to draft a contract, include questions regarding the funding source, including contact information for the lender. The more normal requesting this information becomes, the less intimidating it will be.
Remember that you have a right to be paid for any work you do. You are essentially extending credit to the project owner, so it makes sense that you want to check on their credit worthiness.
Most retailers ask consumers to fill out a credit application when they are looking to buy on credit. Why wouldn’t you? Although you may not need a full credit history to ensure payment, it is worth it to ask a few questions about the owner’s financial position before you start work.
Let other people request the info
If you are being asked to provide performance and payment bonds on a project, the surety company may ask for proof of project financing.
In this case, you can let them be “the bad guys.” Explain to your customer that this is standard procedure from the bonding company and not a reflection on their credit. If your bonding company is satisfied with the proof they receive, then you can rest assured.
How to protect yourself from unfunded or short-funded projects
One way you can be proactive and protect yourself from unfunded projects is to add a clause to your construction contract stating that the owner must provide evidence of funding before work can begin.
It may also state that late payments or significant project changes are cause for re-verification of funding, and you can suspend work if the evidence is not provided.
AIA contract language
The 2017 version of the AIA general conditions includes such language:
“Section 2.2.1: Prior to commencement of the Work and upon written request by the Contractor, the Owner shall furnish to the Contractor reasonable evidence that the Owner has made financial arrangements to fulfill the Owner’s obligations under the Contract. The Contractor shall have no obligation to commence the Work until the Owner provides such evidence. If commencement of the Work is delayed under this Section 2.2.1, the Contract Time shall be extended appropriately.
Section 2.2.2: Following commencement of the Work and upon written request by the Contractor, the Owner shall furnish to the Contractor reasonable evidence that the Owner has made financial arrangements to fulfill the Owner’s obligations under the Contract only if (1) the Owner fails to make payments to the Contractor as the Contract Documents require, (2) the Contractor identifies in writing a reasonable concern regarding the Owner’s ability to make payment when due, or (3) a change in the Work materially changes the Contract Sum. If the Owner fails to provide such evidence, as required, within fourteen days of the Contractor’s request, the Contractor may immediately stop the Work and, in that event, shall notify the Owner that the Work has stopped. However, if the request is made because a change in the Work materially changes the Contract Sum under (3) above, the Contractor may immediately stop only that portion of the Work affected by the change until reasonable evidence is provided. If the Work is stopped under this Section 2.2.2, the Contract Time shall be extended appropriately and the Contract Sum shall be increased by the amount of the Contractor’s reasonable costs of shutdown, delay and start-up, plus interest as provided in the Contract Documents.”
Protect your lien rights
The other sure way to protect yourself from an unfunded project is to always protect your lien rights on every job. Depending on the state requirements, this means you will need to send preliminary notices at the start of each project and send interim notices as required.
If payment is late, you will need to send a notice of intent to file a lien, and then follow it up with a lien before the required deadline for doing so.
Your payments depend on project funding
It is important to be aware of your rights as a contractor, including the right to know if your client has funding set aside for their project.
The more you ask your clients about their funding status, the easier it will become. You can ask them to fill out a “standard project information form,” that includes their funding information. By presenting a standard form, it won’t seem like you are questioning them personally.
Whether you ask your client about project funding or not, it is a good idea to always protect your payment rights by filing the necessary documents. This way, you can ensure that you will be paid for the work you perform, whether the client has adequate funding or not.