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If a contractor begins to show signs of financial distress while a project is mid-construction, the one thing an owner should not do is rush to terminate the contractor unless it is clear that the contractor is in such a state of financial distress that it is incapable of completing the project.

If not termination, then what should an owner do? Here are four steps to protect an owner’s interests.

  1. Critically assess the contractor’s financial ability to complete the project. The owner should demand that the contractor provide current financial statements and data so that the owner can make a reasoned assessment of the contractor’s financial condition and financial ability to perform.
  1. Independently determine the cost to complete the work and compare that cost estimate with the balance remaining to be paid on the contract. This exercise is critical in order for the owner to determine whether the contract balance is sufficient to finish the work or whether additional funds are necessary to complete the project.
  1. Determine the status of payments to subcontractors and suppliers. This serves to further inform the owner regarding the contractor’s financial condition, whether the contractor has properly applied payments received to date, and whether there are potential mechanics’ lien liabilities lurking under the surface for which the owner needs to withhold payment from the contractor.
  1. Consider whether to supplant the contractor’s forces with another contractor or to de-scope portions of the work and contract with others for such work. Such an approach may serve to reduce the financial strain on the contractor and be welcomed. Of course, it is also possible that the contractor will object. Therefore, the owner must review its contractual rights, obligations and options before actually de-scoping any work.
Depending on the circumstances, the owner also may choose to pay the contractor by way of a joint check arrangement. Such an approach will reduce the risk of subcontractor liens and assure the owner that money is being spent properly. If the contractor is bonded, the owner should carefully review the bond requirements and take any steps as the bond requires to protect its rights against the surety.

If the contractor’s financial condition is so desperate that it cannot complete the work, and therefore the owner has no choice but to terminate the contractor, the owner must ensure that it strictly follows all contractual requirements, including notices and cure periods. In re-procuring the work, the owner must be mindful that the law does not give it a “blank check” and it has a duty to mitigate damages.

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