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INDUSTRY PERSPECTIVES: A closer look at the prompt payment problem

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by Geza Banfai

Paying a bill is the final step in an exchange of value between the payer and the payee. That this is an exchange is a crucial point, and the fact that payers – who have already received their value – sometimes seem to overlook this is the cause of much rancor. Delayed or non-payment instantly triggers a deep-seated sense of injustice.

A monthly payment cycle is a norm enshrined in all of the industry standard form construction and design contracts used in Canada and elsewhere. There is good reason for this: it regularizes the flow of cash throughout the construction pyramid, as well as with others outside the pyramid who typically operate on a monthly cycle. Some obligations such as wages and salaries are shorter, but these are accepted and accounted for. Overall, it is safe to say that a cycle of monthly payments accords with the reasonable expectations most participants in the construction process hold most of the time. Any interruption or delay in that payment flow has consequences which are only too familiar.

A recent survey conducted by Raymond Chabot Grant Thornton, however, has reported that the average payment time in the construction industry in Quebec is currently 80 days and has been increasing.  Furthermore, the gap between the average payment time in the construction industry and in non-financial industries as a whole has almost doubled in the past decade. This is in line with strong anecdotal evidence from elsewhere in Canada. Why is this?

In principle, there can be only these possibilities: payment terms longer than one month are being accepted and/or agreed payment terms, however long, are being ignored. Each brings slightly different considerations to the problem.

Reasons for not making payment within the agreed time (monthly or otherwise) are many and varied, but all are reducible to this: delay in payment benefits the payer. Payment closes the loop of exchange in value that the payer may wish to keep open or about which the payer may simply not care. The payer's motivations may range from the overreaching and malicious to the clear, convincing and fully justifiable. Whatever the reason, the payer benefits by delay in making payment, at least in the short term.

There are countervailing pressures tending to prevent the payer from delaying payment forever. These can be formal, such as the threat of legal action, or informal, such as reputational considerations. Considering the evidence that payment cycles have been extended, it would appear that these formal and informal mechanisms are not as effective as they once might have been. One reason may be that the existing system of legal enforcement is essentially useless in efficiently and economically resolving a payment delay of, say, 20, 30 or 40 days, and is only marginally useful when the delay is longer. If there is a dispute, that delay is measured in months or years.

People play that broken system. And when many people play a broken system, the threat of reputational harm is felt less. Ask the taxpayers of certain Mediterranean countries.

People also play one another. Being too pushy about enforcing timely payment may be seen as hurting the chances for future work, and some recalcitrant payers are not shy about so reminding their payees. At the extreme, we have blacklist clauses in the tendering by-laws of certain municipalities which provide that any previous or current litigation or claim by the tendering contractor against the municipality disentitles that contractor from bidding on further work. That such claim may be grounded upon the municipality's own unjustified failure to pay is quite irrelevant.

Some payers maintain that they simply cannot make payment within 30 days because their internal review and approval processes are such that they need more time. It is interesting that amid such feedback as took place concerning Ontario's abortive Bill 69, the design community, which has a primary responsibility for certifying payments, did not raise this as a concern. One might reasonably ask why internal approval following consultant certification takes so long. In any event, this seems like a hard sell in a world of instantaneous electronic communications and nearly instantaneous electronic payment.

Payers who are able to impose extended payment terms upon their payees of, say, 60, 90 or more days present a different set of issues. These tend to be larger organizations with considerable market clout, and they do this because, well, they can. In a highly competitive marketplace, someone will accept their terms even if others refuse.

This raises an ethical dimension. Agreeing to pay within 30 days in circumstances in which the payer has no real intention of complying is clearly unethical. But less clear are the ethics of forcing an agreement for extended payment terms in circumstances in which the payer knows that the financial burden of those terms will be absorbed by the payee, or is indifferent to that fact.

A libertarian would see no ethical issue here at all - choosing to contract on such terms is a choice freely made, if not by that party than by someone else. If the payee cannot absorb the financing cost, it's her problem, and devil take the hindmost. That's the way a free market works, and that's what freedom of contract is all about. For the libertarian, the proper role of the state is to remain hands off and let the market regulate itself.

Others, however, might point out that the libertarian's unrelenting focus on commercial freedoms ignores other important considerations, and besides, his entire argument is grounded upon a fiction. There is no such thing as unrestrained freedom of the market, they would say – the Competition Act and lien legislation itself being two obvious examples – and the law has always constrained freedom of contract where doing so achieves some higher societal purpose or the common good. It's about maximizing that common good, they would argue, and it's entirely appropriate in the right cases to restrict freedoms to the limited extent necessary to protect the good of all. These people would maintain that the survey and anecdotal evidence mentioned earlier strongly suggests that this is one of those cases, where unchecked market forces have allowed too many powerful players to distort the market to the detriment of too many payees, and that this requires correction.

Still others might go even further. It's not about maximizing freedoms, they would say, or even about maximizing the common good. Rather, it's about achieving a just construction industry, in which the right qualities are nurtured. As Harvard political philosopher Michael J. Sandel has pointed out: "Justice is not only about the right way to distribute things. It is also about the right way to value things." Shouldn't we above all be valuing good, competent construction and design work, they would argue, over the vagaries of the balance sheet and the serendipitous ability of some firms to weather payment delays over other firms?  And if distortions in the market and systemic problems of legal enforcement are hurting people, shouldn't we be repairing those problems rather than allowing them to continue because it is right and just that we do so?

Reasonable people can disagree about all this, and will. Ultimately, these kinds of ethical questions merge into questions of politics and the need to make political judgments. The essential thing is that we engage in a wide consultation and respectful sharing of views in deciding them. While doing so, we might consider the experience of other jurisdictions including the United States, Australia, New Zealand, the United Kingdom and others, who have already considered these problems within their own construction industries and have enacted some form of prompt payment legislation. In the U.K. and Australia, processes for the fast-track interim adjudication of disputes have been introduced in an effort to address collateral systemic problems in the legal system. It may now be time for Canada to do the same.

Geza R. Banfai is counsel at McMillan LLP and these views expressed are solely those of the author. He also is a member of the Daily Commercial News Editorial Advisory Board. Send any comments to editor@dailycommercialnews.com.

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One comment

  • # 1

    Derek Smith

    The ICI industry can easily deploy a regime similar to that of the custom residential construction payment flow, controlled by the banks but with a more waterfall effect. A mutual or trust bank system built solely for the benefit of the construction industry in Canada (Think Farmer trust or co-op) will ensure monies for the project committed by the owner are held in trust as is the intent and contemplation of CCDC contracts. Similarly on the payment pyramid, take the money out of the hands of the GC, thereby ostensibly eliminating the pyramid and apportion Division 1 funds to the GC just like a subcontractor in a schedule of values and have a third party distribute funds based on consultant payment certificate. Interest from trust funds (managed by the co-op) then remitted back to the owner upon successful completion of the project, so no loss to them. Just an idea as I am staring at Stat Dec today that I really know is not worth the paper it is written on due to very broad privilege clauses.

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