Unpaid stage payments and retention: contractor options

Construction runs on cash. Labour, materials and subcontractors are paid first, always. One unpaid stage affects the whole project, and the retention held back at every stage often adds up to most of the profit on the job.

This guide is written for contractors and subcontractors: when a stage payment falls due, how to chase it, whether you can stop work, and when retention must be released.

When does a stage payment fall due?

The rule in law is that the price is payable when the employer accepts the work. Where the contract provides for delivery in stages with a price for each stage, that stage's price is payable when the employer accepts that stage. Most construction contracts work this way, so the key is how the contract describes inspection and acceptance of each stage.

A common problem is an employer who will not inspect, or inspects but will not sign, to put off paying. A contractor should:

• request inspection of the stage in writing, stating the completion date;
• photograph and film the finished work with dates, and ask the supervising engineer to record progress;
• if the employer says items need fixing, ask for the list in writing, fix them, and request inspection again;
• if the employer has started using the stage or had others build on it, keep evidence of that, since it shows the stage was fit for use.

One caution: if the work handed over really is defective, such as cracking in many places, the law lets the employer withhold the price until the contractor fixes it or provides security. The Supreme Court has allowed an employer to withhold payment where the building had many cracks and the contractor did not provide the security asked for, while still requiring payment for additional work that had no defects. Separating defective work from sound work helps you recover the undisputed amount first.

How do you chase payment so it counts in law?

Calls and short messages help the relationship but are not enough to prove a case. Once a stage is overdue, send a written demand stating the stage, the amount, the acceptance date and a deadline to pay, to the contract address by a method that proves receipt.

A demand works two ways. It is evidence that the employer is in default, which lets you claim default interest. And if the employer replies admitting the debt or asking to pay in instalments, that reply is an acknowledgement of debt that also affects the limitation period.

Can you stop work if you are not paid?

Stopping work is effective leverage, and also where contractors most often go wrong. Stop without the right to, and the employer may treat it as abandonment, terminate, keep the security, and claim the higher cost of a replacement contractor.

• First check whether the contract lets the contractor suspend work or extend time when the employer pays late.
• If you suspend, give written notice in advance citing the unpaid stage and stating that work will resume as soon as payment is made.
• Ask for the completion date to be extended by the period of suspension, or daily penalties may run for that period.
• Do not remove materials or equipment in a way that looks like abandonment, and keep the site safe.

Where the employer has missed several stages and has made clear it will not pay, the contractor may be able to terminate and claim the price of work done plus damages. Termination cannot be undone, so have a lawyer review the contract and evidence before sending notice.

When must retention or an upfront security deposit be returned?

Two kinds of security are common in construction.

• Retention: money the employer holds back from each stage payment, such as five or ten percent of each stage.
• A performance security: a lump sum the contractor lodges with the employer before work starts, in cash, a cashier's cheque or a bank guarantee, to secure completion of the contract.

Both are contractual security, not part of the price, so when they must be returned depends mainly on the contract. Commonly the performance security is returned on handover of the final stage, and retention at the end of the defects liability period, for example one or two years after the final stage is handed over.

A contractor asked to lodge a lump sum before starting should check, before signing, that the contract states clearly when it is returned, when the employer may forfeit it, and when it comes back if the project is cancelled before work starts. Where possible, offer a bank guarantee instead of cash, because cash already handed over is much harder to recover if the employer runs into financial trouble.

• Note the release date from the day the final stage is handed over.
• When it arrives, ask in writing for the retention or the bank guarantee to be returned.
• If the employer alleges defects, ask for a list and evidence, and offer in writing to come and fix them.
• If the employer refuses access but has others do the repairs and keeps the whole retention, the contractor has grounds to dispute it.

An unreturned bank guarantee keeps costing fees and ties up the credit line you need to tender for new work, so follow it up from the due date.

Can an unpaid subcontractor sue the project owner?

As a rule, the subcontractor's contract is with the main contractor, so the claim is against the main contractor, not the owner, even though the work sits in the owner's building.

But sometimes the main contractor does not pay the subcontractor and also does not chase the payments the owner owes it. The law lets a creditor exercise a debtor's claim in its own name where the debtor neglects to do so and the creditor suffers as a result. A subcontractor may therefore be able to claim from the owner in place of the main contractor. This route has several legal conditions and has to be assessed case by case.

Better protection is written into the contract from the start, such as allowing the owner to pay the subcontractor directly when the main contractor defaults, or requiring proof of payment to subcontractors before the next stage is released.

How long do you have to claim payment or security back?

A contractor's claim for the price of work generally has a two-year limitation period. Where the work was done for the employer's own business, it is five years. The Supreme Court applied five years to the final stage and additional work on a resort the employer built to let as guest rooms, because the work was for the employer's own business.

The contractor has to raise this exception and prove that the work was for the employer's business, such as a factory, hotel, rental building or company office. A house the owner builds to live in generally falls under two years.

Time runs from the date each stage payment fell due, so stages may expire at different times. A contractor who has let an early stage sit unpaid while finishing the job should check that stage's date.

Retention held back is different. The Supreme Court has held that it is not unpaid price, so the two-year period does not apply and the general ten-year period does.

This page is general information, not advice on your situation. The right to suspend, terminate or recover retention turns mainly on the contract. Send the firm the contract, acceptance records and demands before suspending work or serving notice of termination.