Complexity in Interim Payment of Construction Projects: History
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Contributor:
Lei Zhu
,
Hui Xiong
,
Yan Ning
,
Miaomiao Lv

An increasing trend in late payment and nonpayment of construction projects would hinder the sustainable development of projects by impeding progress or causing disputes.  

  • construction finance
  • interim payment
  • perceived ease of use
  • complexity

1. Introduction

There is an increasing trend in late payment and nonpayment of construction projects in both developed and developing countries. Recent research revealed that 65% of contractors in the UK have experienced slower payments since the start of the pandemic, and a staggering 75% of UK businesses are forced to wait a month beyond their agreed contract terms before getting paid [1][2]. Similarly, a study of eight construction central enterprises in China found that the average collection period and the maximum average cash collection ratio in 2020 were around 150 days and only 5.0%, respectively, indicating a large number of accounts receivable and a large inventory [3]. Late payment would directly impede the progress of projects. In addition, it causes a variety of economic and social problems, such as cash-flow problems of contractors and subcontractors, disputes, and wage arrears to workers [4]. Ramachandra and Rotimi [5] found that 70% of payment disputes in construction projects were related to progress payments, whereas 75% and 25% were related to interim payments and final payments, respectively.

2. Causes and Countermeasures of Payments Problems

The unique characteristics of construction projects contribute to various payment problems. Different from general spot commodities, construction products are futures that are customized products and need to be gradually supplied in the future. Therefore, an interim payment is a partial payment that equals the actual value of completed and qualified work conducted by contractors over a period of time or after an agreed milestone, taking into account variations, etc. [6]. During the project construction, there are rounds of applying and verifying interim payments between the contractor and the owner with the help of the consulting enterprise.
Late payment and nonpayment are of the most significant concern. Studies have explored the potential causes and countermeasures for late payment and nonpayment from the project or industry levels. Causes from the owner are often ranked top. The identified important reasons include insufficient funds to make payments [7], poor financial management [8][9][10], the lack of financial resources [8][11], delay in evaluation and certification of interim and final payment [8], and controlling payments to reserve the bargaining power to ensure that the contractor completes a project with due diligence [12]. For public projects, if the project works that are carried out exceed the government budgets, government agencies may not make payment to the contractor until they get the next year’s budget [4][11][13]. From the aspect of project management, payment problems lie in works that are not completed correctly or on time, defective construction works, controversial works, rework due to errors, contract changes, and conflicts or disputes among parties involved in the contract [5][10][13]. In addition, slow processing and delay in finalizing variations and final accounts, and poor documentation were also ranked as important reasons [8][9]. For public projects, late payment can also be caused by bureaucratic procedures, such as government audits [4]. From the aspect of the culture, that work first and getting paid later and the perception that late payment is acceptable are also important reasons for payment problems [4][13]. In practice, irregular payments are ranked as a major cause of disputes [14][15].
Many measures are proposed to mitigate payment problems. From the aspects of legislation, the European Union adopted Directive 2011/7/EU on Late Payment in 2011, which makes late payment less attractive for debtors and compensated the creditor for late payment practices [16]. From the aspect of project management, Peters et al. [4] and Abdul-Rahman et al. [8] suggested training the owner in cash-flow management and investigating the owner’s ability to pay. From the aspect of new techniques and tools, blockchain and smart contracts are recently proposed to alleviate payment and related financial problems [13][17]. Using the Bayesian belief network, Wang et al. [9] developed a model to predict the possibility of payment issues, endowing that contractors proactively evaluate if they can afford the payment risks. Nanayakkara et al. [13] explored the suitability of applying blockchain and smart contract technologies to solve payment issues in the construction industry. The findings showed that the application can enhance the traceability of inter-organizational processes and decrease transaction costs. However, these technologies have low efficacy to solve problems, such as cost overruns, payment disputes, and payment hold, which are related to stakeholders’ decisions. In addition, the major difficulty in implementing these technologies is not that they are immature but that the developments across the legal, social, and process dimensions are not accompanied [18]. For example, participants are unfamiliar with or unwilling to use them.

3. Increasing Complexity in the Interim Payment of Construction Projects

Tracking changes in the interim payment method from a historical perspective can help us to understand the formation of practitioners’ behaviors. Taking China as an example has a good advantage. China’s national system has gone through several periods of planned economy, planned commodity economy, and socialist market economy. Studying the execution of the interim payment in these processes is easy to show how interim payment changes from simple to complex.
An interim payment is a partial payment that equals the actual value of qualified work completed by contractors over a period of time, taking into account variations, etc. Factors from two aspects will lead to the different workloads of payment application and verification in the construction industry. On the aspect of contract type, payment of lump sum contracts are based on milestone nodes specified in a contract; payments of unit price contracts are not only based on the unit price agreed in a contract, but also based on an accurate measurement that takes a lot of time and effort during the construction [19]. On the other aspect, payments for significantly defective construction works, disputed works, variation orders, project visas, and other disputed claims usually consume a lot of time and effort to settle [4]. Some even need to be resolved through judicial procedures. Considering the great personnel turnover of the industry, without the timely interim payment, once the relevant personnel leave their position, the successors have great difficulties providing key evidence due to poor documentation and lack of information, easily leading to disputes.
China’s construction projects strictly implemented monthly advance payments, monthly interim payments, and completion settlements in the history of China [20]. However, projects with short construction periods and low contract value only implement monthly advance payments and completion settlements. With the increase in the scale of China’s capital construction investment, government authorities gradually relax the requirements for not implementing monthly interim payments. The construction period was relaxed from three months in 1953 to six months in 1980, 12 months in 1989, and no requirement in 2004; the contract value was relaxed from 300 thousand RMB in 1980 to 1 million RMB in 1989, and no requirement in 2004 [21]. Accordingly, the owner and the contractor gradually stopped strictly adhering to interim payments.
Moreover, in the past 50 years, before 2003, Chinese construction enterprises used as-built drawings and the Quota valuation method rather than signed contracts as the only basis to calculate payments. The Quota valuation method calculates payments based on government-issued cost-related norms and standards, which are based on full-cost compensation and are relatively stable. Under the administrative management of the government, the owner and the contractor can get full-cost compensation and are equal brothers. In 2003, China started implementing the “Code of valuation with bill quantities of construction works” to be in line with international standards and practices [22]. Thereafter, the owner and the contractor began to use the Bill of Quantity (BQ) valuation method and pay attention to the contracts signed through bidding. In 2004, China issued an important decision on the reform of the investment system to differentiate public investment and private investment under the socialist market economy [23]. With the gradually weakened administrative management, market-oriented management is gradually strengthened. Market factor prices are also gradually fluctuating. In addition, the owner and the contractor have equal civil relations. However, habits and mindsets change very slowly. Even now, a lot has not changed.
In a long run, interim payments made by the owner are only based on rough estimates and have the nature of advance payments. Because of no measurement, the owner intentionally lowers the payment proportion, such as to 60~80%, to avoid overpayment. The lack of real interim payments and improper contract management in the construction phase makes all problems pile up to the completion settlement (Sun et al., 2015), leading to numerous payment problems. Although China has issued many policy documents from 2020 to strengthen stakeholders’ performance according to signed contracts and implement the interim payment method, industry acceptance is very low. The Ministry of Finance of the People’s Republic of China [24] issued a notice to arbitrarily require that government agencies, institutions, and state-owned enterprises pay no less than 80% of the value of completed projects. However, the notice has low operability and causes another kind of chaos in the industry. The real situation indicates the huge difficulty in returning to this method once giving it up.
Under the market economy, the interaction between the stakeholders changes to a game-based balance. It is well-known that bidding on construction projects and the replacement of contractors mean huge transaction costs. There is process specificity and reversal of bargaining power in construction projects [12]. Once a project starts construction, payment is the bargaining chip for the owner to ensure that the contractor can complete the project with high quality and on time [13][25]. The 60~80% payment proportion is treated as a bargaining chip to help the owner promote the progress of a project [10]. Because of process specificity, project progress is the bargaining chip for the contractor to ensure that the owner can make sufficient payment. Slowing down work is a recommended measure for the contractor to incorporate the risk of late payment or nonpayment [8].

This entry is adapted from the peer-reviewed paper 10.3390/su15097120

References

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