Most of the risk during construction projects comes not from performance issues, but instead from payment issues. As with most of us, general contractors are great at doing their jobs – in their case, construction – but are not necessarily adept at the paperwork or accounting side of the construction equation. Historically, 80-85% of construction defaults are due to errors in payments and/or funds disbursement. Specifically, the money is not getting distributed to the people who are performing most of the duties on a construction project – the subcontractors and suppliers. Many factors can contribute to this problem: poor management; accounting or paperwork errors; comingling of funds between projects (not a sound business practice); and, yes, although admittedly rare, even through the intentional diversion of funds.
Over the past several years, a solution to this problem has evolved in the construction lending industry. Construction Risk Management has become a commonly accepted outsource tool for managing the risk of construction lending by a 3rd party risk management firm. One service within the Construction Risk Management toolkit is Funds Control and Disbursement, which allows for a much greater level of oversight, management, and control of the general contractor’s monthly draw request and payment process.
What is Funds Control and Disbursement?
Essentially, Funds Control and Disbursement encompasses all of the activities necessary to manage the pay application and disbursement process.
From a construction risk management standpoint, sound accounting and business practice dictates not only keeping funds for different projects separated, but also examining the payment requests within each project very carefully. Appropriate invoice support and documentation must be submitted with the draw requests in order to verify that the requests are, in fact, valid and appropriate.
Furthermore, before any payments are made, it is critically important to review the progress of the project to ensure it is on track. Construction Progress Monitoring, which determines the percentage completion by line item, is usually done in conjunction with the Funds Control process for this very reason.
Finally, the documentation that is inherent in a Funds Control and Disbursement program can significantly increase transparency to bank regulators, particularly during an audit.
What Does a Funds Control Program Entail?
The 3rd party risk management firm’s role should include:
- Reviewing the pay application request
- Collection and review of supporting documentation
- Review of the percentage of the work completed
- Tracking change orders
- Lien waiver collection
- Distribution of draw proceeds upon approval – single payee checks are made directly to the subcontractors (sent via the GC for distribution purposes) to make sure the money gets to the right people in a timely manner.
What’s the Advantage of Funds Control?
Construction Risk Management, including Funds Control and Disbursement, is a government-approved alternative to a payment and performance bond, and with good reason: it is a proactive tool that can identify problems as they occur, or even before, and allow for early correction. It is also far less expensive than a bond (usually about