How to review a contractor pay application

The monthly pay application is when payment leaves the owner’s account. On a $2,000,000 project paid over ten or twelve months, one pay application can move a few hundred thousand dollars. Once paid, it is hard to get back.

Anatomy of a pay application

Most contractors use the AIA format or something like it: a summary page (AIA G702) and a continuation sheet (AIA G703). The summary page shows:

1. Original contract sum
2. Net change by change orders
3. Contract sum to date
4. Total completed and stored to date
5. Retainage
6. Total earned less retainage
7. Less previous certificates for payment
8. Current payment due
9. Balance to finish, including retainage

The continuation sheet breaks the total down by schedule of values line.

Start with the schedule of values

The schedule of values (SOV) divides the contract sum into line items, and every pay application measures progress against it. Agree on it before the first invoice and check for:

• Front-loading: early lines such as mobilization, sitework, foundations and general conditions carrying more than their real cost, so the contractor is paid ahead and the back end is underfunded
• Measurable lines: “MEP $360,000” is hard to verify; separate plumbing, electrical and HVAC lines for rough-in and trim are not
• General conditions billed in step with time, not up front
• Allowances and change orders on their own lines

If a contractor fails mid-job with 60% of the contract paid and 45% of the work done, the balance won’t finish the building.

The review, step by step

1. Check the header math. Contract sum to date should include approved change orders only, never pending ones. Previous certificates should match what was paid.
2. Walk the site. Compare each line’s percent complete with what is installed. Contractor photos are not a substitute.
3. Compare to the schedule and inspections. If framing is billed complete but hasn’t passed inspection, ask why.
4. Audit stored materials against the documents described below.
5. Confirm retainage is withheld at the contract rate on every line.
6. Match change-order lines to signed change orders.
7. Collect lien waivers and check them against the Notices to Owner you’ve received.
8. Respond in writing with the approved amount by line and the reason for each adjustment.

Percent complete: what “60%” should mean

A line is 60% complete when 60% of its value is in place, not when 60% of the time has passed or 60% of the material has been bought. Useful checks:

• Has the work passed inspection? Rough-in that hasn’t passed rough inspection isn’t finished.
• Is it installed or only delivered? Delivered material goes under stored materials, with documents.
• Does it match the subcontractor’s billing? A sub billing 40% on a line the GC bills at 60% needs an answer.

Stored materials

Contractors often bill for materials bought but not installed, such as impact windows, tile, cabinetry and switchgear. Before paying, require:

• An invoice and proof of payment, or a bill of sale transferring title to the owner
• Insurance covering the materials where they are
• For off-site storage, a secure location, materials tagged for your project, and the right to inspect
• Tracking so stored amounts move to “completed” when installed and are never billed twice

A deposit to a manufacturer for product that hasn’t been made is not stored material. It is a financing request and should be negotiated as one.

Retainage

Retainage is a percentage of each payment held back until the end of the job. On private work in Florida, the rate and release terms come from the contract. Ten percent, sometimes dropping to five percent at half complete, is common. The contract should state when retainage is released, usually part at substantial completion and the rest at final completion, subject to the punch list, closeout documents and final lien waivers.

Lien waivers and Florida lien law

Under Florida’s Construction Lien Law (Chapter 713, Part I, Florida Statutes), contractors, subcontractors, suppliers and others who improve a property can record a lien against it if they aren’t paid, in some cases even when the owner has already paid the general contractor. Three documents do most of the work:

• Notice of Commencement. The owner records it with the county before the first inspection and posts a copy at the site. It names the owner, contractor, property and any lender, and expires one year after recording unless it states another date.
• Notice to Owner. Subcontractors and suppliers who don’t contract with you directly serve one to preserve their lien rights. Keep every one. They are the list of parties whose waivers you need.
• Lien waivers. Section 713.20 sets out statutory forms for a waiver and release of lien upon progress payment and upon final payment, and generally bars an owner from requiring a lienor to sign a different form.

Conditional vs. unconditional. A conditional waiver releases lien rights only once the stated payment is received. An unconditional waiver releases them when signed. On each pay application, collect a conditional waiver for the current payment and an unconditional waiver for the prior payment once those funds have cleared, from the GC and every sub and supplier that served a Notice to Owner.

At final payment, Florida law requires the contractor to give the owner a final payment affidavit stating that all lienors have been paid or naming those who haven’t. Get it, with final waivers, before releasing final payment and retainage.

Note: This is general information about Florida’s lien law, not legal advice. Have a Florida construction attorney review your contract, waiver forms and payment procedures.

A worked example

For illustration: a $2,000,000 contract with 10% retainage, pay application number five, as submitted.

As submitted:

• Total completed and stored to date: $1,134,000
• Retainage at 10%: $113,400
• Total earned less retainage: $1,020,600
• Less previous certificates ($712,000 less 10% retainage): $640,800
• Current payment requested: $379,800

The site walk and document review find three issues:

1. Structure and framing billed at 100%. Part of the second-floor framing is open and the framing inspection hasn’t passed. Certified at 90%: $378,000 instead of $420,000.
2. Impact windows, $108,000 stored. The backup is a manufacturer’s deposit invoice for windows not yet made, with no bill of sale or insurance certificate. Held at $0 until delivered or documented.
3. MEP rough-in billed at 60%. Plumbing rough is mostly in, electrical is about half done and HVAC ductwork hasn’t started. Certified at 40%: $144,000 instead of $216,000.

Revised:

• Total completed and stored to date: $912,000
• Retainage at 10%: $91,200
• Total earned less retainage: $820,800
• Less previous certificates: $640,800
• Current payment certified: $180,000

That is $199,800 less this month: $222,000 of work not yet earned, less the 10% retainage on it. It is paid when earned. If the contractor walked off next week, the owner would be $199,800 better placed to finish.

Red flags

• Percent complete running ahead of the schedule month after month
• Pending, unsigned change orders in the contract sum
• Large stored-material claims with thin backup
• Retainage missing from some lines
• Subs or suppliers who served a Notice to Owner but never appear on a waiver
• Pressure to pay immediately or “the subs will walk”
• The schedule of values revised mid-job to move value between lines

How Monster Project Group reviews pay applications

On MPG projects, the pay application comes to us before the owner. We walk the site, check every line against the schedule of values and the work in place, audit stored materials and change orders, track Notices to Owner against lien waivers, and send the owner a recommendation with the reason for every adjustment.