This document discusses best practices for managing payments to subcontractors in order to minimize financial risk. It recommends establishing thorough corporate payment protocols, carefully reviewing project-specific requirements, evaluating payment applications based on field observations, being aware of warning signs of subcontractor distress, and encouraging communication across departments. Developing and adhering to standardized, consistent processes can help ensure timely, fair payments while protecting the company's interests and preventing costly defaults.

1. XL Group
Insurance
Construction Insider
Cheri Hanes
Construction Risk Engineer
By the time you begin making payments
to your subcontractors, a tremendous
amount of time, thought, and energy has
already gone into assessing and managing
the risk of subcontractor default on your
project. Careful handling of payments to
your subcontractors is a crucial step in
preserving the effectiveness of the risk
mitigation efforts you have undertaken up
to this point. Your payment processes and
procedures — at the corporate level and in
the field — directly influence your exposure
to financial risk. Unless your payment
procedures address these risks thoroughly,
you could easily end up paying twice for the
same line item in the event of a default if
your subcontractor:
• has unpaid lower tier subs or suppliers
• is holding key project materials off site,
or
• is overpaid — as happens in a majority
of claims.
Continued
Follow
the Money:
Subcontractor
Payment
Practices

2. • Follow the Money: Subcontractor Payment Practices • September 2013 • 2
Payment-related factors that affect the risk profile of your
projects include:
• Corporate Payment Protocols
• Project Specific Payment Requirements
• Subcontractor Specific Payment Requirements
• Field Payment Application Procedures
• Payment Related Warning Signs
• Interdepartmental Communication
Corporate Payment Protocols
Your corporate policies and procedures set the stage for
fair, responsible payment practices. Do you have written
policies? Do they drive consistent payment procedures
with clear limits of authority? Does everyone understand
his or her responsibilities? By setting out your company’s
expectations up front, in writing, you have a much better
chance of having a smooth, consistent process that is fair
to your subcontractors and also protects your interests.
The time invested in developing and updating your written
processes should provide a significant return in future
efficiency and accountability.
Important Areas to address within your policies include:
• Workflow – What is the sequence and who has the
responsibility at each step?
• Dealing with Problems – Protocol for communication of
issues with subs, accounts payable and project teams
• Compliance – Is your process for tracking compliance
items automated or manual? Who is responsible for this
process? Can checks be cut without all compliance items
or does the system prevent this until all items are in place?
Typical compliance items include:
• W9s
• Signed subcontract
• Insurance certificate and endorsements that are current
and sufficient
• Lien Waivers and Sworn Statements of Obligations -
Best practice is to collect lien waivers for both first and
second tier (cross check second tier waivers with Sworn
Statement), and have a process for checking in with
second tier on a scheduled basis.
• Project specific compliance items (See below)
• Limits of Authority (LOA) and Process – for Project or
Vendor Holds (for compliance or performance issues) and
for overrides
• Payment – What is the process for distributing checks to
subcontractors? Will you distribute payment via direct
deposit, mail, or on site? Industry best practice suggests
the release of checks to subcontractors only after all
compliance criteria have been met.
• Use of Standardized Forms – How will you ensure
that subs understand both your process and required
documentation before the first pay app? Some Builders
have found that having subcontractor payment process
meetings or webinars with the subs’ accounting contacts
are helpful in clarifying expectations and reduce the
potential for confusion up front.
Project-Specific Payment Requirements
Each project has its own set of requirements for payments to
subcontractors. Are you reviewing and complying with these
requirements consistently, taking into account the legal and
contractual aspects of each project? Your subcontract most
likely has provisions for Owner Contract requirements to
flow through to your subcontractors, but do your processes
back that up? Examine your protocols regarding the following
to ensure that you have a consistent method of tailoring
them to each specific project’s requirements:
• Offsite materials billing requirements
• Tracking MWBE percentages and current certificates
• Correct Retainage withholdings
• Project Specific Compliance Items:
• Drug Testing
• Trade Licenses
• Certified payrolls (Davis-Bacon or other). This labor-
intensive process requires that you confirm timely
receipt, accuracy, and compliance. How are these items
being checked and approved?
Continued
Your corporate policies
and procedures set the
stage for fair, responsible
payment practices.
Are you reviewing and
complying with payment
requirements consistently,
taking into account the
legal and contractual
aspects of each project?

3. • Follow the Money: Subcontractor Payment Practices • September 2013 • 3
• Close Out Items: How are you communicating up front the
requirements for the following to your subs and ensuring
they are received on a timely basis?
• Punch
• Attic Stock
• Owner Training
• Special Documentation (i.e. LEED Information,) and
• Warranty Paperwork requirements
Subcontractor-Specific Payment
Requirements
Specific subs may also have additional requirements
like extra attention to Quality Control, Joint Checks,
Funds Distribution Services (a.k.a. funds administration,
construction escrow services, etc.) or other requirements as
per your risk mitigation plan. Your payment process needs to
provide you with assurance that all required risk mitigation
activities are taking place as scheduled.
Field Payment Application Procedures
Evaluating your subcontractors’ pay applications against
their actual field performance is perhaps the most important
step in the payment process. Field personnel are your “eyes
and ears” on the progress subcontractors have made and
are able to assess the accuracy of your subcontractors’
pay applications. Are you taking full advantage of their
expertise? Consider who is responsible onsite for the
following:
• Field approval – Who signs off on progress pay apps and
how do they communicate approval? Percent Complete /
Cost-to-Complete assessment must be fair, but realistic.
• Schedule of Values - Initial review and approval of
Schedule of Values (SOV)
• Schedule and critical path – is the sub staying on track?
If not, why?
• Quality Control – Close attention to the quality of each
sub’s work will protect against paying for work that may
need to be re-done.
• Other requirements – Is the sub staying on top of
requirements (Administrative, LEED, Submittals,
Meetings, etc.)?
• Changes - Communication with subs regarding owner/
architect changes to their pay app – a “no surprises” policy
is called for.
• Final approval - Sign off for punch list completion / final
payment.
Payment-Related Warning Signs
Your subcontractors’ actions on site, pay applications and
related documents can reveal important clues about their
financial state. Are your teams aware of this? Are they
communicating this information appropriately to other team
members and up the chain of command? Warning signs to be
aware of include:
• On the Pay App and Documentation:
• Different vendors on sworn statement or lien waivers
• Difficulty in obtaining timely and accurate 2nd
tier
releases
• Billing for non-approved change orders and/or frequent
change order requests
• Overbilling or “speeding”
• Requests for advance payments – sometimes necessary,
but you need to understand why
• Staying with the scheduled order (on SOV) or varying? –
Again, why?
• In general:
• Unexpected Vendors/Suppliers showing up on site
• Rumors or grumbling among field personnel regarding
monies they should have been paid already
• COD Deliveries
• Requests for joint checks
• Materials that cannot be delivered until next payment
Evaluating your
subcontractors’ pay
applications against their
actual field performance
is perhaps the most
important step in the
payment process.
Your subcontractors’
actions on site, pay
applications and related
documents can reveal
important clues about
their financial state. Are
your teams aware of this?
Continued

4. • Follow the Money: Subcontractor Payment Practices • September 2013 • 4
XL Group Construction Insider
© 2013, X.L. America, Inc.
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CONSTRUCTION INSIDER is a newsletter published for clients of XL Group.
We welcome your comments, suggestions and questions. Please feel free to
contact one of our Construction experts:
jim.richert@xlgroup.com
cheri.hanes@xlgroup.com
Obviously, you want the money you pay to your subs to go
towards satisfying their obligations on your project. Any
of the above could indicate that this is not happening, and
could be worthy of investigation. Understanding these
occurrences as they emerge will give you the best possible
chance to develop a course of action that is both proactive
and fair to your subs, while preventing serious impacts to
your projects. For more information about subcontractor
warning signs – including those not related to the payment
process – see your Risk Engineer for XL’s white paper “Early
Warning Signs of Subcontractor Distress.”
Interdepartmental Communication
In addition to the communication opportunities listed
above, there are other areas that are frequently overlooked
or under-used that could yield valuable insight into a
subcontractor’s financial state. Think of the value to your
organization of clear enterprise communication around:
• Administrative staff’s contact with subs’ accounting
departments, administrative staff, and suppliers. They are
the front line. What are they hearing?
• Project specific issues with subs. If a sub is on more than
one job for your company or is being considered for more
work, any information you can share about that sub
(positive or negative) could be valuable in the decision-
making process.
• Lien (or intent-to-lien) notices. This information is very
helpful to communicate, especially if it can be done with
some commentary regarding the circumstances.
Empowering your teams with easy access to all available
information is a critical step towards reducing the risk of
subcontractor defaults. How will you share this information
across your teams so that they can make sound business
decisions?
Summary
Your consideration and handling of your subcontractor
payments is among the most important risk mitigation
techniques available to you. In a majority of default claims,
the sub is overpaid, increasing the outlay necessary to make
things right again – a situation you definitely want to avoid.
This can be prevented with diligent application of thoughtful
payment processes. Even more encouraging is the fact that
some defaults could be prevented entirely by the application
of well-developed protocols that ensure fair and timely
payment to your subs, while protecting your company’s
interests. This should be the goal of your subcontractor
payment practices.
Please direct any questions regarding this or related
industry matters to:
Jim Richert
Construction Risk Engineering Leader
Phone 860-620-2240
Email: jim.richert@xlgroup.com
Cheri Hanes
Construction Risk Engineer
Phone 214-558-3137
Email: cheri.hanes@xlgroup.com