I recently published an Article on the topic of project bank accounts (PBA). In that article I discussed how PBA’s work and briefly touched on ways that they benefit both parties. I wanted to take a step further and do a pros and cons list for GC’s and for Owners.
For this article, I will focus on the pros and cons for Owners, I’ll post a second article where I will contemplate the perspective of a General Contractor.
Since the rules and method of using PBA’s is still under development, I will assume some simple basic regulations. I am also assuming these regulations would be strictly followed and handling of the funds would be monitored, tracked, and reported by the bank.
- The Owner will fund the full value of the contract from the start of the project.
- All payments are made in arrears based on percentage of completion.
- All payments are subject to a percent of retainage.
- The Owner will authorize release of funds based on typical payment application processes (GC submits payment application to the Architect, percentage complete payments must be certified by the Architect before Owner authorizes release of funds).
- GC’s are required to issue milestone payments to sub-contractors before they can take any payment for themselves.
- All payments made by the GC must be made directly from the Trust.
So with those basic regulations in mind, here are the pros and cons for Owner
Transparency regarding payments to subcontractors
With a PBA the Owner will be able to see how much the GC pays to it’s sub-contractors. This transparency reduces the Owner’s risk with respect to Tier 2 Liens and gives the Owner the peace-of-mind that payment allocations are being made properly.
Reduced internal accounts payable activity
By issuing a single payment to fund the Trust, the amount of internal activity from Account Payable (AP) is dramatically reduced. One of the most time consuming and frustrating internal struggles of any large organization is ensuring that payments are issued in a timely manner.
Milestone payments on large construction projects can often mean dozens of invoices and payment requests that require monitoring and sometimes expediting through cumbersome and complex AP approval gates.
With a PBA the Owner requires a single lump sum payment to be made to the Trust at the start of the project. The only time additional payments would be required is if there were change orders that altered the total project value.
Low Cost Project Accounting
Using a PBA Trust means creating a specific account for the project. Deposits and withdrawals made from this account will be strictly monitored and managed by the financial institution where the PBA is held. Typically the cost for such accounts is quite low, but the accounting is specific and efficient. A Facilities Manager or Owner would have ready access to accounting statements specifically for the project.
Auditable Trail for all funds
From the issuance of the initial project funding to the final payment to the last sub-contractor, the accounting trail for the project will be clear and complete. One of the greatest benefits of PBA’s is the simplicity of the audit trail. Using internal AP systems there is risk of improper categorization or an ability to reference related payments. All of these issues go away with PBA’s.
Protection from insolvency of the Contractor
The reason the SEC is so firmly behind PBA’s is because when a Trust is formed in the name of the project, the funds do not get intermingled with other funds from the GC’s other projects. If something happens during the project that causes the GC to become insolvent and his assets are liquidated, the Trust remains intact.
When a GC’s assets are liquidated the funds get distributed to satisfy the GC’s debts. Under a traditional scenario (with no PBA), the court decides who gets paid. If the GC’s funds from various projects are intermingled into the GC’s business account it is impossible to separate funds that were set aside for one project from another. This means that funds that were intended for one sub-contractor may be appropriated to another. Since the court is unable to discern which funds were for which project, the disbursement may not be equitable and since there are not regulations governing how funds are distributed in a traditional business account, the GC may have taken payments earmarked for sub-contractors for himself leaving less than sufficient funds to satisfy all of the GC’s debt.
A PBA Trust keeps the funds separate and because they are regulated accounts, the GC must issue sub-contractor payments from the Trust. This is positive for both sub-contractors and the Owner because if the GC becomes insolvent, the project can continue almost seamlessly. Of course, a new construction manager would be needed and all the subcontracts would have to be reissued to the new GC, but the liquidation of the GC would in no way affect the finances of the project.
Full funding is required up front
The notion of loading the Trust with the full funding for the project is my own. Current regulations for PBA’s (in Australia) do not contemplate full up front funding. Instead, those jurisdictions assume that the Owner will fund the account in accordance with a traditional milestone payment process. In other words, the Trust is funded only after an invoice is approved and the amount the Trust is funded is only as much as the approved payment.
For me, this method of funding limits the functionality and benefits of a PBA Trust. So, I prefer to consider that the Owner would fund the project in full at the very start of the project.
I list this as a con for Owner’s because I can imagine that (at least initially) Owner’s may be suspicious of how this would work. I imagine that they would have fears that funding the full amount would raise their risk. I also can imagine that some may not have the full funding available right from the outset. All of these are reasons why Owner’s may have concerns over using fully funded PBA Trusts.
Loss of Control
Another reason why an Owner may perceive a PBA Trust negatively is the notion that they are giving up control of the funds. As the Owner of the Trust, the Owner funds the account and then authorizes the GC to make disbursements from the Trust. Owner’s accustomed to scrutinizing a payment application and then issuing a partial payment may perceive the act of allowing the GC to manage an account that is fully funded as a loss of control. In fact, the transparency and governance that goes along with a PBA Trust gives Owner more visibility and control than traditional methods.
Commitment of funds
Additionally, Owner’s may have concern that if they decide to abandon a project, they may have difficulty pulling money out of the Trust. This seems like a valid concern, but since the trust is created in the name of the project, I’m certain that if the project is cancelled there would be some way to dissolve the Trust.
PBA Trusts offer a new and unique way to manage the finances of a construction project. I believe these new accounts offer significant benefits for Owner’s. In my opinion, these benefits far outweigh any concerns an Owner might have.
As these accounts begin to gain traction and eventually become standard, I believe Owner’s will begin to see the value and one day, managing a project in any other way will seem impractical.
What do you think? Do PBA’s sound like a good idea? Do you agree with me that they should be fully funded? Have you used a similar method of accounting? Tell me your stories.
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