What’s New?

Wishing you a Happy New Year! In this issue, you will learn about Smart Contracts and the use of blockchain technology in the construction industry, subcontracting considerations for engineering, procurement, and construction (EPC) contracts, and new legislation in Virginia related to contingent payment provisions in construction subcontracts. If you have any questions or suggested topics for future issues, do not hesitate to reach out.

Michael I. Schwartz, Co-Editor-in-Chief
Christopher W. Sexton, Co-Editor-in-Chief

New Faces

William M. Buchanan is a partner in our Pittsburgh office and co-chair of the new Creditors’ Rights & Bankruptcy Group. He focuses his practice on bankruptcy, creditor rights, commercial litigation, collections, real estate and litigation. His clients include banks, lenders, credit unions, mortgagees, property managers, condominium and planned community associations and medical facilities. Will counsels and represents clients who are creditors or interested parties in bankruptcy proceedings, clients who are seeking to obtain judgments or to utilize their collection and foreclosure remedies and clients who are in involved in contract disputes.

As a partner in the Newark office, Craig H. Parker offers local and national construction contractors, surety companies, and commercial clients strategic legal and business counsel. His work begins at the onset of project development when he drafts, reviews and negotiates construction contracts and financing, indemnity, and security agreements. Throughout construction, Craig works with architects, engineers and design professionals to ensure compliance with state and local regulations and manage potential claims.

Kanwal S. Awan is the newest addition to our Newark office. As an associate, she represents owners, general contractors and subcontractors in all aspects of business disputes, including matters of general liability and construction-specific litigation issues. Kanwal researches complex legal issues, drafts memoranda and helps analyze risk and potential outcomes. She also drafts pleadings, motions, legal briefs and supporting documents for submission to court including summary judgment motions, motions to dismiss, and motions to reconsider.

Nicholas M. Bencsics is an associate in the Pittsburgh office. He advises owners, contractors, subcontractors and design professionals on all aspects of commercial disputes. In his practice, Nick researches and drafts pleadings, memoranda and briefs involving complex legal issues. He also drafts and responds to discovery requests, counsels clients on litigation strategies, and has experience taking and defending depositions.

As an associate in the Labor & Employment Group in Philadelphia, Dana B. Hasness counsels public and private employers in all aspects of employment law and litigation, from employee policies to disputes over wrongful termination. She crafts employee handbooks and employment contracts, and regularly advises clients on employment issues involving leaves of absence, wage and hour, discrimination and other workplace issues.

Cohen Seglias Launches Creditors’ Rights & Bankruptcy Group, Names William M. Buchanan and William R. Firth, III as Co-Chairs

We are pleased to announce that William Buchanan and William Firth have been named co-chairs of the firm’s newly formed Creditors’ Rights & Bankruptcy Group. The Group works with clients to enforce their rights as creditors and interested parties, ensure priority and distribution rights, and navigate debt collections. The team is composed of attorneys who work with clientele of all sizes across various industries, with experience in reorganizations, receiverships, workout and forbearance agreements, commercial foreclosures and insolvency proceedings. The group also handles matters involving the Uniform Commercial Code (UCC) and represents parties in secured transactions under Article 9.

Cohen Seglias’ DC Office Among the 2022 “Best Places to Work”

Our DC office is one of the Washington Business Journal’s 2022 “Best Places to Work.” The office, led by managing partner Paul Thaler, makes its first appearance on the list and ranks ninth among the list’s 20 small businesses (10-24 employees).

The publication’s “Best Places to Work” honors 75 Greater Washington area companies that scored highest in a Quantum Workplace employee engagement survey. Results are based on survey responses from employees; all honored companies earned high scores for leadership, culture, benefits and other metrics.

Cohen Seglias Ranked in Chambers USA 2022

The firm is recognized in the 2022 edition of Chambers USA: America’s Leading Lawyers for Business, the preeminent legal ranking of attorneys and law firms.

The firm’s Construction Group is named a leading practice in Pennsylvania and our New Jersey construction practice is again similarly recognized. Chambers USA describes the firm as having “an exceptional construction practice.”

The firm continues to increase its rankings from the previous year, and this group represents the largest number of Cohen Seglias attorneys recognized by Chambers USA, with three additions in 2022:

• Anthony L. Byler – Pennsylvania Construction (new this year, Band 3 )
• Christopher D. Carusone – Pennsylvania White Collar Crime & Government Investigations (new this year, Band 4)
• Roy S. Cohen – Pennsylvania Construction (Band 3)
• Jason A. Copley – Pennsylvania Construction (Band 3)
• Shawn R. Farrell – Pennsylvania Construction (Band 3)
• Lane F. Kelman – Pennsylvania Construction (new this year, Band 3)
• Mike F. McKenna – New Jersey Construction (Band 1 )
• George E. Pallas – Pennsylvania Construction (Eminent Practitioners)
• Edward Seglias – Pennsylvania Construction (Band 2)

Cohen Seglias Ranked Sixth Nationally by Construction Executive’s “The Top 50 Construction Law Firms® of 2022”

Cohen Seglias ranks sixth in Construction Executive’s “The Top 50 Construction Law Firms® of 2022,” a list ranking construction law firms nationwide.

Construction Executive, a leading industry publication, surveyed hundreds of law firms with dedicated construction practices throughout the United States. Factors in the rankings covered the general scope and breadth of the firm’s construction practice, including the number of construction attorneys; the number of states in which the firm is licensed to practice; and the year in which the construction practice was established.

Cohen Seglias Recommended for Education in the 2022 Edition of The Legal 500

We are excited to announce that the firm is recognized in The Legal 500 for our work in the education sector. The firm’s Research Misconduct, Student Defense and Title IX Groups are lauded in the editorial.

Partners Paul Thaler and Shan Wu are noted for their leadership of the groups and considerable experience in their fields, and partner Julie Grohovsky is highlighted for her work with sexual harassment matters. Associate Paul Simon’s efforts on behalf of scientists in plagiarism and fabrication matters are also recognized, as is Ashling Ehrhardt’s noteworthy Title IX work for educational institutions and private individuals.

The Legal 500 analyzes the capabilities of law firms across the world with a comprehensive research program that highlights the practice area teams providing the most cutting-edge and innovative advice to corporate clients. The publication’s research is based on feedback from 300,000 clients worldwide, submissions from law firms and interviews with leading private practice lawyers.

George Pallas Named a Distinguished Leader by The Legal Intelligencer

George Pallas is among The Legal Intelligencer’s 2022 “Distinguished Leaders.” The award recognizes lawyers or law firm professionals who achieved impressive results and demonstrated notable leadership skills.

Over his six-year tenure as managing partner, George has guided the firm’s continued growth, adding both experienced attorneys and capabilities to enhance our services. His dedication to his employees and leadership has helped carry the firm through an unprecedented pandemic. George’s efforts led to the deployment of new technologies and the implementation of a more flexible work environment. He is a strong advocate for his clients, providing day-to-day business guidance and resolving disputes through arbitration, mediation and, when necessary, trial.

The American Lawyer Northeast Trailblazers 2022: Michael Payne

Partner Michael Payne is noted among The American Lawyer’s 2022 Northeast Trailblazers. Trailblazers are recognized attorneys based in the Northeast region of the United States who have made significant marks on the practice, policy and technological advancements in their practice areas. Attorneys must be barred or based in the region encompassing Maine, New York, New Jersey, Vermont, Massachusetts, Rhode Island, Connecticut, New Hampshire and Pennsylvania.

Michael McKenna Honored Among NJBiz’ ICONS

Newark managing partner Michael McKenna is included among NJBiz’ 2022 ICONS. The awards recognize local leaders over the age of 60 for their career-long dedication to their industries and the state’s larger business community.

Mike concentrates his practice on the construction industry, counseling contractors, engineers, architects, owners and subcontractors on myriad legal issues. He was previously recognized as one of NJBiz 2021 “Leaders in Law” and is ranked in Chambers USA for his construction work.

Lisa Wampler and Steve Williams Named to City & State Pennsylvania’s 2022 “Construction Power 75”

Pittsburgh partner Lisa Wampler and Harrisburg managing partner Steve Williams are noted among City & State Pennsylvania’s inaugural “Construction Power 75,” a list highlighting notable builders, contractors, public officials, construction managers, consultants, lawyers and advocates who are building (and rebuilding) the commonwealth. Lisa and Steve are lauded for their experience and leadership in their respective practices of construction and real estate.

Christopher D. Carusone Listed Among City & State Pennsylvania’s “2022 Law Power 100”

Christopher Carusone, managing partner of the firm’s Pittsburgh office, is among the City & State Pennsylvania’s “Law Power 100.” The list recognizes the district attorneys, federal prosecutors, white collar defense attorneys, public interest lawyers, law school deans and bar association leaders who are shaping the legal and political direction of Pennsylvania. Chris is noted for his extensive government experience and work advising corporations in their dealings with government agencies.

No aspect of these rankings has been approved by the Supreme Court of New Jersey. View award methodologies.

Who’s Got the Power? Subcontracting Considerations for EPC Contracts

Some of the largest, and most lucrative, construction projects are those in the energy and power sector. Power plants, generating stations, oil and gas rigs, solar fields, and similar projects require complex planning and bidding, but if successfully executed, they can be a financial and reputational boon to trade subcontractors. Many of these large projects are financed and organized as engineering, procurement, and construction contracts (EPC contracts), specialized agreements between an owner and a general contractor with unique features and pitfalls. While EPC contracts are utilized for large power and energy construction projects nationally and internationally, there is little information about subcontractor-specific considerations for bidding and executing a subcontract on such a project. Due to this lack of guidance, trade subcontractors seeking to perform successfully on an EPC project in the energy and power industry should heed the following considerations.

In contrast to the traditional design-bid-build delivery method, EPC contracts are design-build. In EPC contracting, an owner maintains a single contract for the project with a general or prime contractor, known as the “EPC contractor.” An EPC contractor supervises and manages nearly all facets of the project, designing the project and often procuring the major equipment and trade services required, allowing the owner to be less involved on a day-to-day basis. In addition, the EPC contractor is usually responsible for providing the owner with a “turnkey” build, delivering a completed product from start to finish so the owner only needs to “turn the key” to operate the finished project.

EPC contracts are inherently risky for the EPC contractor because of the number of responsibilities that can include: obtaining relevant permits; creating a complete design and specifications; competently constructing the project; commissioning the project; performing start-up; and delivering the project to the owner. Because of the single contract between the EPC contractor and the owner, if the project goes awry, the EPC contractor has few parties outside its own designers and subcontracting partners at which to point a finger. For accepting the bulk of design and construction risk, EPC contractors are paid a “risk premium” by the owner, who would otherwise be responsible for design and other potential risks of direct involvement. Inevitably, the EPC contractor will seek to pass down as much of its risk to its subcontractors with as little risk premium as possible.

Subcontractors interested in bidding on and building power and energy projects must be aware of the risks inherent in EPC contracting to avoid project impacts, overruns and legal issues. Understanding the relationship between the owner and the EPC contractor is essential for the subcontractor to protect its interests. In fact, many EPC subcontracts specifically incorporate provisions of the EPC contract into the subcontract, so it is crucial for subcontractors to obtain a copy of the EPC contract between the owner and the EPC contractor at bid time to understand how the EPC contract operates and how it will impact the subcontract.

Pricing Structure and Design Completion

EPC contracts and their subcontracts typically come in three pricing types: lump sum, cost-plus/cost-reimbursable, or unit price.

1. Lump sum pricing, where work performance is tied to a fixed price, is by far the riskiest for a subcontractor, especially because EPC design is not always well-developed at bid time. Lenders and owners may prefer a fixed lump sum price to ensure near financial certainty in its revenue coverage ratios for debt repayment. However, lump sum pricing provides little room for error both in the overall design and the labor and materials. That means that adjustments to the subcontract will depend principally on the subcontract’s change provisions and the subcontractor’s ability to comply with those provisions. Thus, it is crucial at bid time to gauge the design completeness and detail level to determine whether lump sum pricing is an appropriate structure for the subcontract.
2. In comparison, unit pricing—when a subcontractor is paid based on its actual costs per an agreed-upon rate—is usually the least risky for the subcontractor. The key to successful unit price subcontracts, especially in a recovering post-pandemic environment, is correctly estimating the unit prices and obtaining the flexibility to re-set those unit prices by an appropriate escalation clause should supply-chain problems and/or inflation significantly impact the cost and availability of labor and material.
3. Cost-plus and cost-reimbursable arrangements float somewhere in the middle of the risk spectrum, especially as they are often tied to a guaranteed maximum price (GMP) structure. Cost-plus contracts can have the benefit of a large margin for the allowable subcontract balance but include the challenge of requiring strict notice and record-keeping requirements to substantiate the subcontractor’s costs.

Scope of Work

Any subcontractor knows having a detailed and accurate scope of work is critical to success on a project, especially when seeking compensation for any necessary or directed out-of-scope work. This is particularly important for EPC subcontracts. Due to the sheer size, complexity and tight schedule of typical EPC projects in the energy and power industries, a subcontractor must be prepared to submit written notice of any changed condition the moment they encounter a need to perform out-of-scope work, even if the full value of that work is unknown. Subcontracts universally require this prompt written response, along with other notice elements and timely submission of change order requests.

Change Provisions and Schedule Impacts

Change provisions, and provisions relating to required notices of schedule impacts (delays, hindrances, acceleration), can sometimes be located in a single subcontract section but are more frequently found scattered throughout. Changes can impact cost, performance time, or both. And subcontracts often contain separate notice and change provisions depending upon the remedy sought (e.g., for additional time or compensation).

A vigilant subcontractor will always take steps to become familiar with the specific notice and timing requirements for change order requests under its subcontract. This is especially important when operating on an EPC contract because of the project’s size, complexity, and number of involved trades. Consider, for example, a power plant project where trades are frequently required to operate simultaneously within partially erected and enclosed spaces, each working with cumbersome equipment and materials among cranes, lifts and scaffolding. A hold-up in any area or system can affect all surrounding trades and create time or cost impacts. As it follows, providing timely notice of those realized or potential impacts is crucial to protecting the subcontractor’s rights to an equitable adjustment of time and/or price. Additionally, change provisions usually require the subcontractor to provide specific supporting information to substantiate its request for additional time or money.

It is often a good idea for the subcontractor to provide its own onsite scheduler, competent in using the scheduling software utilized by the EPC contractor and capable of meeting regularly with the EPC’s master project scheduler. This may be the only way for the subcontractor to identify and review impacts to the schedule as they occur, which is essential to making adjustments, providing timely notice of impact, and advocating for the performance of the subcontractor’s activities in a congested worksite.

Because the cost and time impact of given change conditions can be extremely hard to calculate at the time of impact, subcontractors must maintain precise records throughout the project. Conditions may even warrant engaging a scheduling and/or accounting consultant to help calculate and potentially present a formal claim.

Claims and Dispute Resolution

Related to change provisions are claims, dispute resolution, and limitations of liability provisions of a subcontract. While not every subcontractor will have a lawyer on standby to review a subcontract, before execution, every subcontractor should carefully examine the following provisions of any potential EPC subcontract:

Incorporation of EPC Contract and/or Flow-Down Provisions
“Flow-down” provisions bind a subcontractor to the same rights and obligations the prime contractor has with the owner. Subcontracts on EPC projects frequently incorporate, among other things, the EPC contract’s claims and dispute resolution provisions. such, a subcontractor who fails to obtain a copy of that prime contract before entering into the subcontract will have little, if any, understanding of its true incorporated contract rights and remedies.

Liquidated Damages and Dispute Resolution Provisions
Subcontracts for EPC projects often permit the EPC contractor to withhold liquidated damages, or a stipulated sum of money, from a subcontractor. Liquidated damages are typically, but not always, calculated on a per diem basis for untimely completion of work. On EPC projects, liquidated damages can amount to tens or hundreds of thousands of dollars per day. A vigilant subcontractor, especially one with finish-trade responsibilities, must carefully examine the project’s overall status at bid time to ensure that the project is progressing as planned and that the current schedule is one with which the subcontractor can comply. If the project deadlines have frequently shifted, or if the current schedule cannot be achieved, a subcontractor should think twice about bidding on the project, as it is likely to lead to the ultimate imposition of liquidated damages. Even on projects where the subcontractor has confidence in the timely performance of its work under the proposed project schedule, the subcontractor should consider modifying the liquidated damage provisions to restrict the EPC contractor from assessing liquidated damages where the subcontractor can show that it was not the source of the delay.

To avoid responsibility for delay damages on EPC projects, it is imperative for a subcontractor to act proactively. This includes not only being fully informed of the subcontract’s notice and change requirements for schedule impacts but also employing an onsite scheduler to provide oversight on the timeliness of day-to-day activities on the project.

A subcontractor must also be aware of its subcontract’s dispute resolution provisions. For example, is there a limitation of liability, providing for a maximum amount of recoverable damages? Is the subcontractor required to arbitrate or litigate and, depending upon which one, what state’s law governs and where is the resolution required to take place? A subcontractor needs to know which law applies because this will often determine the availability of and the manner of preserving crucial remedies such as liens, bonds and prompt payment rights.

For example, a subcontractor must know whether the applicable jurisdiction considers the project public or not. Since many EPC projects are energy or power projects run by a public utility, the jurisdiction may classify it as a public project with a public owner. This is significant because many jurisdictions prohibit liens on public property. Additionally, is the subcontractor required to mediate first? Are the subcontractor’s claims tolled if they involve a claim the EPC contractor can pass along to the owner? Is the subcontractor required to let the EPC pursue its rights against the project owner on its behalf? Each of these questions is important because they all determine what the subcontractor must do to pursue its remedies and they ultimately impact the cost and outcome of claims.

Role and Identity of the Owner
Subcontractors need to understand who their point of contact is with the project owner and how frequently, if at all, they will be able to communicate with the owner’s representative. Owners generally seek to communicate only with the EPC contractor, as having a single point of contact is one of the principal reasons for EPC arrangements. An EPC contractor is likely to discourage direct communication between a subcontractor and the owner for this reason alone and to ensure the EPC continues to control project messaging to the owner. In light of a contractor’s practical and contractual ability to control project communications with the owner, an owner may be ignorant of ongoing project hindrances, accelerations and delays. While the contractor is responsible for managing schedule impacts, an owner has legitimate interests in knowing the true status of its project, and it is capable of making decisions that can impact the subcontractor’s rights, especially where provisions of the EPC contract are incorporated into the subcontract. Therefore, it is extremely valuable for a subcontractor to have contact with an owner at monthly meetings to communicate, in a constructive and professional manner, project impacts on its work. This is all the more reason for a subcontractor to select project managers and executives who can clearly communicate issues to the owner.

Conclusion

While EPC projects in the energy and power sector present significant risks to trade subcontractors, the rewards for projects of this size are great when parties can mitigate the risks. With planning and careful review of the subcontract and the EPC contract, there is no reason why a subcontractor cannot profit from these projects.

Cohen Seglias 2022 summer associate Haley Norwillo also contributed to this article.

The Shifting Tide Against Contingent Payment Provisions in Construction Subcontracts

Co-authored by Nicholas Morello of bet365.

In construction subcontracts, contingent payment provisions like “pay-if-paid” and “pay-when-paid” clauses are being banned in an increasing number of states. “Pay-if-paid” clauses state that a subcontractor will not be paid by the general contractor for their work unless the owner pays the general contractor for that work first. This passes the risk of owner non-payment onto the subcontractor. “Pay-when-paid” clauses are interpreted as a timing mechanism for payment. In other words, a “pay-when-paid” provision says that the contractor will pay the subcontractor within a certain amount of time after receiving payment from the Owner. But, if the contractor is not ultimately paid by the owner, a “pay-when-paid” clause will not work to absolve the contractor from its obligation to pay the subcontractors. These contingent payment provisions are seen as unfair and against public policy by many courts and legislators since they ultimately lead to the subcontractor facing added risk and duties in evaluating the owner’s financial position. This is often more difficult and unrealistic for a subcontractor since they are often smaller, more specialized businesses.

Virginia is the latest state to continue this trend. Pursuant to the state’s newly passed Senate Bill 550, contingent payment provisions are to be void and unenforceable in construction contracts signed after January 1, 2023. This is surprising for construction companies because Virginia has a reputation for allowing parties the freedom to negotiate and agree to almost any term in a construction contract.

In addition to the ban on contingent payment provisions, the law requires that any public contract include a provision that makes a contractor liable for the entire amount owed to the subcontractor, except for “amounts otherwise reducible due to the subcontractor’s noncompliance with the terms of the contract.” If withholding funds for non-compliance, the contractor must provide the reason for withholding the funds in a written notice. The law also enhances prompt payment protections for contractors in private contracts by stating that the owner shall pay the contractor within 60 days of an invoice of any undisputed portion of the work invoiced. Similarly, in a subcontract, the contractor must pay a subcontractor for undisputed portions of invoices “within the earlier of (i) 60 days of the satisfactory completion of the portion of the work for which the subcontractor has invoiced or (ii) seven days after receipt of amounts paid by the owner to the general contractor or by the higher-tier contractor.”

In passing this bill, Virginia joins California, Delaware, New York, North Carolina, Ohio, South Carolina, and Wisconsin in banning the use of these provisions for being against public policy. While Virginia has done so legislatively, some states have banned contingent payment provisions judicially. For example, in 1995, the Court of Appeals in New York held in West–Fair Electric Contractors v. Aetna Casualty & Surety Company that a provision that “forces the subcontractor to assume the risk that the owner will fail to pay the general contractor is void and unenforceable as contrary to public policy,” but “a pay-when-paid provision which merely fixes a time for payment does not indefinitely suspend a subcontractor’s right to payment upon the failure of an owner to pay the general contractor, and does not violate public policy.” Similarly, in 1997, the Supreme Court of California in Wm. R. Clarke Corporation v. Safeco Insurance Company of America held that such provisions are against public policy “because they effect an impermissible indirect waiver or forfeiture of the subcontractors’ constitutionally protected mechanic’s lien rights in the event of nonpayment by the owner.”

Many other states including Illinois, Massachusetts, Texas, Utah and Vermont restrict parties’ rights to use these provisions and narrow the provisions’ application. For example, Illinois permits these provisions but requires very specific language for them to be enforceable. Texas law states that contingent payment clauses are unenforceable to the extent that the owner’s nonpayment to the general contractor is the result of the contractual obligations of the general contractor not being met unless the nonpayment is the result of the subcontractor’s failure to meet the general contractor’s contractual requirements. Massachusetts law states that contingent payment provisions are void and unenforceable, except to the extent amounts not received are caused by the subcontractor’s failure to perform under its contract and to the extent of amounts not received are because of the owner’s insolvency. In Massachusetts, these exceptions must be expressly stated in any conditional payment provision for the party seeking enforcement of the provision to have the burden of proof as to each element.

While contingent payment provisions are still permitted in the majority of states, the above-mentioned case law and other authorities signal a shift in the tide throughout the country narrowing and/or banning the use of such provisions. It is reasonable to think that, in the coming years, more and more states will restrict and ban these provisions for being against public policy.

If you are a contractor or subcontractor, depending on where you operate, you may need to revise your contract forms by the end of the year to make sure they are compliant with the new Virginia law. If you operate in multiple states, each with varied laws on things like contingent payment provisions, you should consider having one base form with several state-specific riders that address state laws like this. This way, you can still have contingent payment provisions in your form for the states that allow it while eliminating them in the states that don’t. Regardless of the solution that you choose, it is important that the contracts you are using and signing in places like Virginia, New York, and California do not contain contingent payment provisions. If you would like to get an understanding of how your contract addresses contingent payment provisions, whether they are enforceable under the applicable law, and how the provision may affect you, contact Jackson Nichols for more information.

Smart Contracts—The Good, the Bad and the Unknown of Blockchain Technology in the Construction Industry

As the construction industry operates within the digital era, the complexity of the sector continues to evolve. Because there are various parties and stakeholders involved on a construction project, there are competing interests with the same goal of pushing risk onto others. This risk-shifting mentality has driven innovation and created new methods of safeguarding interests over time. One concept that is gaining popularity throughout the construction industry is the use of blockchain and smart contracts. Never heard of it? Read on so that you are prepared when it is presented to you as an option for your next project.

What is Blockchain?

“Blockchain” is often associated with cryptocurrency and is the underlying technology that allows Bitcoin and other cryptocurrencies to exist. It is a technology that allows for a shared ledger that records and tracks assets across networks—essentially, Bitcoin and other cryptocurrencies are recorded along a blockchain. However, the unique benefits of blockchain technology, namely, safety, security, and efficiency, allow it to accomplish far more than a traditional ledger or document. As a result, blockchain provides a host of benefits that can propel the construction industry forward.

Initially, blockchain provided security and constant authentication of transactions. This, coupled with its “proof-of-work” technology, prevented possible losses resulting from fraud or embezzlement. Further, while traditional ledger systems were subject to cyber-attacks, blockchain’s distributed ledger technology allows each party to hold a copy of the original chain so that the system remains even if large databases along the system fail. Blockchain’s proof-of-work technology and its decentralized location make fraudulent modifications a virtual impossibility.

The efficiency of blockchain technology accelerates transactions. It removes traditional methods of facilitation, verification and enforcement, as such conditions are automatically checked and executed. The resulting algorithmic technology is particularly beneficial to those industries that frequently deal in trades and contracting because it executes conditions in a real-time “if X then Y” format. For these reasons, blockchain technology serves as the foundation for smart contracts.

Blockchain and Smart Contracts

While blockchain is generally associated with cryptocurrency, other uses have emerged in recent years, including smart contracts. With the use of blockchain technology, parties can transfer digital assets according to pre-specified contractual conditions, resulting in a real application of the “if X then Y” format for contract implementation. As the underlying technologies continue to improve and evolve, smart contracts have gone beyond simply a self-implementing contract and now encompass other functionality such as compliance checking, supply chain tracing, and providing a shared space between parties for common data viewing.

The automatic verification and enforcement technologies within blockchain allow for a self-executing agreement. Beyond the traditional contractual provisions, smart contract algorithms are recorded along the blockchain with the consent of the contracting parties. As specific conditions or events occur, the smart contract automatically enforces the terms, thereby preventing parties from wrongfully failing or refusing to fulfill their end of the bargain.

Smart legal contracts work on three core features:

1. The contract is legally enforceable within the relevant jurisdiction;
2. At least some of the obligations are performed automatically via algorithm; and
3. The contract exists on blockchain.

The security and efficiency of blockchain technology complement other benefits of utilizing a smart contract. The autonomy of such contracts allows for cost savings on intermediaries, such as processing payment of insurance claims to escrow. The accuracy of self-executing technology circumvents the risk of errors in manually completed documents. Documents and records are saved and available to all parties in real-time, which minimizes claims and disputes, as transparency of cost, time, and scope of the project are updated.

Smart Contracts in the Construction Industry

Disputes are inevitable in the construction industry, and the terms of the contract are often at issue. Smart contracts and their underlying technology aim to avoid these disputes in a variety of ways throughout a project’s duration. Many of the following benefits are subject to pitfalls, especially in the short term. However, as technology improves, the creative solutions to everyday problems are endless.

In the age of seemingly constant supply chain delays, blockchain technology and smart contracts offer a potential reprieve. Have any of your projects been impacted due to a delay in ordering material? With smart contracting, applications operating from sensors, scales and cameras at a jobsite can collect information and monitor material supply levels. Terms within a smart contract can be automatically triggered when inventory dips below a specified level, suppliers are automatically contracted and an order is placed. This ensures that materials are ordered in a timely manner and notifies all parties of the delivery date. Unfortunately, many issues plaguing businesses today, such as improper use of or theft of materials, still remain notwithstanding this available technology.

Have any of your payments been delayed because of missing documentation or a failure of a party to process a payment application? With smart contracts, as inspections and walkthroughs occur, payments can be triggered and processed automatically. While this will increase efficiency, there are concerns regarding automatic payments in the event of later discovered defects. Such issues will necessarily require additional conditions within the smart contract and may unfortunately raise the potential for litigation before such systems are normalized.

As conditions along the blockchain of the smart contract are triggered, the contract will remain an open and consistent record for contractors, subcontractors, and owners to review and constantly evaluate project progress from the same viewpoint. This transparency reduces the potential for disputes at each phase of the project. For example, as designs are formulated and updated, all parties access changes in real time, allowing for prices and scope to be adjusted accordingly. In the tendering, bidding and contracting phase, parties can easily exchange revisions to documents and more efficiently negotiate terms. During construction, labor information can be stored and reviewed for accountability, allowing for the potential of authentication by all parties of e-verify and other required standards. Lastly, the demolition stage can benefit from the ability to track waste generation and elimination in real-time.

Potential Pitfalls

Smart contracts and the technology behind them continue to improve at a significant rate; however, there remain many issues with smart contracts. The technology is still relatively new, and users must become familiar with and understand its basics before effectively negotiating and implementing such contracts. Users must understand which terms are suitable for automation and which are not. Further, while a significant benefit of blockchain technology and smart contracts is the reduction of human error, the blockchain technology itself is still, relatively speaking, in a state of infancy, resulting in potential conflicts. Because the execution of events when certain contract conditions are met is irreversible, incorrect terms encoded within the blockchain have the potential to cause significant headaches and financial losses.

Additionally, while the automatic enforcement nature of smart contracts provides benefits, there are drawbacks. The modification process remains in development and can be challenging once the contract is set into motion. Further, while many disputes can be avoided at the onset of a project, a party’s ability to act or withhold payment for what they believe to be genuine issues can be at risk.

If your company is considering using smart contracts, human oversight to double-check all information remains a necessity. It is critical to note that while certain human involvement can be circumvented, the streamlined process does not replace employees; instead, the technology assists employees in accomplishing tasks more efficiently. For now, experienced administrators remain necessary to ensure the process and application is running as intended.

The absence of laws across states directly addressing smart contracts is a drawback. As legislation is slow to keep pace with technology, many states fail to address smart contracts at all. Some states, like Ohio, dipped its toe in the water by taking narrow measures, such as giving legal recognition to electronic records and signatures secured through blockchain technology. Other states, like Wyoming, are leading the way with a host of laws formalizing digital assets and securities and directly defining and addressing smart contracts and how they may control and transfer data. As with any contract, it is important to confirm and understand your state’s laws regarding smart contracts before proceeding.

Conclusion

Blockchain technology and smart contracts continue to evolve daily. The real-time updates and information availability of smart contracts follow the trend of having instant access to information. While it may not be a prudent time for your company to implement smart contracts into its daily business, that day will come eventually. Until then, the attorneys at Cohen Seglias will continue to follow the evolution of smart contracts and will be ready to assist on future projects.