Building blocks

If you have used Google Drive to store and share files, you're familiar with the concept of managing a project with blockchain technology. Google Drive allows multiple users to access a document at the same time and view the edits of all users in real time. Blockchains function in a similar fashion to track and record transactions in the order they occur.

When combined with "smart contracts," blockchains can create a new form of project management helpful to the roofing industry.

A closer look

According to construction consultant Dave Hughes, general manager of architecture, engineering and construction for London-based digital portfolio and project management company Keepsite Software, a smart contract is "a computer program that works on the if/then principle."

For example, if a roofing contractor has completed dry-in of a structure, then an inspection is requested. If the roof system passes inspection, then the roofing contractor is paid for that component of the work. When one task is completed, a smart contract self-executes the next step. Multiple smart contracts can be used to manage a large construction project with all changes and updates permanently recorded on blockchains, eliminating several problems inherent with standard project management.

Although the Google Drive analogy allows for a simple conceptualization of blockchains, a more developed description of the technology is necessary to understand the profound effect it can have on the roofing industry.

According to the article "BlockChain Technology: Beyond Bitcoin" published in the University of California, Berkeley, Sutardja Center for Entrepreneurship & Technology's Applied Innovation Review, June 2016, Issue 2, a blockchain is "essentially a distributed database of records, or public ledger of all transactions or digital events that have been executed and shared among participating parties."

Once a record has been made on a blockchain, it never can be erased. This allows for instant verification a transaction has occurred and enables all participants to view the transaction. Blockchains eliminate uncertainty and promote consensus among participants. In the construction project context, everyone involved with a project can view transactions as they occur, removing the uncertainty that usually accompanies a project's deadlines and status.

The biggest problem blockchains attempt to solve is the traditional reliance individuals, companies and governments place on third parties to "validate, safeguard and preserve transactions," according to the Applied Innovation Review article. Currently, all online transactions require trust in third parties. For example, users trust emails are delivered, Facebook posts only are shared with selected people and banks deliver funds to described destinations. However, third parties are subject to manipulation, hacking and other malicious tactics.

Successful manipulation of a transaction typically results in large transaction costs being passed on to the parties involved. For example, if a subcontractor sends an email to his or her supervisor verifying a project's contractual requirements have been completed, he or she is relying on a third party to ensure the notice has been sent. If the email isn't delivered or is lost, the subcontractor must deal with the repercussions. But if a smart contract is used with a blockchain to create a permanent record of such a notice, the subcontractor doesn't need to rely on a third party to safely deliver the information. The need for a middleman is eliminated.

Smart contracts and DAO

Smart contracts are the backbone of blockchain implementation for construction projects. According to "Smart Contracts—How will Blockchain Technology Affect Contractual Practices?" published in The Research Institute of the Finnish Economy's Report No. 68 in January 2017, smart contracts are "machine-readable programs, written in code, that self-execute when a set of pre-determined terms are met."

An example of pre-determined terms could be a framer's completion of framing a building for a project, which triggers a smart contract to self-execute an order to inspect the framer's work followed by the smart contract self-executing an order either to pay the framer (if inspection is passed) or instruct the framer to remedy issues found in the inspection (if the inspection fails). It is easy to see how smart contracts could be used to run an entire project.

Although the framing example shows how a single smart contract operates, a construction project likely requires dozens or possibly hundreds of smart contracts depending on the project's size. A decentralized autonomous organization (DAO) can help multiple smart contracts work together so construction proceeds smoothly.

In its simplest form, a DAO operates using rules encoded in smart contracts. Smart contracts provide the rules (to pay or not to pay, to approve or not to approve) through which the DAO provides a record on a blockchain. In other words, the DAO enables blockchains to deliver secure records of the transactions that occur during a project. This enables all parties involved on a construction project to view the project's status and a permanent, fixed record of all transactions that have taken place during the project.

Project bids

The combination of blockchains, smart contracts and a DAO can help solve major issues currently plaguing U.S. construction projects. At the beginning of a project, smart contracts and a DAO can be used to solicit bids. An owner can create a smart contract containing all necessary project information, such as a roof area's square footage, for suppliers and roofing contractors to place bids. After the winning bids are selected, the supplier immediately can begin supplying the necessary materials, and the roofing contractor can install the roof system without delay. All the bidding and project information is handled online, reducing costs.

Owners concerned that a less-than-qualified contractor or supplier may win a bid can review the bidder's previous transactions on blockchain to determine if they wish to contract with them to complete a roofing project. However, bidders that did not use blockchain for previous project submittals would not appear on the smart contract ledger.

For a larger project, such as a commercial shopping plaza or condominium building, the building owner can use smart contracts and a DAO to find leveling and grading contractors, suppliers, roofing contractors, framers, carpet installers, electricians and every other specialty trade needed to complete the project. The owner also can automate the administration of the building and subcontracts, resulting in more direct contracts between the owner and contractors and fewer contracts between subcontractors and the general contractor. The general contractor maintains the role of monitoring and organizing all labor for the project.

Another advantage to using blockchains for construction project management is avoiding costly bid protests. When a project is performed by state or local government entities, companies are invited to bid for the project. The public entities use (or should use) competitive bid procedures to procure the lowest bid for the project. If the bid letting is not conducted in a competitive manner, the bid letting may be protested in accordance with published procedures.

For bidding to be competitive, all bids must be based on the same requirements and must be evaluated on the basis of the same criteria. In other words, the bids must be capable of an "apples to apples" comparison, and all criteria by which the bids will be judged must be known to the bidders in advance.

If a bid fails to comply with the instructions to bidders in some material aspect, the bid must be rejected as being nonresponsive because nonresponsive bids cannot be compared with bids that have followed instructions. If a contract is awarded to a bidder whose bid fails to comply with instructions, the award has been made based on other-than-published criteria. In such a case, the award is arbitrary or capricious because the letting authority has arbitrarily awarded the contract based on criteria that was not published and made known to all bidders, which opens the door to favoritism and collusion.

Blockchains' transparent nature allows all bidders and others involved in the project to view the bids and bid requirements as they are made. The public entity requesting the bids and all those submitting bids can determine immediately whether a submitted bid is nonresponsive, eliminating the potential for a contract to be awarded to a bidder who failed to comply with instructions. In addition, offering micro-contracts to subcontractors for bidding rather than one contract for an entire project makes it easier to specify scope and determine efficiencies in estimating.

The elimination of favoritism and collusion reduces the need for expensive legal bid protest actions, making the construction industry more efficient and profitable for all involved. Further, it helps reduce the animosity and mistrust between contractors and the public entities soliciting bids for projects.

Payment issues

Perhaps the biggest effect blockchains can have within the roofing industry is remedying numerous issues inherent with requesting, obtaining, securing and sending payment.

Subcontractors who finish their work want to be paid promptly. If a payment isn't made in full at a project's conclusion, subcontractors want regular disbursements of payments, and they want the retainage held by the general contractor or building owner. General contractors want to ensure the work performed by their subcontractors passes inspection before releasing funds and will hold on to the retainage until inspections are passed. When disputes arise regarding the quality or progress of work performed, late payments inevitably become issues. Blockchains and smart contracts can be used to avoid or mitigate many of these issues by automatically providing payment when different aspects of a project are completed.

To better understand the impact these technologies can have regarding payment issues, the following examines a few of the biggest payment problems.

Contingent payment clauses

Often, one of the justifications used by a general contractor to avoid paying a subcontractor is a contingent payment or "pay-if-paid" clause contained in a subcontract. This clause usually states the general contractor has no obligation or duty to pay the subcontractor until the general contractor receives payment from the owner. The purpose of the clause is to protect a general contractor from having to pay subcontractors when the general contractor has not received payment. This causes problems for subcontractors who rely on steady disbursements of payments to pay their employees, purchase supplies and cover other expenses.

More than a dozen states do not allow contingent payment clauses, and many states place restrictions on such clauses. However, in some states such as Florida, a general contractor can use a pay-if-paid clause to avoid paying a subcontractor if the clause makes it clear payment to the subcontractor is conditioned upon receipt of payment by the general contractor from the owner. If the pay-if-paid clause does not unequivocally state the promised receipt of payment is a condition precedent, courts will find the provision ambiguous and hold payment must be received by the subcontractor within a reasonable time frame.

For states that allow contingent payment clauses, blockchains may provide a solution to the frustration the clauses cause subcontractors, general contractors and owners. Through blockchains and smart contracts, subcontractors can receive immediate disbursement of funds once the agreed-upon conditions are met with money held in escrow for disbursement. Pay-if-paid clauses won't be necessary because general contractors don't need direct contracts with subcontractors. Rather, subcontractors' smart contracts with the owner disburse payments upon satisfactory completion of work.

A benefit of not having pay-if-paid clauses is simple and two-fold. Subcontractors are paid when their work is complete, and general contractors don't need to worry about subcontractors filing suits against them to collect payments. Further, owners can avoid contractor's liens placed on their properties as a result of subcontractors not being paid for their work or supplies.

An interesting legal question is how lien law intersects with blockchain contracts. In many states, the ability of a contractor's lien follows the contract. If multiple contracts are created, those micro-contracts could form separate liens with separate lien requirements depending on the state. Contractors can consult their state statutes to determine whether they would have the ability to assert liens on micro-contracts.

Retainage

Retainage is the portion of the contract price withheld until the work is either fully or substantially completed to ensure contractors meet their obligations. In a blockchain-controlled construction project, the need for retainage may be reduced or eliminated. Because of the transparency in blockchains and smart contracts, all parties involved in the project can see the retained funds are available. Upon completion of the project, and after inspections have been passed, the retained funds automatically are distributed to the appropriate parties.

Prompt payment laws

Almost all states have some form of prompt payment laws intended to protect subcontractors and ensure payment is made within a specific time frame. Prompt payment laws provide those involved on a construction project with legal recourse against parties that do not meet payment obligations as required by the construction contracts. The automatic disbursement of funds through blockchains and smart contracts after obligations are met removes most technological and human errors that can result in payments not being promptly made. This greatly reduces the need for legal recourse against owners and general contractors because payment is contingent on subcontractors completing their requirements.

Interim payments

Smaller subcontractors often do not have the capital necessary to continue working on a project without receiving interim payments as the project moves toward completion. As a result, a subcontractor is paid in regular intervals throughout the project either based on a contractually slated schedule or the subcontractor's progress.

When there is a dispute regarding a subcontractor's progress, owners and general contractors withhold interim payments until the issue has been resolved. This often leads to litigation or contractor's liens being filed to secure payment by the subcontractors, delaying the project even more. With smart contracts' ability to make payments when certain conditions are met, there is far less ambiguity regarding when interim payments should be made.

Late payments

Late payments can result when an owner or general contractor willfully withholds payment or an error causes payment not to be sent or to be sent to the wrong place. Smart contracts can provide a remedy to these issues through their immediate disbursement of payment upon completion of specified conditions, and all payments are permanently recorded on blockchains.

Litigation

Owners have become litigation- and insurance-savvy and know how to take advantage of an unprepared contractor. If a problematic project results in litigation, my law firm has found nine times out of 10 the party with the most detailed and descriptive paper trail supporting its side succeeds in court or arbitration.

Keeping accurate written records of all communications involving defective workmanship, delays or other claims on a project is an industry best practice. With blockchains and smart contracts in use, all the "paper" from a project will be contained in one location. The record will be public and not subject to editing. If litigation arises from a project, all parties can access the same documents, reports and memoranda, allowing for fair examination.

Drawbacks

As with most new technology, the implementation of blockchains comes with certain drawbacks. The construction industry often is hesitant to adopt new technology, and the use of blockchains and smart contracts for construction project management would require participants to go through an onboarding process to learn how to conduct business in a new manner.

Managing claims, delays and defects also can be challenging and may require the use of a third-party monitoring system to resolve disputes in a timely and efficient manner. When drafting smart contracts, the goal is to balance autonomous decentralization with supervisory oversight of as-built conditions. Too much human oversight guts the purpose of smart contracts, and too little human oversight may cause delays in the approval of change orders for extra time and costs.

A promising system

By converting to a DAO system using blockchains and smart contracts, roofing contractors, subcontractors and suppliers could see an increase in prompt payments and experience fewer payment issues. The concept will need to be fine-tuned to ensure the if/then principles are not left to discretion. However, smart contracts already are in use on many construction projects, and roofing contractors and suppliers may soon be asked to participate in a DAO for vertical, ground-up construction projects. Obviously, the devil is in the blockchain details, but in theory the construction industry has all it needs to implement a promising new system.

Trent Cotney is CEO of Cotney Construction Law LLP, Tampa, Fla.