Blockchain Construction Contracts

Imagine an entire construction contract in the form of a blockchain smart contract where funds for each stage of construction are locked into the agreement in advance and released as work is performed or materials are delivered.

Fundamentally anything that could be included on a standard pen and paper construction contract could also be included in a blockchain constrained smart contract. In fact a handful of US states have passed or are in the process of passing legislation that makes smart contracts legally binding on and off the blockchain.

The benefits of this use of blockchain technology would be game changing.

Take a typical material supplier for example. That supplier will often require a deposit which the subcontractor must finance or request from the general contractor who in turn must also either finance or pass the bill along to the building owner. This deposit and the paperwork it generates can often be thousands of dollars and could cause major delays in construction as it is funded.

From a material supply standpoint specific payment terms can be dictated but the reality is that the supplier is unlikely to be paid until the subcontractor gets paid. Most subcontractors are subject to billing cycles of the general contractor, meaning that the materials may not be paid for until 60 days after completion of the work or more.

To make matters even worse the following phrase is all too common in the construction industry: “I’ll get you paid next week I’m just waiting on funding from another project”. The industry, especially at smaller and less professional scales, is riddled with “robbing Peter to pay Paul” scenarios which create cash flow problems detrimental to every entity involved on the construction project.

Now let’s theorize a similar situation utilizing immutable smart contracts on a blockchain.

At the signing of the “contract” the building owner, or more likely the bank, pre-deposits funds into a cluster of dozens of smaller sub-smart-contracts that are transparent and visible to anyone with the right credentials working on the project.

Due to the transparency inherent to blockchain technology the supplier in this situation will be able to see his or her funds sitting in the contract in advance. The smart contract will specify a list of criteria which must be met in order for the supplier to receive funds before material orders are placed. In this case, for example, the smart contract can specify that once goods arrive to the job site the funds will be released to the supplier through multi-sig style validation from a series of interested parties including the building owner (or representative), the bank, the subcontractor, the owner’s project manager, and the architect. Once everyone achieves consensus that the correct material has arrived at the job site and meets the required specifications the supplier could receive payment immediately. Furthermore, knowing the funds are accessible upon successful completion of the smart contract might compel a supplier to reduce or waive material deposits in the first place reducing delays and friction in the overall supply process.

By using blockchain based smart contracts the construction industry as a whole is transferring trust from the hands of contractors and subcontractors to the blockchain itself which will interpret smart contracts in black and white. Project owners immediately reduce their lien liability on a project since materials and subcontracts are inherently substantially paid on time when the work is done directly from the blockchain smart contract (eliminating intermediaries and greatly reducing the potential for misappropriation of funds). Grey areas that are extant in existing contractual relationships would be resolved in a similar way. For example, a change order could be a separate smart contract to address one specific situation that could not be resolved inside of the original contract.

The use of immutable smart contracts in construction would encourage general and subcontractors to submit more thorough bids from the onset. This extra due diligence prior to signing a construction smart contract could ultimately save the owner of the project a significant amount of money and heartache as there is a great potential to reduce the number of surprises that will be encountered along the way. Consider that even a 5% savings on a large scale construction project is substantial. We feel that migrating the typical pen and paper construction contract onto the blockchain could help building owners not only save money but possible get their project built faster and certainly more transparently than with traditional contractual agreements and distribution of funds.

Guest post

CotB Group Houston, TX

Blockchains and Supply Chains discussion with SAP

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