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In today's economy, NSF checks are becoming a fact of life for those in the construction industry.   When it comes to your company's collections problems, however, receipt of NSF checks may not be all that bad.

That's because nearly every state imposes stiff penalties against those who pass hot checks.   What type of penalties you ask?   If you're forced to collect on an NSF check, you'll likely be entitled to attorneys fees, legal costs and interest, and that's in addition to statutory liquidated damages that can be as stiff as double the amount of the check.

In all the states where I practice (Oregon, Washington & Louisiana), there exists powerful statutes designed to deter bad checks.  If you receive a NSF check, it's important you follow the procedures of these statutes to ensure you will qualify for the penalties.

Over the past few days, I've been contacted by folks about NSF check collections a bit more than usual, and so I spent some time over the weekend drafting short and understandable step-by-step guides on how to collect on a NSF check in these three states.   

We published them as Legal Guides over at Avvo.com.   Take a look at them here:

How to Collect on NSF Check in Louisiana

How to Collect on NSF Check in Washington

 

 

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In February 2008, the Louisiana Supreme Court decided Frey Plumbing Co., Inc. v. Celeste Foster, 996 So.2d 969, which dealt with the question of whether an agreement between a homeowner and a plumber was an "open account" or a construction contract.

Distinguishing between open accounts and construction contracts is important for a number of reasons, and namely because one can statutorily recover attorneys fees and interest under Louisiana open account law.

At trial level, the court granted the homeowner's summary judgment, agreeing that that plumbing agreement was a "construction contract" and not an open account.  The trial and La. 4th Circuit based its decision on a jurisprudential "factors test."

In Frey, the Supreme Court reversed this decision, and overruled all cases in Louisiana that relied on these "factors" to determine whether an agreement is a contract or an open account.   The Supreme Court stated that the statute (§9:2781) must be simply applied as written.

Here is how "open accounts" are defined in the statute:

'Open account' includes any account forth which a part or all of the balance is past due, whether or not the account reflects one or more transactions and whether or not at the time of contracting the parties expected future transactions.  'Open account' shall include debts incurred for professional services, including but not limited to legal and medial services. 

The defendant in Frey warned that such a liberal reading of the statute would be problematic:

Frey reads out the repeated references to 'open account' and 'account' and would have this Court hold that all unpaid debts fall within the purview of the statute.  Frey's interpretation of the statute is contrary to well established principals of statutory construction and leads to absurd results clearly unintended by the Legislature.

The Plaintiff in Frey didn't deny this allegation, saying instead that there's no explanation or indication that "this is not what the legislature mandated pursuant to the express provisions of the open account statute."

The Louisiana Supreme Court did not comment on the debate between the parties as to the exact broadness of the open account statute.  However, the court did make it clear that construction agreements are not automatically exempt from open account analysis.  

The prior "analysis" was trashed, and the court now requires that the facts of the case be applied to the plain language of 9:2781(D).

The Frey decision dealt with an unwritten plumbing agreement that was billed to the property owner after the work was complete.   Wolfe Law Group just this week filed a memorandum with the 22nd Judicial District Court analyzing the Frey decision and how it might apply to a more traditional lump-sum construction contract.

The memorandum can be read on JDSupra here.

We'll update with the judge's decision when received.

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This weekend, I read a post on the South Carolina Construction Law Blog about Texas' Prompt Payment Act.  It caused me to do a little online research on similar acts around the country, finding them in Alabama, Tennessee, Georgia, Wisconsin, New York, federally, and elsewhere.  

A "Construction News" pamphlet from Baker Donelson [pdf] in the Winter of 2004 has a good article about the statutes in AL, TN & GA, the theme of each act simply being this:  "Prompt Payment Acts Set Payment Guidelines for Construction Work."

It's no secret that payment problems are rampant in the construction industry.  And unfortunately, the old statement that "possession is 90% of the law" has some truth to it. 

Large well-funded construction companies can hold progress payments at the end of a project for trivial reasons, and strong-arm its subcontractors into settling for less.  Prompt Payment Acts aim to equalize the playing field a bit, applying penalties against those who misapply funds or try to strong-arm subs and suppliers.

So, do they exist in Louisiana and Washington?   Mostly....no.  

Both Louisiana and Washington lack a pure "Prompt Payment Acts."  Those victim to the misapplication of funds must rely on jurisprudence or other possibly applicable statutes, discussed below. 

Misapplying Funds in Louisiana
Buried within the Private Works Act in Louisiana is La. R.S. 9:4814 (A), which provides as follows with regard to the misapplication of funds:

No contractor, subcontractor, or agent of a contractor or subcontractor, who has received money on account of a contract for the construction, erection, or repair of a building, structure, or other improvement, including contracts and mortgages for interim financing, shall knowingly fail to apply the money received as necessary to settle claims to sellers of movables or laborers due for the construction or under the contract. Any seller of movables or laborer whose claims have not been settled may file an action for the amount due, including reasonable attorney fees and court costs, and for civil penalties as provided in this Section.

This provision actually works as a "prompt payment" requirement, but as is evidence from its terms it only has limited applicability. 

First, the contractor must "knowingly" misapply the funds.  Second, the only parties qualified to recover the penalties of the provision are "sellers of movables" and "laborers." 

The Private Works Act in Louisiana specifically distinguishes between laborers and subcontractors, and so subcontractors who provide labor to the project would not likely qualify for the penalties under La. R.S. 9:4814 - although the matter has never been decided.

Unfortunately for everyone not mentioned by §9:4814, Louisiana doesn't provide a remedy when funds are misapplied, and the parties must rely exclusively on the conditions of its contract.

Misapplying Funds in Washington
In 2006, the Washington Court of Appeals published an interesting reversal in Westview Investments, Ltd. v. U.S. Bank National Association [pdf of decision], addressing the issue of misapplying construction funds in Washington.

Since progress payments are not funds held in "trust" by statute in Washington, the court explained that they may be considered trusts if appointed as such by the parties - namely, through contract.

According to the Westview decision, progress payments made by a project owner to a general contractor constitute "trust funds" for the benefit of subcontractors, when the agreement between owner and contractor is based on AIA A201 (1997).    

Interfering with any "trust funds" would be a tortious conversion - and the Westfield court even goes so far as to rule that banks may be liable for misappropriating trust funds when it uses these funds to  pay down the borrower's debt to the bank (see discussion here).

Time for A Prompt Payment Act?
Is it time for a Prompt Payment Act in these Washington and Louisiana?  

While many statutes and regulations have drawbacks, there doesn't seem to be a downside to requiring contractors to pay its bills!

Litigation is costly and time-consuming - and it doesn't seem fair that after a long, expensive battle with a better-funded opponent, subcontractors and suppliers must settle for the principal debt. 

There are ways to punish contractors in Louisiana and Washington when funds are misapplied, but it's always dependant on circumstance.  A Prompt Payment Act would help equalize the playing field for subcontractors and suppliers who rely heavily on prompt payments.

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Everyone wrestles with the difficult choice of whether or not bring a lawsuit for their loss. With fraudulent contracting and capital-empty businesses running rampant, there is always a risk of non-recovery from your legal action.

The modern world makes it more simple to determine whether or not your potential defendant has property, and therefore whether or not that person has the incentive to work to resolve your claims.

But even in a world where a lawsuit looks like a homerun, many are still stuck with a judgment in hand and no means to recover. Louisiana law provides several means of recovering your judgment.

You may seek to execute a writ of fieri facias, an mechanism which asks the sheriff to seize assets for the purposes of satisfying the judgment. You may also seek a writ of attachment, so that you can attach to proceeds active in another lawsuit or disbursement. A final method, the writ of garnishment, provides an opportunity to seek garnishment of wages earned by your debtor.

But alas, each of these methods are extremely costly and excruciatingly time consuming. Remember the mantra of Wolfe Law - the lien is a powerful tool. We have, over time, offered many takes on the manner in which the lien can be used as an effective tool in recovering your damages. Now you can turn your judgment into a similar tool.

Sometimes little used, the judgment lien can be an effective tool against debtors. A money judgment - a judgment for a sum certain - creates a judicial mortgage against the property of your debtor. You can secure this judgment by filing a judicial mortgage under La. C.C. Art. 3299, et seq. A judicial mortgage will provide you with a privilege to the property, which acts similar to a mortgage against the property.

Once you hold a privilege against the property, you are in a good position to settle your debt. Working towards settlement is much less costly, strenuous and lengthy process towards gaining recovery. A lien provides incentives to settling these claims - and quick.

A judicial mortgage can be drafted by your attorney. 

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In the construction industry where litigation is frequent and costly, legal preparations are especially important. And while you can never completely isolate your organization from legal exposure, it will benefit from a conscious effort to place it in the best possible situation in the event of a dispute or injury.

Here are some ways your organization can be legally proactive to avoid costly and unnecessary legal expenses in 2008 and 2009:

1) Have a great written contract. Entering into a construction project of any size without a written contract is a recipe for disaster.

Your organization should have a "form contract" that meets your business' requirements, and addresses certain legal hot topics such as the scope of work, the indemnity requirements, the obligations of each party in the project, dispute resolution mechanics and procedures, etc. Written contracts should be a way of life for your organization, with contracts executed between contractor and owner, contractor and subcontractor, contractor and supplier, owner and architect, etc.

An attorney should be consulted to help make changes and insert provisions as required project-by-project, as each project has different needs. Even AIA or ConsensusDOCS form contracts are frequently edited by the parties to accommodate the needs of a particular project or agreement.

In the event of a dispute, a well-drafted written agreement can save your organizations thousands, and even hundreds of thousands or millions depending on the project's size.

2) Never Sign A Bad Contract. This is particularly a problem with subcontractors who enter into written contracts with subs or GCs who are larger and better funded then themselves. In these situations, it is common for the larger party to present the smaller party with a very one-sided contract.

The larger contractor uses its size and the allure of the project to strong-arm the smaller entity into agreement. Be very weary of this type of practice.

In the event of a dispute under one of these unilateral contracts, your organization can sustain a fatal blow. In our experience, we've unfortunately witnesses companies who have had to file bankruptcy or dissolve themselves not because their work was poor or they were legally wrong, but because they just couldn't afford to fight their position under the contract.

One proactive measure your organization can take to avoid costly litigation is to avoid signing these types of agreements.

While the heavy-handed form contract might seem mandatory, in fact these corporations are usually used to making certain changes to the contract terms. Have an attorney consult with you regarding the consequences of the contract provisions, as well as suggested changes - and propose these changes to the other party.

If you cannot get the contract altered to meet your concerns, you may want to seriously consider whether the project is worth the risk in liability and exposure.

3) Create and Follow In-House Collection Procedures. The importance of your in-house collection procedures will vary depending on the type of construction business you run. Certainly if your organization enters into hundreds or thousands of smaller contracts every year, collection procedures will be very critical to your operation. Conversely, if your organization has just a few big contracts each year, collections are likely more under control.

In any event, your organization should have a clear "plan of attack" in the event of non-payment.

In today's construction market and vulnerable economy, credit applications are often denied and cash flow can be tight. A high accounts receivables number can cause displeasure to your company.

The most effective way to prevent bad collection scenarios is not litigation (which is costly), but consistent collection practices and pre-litigation preparation.

Of course, a non-paying client can warrant litigation - and should, if payment is not tendered after collection procedures are employed. However, by taking in-house or outsourced collection measures prior to litigation your organization can limit the number of lawsuits required, and by preparing for litigation in each non-payment scenario, your organization will decrease the overall amount spent in court.

Collection procedures are most effective when they are structured, consistent, and employed early. By sending prompt demand letters you accomplish two important things: (a) you let the non-paying client know you are serious about collecting the account; and (b) you start the clock to collect attorneys fees, interests, etc. that you may be qualified for under contract or by law.

 

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Some have warned that we are facing an "economic pearl harbor," while others have cautioned Americans to avoid panic.

From a legal perspective, it seems clear that while the economic situations may not turn small business owners upside down, we are facing a time where cash flow is tight and accounts receivables should be kept as low as possible.

We have previously written about the importance of good collection practices in avoiding high accounts receivables and noncollectable - you can read these articles here. As clients and customers are becoming slower and slower in paying their bills, and credit is tight, it's now more important than ever for your business to have good collection procedures.

Wolfe Law Group has published as "Collections Toolkit" for contractors that discusses collection laws relevant to the industry, information on filing construction liens and even form letters and templates to use in your accounting department.

See a preview of the book here: http://www.lulu.com/content/3854624

Purchase a copy of the book in ebook ($69) or print ($139) format here:
http://www.lulu.com/wolfelaw

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Taking a reactive approach to collections instead of a proactive approach
Sometimes, unfortunately, the best collection procedures and attorneys on earth cannot fix a collections problem. An insolvent company who owes you $100,000.00 may owe you that amount forever. Good collection procedures, therefore, begin before you are owed any amount of money; they begin at the time of contracting."An ounce of prevention is worth a pound of cure" rings true for those seeking to avoid a high receivables account. Starting with a good contract and following through with smart project management can help keep your uncollected accounts low. Common contract provisions that may help avoid a collection scenario is discussed in a related blog post at:

Getting "Too Deep"
The worst collection problems are usually the most avoidable. Frequently, construction company will continue dumping materials and resources into a project without compensation.
It's important to reject the urge to perform your services upon a "promise" to pay. These promises are all too common between contractors, and in most cases, are all too empty as well.
Learn to notice cues from your prime contractors or customers that money is tight, and react by demanding exactly what you're entitled to: payment. You may fear that the paying party will seek someone else to perform the work, but not only are they likely contractually restricted from doing this, but the substituted company will certainly expect payment as well.

Being Unprepared for a Non-Paying Customer
The longer an account goes unpaid, the less likely you'll ever collect. One of the biggest mistakes you can make when faced with an overdue account, therefore, is to delay your attempts to collect.

It's easy to put off attempts to collect when you're not prepared. However, with a collection procedure in place, you can start collecting easily and automatically
as soon as an account becomes overdue. Collection procedures will keep you proactive, consistent and more successful at collecting on unpaid accounts.

Disorganization
Finally, the most common and avoidable collections mistake is being disorganized, and specifically being incapable to prove what you are owed. As soon as an account goes into collections, it will go into dispute. The paying party will disagree with the amount of work performed, the quality of the work, its scope, the project's change orders, etc.

In construction as you likely know, there's no such thing as a perfect project, and so it's not difficult for an adversary in collections to dispute the quality of your work because of paint chips or an incorrect doorknob.

Organization and a detailed record of the work you performed will help you avoid these time-consuming and expensive arguments. If you have photographs, time-sheets, job logs, etc., you'll have the evidence necessary to combat these arguments and keep your overdue account from turning into a settled account.

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In construction, owners, general contractors, subcontractors, and suppliers are all susceptible to bankruptcy. If any one of them chooses to declare themselves bankrupt, they not only leave the project vulnerable but the remaining parties are put at risk for not being paid, at all or in part.

Bottom line, any bankruptcy filing leaves the construction project irretrievably impacted and every party facing increased expenses in both time and money. In order to be paid, they've all got to work on two fronts now: the construction site and the bankruptcy courtroom.

Overview of the Bankruptcy Process - How It Begins

Declaring bankruptcy is a legal right guaranteed by the United States Constitution. Federal law and regulation defines and protects that right, and special federal courts have been created solely to deal with bankruptcy matters.

So much federal law has been created to control the bankruptcy process that it has been gathered together (codified) in a group of laws named the Bankruptcy Code. Within that code are several chapters, organizing various aspects of bankruptcy law by topic.

When an individual or a company involved in construction declares bankruptcy, they will most likely do so under one of three chapters:

•· Chapter 7 ("liquidation"), which essentially distributes the bankrupt venture's assets (some assets are exempt from this process under the law) to the creditors and thereafter, the business dissolves;

•· Chapter 11 ("reorganization"), where the bankrupt business is reorganized or restructured, and continues in business in a new way; and

•· Chapter 13 ('wage earners"), the most common choice overall, where unincorporated ventures (e.g., owners), keep their assets and pay creditors according to a court-approved plan usually for less than the full amount owed.

Immediately upon filing a petition for relief with the local bankruptcy court under one of these three chapters, the bankrupt will receive a case number as identification, and an assignment to a particular court and its presiding judge. Hearings will be held in the matter before that judge, and all correspondence to the court must contain the case number identifying the matter.

As soon as the bankruptcy case is created in the courts, the law stops everything with a procedure known as the "automatic stay." This stay cuts off any actions by or against the debtor and forces everyone involved to participate in the judicial process overseen by the bankruptcy judge.

News of Bankruptcy -- The First Response

It is wise to hire experienced legal counsel to deal with bankruptcy proceedings, and lawyers usually diversify their practices between debtors and creditors, large and small. Word of mouth is usually the best way to select good bankruptcy counsel.

An attorney can be very helpful in these situations. For example, if you want the general contractor to finish the job, your attorney can file the appropriate documents with the bankruptcy court to request that the automatic stay be lifted and the bankrupt company be allowed to finish the project. If the court grants your request, then the contract will continue as a "post-petition obligation," with all the rights and duties contained within it.

An attorney can also advise you on the nuances of bankruptcy law and how it changes your previous arrangements. For example, the standard contractual provision that filing bankruptcy is an automatic default will not be respected under federal law: the contractual provisions defining default as being unable to properly man the job, or to pay subs and suppliers, must also exist in order to lift the stay and terminate the contract.

Your attorney can also file a proper "Proof of Claim" for you. This will be accepted by the court as valid unless the bankrupt disputes it in some way. If you do not file a proof of claim with the bankruptcy court, you cannot be paid. Always file a Proof of Claim.

In large bankruptcy cases, the court will segregate the creditors into secured and unsecured groups, and create committees for both with certain creditors serving on both committees as representatives of the whole. There are advantages and disadvantages to serving on a Committee, such as you may or may not be paid for your time, and it is best to discuss this option with your attorney before agreeing to serve.

There's a Bankrupt on the Project: What Now?

When it's a general contractor that files bankruptcy, the entire project comes to a sudden halt. The owner can rely upon his performance and payment bond surety - if the work has been bonded - to get things going again. If not, then the owner can ask the Bankruptcy Court for permission to try and find some assurance that the contractor will continue his work to completion.

When a subcontractor or supplier files bankruptcy, the project will not be completely stymied. Construction will work around the gap made by the bankrupt. Meanwhile, the general contractor will ask the Bankruptcy Court for permission to either terminate the bankrupt's contract or to set up some type of assurance that they'll get their commitments to the project met.

Regardless of who has filed, when they learn of any bankruptcy filing on a project, subcontractors and suppliers will usually file lien claims immediately in order to protect their rights to payment. This is a good strategy as long as the applicable state law defines their right as existing before the bankruptcy filing. Federal law allows perfection of pre-existing security interests.

No one should act based upon a contractual provision that attempts to deal with bankruptcy by stating such things as filing bankruptcy is an automatic default under the agreement. Every single action connected with the bankrupt must occur under the auspices of federal bankruptcy procedure, which means that you must appear before the court and obtain the judge's approval before taking any action pursuant to the contract or otherwise. Act based upon the contract alone, and you will face the wrath of the bankruptcy judge.

Furthermore, everyone should check their payment records for any monies received from the bankrupt in the past ninety days. This is because federal law allows the bankruptcy court to order a return of payments received from a bankrupt for up to 90 days prior to the date the bankruptcy was filed. These are called "preference claims," and while they were traditionally sought for only large amounts ($7500+), today preference claims for amounts as small as $250 are not uncommon.

Having an attorney is especially important if you want to fight a preference claim. There are legal defenses available to you, such as demonstration of a contemporaneous exchange of value, that can allow you to avoid a refund.

Depending upon the situation, the construction project may or may not proceed with a bankrupt debtor participating in the process. Regardless of whether or not they continue, or they are terminated, the project's expense will increase for everyone in both time and money by the mere filing of the bankruptcy.

Preventative Measures

It goes without saying that the profit margin is shortened, if not erased, for many when a bankruptcy is filed. To minimize this cost, certain steps can be taken before starting any project:

1. Choose reputable parties to work with on each project you undertake. Established business ventures (5+ years) are less likely to fold.

2. Have legal counsel to review any construction contract before you sign it, with concerns not only for your legal rights and duties, but the ways you can protect yourself from the unfortunate circumstance of another party's bankruptcy filing. Your construction law attorney should undertake the basics of bankruptcy law as it applies to the construction industry.

3. When you hear rumors of a project participant being in financial trouble, do not wait for notice of a bankruptcy filing. Check with your lawyer on what you can do proactively to protect your interests: he may suggest liens be filed, or various defenses to preference claims be established, as well as contingency plans including having alternatives at the ready (a new supplier if the current one goes belly up; an alternative electrical subcontractor if the project's electricians go out of business).

4. Immediately seek the advice of counsel when you receive notice of a bankruptcy filing. There are set deadlines within which you must act or you will lose your right to any payment whatsoever for your work on the project.

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Efficient payment is critical in construction. Without timely, dependable payments to those who are actually doing the work and providing the materials, construction projects of any size become vulnerable.

Non-payment or slow payment can cause abandonment of the job, sub-standard work, and decreased productivity -- as well as an increase in claims and liens. Reputations in the community can also be tainted by slow and unreliable payment procedures, resulting in harm which can take years to repair.

Still, slow payment and non-payment remains one of the biggest risks facing a contractor. Owners withhold payment for many reasons: they are dissatisfied with the work; they want to push a project that is behind schedule; or they may just be strapped for cash. Regardless of who is at fault, payment controversies can destroy a project.

Prompt Payment Acts - When They Apply & How They Help

Every state in the union has passed legislation that is similar in character to federal law requiring the prompt payment of government receivables. Prompt Payment Acts cover a variety of industries, but they are particularly important when construction is involved.

In any work performed for a governmental entity, payment of the invoices will be covered by the Prompt Pay law regardless of whether or not a contract exists to support the work. Invoices submitted to the government legally must be paid within a relatively short period of time or interest will be assessed, which the governmental entity will be required to pay, as well. The time limits vary from state to state and may or may not mirror the federal time limit of 30 days.

These statutes also set requirements for the invoices that are presented: if the invoice does not conform to the statutory requirements, then it will not be honored. The Acts will not force a timely payment on an improper invoice. Therefore, the preparation of applications for payment becomes very important in governmental work and many companies use automated software designed especially for this task.

Automated Payment Systems

A simple web search reveals a cornucopia of software packages available for the construction payment process. Pricing and product features run the gamut. However, good quality automation need not be expensive: QuickBooks offers a highly regarded system for under $200 which should be well within range for most subcontractors and craftsmen.

What if it's Not a Government Project?

Projects that do not involve a public entity usually will not be covered by prompt pay legislation. However, those statutes can be used as a guide on how fast payments should be made, as well as how detailed payment applications should be. More importantly, however, will be the basic written contracts that the parties have signed: what the contract language relates -- or fails to address -- will control the project's payment process.

For example, in Louisiana, payment is not legally due in private contracts until the project is completed -- unless the contract language provides otherwise. (For more information here, see Wolfe Law's May 2007 article on Pay When Paid clauses, link shown below.)

Without a written contract, state law will control. Which state's law? The state where the construction is located controls. Thus, the importance of a strong contract in the construction payment process cannot be underestimated.

Securing Payment and Performance: Bonds Versus Liens

There are various methods of securing payment and performance of a construction contract that are recognized across the industry, in every state. These usually involve bonds or liens.

Owner's Security

One common method that owners use to insure that there will be performance under the contract is a performance bond. Here, a bonding company ("surety") issues a bond which documents that the bonding company is guaranteeing payment of a set amount ("face value") to the owner should the contractor fail to finish the job. The surety agrees to pay this sum to the owner if the contractor fails to perform all the required services and deliver all the required materials and equipment. Usually, the bonding company reserves the right to take action before paying on the bond, such as having the general contractor remedy any outstanding claims, or hiring another contractor to finish the work.

Contractors' Security

Mechanics' liens are used by contractors to secure payment. These are writings filed with the public real property records pertaining to the property involved in the construction, giving public notice of the contractor's priority interest.

Overall, there are two forms of mechanics' liens: general and particular. General mechanic's liens allow the owner's property to be held, and sometimes sold, to pay the unpaid amount that is due and owing to the contractor. Particular liens are those filed by contractors claiming a right to retain certain, identified property because of money or labor they have invested in that specific property. A security system company, for example, may have a particular mechanics' lien on all alarms and related equipment.

Contractors can create liens in a variety of ways. Mechanic's liens can be created by an express contract, in a standardized document that the parties sign. These liens can also be created under the law by "implied contract," which usually occurs as part of a particular usage of trade or from the dealings between the parties. When goods are delivered to a subcontractor that he needs in order to complete his part of the project, for example, that subcontractor has a legal right to hold those goods until he gets paid for his work.

Payment Under The Contract

Today, most construction projects will see the use of one of two American Association of Architects ("AIA") contracts: either AIA Form 201 (most popular) or AIA Form 200. However, these forms both have problems when issues of slow payment or non-payment arise if they are signed without revision. For example, while AIA Form 200 does include language regarding the creation of a lien in the event of non-payment, it fails to include any specific time period for making payments to subcontractors. Similarly, AIA Form 201 does not prevent the commingling of funds, and fails to address possible delays in disbursements.

Both of these popular forms of written construction contracts have been criticized for their inadequacies in dealing with payment controversies. In response to this, in part, 2007 saw the introduction of an industry alternative to the AIA contract forms, the Associated Owners & Developers Standard Form of Contract Between Owner & Contractor ("AOD Form").

The AOD Form simplifies matters by requiring owners to pay general contractors within an agreed-upon time (e.g., 30 days) and requiring general contractors to hold monies due to their subcontractors and suppliers in trust, paying them within 7 days from the time that they receive payment.

The AIA has responded to the criticisms of the AOD by upgrading its own set of construction contract forms. Experienced contractors as well as owners using either set of forms, however, are careful to work with experienced construction attorneys to insert clear contractual provisions at the outset.

No contract form (AIA or AOD) should be signed without first obtaining the advice of legal counsel. Experienced construction attorneys may see holes in the forms that fail to address payment issues, as well as other concerns, that are particular to the project. Particular contractual provisions, or clauses, may be needed that the attorney will know are appropriate.

Clauses which owners should consider regarding payment include those addressing:

description of the work; contractor's cost of the work plus fee; separate contractors; subcontractors and subcontracts; applications for payment; retainage; conditions for final payment; insurance; warranties; changes; no damages for delays; defaults and remedies to default; right to terminate without cause; alternative dispute resolution; concealed conditions; and unknown conditions.

Clauses which general contractors should consider regarding payment include those addressing:

incomplete or deficient plans and specifications; architect's right to withhold funds; changes in taxation; architect's approval or disapproval of payments, or final payment; warranty; concealed conditions; weather delays; separate contractors; change orders; schedule of values; stored materials; substantial completion inspections; retainage; and right to terminate for convenience.

Subcontractors: Contingent Payment Clauses and Liquidating Agreements

To buffer themselves against a slow-paying or non-paying owner, general contractors have developed several methods of sharing this burden with their subcontractors and suppliers. Two of the most common are contingent payment clauses and liquidating agreements.

Contingent payment ("pay when paid" or "pay if paid") clauses are inserted into agreements by the general contractor, making the sub-contractor or supplier wait along with the general contractor for the owner to make payment. These provisions are not legally recognized in all states. (For their use in Louisiana, see the May 2007 Wolfe Law Article on Pay When Paid Clauses.)

Liquidating ("pass through") agreements are contracts entered into between a general contractor and a subcontractor, where the subcontractor agrees to be paid only when, and if, the general contractor is paid by the owner. The agreements may not, however, provide for the subcontractor to have any remedy against the general contractor should the owner decline to ever make payment. Accordingly, pass through agreements are not recognized as valid contracts in every state.

Suppliers: The Joint Check Rule

Joint checks are commonly issued to pay both a subcontractor and a supplier at the same time. Since these are often accompanied with a number of legal issues (endorsement, allocation of proceeds, etc.), many states have enacted a "joint check rule" which requires any supplier endorsing a joint check to collect its proceeds from that check or be legally barred from later asserting a lien or bond claim on that amount.

State law bases this rule upon a variety of doctrines (release, waiver, estoppel), but all share the perspective that a joint check is intended to protect the issuer from the supplier's claim, as well as protecting the supplier by ensuring payment, and the owner from any lien.

Tools developed by the construction industry, as well as protections created in the law, to deal with the issues of payment during the construction process are numerous, and they are constantly evolving. While standardization across the county has removed many of the payment pitfalls, the best protections for smooth payment remains strong, written contracts entered into by all the construction participants.




For more information:

Federal Prompt Payment Act
39 USC 3901 et seq
http://caselaw.lp.findlaw.com/casecode/uscodes/31/subtitles/iii/chapters/39/toc.html

Louisiana Prompt Payment Act
La. Rev. Stat. Section 38:2191; 9:2784
http://www.legis.state.la.us/

Washington Prompt Payment Act
RCW Sections 39.04.250; 39.76.010-39.76.040
http://apps.leg.wa.gov/RCW/default.aspx

QuickBooks Construction Application for Payment Solution
http://marketplace.intuit.com/AppID-859-Reviews.aspx

Wolfe Law Article: Payment Provisions and "Pay When Paid" Clauses
http://www.wolfelaw.com/main/news/index.php?atype

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