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#6:  Pay-when-paid, Pay-if-paid and Good Faith Obligations

5/27/2014

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It’s a common scenario in construction: the owner pays the GC, who then pays the subs, but because the subs have contracted with the GC rather than the owner they look to the GC for payment.  And unless the subcontract says otherwise, the GC must pay for their performance regardless of whether the owner pays the GC.

Many subcontracts do say otherwise.  GC’s are understandably reluctant to risk liability to their subs despite nonpayment by owners, and often try to pass the risk of owner default down to their subs by making their obligation to pay contingent upon receipt of payment for their work from the owner.  The law will enforce that risk-shifting if the sub has clearly and unambiguously agreed to assume the risk of an owner default.

In this regard, courts frequently distinguish “pay-when-paid” clauses from “pay-if-paid” clauses.  A "pay-when-paid" clause typically provides that the GC will pay the sub within X days of receiving payment from the owner.  Some contractors mistakenly assume that this shifts the risk of nonpayment to the sub (reasoning that if the GC never gets paid, the sub has to wait forever plus X days before its payment falls due!), but most courts view these provisions as timing mechanisms rather than permanent excuses not to pay, and will require payment to the sub eventually regardless of whether the owner pays the GC.  By contrast, a "pay-if-paid" clause makes receipt of payment from the Owner a condition precedent to the GC’s obligation to pay a sub.  (An example might be “Contractor shall have no obligation to pay Subcontractor unless Contractor has first been paid by the Owner for Subcontractor’s work, receipt of which payment by Contractor is a condition precedent to any right of Subcontractor to be paid for its work.”)

There is an important qualification to this, one which arises most often in the context of change order disputes: the GC must make a good faith effort to get paid by the owner for the sub’s work.  And it must do so even if it disagrees that the sub is entitled to extra payment.  This principle was in play in Seaward Const. Co., Inc. v. City of Rochester, 118 N.H. 128 (1978).  In that case, a contract to lay sewer pipe for the city provided that “All monies due under the Contract are subject to the receipt of said monies by said Rochester Housing Authority from the Federal Housing and Urban Development Agency (HUD)” and "Payment to said Seaward Construction Company, Inc. is contingent upon receipt of funds by the Rochester Housing Authority.”  The price per installed foot depended on the depth, and when a dispute arose over how deep 920 feet of pipe was laid, the city refused to pay Seaward the higher price, pointing out that it had received no money from HUD to do so.  The Court
acknowledged that “the agreement is perfectly clear that the city will not be required to expend its own funds for payment,” but also held that “the city was under an implied obligation to make a good-faith effort to obtain funds from HUD to pay the plaintiff.”  Id. at 129-130.  The Court ruled that the city would be liable “unless it proves that, given a reasonable time, it has made a good-faith effort to obtain the funds from HUD and it has been unsuccessful.” Id. at 130.

Broadly worded “pay-if-paid” clauses can conceivably shift risk the risk of nonpayment even onto subs whose work is acceptable to the owner.  If the owner refuses to pay the GC due to some separate breach not involving a particular sub, will a “pay-if-paid” clause avoid the GC’s obligation to pay that sub?  That depends on the intent of the parties.  Rather than leave it to chance, this scenario should be addressed in the subcontract. 


Because subcontract terms only bind the parties to the agreement, a “pay-if-paid” clause will not protect an owner who hasn’t paid the GC for the sub’s work from direct liability to the sub on principles of unjust enrichment.  (The Merrimack County Superior Court so ruled in 2011 in Axenics, Inc. v. Turner Construction Company, No. 217-2010-CV-5001), rev'd on other grounds, 164 N.H. 659 (2013).  I’ll address this in a future blog.

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#5:  Mechanic's Liens and the Notice of Intent

5/20/2014

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New Hampshire law gives unpaid contractors, material suppliers and others involved in the construction process a lien on any private property improved, to secure the amount they are owed.  General contractors (those whose contracts are directly with the owner of the property) can obtain a mechanic’s lien without any advance notice to the owner, simply by marching into court any time within 120 days of the last date of work and getting a court-approved attachment of the property.  Subcontractors and others who do not have direct contracts with the owner, however, must give advance written notice of their intent to “lien the job” if they want to protect the full amount owed to them.

The rationale for this is easy to see.  Owners presumably know what they owe their general contractors, so they don’t need any advance notice in order to protect themselves.  But they may not know who all of the subs and suppliers are, or whether they have all been paid – even if they are smart enough to ask their GC for subcontractor and supplier lien waivers prior to cutting checks.  So, to protect the owner against having to pay twice for the same work (once to the general contractor and again to an unpaid sub or supplier), New Hampshire law provides that such lower-tier parties must give the owner a written “Notice of Intent to Lien” – or risk losing their liens, which will be capped by the amount that the owner still owes (or will owe) the general contractor on the date the notice of intent is received. 

This notice can be given before work starts, or during construction, or even after the construction is finished (although obviously not later than 120-days after the last date of the lien claimant’s work – the legal deadline for obtaining a lien).  But if the sub or supplier waits until after the GC has been fully paid the agreed contract price (or most of it), his notice will come too late to protect himself.  So why is it that subs and suppliers rarely take the ten minutes required to send owners a simple “Hi, I’m here, you need to worry about me” notice, alerting the owner up front of their intent to file a lien for any unpaid amounts?  Laziness?  Blind trust?  Not knowing who the real owner is?  These are all possible explanations, but I’ve found the most common reason is this:  For fear of upsetting the GC.


Here’s the thought process:  (1) “I want to continue to sell or work for this GC in the future.”  (2)  “If I notify the Owner of my intent to lien before my payment is due, my GC will find out and take it as an insult.”  (3)  “I’ll never do another job for this GC.”  Sub-subs go through a similar thought process with their subs.  So do supply houses (although this is less likely the larger the supply house is.)  Is it a valid concern?  Perhaps.  Can it be lessened?  Definitely!

The Notice of Intent has no prescribed form; anything that alerts the Owner to your existence as a potential lienor is sufficient.  You can soften it by making it appear –and actually BE – a matter of routine.  I recommend sending a benign statement after you start performance, one which puts the owner (and thus the GC) at ease.  You might try “Dear [owner]:  We have been contracted by [name of GC or sub] to furnish [describe the labor and/or materials] to your construction project, and have [now started/just completed/substantially completed] our performance.  While we anticipate no payment issues with our customer, it is our policy to alert owners up front that a mechanic’s lien may be placed on their property if, for some reason, that flow of funds is interrupted and we are not paid for our performance.  In that unlikely event, we will be placing a lien on your property.  You can minimize that risk by ensuring that your general contractor is timely paid for work performed, and by asking your general contractor for a lien waiver from us, which we will be happy to sign.” 

No GC should be offended by that.

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#4:  Warranty Obligations and Substandard Construction

5/14/2014

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When a builder builds for an owner, the contract will usually recite one or more warranties―what we lawyers call “express” warranties.  Or, the contract might be silent on the issue, raising the possibility of what we lawyers call “implied” warranties.  (I suppose a building contract could also disclaim all warranties express or implied, but I’ve never seen one of those.)  Building contracts can carry both express and implied warranties as long as they pertain to different subjects; if they are on the same subject, the express warranty will override any implied warranty.

Some construction contracts expressly warrant “good workmanship.”  Even if that is not expressed, New Hampshire law “recognizes an implied warranty that the contractor or builder will use the customary standard of skill and care," Lempke v. Dagenais, 130 N.H. 782, 794 (1988).  In either case, the warranty is that the work will meet the standard of care applicable to the building trades―that threshold level of quality we think of as acceptable construction. 


Building codes may prescribe the standard of care for some aspects of construction, but these codes are generally safety oriented, and don’t address everything.   Efforts to define the standard where the code is silent―when something should be deemed out of square or out of plumb, what fraction of an inch will be deemed “within tolerance” for some given aspect of the work, and so on―have occasionally been attempted (the National Association of Home Builders’ Residential Construction Performance Guidelines comes to mind).  But no written set of rules governs every possible situation.  Like Justice Potter Stewart’s famous “I know it when I see it” comment on the difficulty of establishing a legal test for obscenity, substandard construction is often easier to spot than to define.

Meeting this threshold standard of care will not always produce a satisfactory result for the customer.  The parties are free to agree on something more, and many express warranties do go further, warranting that materials used will be of a given quality, that a particular result will be achieved, or that the end result will be structurally sound.  (The one-and-only statutory warranty I am aware of, RSA 356-B:41, II, is of this type, providing that the declarant of a condominium “shall warrant or guarantee, against structural defects, each of the units for one year from the date each is conveyed, and all of the common areas for one year.”)  In such a case, meeting the standard of care won’t be enough; the builder must do what he promised, and repair or replace the warranted item regardless of whether the work was otherwise up to industry standards. 

Whether they are express or implied, warranties don’t last forever; they have a particular duration, and if a problem with the construction arises during that time frame, the builder is legally bound to make it good.  Notice that I said “arises,” not “is discovered.”  If the warranty period runs out before a problem is discovered, but the owner can prove that it actually arose earlier (although nobody noticed at the time), the builder is still on the hook.  Our Supreme Court said in Terren v. Butler, 134 N.H. 635, 639 (1991), in commenting on the condominium structural warranty, “We do not construe the one-year life of the statutory warranty to be a statute of limitations or even a time limit on the delivery of effective notice.  The one-year period describes the life of the duty, that is, the period during which breach may occur.”  Chances are good that the same analysis will apply to contractual warranties of good workmanship.

The length of an express warranty is a matter of negotiation.  Most express warranties I have seen recite a one-year duration.  Implied warranties last “a reasonable time,” and depending on the circumstances that could be more than a year―which is why I usually recommend to my builder clients that they specify a one year period for a warranty of good workmanship rather than roll the dice on how long a court might think the implied warranty lasts.  (As I said before, if they are on the same subject, the express warranty will override any implied warranty.)


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#3:  Is Your Sub-sub Really an Employee?

5/10/2014

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On May 8, the New Hampshire Supreme Court dealt a blow to businesses that hire one-person “independent contractors” on a regular basis to help them perform the usual scope of their services.  The case did not arise in the construction setting, but it has implications for subcontractors. 

Appeal of Niadni, Inc., 166 N.H. 256 (2014), ruled that a musician was an employee of the resort whose night club he had performed at nearly three hundred times in a two year period, even though he performed at other venues as well during this time.   The parties negotiated a pay rate for his services, and he was paid weekly for his performances.  He provided his own instruments and selected the songs he performed; the resort provided the stage and sound system.  After the relationship terminated he filed for unemployment benefits with the Department of Employment Security.  Following a hearing, a DES tribunal concluded that he was not an employee under the relevant statute, RSA 282-A:9, III, which provides:

"Services performed by an individual for wages shall be deemed to be employment subject to this chapter unless and until it is shown to the satisfaction of the commissioner of the department of employment security that:

(a) Such individual has been and will continue to be free from control or direction over the performance of such services, both under his contract of service and in fact; and

(b) Such service is either outside the usual course of the business for which such service is performed or that such service is performed outside of all the places of business of the enterprise for which such service is performed; and

(c) Such individual is customarily engaged in an independently established trade, occupation, profession, or business."

Specifically, the tribunal focused on item B of this ABC test, and concluded that the resort was in the business of, among other things, “coordinating” entertainment, which it distinguished from “the business of singing, playing instruments, or other forms
of entertainment.” 

The musician appealed to the DES Appellate Board, which had a very different view, finding that tribunal’s decision regarding the coordination of entertainment services was a “distinction without substance.”  It awarded benefits.  The resort then appealed to the Supreme Court, pointing to all the other things it did besides provide musical entertainment and arguing that these facts made the musician’s services “outside the usual course of the business for which such service is performed.”  While the Court acknowledged that this “can be an elusive concept,” it ultimately adopted a standard that doomed the resort’s appeal:  “[i]f . . . an enterprise undertakes an activity, not as an isolated instance but as a regular or continuous practice, the activity will constitute part of the enterprise’s usual course of business irrespective of its substantiality in relation to the other activities engaged in by the enterprise.”  Under this standard, it didn’t matter to the Court that the musician “was free to perform, and did perform, for other entities,” nor that its ruling “could encourage New Hampshire businesses to refrain from hiring those individuals and thus jeopardize the employment prospects of independent musical artists.”

Suppose you have a painting business or a drywall business, acting as a sub to various GC’s.  If you hire the painters or drywallers who do the actual work on an independent contractor basis, you’re going to want to keep using the good ones over and over, and if you are providing them steady work they may want that as well.  At some point the regularity of the relationship may convert these independent contractors into your employees, regardless of whether they furnish their own tools, regardless of whether they also work for others from time to time―perhaps even regardless of whether they buy the paint or the wallboard.  While your business may entail a lot more than just applying paint to surfaces or hanging wallboard on studs, under the standard adopted by Appeal of Niadni, Inc., their services are unlikely to be deemed “outside the usual course of the business for which such service is performed,” which would make them your employees at least for unemployment compensation purposes (the ABC test is not used for all employment determinations, e.g., workers compensation).


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#2:  Builder's Risk Insurance and Waivers of Subrogation

5/7/2014

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Almost all construction contracts require contractors to carry liability insurance, which covers most project accidents resulting in (a) bodily injury and (b) damage to property other than the work being constructed.  But liability insurance generally does not cover damage to “the Work,” i.e., the structure being built or the materials being used; it will almost always have an exclusion for “‘[p]roperty damage’ to ‘your work’ arising out of [‘your work’] or any part of [‘your work’].”  Nor will most owners’ ordinary property insurance policies cover that type of loss, thanks to typical coverage limitations excluding damage to an ongoing construction project.   For that, a “builder’s risk” policy is needed, with coverage for property losses during the course of construction.  

Either the owner or the contractor can obtain a builder’s risk policy, and the parties’ contract will typically specify which party buys the coverage.  In my experience, it is more common for owners than contractors to purchase builder’s risk insurance―perhaps due to the AIA form contract (The A201- 2007 provides at section 11.3.1: "Unless otherwise provided, the Owner shall purchase and maintain … property insurance written on a builder’s risk ‘all risk’ or equivalent policy form … comprising total value for the entire Project…This insurance shall include interests of the Owner, the Contractor, Subcontractors and Sub-subcontractors in the Project").  If the owner hasn’t bought builder’s risk insurance, the contractor still has the option to buy it.  It’s always wise to make sure up front, and not assume that the owner is obtaining builder’s risk insurance―even if the contract says the owner must procure it.  That’s better than buying a lawsuit, even one the contractor is likely to win (breach of an owner’s obligation to buy the builder’s risk insurance will almost surely result in a win for the contractor if the owner sues him for damaging “the Work”).

One pitfall here is that an owner’s builder’s risk policy does not automatically protect the contractor from liability if property loss occurs as a result of the negligence of a contractor (remember, the contractor’s liability policy won’t help here).  Without more, the contractor is at risk of being sued and having to pay damages―not to the insured owner, but to his insurance company who, upon paying out, is “subrogated” to the owner’ s rights. 


Although an insurer acquires a right to be subrogated to any claim an insured may have against the offending party upon payment of the loss, the insurer's right to subrogation derives from the insured's right against the offending party and is limited to those rights.  So, if the insured releases any claims the insured has against third parties to the extent covered by insurance―precisely what results from a “waiver of subrogation” clause such as is found in the typical AIA form―the insurer cannot chase the offending party for reimbursement of what it pays out under the policy.  (Naturally, insurers aren’t thrilled about this arrangement.  Some builder’s risk policies actually prohibit such waivers, in which case execution of the construction contract will violate the policy conditions and prevent recovery under the builder’s risk policy.)

The typical “waiver of subrogation” is a mutual one; each party waives rights against the other to the extent of insurance coverage.   (For instance, the AIA form says “The Owner and Contractor waive all rights against each other … for damages caused by fire or other perils to the extent covered by property insurance obtained pursuant to this Paragraph 11.3 or other property insurance applicable to the Work, except such rights as the Owner and Contractor may have to the proceeds of such insurance held by the Owner as fiduciary.”)  But for builder’s risk insurance purposes, it is the owner’s waiver that matters.  If the owner gets paid out by builder’s risk coverage and has waived the right to chase the contractor for any loss to the extent covered by insurance, the insurer is stuck with this, and contractor is safe from both owner and insurer.


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#1:  Contracting Around the Flow of Funds in the Construction Process

5/4/2014

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We live in a credit economy; few of us pay COD for anything anymore.  This is certainly true in construction.  Typically, everyone is paid for their labor or materials a month or more after their performance―owners need time to satisfy themselves (or to have their architects satisfy them) that work being invoiced for has been accomplished satisfactorily, and so they pay general contractors weeks after the end of a requisition period; general contractors pay their subs a week or so after that; subs pay their sub-subs and suppliers after they are paid (hopefully before their supplier’s “net 30” terms kick in).  And the lower you are in the food chain, the more risk of something going wrong above you; a weak link in the chain will plunge those below into the abyss when it snaps.

It all starts at the top.  Reasons that owners might not pay their GC’s for work performed usually fall into one of four categories: either (a) they don’t have the money, or (b) they think (rightly or wrongly) that some or all of the work being billed for is deficient, or (c) they think (rightly or wrongly) that “extra” work being billed for under a lump-sum or fixed-price contract is within the original agreed scope of work and not a true change, or (d) they think (rightly or wrongly) that the GC isn’t paying its own bills, e.g., insurance has lapsed, subjecting the owner to a risk of liability, or lower tiers aren’t being paid, subjecting the owner to a risk of mechanic’s liens.

What will happen in each of these scenarios is a matter of agreement between the parties.  Each party in the process can seek contractual provisions to limit its risks under each of these potential link-busters.  For example, GC’s can bargain for suspension and termination provisions in their contracts if payment is not timely received due to (a), or insert “pay when paid” or “pay if paid” clauses in their subcontracts in order to share the risk of (a) with their subs.  [I’ll be discussing this tool in a future blog.]  Subs can bargain for the right to be paid by the GC for their portion of the work even if there is a dispute under (b) regarding someone else’s scope of work.  Owners can bargain for “continue to work during disputes” clauses in their general contracts, foisting more risk onto the GC when payment is stopped due to (c).  Owners can bargain for “joint check” or “direct payment” methods of seeing lower tiers paid when (d) is in play.  I can think of dozens of other approaches.  The key is simply anticipating that what can go wrong will go wrong – and contracting around the problem up front as best you can.

Successful bargaining on these and similar matters is generally a matter of negotiating leverage.  A party will have more or less bargaining power depending on how much competition there is for their particular scope.  It all comes down to the alternatives available to the bargainers, and how badly they want/need the party with whom they are contracting.  Form contracts provided through the AIA and other groups attempt “fair” solutions on many of these issues, and are so popular that they have come to establish informal “default” rules on a number of payment topics.  This is often a useful bargaining chip when resisting an onerous payment provision in an owner’s or a GC’s proposed contract form – even one presented on a “take it or leave it” basis.

You don’t need a lawyer to negotiate a contract, and as long as you are savvy enough to anticipate the things that might go wrong and address them in your contract up front, you are probably well-served to try and negotiate your own deal with an AIA form as your template – at least for smaller contracts.  The larger the job, the more running a contract by your attorney makes sense.  But don’t wait too long; you will lose leverage once you are into the job.  If I had a nickel for every client who started work before their contract was signed, I’d retire from the practice of law and just write bogs full time!


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    Frank Spinella

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