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Texas Construction Law Blog

For Subcontractors & Suppliers

Implied Warranties: Part One (Goods)

Posted in Construction Contracts

Texas law imposes certain implied warranties on the sale of goods, regardless of whether the warranties are mentioned in the contract.  In particular, Texas law creates the warranty of “merchantability” and the warranty that the goods are “fit for a particular purpose.”

Merchantability

The implied warranty of merchantability requires goods to be merchantable.  Merchantable means the following:

1.  pass without objection in the trade under the contract description;

2.  in the case of fungible goods, are of fair average quality within the description;

3.  are fit for the ordinary purposes for which such goods are used;

4.  run, within variations permitted by agreement, of kind, quality and quantity for each and all units;

5.  are adequately contained, packaged, and labeled as the agreement may require;  and

6.  conform to the promises or affirmations of fact made on the container or label if any.

Thus, whether express or implied, warrantying the merchantability means a seller warrants that its goods will possess each of the foregoing qualities.

Fitness for a Particular Purpose

The implied warranty of fitness for a particular purpose applies to a sale of goods if the seller knows or has reason to know the buyer will use the goods for a particular purpose.  Unless disclaimed (more on this below), a seller with such knowledge (or reason to know) impliedly warrants that the goods are suitable for that particular purpose.

Disclaiming the Implied Warranties

 Sellers of goods often do not realize they are making such implied warranties.  In many circumstances, sellers may not want to make any such warranties.  This is especially so, if the seller is a distributor rather than the manufacturer.  A distributor may wish to assign the manufacturer’s warranty rather than make any warranties itself.

 Fortunately for sellers, the implied warranties of merchantability and fitness for a particular purpose may be modified or disclaimed.  However, to do so, the disclaimer must be in writing, conspicuous (e.g., bold and all caps) and specific (i.e., it must mention the specific warranty to be disclaimed rather than disclaiming warranties in general).   Prudent distributors and other sellers should include such disclaimers in their terms and conditions.

 On the other hand, buyers rightfully often want some type of warranty.  If the proposed agreement disclaims the foregoing implied warranties, then the buyer should take care to ensure it is receiving a warranty of acceptable scope from someone in the chain of distribution of the goods.

Filing a Lien When the Work is Done for a Tenant Rather Than an Owner

Posted in Uncategorized

Commercial landlords often allow commercial tenants to construct a buildout tailored to their business (e.g., retail stores, restaurants, redesigning office space, etc.)  Such tenants hire general contractors who in turn hire subcontractors and suppliers.  What lien rights do such subcontractors and suppliers have?

The General Rule

If the chain of contract is with the tenant, then the claimant’s lien will only cover the leasehold.  It will not attach to the owner’s fee simple interest in the property.  This should not deter you from filing a lien because there are exceptions to this rule.

Exceptions

If the tenant is shown to have acted as the agent or the general contractor of the owner, then the lien may cover the owner’s fee simple interest.  Often the owner exercises at least some degree of control and supervision of these projects, and the lease agreement evidences this control.  If so, this can be used to establish evidence of the foregoing exceptions.

The Bottom Line

If the work is done for a tenant rather than the owner, send your lien notices (include landlord and tenant) and file your lien against the property anyway.

How to Perfect and Enforce a Mineral Lien: Six Steps

Posted in Uncategorized

If you furnish labor or materials to an oil or gas well and are not paid, then you should consider filing a mineral lien.  Below are the steps to perfect a mineral lien.

1.  Identify the well and the chain of contract.

The best way to identify the well is to determine the API number.  The API number is a unique, permanent, numeric identifier given to each well in the United States.  Similarly, if you do not have a contract with the operator, then identify each party in the chain of contract, including the operator.

The best time to gather this information is up front by using a job information sheet.  If you provide services, then the employee that actually goes out in the field should also be able to note the API number and party information in the file.  If you are a supplier, then it is imperative you get this information from your customer before you ship any materials.

2.  Identify the lease, legal description of the land, and working interest owners.

This is often the most time consuming task.  It may require hiring a landman to pull the necessary documents so that you can compile the chain of title and identify who owns the working interest.

3.  Send the notice.

Required or not, it often makes sense to provide notice that you are going to file a lien because it may spark a dialogue and avoid the necessity of filing the lien.

Texas law only requires notices to be sent by those who are “mineral subcontractors.”  Mineral subcontractors are those who do not have a direct contract with the ”mineral property owner.”  ”Mineral property owner” means an owner of land, an oil, gas, or other mineral leasehold, an oil or gas pipeline, or an oil or gas pipeline right-of-way.

The notice must identify the amount of the debt; the name of the party you have a contract with; and a description of the land and lease to which the labor or materials were furnished.

You must serve (i.e. mail) the notice at least ten days before you file the lien affidavit.  You should send this notice by certified mail, return receipt requested.

4.  File the lien affidavit.

The lien affidavit is due six months after you last furnished (i.e., delivered) labor or materials.  For example, if you furnished materials on June 1, your lien affidavit is due on December 1.  Do not wait until the last day.  In rural counties clerks do not always (although they should) record a lien affidavit the same day they receive it.

The lien affidavit must contain:

  • name of the mineral property owner;
  • your name and mailing address;
  • dates of performance or furnishing;
  • description of the land, leasehold interest, pipeline, or pipeline right-of-way involved; and
  • itemized list of amounts claimed.

If you are a mineral subcontractor, your lien affidavit must also include:  (1) the name of the person for whom labor was performed or material was furnished or hauled; and  (2) a statement that the subcontractor timely served written notice that the lien is claimed on the property owner or the owner’s agent, representative, or receiver.

 5.  Send notice of the lien affidavit.

This is not required by the mineral lien statute, however, it is a good practice to notify the parties that the lien has been filed to encourage resolution.

6.  File suit.

You must enforce the lien within the same time and in the same manner as a mechanic’s, contractor’s, or materialman’s lien under Chapter 53.  This means you must file suit in the county in which the lien is recorded within two years of the deadline to file your lien affidavit.

7 Ways to Manage the Credit Risk of a New Customer

Posted in Collection

Get the project information up front

You should ask your customer for the owner’s name and address, the location of the project, a copy of the payment bond (if any), and the general contractor’s name and address (if you are a second tier subcontractor or supplier).  Having this information at the outset will help you quickly send out bond and lien notices if the new customer falls behind on making payments.

Require a Credit Application

Request that the customer sign a credit application.  The credit application should include the contact information of the customer, references, the name of the customer’s bank, and favorable terms and conditions.  The credit application should also include the information necessary for you to run a credit check.  Make sure the credit application is signed by an officer of the customer or someone else authorized to bind the company.

Get a personal guaranty

Request a personal guaranty from an officer or interest holder of your customer.  The most opportune time to acquire a personal guaranty is on the front end when the customer is applying for credit.  You should consider attaching the guaranty to the credit application or incorporating the personal guaranty therein.

Read (and revise) the subcontract carefully

Strike or modify clauses that weaken your rights to payment, such as contingent payment clauses, lien waivers, and broad termination clauses, and make sure the indemnity clauses are even handed. 

Joint Check Agreement

Joint Check Agreements are common in the construction industry (not so in the oil and gas industry).  A typical joint check agreement provides that the customer’s customer (e.g., general contractor or the owner) will issue a check jointly made to you and your customer.  This ensures that the customer uses the funds to pay you rather than some other bill.   

Draft and use invoices with favorable terms and conditions

Draft invoices with favorable and clear terms and conditions.  Such terms and conditions may not preempt your subcontract, but it may still be beneficial to have favorable terms and conditions in your transactional documents.  This is especially so if you are a supplier because suppliers often do not have a formal contract with a subcontractor.

Watch Your Notice Deadlines

If you fear non-payment and the amount justifies the legal expense, then contact an attorney immediately.  Perfecting a lien or bond claim is the best way to get paid.  These deadlines, however, pass quickly and are often difficult to calculate.  As a general rule of thumb, you should contact counsel well before the 15th day of the second month after you furnished the labor or materials underlying the unpaid invoices.  For example, if you were not paid for labor and materials provided in June, you may be too late to perfect your lien and/or bond rights after August 15th.

Increasing Your Recovery Under a Federal Payment Bond Claim

Posted in Bonds

Federally owned construction projects are covered by a Miller Act Payment Bond for the benefit of the subcontractors and suppliers thereof.  If you make a claim for payment under the Miller Act, you may, under certain circumstances, also have a claim for attorney fees and interest.  The text of the Miller Act is silent with respect to attorney fees and pre-judgment interest.  However, federal common law allows the recovery of both under certain circumstances.

Attorney Fees

Miller Act claimants are entitled to attorney fees if the claimant has a contractual basis for attorney fees.  In many cases, the bond claimant need only show there is an attorney fee provision in the bond claimant’s contract.  For example, courts have awarded suppliers attorney fees under the Miller Act where their contract or credit application with the subcontractor contained an attorney fees provision.

In addition, attorney fees are also available if the opposing party acted in “bad faith, vexatiously, wantonly, or for oppressive reasons.”  This is a high threshold, thus this exception is not nearly as commonly invoked as the contractual exception.

Miller Act claimants may also pursue additional claims against parties other than the surety that may give rise to attorney fees.  The Miller Act does not exclude other claims.  For example, a supplier could pursue a subcontractor for attorney fees under a breach of contract or sworn account claim.

Interest

Federal courts will consider state law as a guide to determine whether or not to award prejudgment interest.  Thus, if the claimant’s contract contains a provision entitling the claimant to interest, and state law would allow the recovery of such interest, then the claimant may be able to recover prejudgment interest under the Miller Act against the surety.

How to Preserve Your Rights

These exceptions are yet another example of why documentation matters.  Suppliers should put attorney fee and interest provisions in their credit applications and invoices.  Likewise, subcontractors should include attorney fee and interest provisions in their subcontract with the prime contractor.  Doing so may preserve such rights against a surety that provides a Miller Act bond on a federal project.  Not doing so may limit your recovery.

The Supreme Court Blesses Arbitration Clauses in Covenants Not to Compete, But is Arbitrating a Non-Compete Always a Good Idea?

Posted in Uncategorized

Non-competes are governed by different rules from other contracts.  Courts limit non-competes to certain circumstances, such as when an individual has received confidential information, goodwill, or specialized training; even then, the restrictions on competition must be “reasonable.”  However, when it comes to determining the applicability of the Federal Arbitration Act, the United States Supreme Court recently held non-competes should be treated the same as any other contract

The Nitro-Lift Decision

In Nitro-Lift Technologies, L.L.C. v. Howard, the United States Supreme Court, overturned a ruling by the Oklahoma Supreme Court permitting judicial review of a non-compete provision despite the contract’s arbitration clause.  The Oklahoma Supreme Court held the non-compete void and unenforceable because it was against Oklahoma’s public policy.

The United States Supreme Court reasoned the FAA applied and, therefore, under the Supremacy Clause of the Constitution, the Oklahoma Supreme Court was bound by the FAA and federal law interpreting the FAA.  The Court reaffirmed “it is a mainstay of the [FAA]’s substantive law that attacks on the validity of the contract, as distinct from attacks on the validity of the arbitration clause itself, are to be resolved by the arbitrator…not by a federal or state court.”  By finding the non-compete unenforceable, the Oklahoma Supreme Court improperly assumed the role of the arbitrator and contravened the FAA.

The Nitro-Lift opinion is worthy of note because it requires all state and federal courts to enforce FAA arbitration clauses contained in covenants not to compete or other similar agreements.

Should You Arbitrate a Covenant Not to Compete?  

As previously discussed in my blog posts available here and here, arbitration has its pros and cons.  Arbitrating a non-compete raises additional unique considerations.

Arbitrating a claim for money damages arising out of a breach of a non-compete may be preferable because (1) arbitration is typically faster and less expensive (though costs are rising) than a trial at the courthouse; and (2) arbitrations are private proceedings.

However, seeking injunctive relief in an arbitration proceeding is a horse of a different color. Obtaining injunctive relief (such as a TRO or TI) in an arbitration proceeding is often problematic.  Injunctive relief typically takes far longer to obtain in arbitration than it would at the courthouse where parties can seek immediate relief in the form of a temporary restraining order and a temporary injunction shortly thereafter.  In addition, arbitrators lack contempt power to enforce the injunctive relief they grant.  Therefore, employers and other parties who wish to arbitrate non-compete claims should draft an exception in the arbitration clause allowing them to pursue injunctive relief through the courts.  Many courts hold that a failure to include such language will deprive a court of jurisdiction to enter injunctive relief.

This blog is based on a web alert co-authored with Jonathan Hyman available at: http://www.lrmlaw.com/NewsResources/Legal-Updates/29502/The-Supreme-Court-Blesses-Arbitration-Clauses-in-Non-Competes

 

Ten Drafting Tips for Covenants Not to Compete

Posted in Uncategorized

A recent article in the Wall Street Journal discussed the rise in litigation regarding covenants not to compete, along with a summary of the positives and negatives of these covenants.  For good or bad, a covenant not to compete is enforceable in Texas if it is ancillary to, or part of, an otherwise enforceable agreement at the time the agreement is made, but only to the extent that the covenant contains limitations as to time, geographical area, and scope of activity to be restrained that are reasonable and do not impose a greater restraint than is necessary to protect the goodwill or other protectable interests of the employer.

Covenants not to compete are becoming more common in the construction and energy industries.  They are commonly used to protect trade secrets, confidential information, and customer relationships.

If you decide to require your employees to sign a covenant not to compete, consider the following issues:

1. Ancillary to Otherwise Enforceable Agreement – This requirement is generally satisfied by incorporating a confidentiality agreement in the contract containing the covenant not to compete.  The agreement should promise access to confidential information and/or trade secrets.

2. Consideration – Simply paying the employee will not work.  Money is not valid consideration for a covenant not to compete.  The safest bets are providing the employee with confidential information, trade secrets, and specialized training.  Each has been held to be valid consideration for a covenant not to compete.  Although unnecessary, it is prudent for the agreement to explicitly promise the employee such consideration.

3. Garden Leave – This is a European concept whereby the employer pays the employee money during the term of the covenant not to compete.  Thus, the employee receives compensation for sitting out and the employer is able to protect its business interests by keeping the employee away from the competition during the covenant not to compete.  Although as stated above, money for a non-compete is not sufficient consideration, as long as the employee received confidential information, trade secrets, and/or specialized training, there is no harm in offering garden leave money in addition to the foregoing.  The reason why this makes sense from the employer’s perspective is two fold: (1) it gives the employee an incentive to abide by the non-compete and (2) it gives the employer a powerful equitable argument if the non-compete is litigated.

4. Time – There is no black and white rule.  But many one year, and some two year, covenants not to compete have been enforced.  Anything over one year may not be enforced.

5. Area – This should be limited to where the employee worked.  However, if the employee was a high level employee, such as an officer or executive, then the court may enforce a covenant not to compete covering the entire territory that the employee oversaw or managed.

6. Activity – The activity that is restrained should be the same type of activity that the former employee performed for the former employer.  Anything beyond that may not be enforced.

7. Non-solicitation of Customers – Such clauses are governed by the same rules as Covenants Not to Compete.  These clauses should generally be part of the agreement containing the non-compete.  The customers should be limited to those who the employee actually called on while he or she was employed.

8. Non-solicitation of Employees – These clauses should always be included in the agreement.  Such clauses prevent one employee from leaving, and then taking additional employees with him/her or shortly thereafter.

9. Waiver – This clause should contain some representations and warranties regarding the necessity of the non-compete and necessity of injunctive relief.  In addition, the clause should waive the employee’s right to object to an injunction or the reasonableness of the non-compete.  Case law is not clear on the effect of this language.  Such language will likely not be dispositive of any future litigation or injunction, but the court may consider this language as a factor in its analysis.

10. Attorney Fees – The agreement should provide that the employer will be awarded attorney fees in the event that the employee violates any of the covenants or the confidential information agreement.

 

Legislative Update

Posted in Uncategorized

Construction legislation in the 2013 session was much different from 2011.  In 2011 many new construction related laws were passed including governance of indemnities and mechanic’s liens.  In 2013 many significant construction related bills were considered, but relatively few passed.  Nevertheless, the few that did get signed into law are worthy of review.

Sovereign Immunity (H.B. 586)

Definitions and Scope

This new law, which will be codified as Tex. Civ. Prac. & Rem. Code 114.001 et seq., waives the sovereign immunity of state agencies for the breach of a written contract for engineering, architectural, or construction services or for materials related to such services if the amount in controversy exceeds $250,000.  The amount in controversy excludes penalties, costs, expenses, prejudgment interest, and attorney fees.  This new chapter, and its waiver of sovereign immunity, will not apply to many highway and Texas Department of Transportation contracts.

The waiver of sovereign immunity does not extend to causes of action for negligence, fraud, tortious interference with contract, or any other tort.  It also does not apply to an employment contract between a state agency and its employee.

State agency means an agency, department, commission, bureau, board, office, council, court, or other entity, that is in any branch of state government and that is created by the constitution or a statute of Texas.  The statutory definition explicitly includes a university and a system of higher education but excludes a county, municipality, court of a county or municipality, special purpose district, or other political subdivisions of the State of Texas.

Awards under this waiver of sovereign immunity are limited to: (1) the amount due under the contract including compensation for increased cost to perform the work as a direct result of owner-caused delays or acceleration if provided by contract; (2) change order amounts owed; (3) attorney fees based on an equitable and just hourly rate if the contract provides recovery of attorney’s fees is available to all parties to the contract; and (4) interest as provided in the contract or, in the absence of contractual interest rate, the statutory post-judgment interest rate (not to exceed 10 percent).  An award may not include consequential damages, exemplary damages, or damages for unabsorbed home office overhead.

Venue

Claims under this chapter may be brought in: (1) a county in which the events or omissions giving rise to the claim occurred; or (2) a county in which the principal office of the state agency is located.  The new chapter does not waive sovereign immunity for suits brought in federal court.  However, the waiver does apply to alternative dispute resolution proceedings, which include mediation and arbitration, that are contractual or established by state agency rules and expressly incorporated into the contract.

Judgment Creditor Remedies

A judgment creditor granted under this waiver of sovereign immunity is limited as to how the judgment may be collected against the state agency.  Satisfaction of such a judgment may not be appropriated from the state agency’s general revenues.  The funds must be specifically appropriated.  Moreover, property of the state or any agency, department, or office of the state is not subject to seizure, attachment, garnishment, or any other creditors’ remedy to satisfy a judgment under this new chapter.

Licensing and Regulation of Architects and Engineers (H.B. 1717 and S.B. 204)

H.B. 1717 extends the sunset date of the Texas Board of Architectural Examiners from September 1, 2013 to September 1, 2025.  It also requires applicants to submit their fingerprints to allow the board to obtain applicants’ criminal history.  It further requires the Board of Architectural Examiners to conduct a criminal history check for each applicant or renewal.  The new legislation also clarifies how penalties for violations of Chapter 1051 of the Occupation Code are calculated: penalties up to $5,000 will be assessed for each violation, and each day a violation continues or occurs counts as a separate violation.

S.B. 204 provides similar amendments to the licensing and regulation of engineers in Chapter 1001 of the Texas Occupations Code.  The sunset of the Texas Board of Professional Engineers is extended to 2025.  S.B. 204 imposes fingerprint and criminal background requirements similar to those in H.B. 1717.

S.B. 204 also creates a mechanism, with some procedural similarities to the temporary restraining order and injunction process, to protect the public from one whose continued practice poses a continuing and imminent threat.  This procedure allows the Texas Board of Professional Engineers to suspend the license, certificate, or registration of a person if the board or panel determines that continued practice by that person would pose a continuing and imminent threat to the public welfare.  This suspension may be done without notice or hearing if: (1) action is taken to initiate proceedings for a hearing before the State office of Administrative Hearings simultaneously with the temporary suspension; and (2) a hearing is held as soon as practicable.  The State Office of Administrative Hearings shall hold a hearing not later than 14 days after the temporary suspension to determine whether a continuing and imminent threat still exists.  A final hearing on the matter shall be heard within sixty-one days of the temporary suspension.

S.B.204 also allows the board, after notice and an opportunity for a hearing, to issue a cease and desist order prohibiting someone who is not licensed, certified, or registered under Chapter 1001 from continuing to violate this chapter or other statutes or rules related to engineering.

Employees with Criminal Records (H.B. 1188)

H.B. 1188, Chapter 142 of the Texas Civil Practice and Remedies Code, limits liability for employers (The statute uses the terms “employer, general contractor, premises owner, or other third party.”), including general contractors and subcontractors, who hire employees with criminal records.  It provides that a cause of action may not be brought against an employer solely for negligently hiring or failing to adequately supervise an employee, based on evidence the employee has been convicted of an offense.

There are, however, exceptions that significantly limit this general rule.  Causes of action are not precluded if: (1) the employer knew or should have known of the conviction; and (2) the employee was convicted of:: (a) an offense committed while performing duties substantially similar to those reasonably expected to be performed in the employment or under substantially similar conditions to those the employee is reasonably expected to encounter in the employment, taking into account the factors listed in Section 53.022 and 53.023(a) of the Occupations Code, regardless of whether the occupation requires a license; (b) any offenses (violent crimes such as assault, murder, etc.) listed in Section 3g, Article 42.12 of the Code of Criminal Procedure; (c) a sexually violent offense as defined in 62.001 of the Code of Criminal Procedure.

In addition, the protections set forth in H.B. 1188 do not apply to a suit involving the misuse of funds or property of a person other than the employer if, on the date the employee was hired, the employee had been convicted of a crime that includes fraud or the misuse of funds or property as an element of the offense, and it was foreseeable that the position for which the employee was hired would involve discharging a fiduciary responsibility in the management of funds or property.

Modifications to Various Procurement Statutes (H.B. 1050)

H.B. 1050 modifies several statutes in the Government Code related to procurements for construction related contracts.  The two primary changes were to Tex. Gov. Code §§ 791, 2267 and 2269.

Section 791.011 of the Government Code will be amended to provide a definition of “purchasing cooperative.”  This term means a group purchasing organization that governmental entities join as members wherein the managing member receives fees from members or vendors.  However, under the new amendment, a local government may not enter into a contract to purchase construction-related goods or services through a purchasing cooperative under this chapter in an amount greater than $50,000 unless someone designated by the local government certifies in writing: (1) the project for which such services are being procured does not require engineering or architecture plans and specifications under Chapters 1001 and 1051 of the Occupations Code; or (2) such plans have been prepared.

Chapters 2267 and 2269 of the Government Code will be amended to allow a governmental entity to require a design-build firm responding to an RFP to identify companies that will: (1) fill key project roles, including project management, lead design firm, quality control management, and quality assurance management; (2) serve as key task leaders for geotechnical, hydraulics and hydrology, structural, environmental, utility, and right-of-way issues.  A design-build firm who has identified such companies may not change the identified companies unless an identified company: (1) is no longer in business, is unable to fulfill its legal, financial, or business obligations or can no longer meet the terms of the teaming agreement with the design-build firm; (2) voluntarily removes itself from the team; (3) fails to provide a sufficient number of qualified personnel to fulfill the duties identified during the proposal stage; or (4) fails to negotiate in good faith in a timely manner in accordance with provisions established in the teaming agreement proposed for the project.  If the design-build firm makes team changes for some other reason not allowed by the foregoing exceptions, then any cost savings resulting from such a change accrue to the governmental entity and not to the design-build firm.

Future Legislation

The session in 2015 promises to be more eventful.  In the 2013 session, the Legislature considered, but did not pass, bills proposing modification of the Construction Trust Fund Act and the mechanic lien provisions in Chapter 53 of the Texas Property Code.

The Construction Trust Fund Act may be tweaked to require the creation of a trust fund account under certain circumstances as was proposed in 2013 in H.B. 3316.  Texas mechanic liens could undergo more significant changes, perhaps even an overhaul.  The complexity of the law of mechanic’s liens in Texas has been roundly criticized, so fundamental change in order to simplify these statutes may very well occur.

The above is based on an article co-written with Ben Aderholt.

Contractors and Suppliers’ Defenses to Bankruptcy Preference Claims

Posted in Uncategorized

Bankruptcy preference claims are always an unpleasant surprise.  They are frustrating and, in many circumstances, are unjust because they allow a bankruptcy trustee or the debtor to clawback money you received in exchange for providing valuable labor, services, or products.

What is a “preferential transfer”?

The elements of a preferential transfer are highly technical.  Here is the basic idea: if you received payments from the debtor within 90 days of the debtor’s bankruptcy filing date and those payments were made on account of antecedent debt, then those payments may qualify as preferential transfers.  Contractors and suppliers are frequently targeted by bankruptcy trustees for such claims.  Fortunately, contractors and suppliers have several defenses, some of which are unique to them.

Primary Defenses

The Texas Construction Trust Fund Act – if the payments were for labor and/or materials furnished to a specific project located in Texas, then the payments should be treated as construction trust funds rather than property of the bankruptcy estate.

Subsequent New Value – if you provided labor and/or materials on credit for which you were not paid and the labor and/or materials were furnished after the alleged preferential transfer, then you may be able to argue the subsequent new value defense applies and bars the preferential transfer in the amount of the unpaid invoice for the subsequently provided labor and/or materials.

Ordinary Course of Business – in order to prove this defense, you must show the debts underlying the payments were created in the ordinary course of business and the payments were either made in the ordinary course of business under your pre-preference period history with the debtor or ordinary with respect to the industry standard.  To analyze this defense, courts look at many factors, including, but not limited to: the timing of the payments, the method of payments, the amount of the payments, and whether collection activities occurred.

C.O.D. (Cash on Delivery) - if the payments are C.O.D. (i.e., made contemporaneous to the delivery of the goods), then the payments should not be a preferential transfer because preferential transfers must be made on account of antecedent debt.

Liens – if you could have filed a lien if you were not paid, then, depending on how encumbered the project is with prior liens, you may be able to negate one of the elements of the preference claim – in particular, that you did not receive more than you would have if the bankruptcy was a chapter 7 liquidation, you were not paid, and you filed a lien.  You may also be able to argue that the payment released your lien and therefore the debtor receive contemporaneous new value.

Jury Trial – This is not so much a defense as it is a procedural right.  If you did not file a proof of claim or otherwise appear in the debtor’s bankruptcy, then you may be able to demand a jury trial and move to withdraw a reference to the district court.

The Importance of Paperwork

The quality of your documentation is key to each of these defenses.  If you get hit with a lawsuit, you will need all relevant documents.  Examples include: contracts, change orders, pay applications, invoices, purchase orders, statements, checks, quotes, delivery tickets and communications related to the payments at issue.

Bottom Line

 If you receive a demand or are sued based on a preference claim, do not write a check just yet.  You may have one or more of the above defenses.  Consult an attorney who is knowledgeable regarding construction law and experienced in defending against these actions.

Weathering the Storm of an Owner or General Contractor Bankruptcy

Posted in Bankruptcy

Bankruptcy court is often the “court of bad news” for creditors.  In particular, subcontractors and suppliers face unique challenges when a customer files for bankruptcy.  But they also have unique rights that may elevate their claims.  Failing to act quickly and correctly on those rights can have significant consequences. 

 Do Not Violate The Automatic Stay

As soon as a debtor files bankruptcy, Chapter 7 or 11, the “automatic stay” immediately protects the debtor from its creditors.  The “automatic stay” is a court order that applies immediately after the debtor files for bankruptcy and prevents the debtor’s creditors from taking certain collection actions.  For example, the stay prohibits a subcontractor from commencing or continuing any activity to collect on debts that a general contractor or owner owed for labor or materials furnished before the general contractor or owner filed for bankruptcy.  The stay also suspends any lawsuit or collection action that was pending. 

Violating the stay is serious and can result in sanctions.  However, there are some activities that are allowed under certain circumstances that may bolster your position.      

Lien

The priority of your claim is vitally important in bankruptcy.  Creditors are not treated equally.  Unsecured creditors generally are the lowest priority and do not fare well in bankruptcy. 

Subs and suppliers should use their lien rights to avoid the fate of an unsecured creditor.  If the project owner has filed for bankruptcy, then perfecting a lien may provide the subcontractor or supplier with a secured claim in the bankruptcy.  If the general contractor files for bankruptcy, then the lien filed against the owner’s property may provide a means for recovery outside of the general contractor’s bankruptcy.

Suppliers and subcontractors should assess their mechanic’s lien rights while oil and gas field services providers should assess their mineral lien rights.  Perfecting such liens (e.g., recording a lien affidavit) should not violate the stay if the lien’s inception relates back, as it does in Texas, to the pre-petition period when the labor and/or materials were furnished. Each state is different on this point.  In some states the liens may not arise until a later date.  If the lien’s inception date is after the bankruptcy filing, then you will not be able to perfect your lien without leave of court.

A lien claimant should not, under any circumstances and regardless of the lien inception date, attempt to enforce a lien (e.g., filing or continuing to prosecute a lawsuit) without receiving leave from the bankruptcy court to do so.  Enforcement is not covered by the exception to the automatic stay that allows perfection (under certain circumstances) and may result in sanctions.

 Reclamation

Suppliers should also consider their “reclamation” claims if their customer files for bankruptcy.  When an unpaid seller of goods discovers that the buyer was insolvent at the time of delivery of the goods, the seller may reclaim the goods upon demand made within ten (10) days after the receipt by the buyer of the goods.  If the tenth day of this period is after the debtor filed for bankruptcy, then the bankruptcy code extends the reclamation period for twenty days after the buyer receives the goods. 

Assuming the demand is properly made and the buyer was insolvent when the goods were received, the seller may receive an administrative claim in bankruptcy for the reclamation amount. This administrative claim is not secured, but it has a higher priority than general unsecured claims.

The Bottom Line

Properly protecting your lien and reclamation rights in a customer’s bankruptcy can significantly reduce your loss.  Before undertaking these efforts, it would be wise to retain counsel to avoid running afoul of the automatic stay and to maximize your rights.