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Texas Construction Law Blog

For Subcontractors & Suppliers

Pay-If-Paid Clauses: A Powerful Shield From Payment

Posted in Construction Contracts

Subcontracts typically contain either a pay-when-paid clause or a pay-if-paid (i.e., contingent payment) clause.  A pay-when-paid clause only deals with the timing of the obligation to pay the subcontractor.  In other words, the general contractor’s obligation to pay the subcontractor (or the supplier) is due at some point in time after the the general contractor receives payment from the owner.  A pay-if-paid clause is much different; it makes payment from the owner to the general contractor a condition precedent to payment from the general contractor to a subcontractor.  That is, if the owner does not pay the general contractor, then the general contractor is not obligated to pay the subcontractor.  Although there are no magic words required for a clause to be considered as a pay-if-paid clause rather than a pay-when-paid clause, courts tend to strictly construe these clauses.  Consequently, many pay-if-paid clauses now use the actual words “condition precedent” and make clear that the obligation to pay the subcontractor is absolutely contingent upon the general contractor being paid.

Pay-if-paid clauses are dangerous for subcontractors because these clauses shift the risk of owner non-payment from general contractors to subcontractors.  Subcontractors should always try to strike such clauses or revise them to become pay-when-paid clauses. Subcontractors are rarely in a good position to determine the credit-worthiness of the project owner.  In practice, however, subcontractors may lack the leverage to completely negotiate away such clauses.  While these clauses are not enforceable in some states, in Texas they are enforceable by statute, and they provide the general contractor with an affirmative defense to a claim for payment.  Fortunately there are some exceptions and safe harbors that subcontractors in Texas may take advantage of.

Certain Types of Contracts are Excluded

A pay-if-paid clause is not enforceable if the contract in which it is contained is solely for:

–design services;

–“the construction or maintenance of a road, highway, street, bridge, utility, water supply project, water plant, wastewater plant, water and wastewater distribution or conveyance facility, wharf, dock, airport runway or taxiway, drainage project, or related type of project associated with civil engineering construction”; or

–improvements to or the construction of a detached single-family residence, duplex, triplex, or quadruplex.

General Contractor’s Fault

A general contractor cannot rely on a pay-if-paid clause to the extent the general contractor is not being paid because the general contractor failed to perform (i.e., failed to properly do its work).

Notice

A subcontractor may object to a pay-if-paid clause being applied to an invoice by waiting 45 days from the date of the invoice and sending a written objection to the general contractor.   The notice becomes effective on the latest of a few different deadlines that are based on the Prompt Pay Act and the date the general contractor receives notice.  A notice of objection, once effective, precludes the general contractor’s enforcement of a contingent payment clause for labor and materials furnished after the effective date of the notice until the subcontractor is paid.  However, the notice exception does not apply if the general contractor gives the subcontractor a timely written notice which states that (1) there is a dispute under the Prompt Pay Act as a result of the subcontractor’s failure to meet it’s contractual obligations and (2) the subcontractor’s  notice to the general contractor will not prevent enforcement of the contingent payment clause.

Unconscionability

A subcontractor may also argue that the clause is “unconscionable.”  The subcontractor has the burden to show this exception, which under Texas law is difficult to establish.  A pay-if-paid clause is not unconscionable if: (1) the general contractor ascertains and notifies the subcontractor of the owner’s ability to pay for the project; and (2) the general contractor has: (A) made reasonable efforts to collect the amount owed to the subcontractor; or (B) assigned or offered to assign to the subcontractor its cause of action against the owner for the amounts owed to the subcontractor and offered reasonable cooperation to the subcontractor’s collection efforts.

Sham Relationship

In addition, a contingent payment clause is not enforceable if there is a sham relationship between the obligor [typically the owner] and the contingent payor [typically the general contractor].

Pay-if-Paid Clause Does Not Waive Lien Rights

Agreeing to a pay-if-paid clause does not waive lien rights.  If you have agreed to a contract with a pay-if-paid clause, it is vital that you enforce your lien or bond rights if you have not been paid.  Otherwise, you may be stuck in limbo if the general contractor asserts its rights under the pay-if-paid clause.  This serves as another important reminder to not ignore your lien rights.

The New Lien Waiver Form Prevents Subs and Suppliers from being Strong Armed

Posted in Liens

Historically, subcontractors and suppliers were compelled to sign onerous and overreaching lien waivers and releases in order to receive payment.  In addition, many subcontracts contain lien waivers lurking in the boiler plate.  Consequently, subcontractors often do not realize they have agreed to these clauses until it is too late.

Texas law was recently changed to require universal statutory forms to waive or release liens and private payment bond claims.  These mandatory forms help subcontractors because they prevent general contractors from slipping broad releases, indemnity clauses and other risk shifting provisions into a lien waiver that subs have to sign in exchange for progress and final payments.  Further, the new law will void many contract clauses that waive and release liens before a project has commenced.

As with most laws, there are exceptions.  If these exceptions apply, the forms are not required and a non-conforming waiver or release, including a lien waiver clause in a contract, may be enforceable.

Some Residential Contracts – The new statutory lien waiver forms are generally not required in order to waive a lien in a contract for residential construction if the contract was made before labor or materials are provided.  Therefore, a residential or residential development contract may still contain a blanket waiver if signed before the work starts.  However, such a waiver is not effective against a subcontractor supplying only materials.  Thus, a supplier who supplies no labor cannot be required to sign a lien waiver that deviates from the statutory form, unless, of course, one of the other exceptions described below applies.

Post-Agreement Payments – Agreements arising after the lien claimant has been paid in full are exempt from the statute.

Settlement and Accord and Satisfaction – The new statute also exempts the use of the new waiver forms when there is an accord and satisfaction agreement, settlement of a pending court or arbitration proceeding, or an agreement made after a lien affidavit claim has been filed or after a bond claim has been made.

Public Payment Bonds – The forms are inapplicable to public projects and nonstatutory bonds.  Therefore, in these circumstances, a customized lien waiver and release form may still be used.

Mineral Liens – The new statute is limited to statutory mechanic’s and materialmen’s lien claims.  It does not apply to the waiver and release of mineral lien claims.

Subcontractors and suppliers should remain vigilant for these exceptions and exclusions.  To be safe, subcontractors and suppliers should always negotiate out lien waiver clauses in all construction contracts and master service agreements, rather than assume such clauses will not be enforceable.

The New Texas Expedited Trial Rule’s Effect on Subcontractors and Suppliers

Posted in Collection

It has been said many times “the wheels of justice grind slowly.”  Indeed most cases take well over a year, and some a few years, to try.  To help solve this problem the Texas Legislature created a new procedural rule to expedite the trial of certain claims.  Rule 169 of Texas Civil Procedure, entitled “Expedited Actions,” is a new rule that applies to actions in which “all claimants” affirmatively plead “they seek only monetary relief aggregating $100,000 or less” (including penalties, costs, expenses and attorney fees).  However, it does not apply to claims arising out of the Property Code.  This would exclude claims based on mechanic’s liens, mineral liens, property code private payment bonds, the Trust Fund Act, and the Prompt Pay Act.  However, the government code is not excluded from the new rule, thus claims on public bonds may be tried on an expedited basis under the new rule.  Claims based on an unpaid account or personal guaranties may also be tried on an expedited basis under Rule 169.  

The bottom line is Rule 169 probably will not apply to many small collection lawsuits filed by subcontractors and suppliers because these lawsuits typically contain at least some property code (and therefore exempt) claims.

Why Delivery Tickets Matter

Posted in Bonds, Liens

Paperwork can win or lose a lawsuit.  This is especially so in construction litigation.  To be entitled to a lien, bond, or any other claim for payment for materials delivered to a construction project, you are not required to show the materials you furnished were installed on the project.  However, you must show the materials were delivered.  The most common way to document delivery is through the use of delivery tickets.  Unfortunately, delivery tickets frequently are not correctly filled out.  

Delivery tickets should always contain the date of delivery, a signature from your customer’s authorized representative, the printed name of this person, a meaningful description of the materials shipped, and a cross reference to your invoice.  A failure to include this information will cause uncertainty and headaches if a lawsuit is ever filed.  The delivery dates are especially critical to lien and bond claims because the delivery dates (not the invoice dates) determine the deadlines to send notice letters, and in the case of a lien, to file a lien affidavit.

Bottom Line

(1)  review the form of your or your vendor’s delivery tickets to make sure it includes the delivery dates and the other critical information discussed above;

(2)  audit your files to see whether the delivery tickets are being filled out properly; and

(3)  save these documents because they may be evidence in a lawsuit someday.

 

Your Last Resort: The Unpaid Account

Posted in Collection

A suit on an unpaid account against your customer will likely entitle you to the principal balance plus interest and attorney fees.  But a suit on an unpaid account is only as good as your customer’s ability to satisfy the judgment.  A claim on an account against an entity provides very little leverage.  The principals may decide to walk away from the entity and set up another one.  Alternatively, they may file for bankruptcy.  If so, you will have an unsecured claim.  Unsecured creditors almost never receive the principal amount of their claim in bankruptcy.  This makes an unpaid account claim the least powerful of all claims available to a subcontractor or a supplier.

In addition to the unpaid account claim, there are quasi-contract theories, such as quantum meruit, but such claims may be difficult to prove.  In addition, the case law regarding these claims is unsettled, especially when they involvle claims arising out of the chain of contract on a construction project.

Joint Check Agreements

Posted in Construction Contracts

If you supply construction materials and/or equipment then you likely have encountered a joint check agreement.  For those that have not yet encountered this arrangement, a joint check agreement is a credit facility frequently used to help subcontractors with unestablished credit obtain supplies and services on credit from a supply house.  For example, if you are a supplier, you may require a subcontractor and the subcontractor’s general contractor to sign a joint check agreement whereby the general contractor agrees to write checks jointly to you and the subcontractor.  In theory, a joint check agreement benefits all three parties: the general contractor minimizes the risk of nonpayment to lower tiered parties, and thus lien claims; the subcontractor may purchase supplies and materials on credit; and the supplier is somewhat further protected against the subcontractor absconding with the payment from the general contractor.

A joint check agreement is better than nothing but it is no substitute for lien and bond rights.  A supplier should preserve its lien and bond rights regardless of whether the supplier has a joint check agreement with the general contractor.  Nevertheless, joint check agreements can be useful.  They can allow a supplier to provide materials on credit to a subcontractor who normally would not be approved to purchase materials on credit.  But bear in mind, there is no standard form.  A joint check agreement is not defined or limited by statute.  Consequently, parties have the freedom to put self serving terms and conditions in the joint check agreement.  For example, a general contractor may use it as a means to impose onerous terms on a supplier (e.g.  lien release and/or waiver language, indemnities, pay if paid clauses).  Suppliers should always draft the joint check agreement to minimize the inclusion of any extraneous and unfavorable terms.

You should contact your attorney to help draft a joint check agreement form so you have it at your disposal when the need arises.  If you must sign a general contractor’s form, read it carefully and watch out for unfavorable provisions.

Adding Another Target: Personal Guaranties

Posted in Collection

In general, a personal guaranty makes an individual or individuals liable for an entity’s debts or obligations.  A personal guaranty which guarantees a general contractor’s obligations to pay a subcontractor is rarely given, but it is common for the principal(s) of a subcontractor with unestablished credit to personally guarantee the debts and obligations of the subcontractor to a supplier in exchange for purchasing or renting materials on credit.

Personal guaranties are understandably unpopular with customers.  The most opportune time to get a personal guaranty is when a customer first applies for credit.  It is common to include a personal guaranty in or attach it to the credit application.

A personal guaranty is nice to have, but it is not a substitute for a lien or bond claim (liens and bonds offer much more security).  A personal guaranty is merely an additional avenue to collect an obligation.  In other words, it provides an additional target for payment of a debt.  However, a personal guaranty is no better than the individual signing it.  If the guarantor does not have the financial assets to support the guaranteed obligation, the personal guaranty is virtually worthless.

You should make the personal guaranty continuing, absolute and unconditional.  You should contact your attorney to help draft a form of personal guaranty so that you have it at your disposal when the need arises.

Mineral Liens: An Underused Tool

Posted in Liens

If you provide services or supplies in the oil field, you  should have at least a basic understanding of Texas mineral liens because filing a mineral lien may help your bottom line someday.

 Who can file a mineral lien?

mineral contractor or subcontractor may file a lien to secure payment for labor or services related to the mineral activities.  These terms are defined broadly.

“Mineral activities” means digging, drilling, torpedoing, operating, completing, maintaining, or repairing an oil, gas, or water well, an oil or gas pipeline, or a mine or quarry.

“Mineral contractor” means a person who performs labor or furnishes or hauls material, machinery, or supplies used in mineral activities under a contract with a mineral property owner.

“Mineral subcontractor” means one who furnishes or hauls material, machinery, or supplies used in mineral activities under contract with a mineral contractor or with a subcontractor; performs labor used in mineral activities under contract with a mineral contractor; or performs labor used in mineral activities as an artisan or day laborer employed by a subcontractor.

 What does the lien cover?

  1. the material, machinery, and supplies furnished or hauled by the lien claimant;
  2. the land, leasehold interest, oil or gas well, water well, oil or gas pipeline and its right-of-way, and lease for oil and gas purposes for which the labor was performed or material, machinery, or supplies were furnished or hauled, and the buildings and appurtenances on this property;
  3. other material, machinery, and supplies used for mineral activities and owned by the owner of the property listed in 2; and
  4. other wells and pipelines used in operations related to oil, gas, and minerals and located on the property listed in 2.

 How to perfect a mineral lien:

Notice – mineral contractors do not need to send notice, however mineral subcontractors must serve written notice on the property owner that the lien is claimed no later than the 10th day before the day the affidavit is filed.

Lien Affidavit – you must record a lien affidavit with the county clerk of the county in which the property is located no later than 6 months after the day the indebtedness accrues.  The day indebtedness accrues is based on the last day you furnished labor, service, or materials.

How to enforce a mineral lien:

Mineral liens are to be enforced in the same manner and in the same time as mechanic’s and materialmen’s liens under Chapter 53 of the Texas Property Code.

Prompt Pay Acts: Preventing Slow Paying

Posted in Collection

Prompt Pay Acts deter late payment by general contractors (and owners) by giving subcontractors and suppliers rights in the event the general contractor does not timely pay.  These rights generally include interest, attorney fees, and the right to suspend performance.

 Texas Private Prompt Pay Act

The Texas Private Prompt Pay Act requires the owner to pay the general contractor within 35 days of the submission date of an invoice.  The general contractor, in turn, must pay the subcontractors for the portion of the owner’s payment that is attributable to the subcontractor’s work within 7 days of when the general contractor received payment from the owner.  The same deadline is imposed on first tier subcontractors with respect to paying their second tier subcontractors.  If the parties have a good faith dispute over the work, the party withholding payment can withhold no more than 100 percent (nonresidential) or 110 percent (residential) of the difference between the amounts each party believes is due. Interest accrues at the rate of 1.5 percent per month or 18 percent annually on overdue payments. The terms of the act cannot be waived or altered by contract.  Any provisions that attempt to do so are void.

Texas Public Prompt Pay Act

The public act has very similar terms to the private act.  The owner must pay 31 days after receiving the invoice and the general contractor must pay the subcontractor no later than 10 days after the general contractor receives payment. Interest accrues at the sum of 1 percent plus the prime rate as published in the Wall Street Journal per month. Similar to the private act, payments for work subject to a bona fide dispute can be withheld.  As is in the private act, the terms of the public act cannot be waived or altered by contract and attempts to do so are void.

Federal Prompt Pay Act

The federal act requires each construction contract awarded by a federal agency to include a clause that requires the prime contractor to include in each subcontract for labor or materials: (1) a payment clause which obligates the prime contractor to pay the subcontractor for satisfactory performance under its subcontract within 7 days out of such amounts as are paid to the prime contractor by the agency under such contract; and (2) an interest penalty clause which obligates the prime contractor to pay to the subcontractor an interest penalty using an interest rate established by the United States Treasury.

The Texas Construction Trust Fund Act, AKA “Plan B”

Posted in Collection

The Construction Trust Fund Act is often “Plan B” for subcontractors and suppliers who have not perfected their lien or bond claim.  The Construction Trust Fund Act provides for civil and criminal penalties to those who misappropriate construction trust funds and fail to pay for labor and materials.  When a general contractor or upstream contractor is paid for its work on a specific project but does not pay its downstream suppliers or subcontractors, then the general contractor or upstream subcontractor is in violation of the Construction Trust Fund Act.

However, such claims can be a powerful tool, primarily because the Construction Trust Fund Act provides for personal liability against the agents, officers, or directors of the general contractor or upstream subcontractor who directed or controlled the use of the funds received by the contractor or subcontractor.  Further, at least one court has held a trust fund claimant is entitled to recover its attorney fees incurred in prosecuting a trust fund claim.

There are some exemptions and defenses to be aware of.  The Construction Trust Fund Act does not apply to lenders, title companies, closing agents, or bonding companies.  Also, it is an affirmative defense under the Construction Trust Fund Act if the funds were used to pay the general contractor’s (or upstream subcontractor’s) actual expenses directly related to the construction or repair of the improvement.  There are also practical limitations.  Trust fund claims require extensive discovery and are much more expensive to litigate than lien and bond claims.  Nevertheless, if you miss your lien and bond claim deadlines, a trust fund claim is often your best hope for payment.