Because of time constraints and the desire to get the business, subcontractors and suppliers routinely sign lengthy subcontracts and master service agreements without closely reading the terms and conditions. Below are some clauses that every subcontractor and supplier should review in a contract. Continue Reading
If you decide to agree to an arbitration clause, then you should carefully consider what issues you want to address in the clause. Below are some key points and provisions that should be considered when negotiating or drafting an arbitration clause.
1. Consider the Number of Arbitrators
Using only one arbitrator may be risky because the grounds to vacate an arbitration award are very narrow. You may be stuck with that arbitrator’s award, even if erroneous. To minimize this risk you may choose three arbitrators rather than one. This will reduce the risk of error, but substantially increase the cost.
2. Define the Procedural Rules
Many parties define their discovery rules and set limitations on depositions, interrogatories, and requests for production. This is desirable because it cuts costs. However, discovery limits are risky because one set of discovery limitations does not fit all disputes. For example, if you are a claimant in a large construction defect dispute, you may regret agreeing to limit discovery.
Likewise, many parties agree to apply the Federal Rules of Evidence. This is wise because it provides the parties with some measure of certainty regarding what rules apply and it enables the parties to use case law construing these rules for guidance.
3. The Scope
The scope (i.e., the universe of claims to be arbitrated) is arguably the most important issue. Surprisingly, this is a frequently litigated issue with respect to arbitration, so make sure the scope is clear (the AAA provides parties with a clause builder program). Most parties prefer a broad scope and use terms like “all claims arising out of or related to this Agreement.” Courts tend to construe such broadly worded arbitration clauses to include torts arising out of the subject matter of the contract.
4. Retain Judicial Relief
The arbitration clause should contain a carve out that explicitly allows you to seek injunctive relief and to foreclose your lien in a court because an arbitrator lacks the contempt power to enforce an injunction and cannot foreclose a lien. If you fail to retain any judicial remedies, your adversary may argue the arbitration clause has stripped the court of jurisdiction to enter such orders.
If the arbitration clause requires mediation as a condition precedent, consider striking that requirement. Mediation, in the right circumstances, is great tool to efficiently resolve a dispute. Naturally, it is popular. However, in many cases mediation at the outset of a dispute is not fruitful because the parties do not yet understand the strengths and weaknesses of their claims and/or defenses. Mediation typically makes more sense after the parties are allowed to conduct discovery and, therefore, are better able to assess liability and damages.
Arbitration clauses are very common in contracts in the construction and energy industries. Many industry players reflexively insist on arbitration despite its pitfalls. While arbitration has its place, a bench trial is a viable alternative to arbitration.
Bench trials are simply trials to a judge rather than a jury. Parties may agree to a bench trial in a contract by agreeing to waive their rights to a trial by jury (i.e., a jury waiver).
When drafting a contract and trying to decide between an arbitration clause and a jury waiver, consider the following factors:
Expense – Contrary to popular belief, arbitration is very expensive. The fees associated with filing the arbitration and paying an arbitrator, the arbitral administrative organization (e.g., AAA or JAMS), and the court reporter fees are often substantial. In contrast, the filing fee for a lawsuit is nominal, and the judge and his/her court reporter are essentially free (they are paid with your taxes).
The Right to Appeal – The grounds to vacate an arbitration award are very narrow. Consequently, arbitration awards are seldom vacated by the courts. This is the biggest drawback of arbitration. Because it is so difficult to reverse an arbitration award, placing your fate in the hands of an arbitrator is risky and could be fatal. On the other hand, appellate courts have broad powers of review over trial courts and routinely reverse trial courts for many reasons.
Confidentiality – Arbitration, unlike a bench trial, is a private proceeding that is closed to the public. Further, the documents filed in the arbitration, subject to the arbitrator’s rules and the parties’ agreement, may be kept confidential. Although a trial is public, the trial court can protect a party’s confidential information by entering a protective order and requiring confidential documents to be filed under seal.
Freedom to Choose the Fact Finder – The parties pick the arbitrator, but they cannot pick the judge. This is an advantage of arbitration. It allows parties to pick a fact finder that both believe will be fair. It also allows parties to pick a fact finder with expertise relevant to the subject matter of the dispute. Picking someone with expertise may reduce the risk of a mistake on a key issue that depends upon understanding a specialized area of law or a specific industry.
Enforceability – In many foreign countries, arbitration awards are generally more likely to be enforced than a judgment from a court located in the United States. If you are contracting with a foreign entity with assets overseas but no assets in the United States, then, in these circumstances, arbitration may be preferable to a lawsuit because of the question of enforceability.
The Bottom Line
Arbitration is expensive and the limited appellate review of an arbitration award makes it potentially dangerous. Nevertheless, arbitration will always have its place. Arbitration is and will remain preferable for certain disputes because it offers privacy, the freedom to select the fact finder, and is more likely to be enforced abroad than a judgment.
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:
–“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).
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.
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.
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.
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.
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.
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.
(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.
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.
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.
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.