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Prompt Payment Provisions Place Time Limits on the Withholding of Retainage on Federally Funded Projects

The United States Department of Transportation ("USDOT") has placed new limits on the time that a con- tractor may withhold retainage on federally funded projects falling under the auspices of the USDOT. These new regulations, pursuant to 49 CFR 26, were published on February 2, 1999 and became effective on March 4, 1999, and now require that states accepting federal money for such projects include a prompt payment provision as a part of their Disadvantaged Business Enterprise ("DBE") programs. These prompt payment provisions will, among other things, require contractors to return retainage payments to subcontractors within a set number of days after a subcontractor's satisfactory completion of its work, regardless of whether the prime contract is complete.

History

The requirement for the inclusion of prompt payment provisions in federally funded projects stems from new regulations which govern the USDOT's DBE programs. These regulations replace the former DBE regulations (except for rules governing the separate DBE program for airport concessions) and were promulgated in response to the 1995 Supreme Court decision in Adarand Constructors v. Pena, which states that racial classifications must be "narrowly tailored measures that further compel government interests."

Interestingly enough, the requirement for a prompt payment provision found at 49 CFR 26.29, while contained within the regulations governing DBEs, is not directed solely at DBEs. Instead, it includes all subcontractors, whether DBEs or not. The reason for this inclusion stems from the USDOT's belief that delayed payments affect all subcontractors. By including all subcontractors within the regulation, the USDOT feels that the requirement is an effective race-neutral measure, consistent with the mandates of Adarand Constructors, and that it will still benefit DBEs.

Official Rule and Suggested Language

As a condition to receiving federal funds through the USDOT, the recipients (state departments of transportation), as a part of their DBE programs, must establish a prompt payment clause. The text of 49 CFR 26.29 is quite clear on this point and states:

(a) [A recipient] must establish, as part of [its] DBE program, a contract clause to require prime contractors to pay subcontractors for satisfactory performance of their contracts no later than a specific number of days from receipt of each payment [the recipient makes] to the prime contractor. This clause must also require the prompt return of retainage payments from the prime contractor to the sub-contractor within a specific number of days after the sub-contractor's work is satisfactorily completed.

(1) This clause may provide for appropriate penalties for failure to comply, the terms and conditions of which [the recipient sets].

(2) This clause may also provide that any delay or post-pavement of payment among the parties may take place only for good cause, with [the recipient's] prior written approval.

(Emphasis added). There is also a paragraph (b) which lists additional elements that the regulation authorizes, but which it does not require.

In order to aid state departments of transportation in complying with 49 CFR 26, USDOT has released a Sample DBE Program which contains sample provisions. The sample language for prompt payment provisions is as follows:

The prime contractor agrees to pay each subcontractor under this prime contract for satisfactory performance of its contract no later than [specify number] of days from the receipt of each payment the prime contractor receives for [Name Recipient]. The prime contractor agrees further to return retainage payments to each subcontractor within [specify same number as above] days after the sub-contractor's work is satisfactorily completed. Any delay or postponement of payment from the above referenced time frame may occur only for good cause following written approval of the [Name Recipient]. This clause applies to both DBE and non- DBE subcontractors.

Recipients are free to use this language, they may draft their own clauses, or they may use existing prompt payment clauses. The only real prerequisite for the clause is that it meet the substantive requirements of 49 CFR 26.29. The recipients also have some leeway in the number of days before which a contractor will be required to make payments to subcontractors. The number of days selected, however, is subject to approval by the appropriate operating agency (within the USDOT there are three operating agencies, the Federal Highway Administration, the Federal Transit Administration and the Federal

Aviation Administration). In approving the time frames as submitted by the recipients, the appropriate operating agency will consider whether such time frames are realistic and whether they are limited enough to ensure genuine prompt payment.

Reactions

Since the promulgation of 49 CFR 26, the Associated General Contractors ("AGC") has come out against the new retainage requirement, labeling it a "pay- before-paid" clause. The AGC has even gone so far as to threaten to seek an injunction to prevent implementation of the new regulation if the USDOT does not modify its position. At its mid-year meeting, the AGC passed a resolution from its Highway Division opposing the retainage provision and called for its removal. Of most concern to the AGC is that the new regulation requires prime contractors to pay retainage to subcontractors even though the state for whom the project is being done is, in many cases, still withholding retainage. The AGC has likened the new provision to requiring prime contractors to finance [highway] construction projects and has stated that the new regulation's impact on prime contractors will be significant.

Additionally, without the ability to withhold retainage, the AGC feels that prime contractors will lose leverage with subcontractors in the event that problems with a subcontractor's work are discovered after the subcontractor has received its retainage. Along these lines, the AGC is also concerned with the form that the state plans implementing the new regulation are taking. Many of the state plans are not uniform in the way in which they address prompt payment provisions and there are concerns regarding varying definitions of "satisfactory completion" of work.

In contrast to the AGC's reaction to the new regulation, the American Subcontractors Association ("ASA") favors the new prompt payment requirement. Citing cash flow as a problem for many subcontractors, the ASA regards prompt payment as critical to the financial well being of sub- contractors. Still, like the AGC, the ASA is concerned with the leeway given to the states and does not believe that the regulation, as it currently stands, will protect subcontractors from pay abuses. The ASA plans to work with the various states to increase the level of protection provided.

Conclusion

It remains to be seen how the prompt payment provisions, and in particular the retainage payment requirement, will play out in actual practice. State implementation plans had been submitted as of early October and the various operating agencies of the USDOT were to begin reviewing them shortly thereafter. For further information on the implementation of 49 CFR 26, readers may refer the USDOT's Office of Small and Disadvantaged Business Utilization web page at http://osdbuweb.dot.gov.

By: Brendan P. Mitchell, Haese, LLC – attorneys at law; 70 Franklin Street, 9^th Floor;Boston, MA 02110; 617-428-0266

Reprinted by ConstructionRisk.com with permission of Haese. LLC from the firm’s Fall 1999/Winter 2000 issue of "Building on the Law" newsletter.

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When a "Promise" Isn't a Promise

Massachusetts Lawyer's Weekly recently reported a case in which Haese LLC attorneys were able to convince a judge that a verbal promise by a corporate officer to take personal responsibility for an acknowledged corporate debt could not be enforced against him even when the creditor relied on the officer's alleged promise.

A decision was entered on a case where a shareholder of a design firm claimed that the company's president forestalled a lawsuit against the company by promising that in return for the shareholder holding off on filing a complaint, the president would personally pay the debt. The shareholder then waited until the statute of limitations had run on his unpaid claim and subsequently brought suit against the president individually, based on the alleged oral guaranty of the corporate debt. To characterize his case, the shareholder claimed even if he didn't "get it in writing" the fact that he was "defrauded" into not filing a lawsuit against the company until it was too late should allow him to recover against the president.

Haese attorneys David McGlone and Brendan Mitchell reminded the court that since the English adopted the Statute of Frauds in 1677, creditors have been required to produce a document signed by the corporate officer in his personal capacity to "pin" the debt of a company on him.

The court employed this doctrine, and found that, at the time of the alleged conversation, there was no legally viable claim against the officer in his personal capacity. Consequently, there was no particular benefit conferred to him personally by the delay in the lawsuit. Since the parties involved were giving each other nothing new, there was no new contract. Therefore, any promise by the president must have only concerned the old obligation of the company to the shareholder. The 300 year-old English statute prevented enforcement of any personal promise of the president regarding the old debt without writing to evidence it. Disappointed, the shareholder joined a long list of un-compensated creditors relying on verbal promises, dating back to the time that design professionals were concerned with the construction of such ancient structures as Saint Paul's Cathedral in London. Simply put, in countries that have inherited the English legal system, the president's promise was no promise at all.

By: David M. McGlone; Haese, LLC – attorneys at law;70 Franklin Street, 9^th Floor, Boston, MA 02110; 617-428-0266

Reprinted by ConstructionRisk.com with permission of Haese. LLC from the firm’s Fall 1999/Winter 2000 issue of "Building on the Law" newsletter.

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Is the Total Cost Method a Viable Means of Calculating Construction Damages Under Massachusetts' Law?

The total cost method is one way to calculate construction damages. Much as its name implies, this manner of calculating damages allows the plaintiff to recover all costs expended on a project in excess of the amount bid. Although the total cost method is a simple way to calculate construction damages, many courts disfavor its use as being unreliable due to this method's inherent assumption that all costs incurred on the project are the responsibility of the owner. In other words, it does not distinguish between costs which are the responsibility of the owner as opposed to those which are the responsibility of the contractor.

Massachusetts’s courts have not taken a well-defined position on whether the use of the total cost method is an acceptable means of calculating construction damages. Courts from other jurisdictions, however, have allowed its use under certain circumstances. Generally, a total cost method of damage calculation may be used when the following four factors are met: 1) the nature of the particular losses make it impossible or highly impractical to determine their value with a reasonable degree of accuracy; 2) the plaintiff's bid or estimate was realistic; 3) the plaintiff's actual costs were reasonable; and 4) the plaintiff was not responsible for the expenses. One area in which a total cost method may be especially useful to Massachusetts' contractors is under a theory of quantum meruit due to the often complex nature of damage calculations under this theory.

Quantum meruit is a non- contractual theory of recovery used to promote principles of equity and fairness. It is generally used in instances where a party cannot recover under a contract due to not completely performing the terms of the contract. Under Massachusetts law, a contractor may recover under a theory of quantum meruit if it can prove substantial performance on the construction contract and an endeavor on its part in good faith to perform fully under the contract. Peabody, N.E. v. Town of Marshfield, 426 Mass. 436, 442 (1998). An intentional departure from the requirements of the contract is per se not in good faith unless the failure is: 1) caused at least in part by the defendant (id.); or 2) the departure is so trifling so as to be de minim is (J.A. Sullivan Corp. v. Commonwealth, 397 Mass. 789 (1986)). Additionally, a party seeking recovery under a theory of quantum meruit which has been terminated wrongly is excused from proving substantial performance of the entire contract, but it must prove substantial performance and an intention to completely perform up until the date of termination. PDM Mechanical Contractors v. Suffolk Const. Co., 35 Mass. App. Ct. 228, 232 (1993).

The proper measure of damages under a theory of quantum meruit in Massachusetts is the value of the services rendered by the plaintiff or the fair value of what the defendant received. Peabody, 426 Mass. at 443. This definition would seem to be consistent with the use of a total cost method of determining damages in situations where the four factors discussed previously have been met. Using a total cost method would vitiate the need for precisely determining the fair value received by the defendant for the work performed by the plaintiff, an often difficult task. However, Massachusetts' courts have held field and home office overhead to be non-recoverable under a theory of quantum meruit because these costs do not directly confer any value or benefit upon the defendant. Id. Although a total cost method of determining damages is not completely consistent with prior Massachusetts case law interpreting quantum meruit, use of the total cost method in determining damages under a theory of quantum meruit in the future may provide con- tractors with an easy method of determining construction damages in certain complex situations.

By: Scott A. Aftuck; Haese, LLC – attorneys at law; 70 Franklin Street, 9^th Floor;Boston, MA 02110; 617-428-0266

Reprinted by ConstructionRisk.com with permission of Haese. LLC from the firm’s Fall 1999/Winter 2000 issue of "Building on the Law" newsletter.

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The Reality Behind Paperless Litigation

One of the most time consuming and expensive aspects of complex litigation is document control. From reviewing documents received via discovery, to preparing for depositions, through presenting evidence at trial, attorneys and their clients must determine the most efficient and cost effective manner to accomplish their goals. Due to recent advances in computer technology, it is now possible to virtually eliminate the need for large document repositories and conduct, in essence, a paperless litigation.

Haese LLC is committed to the use of cutting edge technology in its practice and has recently conducted a case with a significant amount of documentation using a paperless system. The case arose out of the construction of a billion dollar semiconductor plant and involved claims brought forth by the owner, general contractor and numerous subcontractors. Over two hundred and fifty thousand (250,000) documents were implicated, consisting of in excess of a million total pages. It was clear from the onset of the case that traditional document control techniques would not be a cost effective means in which to manage the case.

The first step in conducting the case in a paperless manner was to have scanned images of documents produced on CD/ROMs rather than as hard copies. The documents were then loaded onto our computer system. Along with the scanned image of each and every document, the system maintained a summary record for each piece of documentation which contained the pertinent information for each document - for example - the author, recipient, etc. These records also provided fields for notes written by the reviewing attorney, such as the topic of the document, specific important issues, its significance, etc. Once the summary records were complete, they could be searched by the computer, allowing an attorney to find specific documents or documents relating to specific topics almost instantly. It was also possible to update the summary records as issues and theories of the case continued to develop. This procedure dramatically reduced the storage space needed to run the case, as well as making a search of the raw documents manageable.

From the initial review of documents for summary information, Haese LLC selected a number of "key" documents, which it put through the optical character recognition ("OCR") process. The OCR process, when complete, allows the computer to read virtually each document and recognize the words contained in it. Once documents have gone through this process, they can be searched and if a specific word is present, the computer will retrieve the document. Additionally, because the OCR process does not always translate a word accurately, the computer system allows one to do a "fuzzy" search, or retrieve documents, which contain a word similar, to the one for which the documents are being searched. The ability to do such a "fuzzy" search is an invaluable tool when working with technology which is not perfect.

During the semiconductor plant litigation, having the documents scanned also helped to streamline the taking of depositions. Documents which were needed for each deposition could be stored on a laptop computer. When an attorney wished to ask a question about a document, he could retrieve the document on the computer with a simple press of a button, and display the document on the computer screen. Additionally, with a stenographer who is so equipped, the laptop may be configured to display a running transcript of the deposition at the same time it is being taken. These tools eliminate the need for multiple copies of documents for each witness and attorney present at a deposition, and provide the added benefit of allowing the questioning attorney to view the results of each line of questioning instantaneously.

Although there are many benefits to a paperless litigation, there are a few potential limitations to its use. Many court rooms are not yet technologically equipped to handle the computer equipment necessary to put on a paperless presentation at trial. Likewise, some judges are wary of allowing the introduction of exhibits which are not in hard copy. However, courts are slowly but surely recognizing the ad- vantages of a paperless litigation system. Going paperless in complex cases is more convenient for attorneys and will save the client both time and money in the long run. In the near future, handling litigation in a completely paperless environment will become the norm rather than the exception, and Haese LLC will be well positioned to accomplish this task.

By: Haese, LLC – attorneys at law;70 Franklin Street, 9^th Floor, Boston, MA 02110; 617-428-0266

Reprinted by ConstructionRisk.com with permission of Haese. LLC from the firm’s Fall 1999/Winter 2000 issue of "Building on the Law" newsletter.

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Can You Tell the Market That Your Patent Is Being Infringed?

A recent federal appellate court ruling may limit a patent holder's right to notify the marketplace of patent infringement. The court, which has jurisdiction over most patent appeals and is subject to review only by the Supreme Court, confirmed that a patent holder may be liable in damages for sending warning letters to customers, accusing a competitor's product of violating the patent laws. Because patentees have traditionally enjoyed the right to make public any good-faith claims about infringement of their patents, the new ruling is a significant legal development.

The United States Court of Appeals for the Federal Circuit ruled this August that a plastics manufacturer violated the Lanham Act, a federal fair trade practices and consumer protection statute, when the manufacturer sent a mass-mailing to its customers warning them of alleged infringement. (The case title is Berry Sterling Corp. v. Pescor Plastics, Inc., No. 98- 1381, 1999 WL 67514 (Fed. Cir. Aug. 30, 1999)). The manufacturer held the patent for the design of a plastic cup for automobile cupholders. It sent the warning letters out in response to competition by a rival company that was marketing a similar design for a cup. The letters notified customers that the patent holder believed that its competitor's similar plastic cup infringed the patent, and that customers buying the product could themselves be held liable for infringement. Shortly after sending that letter, the manufacturer filed suit against its competitor for patent infringement, and the defendant company counterclaimed for unfair competition.

At trial, the jury confirmed that the accused product infringed the patent, but found that the patent was unenforceable for several reasons. The jury also found that the manufacturer's warning letter did not sufficiently identify the products at issue, with the result that customers were confused as to which of the defendant's products were being accused of infringement. The jury accordingly awarded damages against the patentee. The Federal Circuit confirmed the jury's verdict and permitted the accused manufacturer to recover damages for the sales of other products that it had lost as a result of the warning letter.

This ruling marked the first time that the Federal Circuit has acknowledged that a patentee could violate the Lanham Act by sending warning letters. Traditionally, patentees have had a broad right to send notice to the marketplace of alleged infringement. The court created a new limitation on this right by holding that customer confusion can be grounds for legal liability. This ruling raises new strategic questions about when and how a patentee should publicize the potential initiation of an infringement action. Warning letters in the future will have to be scrutinized for any possibly misleading expression or description, which in turn may raise other issues under the complex body of laws governing patent cases.

Federal statutes provide the basic rules for patent applicants and holders. When a patent is issued by the United States Patent and Trademark Office, the patent holder has exclusive rights for a set period of time — seventeen years, for the most common types of patents. A patent is effectively a legal monopoly, and allows the patentee to exclude competitors from the market. This permits a patentee to charge higher prices for patented products during the term of the patent. The theory behind this law is that patentees should be rewarded for bringing new ideas to the market, and reimbursed for those costs of research and development which their potential competitors have not shared.

Patent protection therefore exists in tension with antitrust laws and other rules ensuring competition in the marketplaces. Courts have developed tests that attempt to balance the protective effects of the patent regime with the anti-competitive effects of its monopolistic nature. Under certain circumstances, these judge-made laws may restrict a patentee's power to discourage competition. Most commonly, courts prohibit a patentee from forcing its customers into "tying arrangements." Tying arrangements require a customer to buy more than just patented products from the patentee, such as an additional charge for future service. The courts generally invalidate tying arrangements as a violation of antitrust law. The courts also step in when a patent holder misrepresents the "scope" of its patent. When a patent holder claims that its patent covers more products or extends for a longer term than the patent states, competitors may recover damages for the misrepresentation, or at least offset their liability for infringement by invalidating the plaintiff's claim for damages beyond the patent's scope. The question of how far a patent extends is complex, and the cautious patentee avoids unnecessary affirmative assertions about the patent's scope until a court has ruled.

Prior to the Federal Circuit's Lanham Act decision, there were almost no affirmative requirements about what the patentee was required to tell the marketplace in a warning letter. Patentees generally were permitted to use warning letters to let purchasers of competing products know that infringement proceedings had commenced. A significant body of precedents confirmed that even mistaken statements that a product infringes a patent could be made to the marketplace in general, limited only by the duty of good faith. Patent holders could exert some influence on the market from a safe harbor by sending warning letters couched in conditional terms and stating without detail that the patentee believed its patent was being infringed by a given product.

The new decision of the Federal Circuit has the potential to change the landscape drastically. Patentees now have to balance their caution about misrepresenting the scope of their patent with the duty to avoid customer confusion about the claims the patent holder intends to pursue in court. It will require some time for clarity on that issue to develop. In the meantime, patentees should seek sound legal advice on how far to take customer warning letters even before they institute formal court proceedings against infringement.

By: Thomas S. Dean; Haese, LLC – attorneys at law, 70 Franklin Street, 9^th Floor, Boston, MA 02110; 617-428-0266

Reprinted by ConstructionRisk.com with permission of Haese. LLC from the firm’s Fall 1999/Winter 2000 issue of "Building on the Law" newsletter.

This newsletter is distributed with the understanding that ConstructionRisk.com, LLC is not engaged in the rendering of legal services. Further, the comments in this newsletter are for general distribution and cannot apply to any single set of specific circumstances. If you have a legal issue to which you believe this newsletter relates, we urge you to consult your own legal counsel. Any content or opinions expressed by the writers of this newsletter are set forth in their individual capacity and do not necessarily reflect the opinion of any writer's employer and are not to be attributed to any such employer. ConstructionRisk.com expressly disclaims any responsibility for damages arising from the use, application, or reliance upon the information contained herein.