Inside This Issue:
• Do You Really Want to Cash that Check?
• Indemnification Clause Unenforceable if Negligent Parties Are Indemnified
• Insurance Carrier not Required to Treat CM as Additional Insured Under Contractor’s Policy
Do You Really Want to Cash that Check?
By M.K. Holohan, Esq. – Wickwire Gavin, P.C.
Everyone involved in construction contracts is concerned about payment. Owners generally refuse to pay general contractors until they have secured lien releases; general contractors are hesitant to pay subcontractors until specific blocks of work have been completed; and subcontractors are concerned about getting paid at all. Given these concerns, it is easy to see why a subcontractor might be quick to accept any payment from the general contractor, but accepting partial payment can have unexpected and harsh consequences. Subcontractors should think twice before cashing a general contractor’s check for partial payment. Accepting partial payment while there is an existing payment dispute, whether related to change orders, delay costs, or some other factor, may foreclose the subcontractor’s right to pursue a claim for the full amount owed. If the paperwork or check itself contains language that states that the payment is meant to satisfy the claim (e.g., “paid in full,” “final payment”), the subcontractor’s acceptance of that partial payment may prohibit a future claim for the remaining amount owed. This concept is known as “accord and satisfaction.”
Accord and satisfaction is a legal principle that modifies a contract, allowing the parties to essentially re-write the terms of the original agreement. In this context, the “accord” occurs because the parties re-write the contract – when the general contractor offers partial payment and the subcontractor accepts. The “satisfaction” occurs because by accepting partial payment, the subcontractor gives up its claim for any additional payment. Accord and satisfaction is the law in virtually every jurisdiction in the country. The concept has been formalized by a provision of the Uniform Commercial Code (UCC), a standard set of laws governing commercial transactions, and 49 states have adopted their own versions of the UCC. Each state has the power to modify the UCC provisions; therefore, it is important to check the controlling law in each jurisdiction to determine the state laws regarding “accord and satisfaction” of contract terms.
A further complication is that the jurisdiction controlling the “accord and satisfaction” agreement may be different from the jurisdiction controlling the underlying construction contract. Because the accord and satisfaction agreement is considered to be separate from the original contract, jurisdiction agreements (known as “choice of law” clauses) in the original contract may not be applicable to the accord and satisfaction agreement. For example, if the original contract said that disputes would be decided under Virginia law, but the subcontractor cashed the partial payment check in Illinois, a Virginia court will apply Illinois law to determine whether accord and satisfaction has occurred.
Generally, to establish accord and satisfaction there are three requirements. First, there must be a bona fide claim dispute, i.e., there must be some real reason the prime contractor is disputing payment. An unjustified refusal to pay the subcontractor does not qualify as a bona fide dispute. Second, the prime contractor must have made a good faith offer to pay the claim in full. Third, the check or accompanying paperwork must contain a conspicuous statement that the payment is intended to be full satisfaction of the claim. “Conspicuous” does not necessarily mean that the language must appear in bold type or a specific color or font. Courts have found a “conspicuous statement” where the memo line of the check read “paid in full,” and a letter accompanying the check clearly stated that payment was intended as “full and final payment.” So, a notation on the memo of the check, or paperwork accompanying the check, will satisfy this requirement. Crossing out the “paid in full” language, or making a note on the check or document that the amount is disputed will have no effect. If the subcontractor has notice that the payment is meant to satisfy the debt, but accepts the partial payment anyway, it waives the right to pursue the disputed amount.
Although the subcontractor’s claim is presumed to be satisfied when the check is cashed, this presumption may be challenged by showing that the “conspicuous notice” language was not clear enough for a reasonable person to understand that payment was for final settlement of the claim. So what standards are used to determine what a reasonable person would understand about the payment terms? The Supreme Court of Virginia recently provided guidance in Gelles & Sons General Contracting, Inc. v. Jeffrey Stack, Inc.
In Gelles, a construction company (JSI) contracted with a contractor (Gelles) for paving work. JSI received a $91,932 invoice from Gelles, and made partial payment of $70,486. When Gelles later invoiced JSI for a $26,175 balance, JSI sent an accounting of expenses incurred to properly complete Gelles’ work, with its estimate for a reduced amount owed to Gelles of $13,580. Gelles disputed the accounting, and JSI responded with a letter outlining defects in Gelles’ work, and the following statement: “JSI . . . stands by its final amounts as stated on the latest correspondence, dated December 8, 2000. Enclosed please find a check in the amount of $13,580.00 representing final payment on the contract.” Gelles cashed the check.
Gelles filed a motion for judgment against JSI and its bonding company for $26,000 plus interest. JSI argued that Gelles’ claim was barred by Virginia’s accord and satisfaction law. Gelles argued that the language was not conspicuous, and that it would not inform a reasonable person that the payment was meant to be full satisfaction of the claim. Gelles asked the court to create exact standards for identifying specific conspicuous language. The court refused, reasoning that the statute’s language simply required a statement “to the effect” that payment would satisfy the claim; no magic words are required to create an accord and satisfaction. The court emphasized that the merits of each case will determine whether a reasonable person should have understood that the payment was for final resolution of the claim. The court pointed to two letters from JSI to Gelles that clearly expressed JSI’s intent that the payment be final resolution of Gelles’ claim, and held that Gelles’ claim was barred by accord and satisfaction.
The lesson for subcontractors is clear: if you have a payment dispute with the general contractor, read carefully, and do not cash a check for partial payment if there is any type of statement about full payment, or satisfaction of claims. However, even if you do cash the check, you may have a second chance to preserve your claim. In some states you will have a certain amount of time, generally 90 days, to return the payment to the prime contractor with notice that you are still pursuing your claim for the full amount owed. Then, you are free to pursue your full claim against the general contractor without being subject to an accord and satisfaction defense.
The lesson for prime contractors may be: don’t wait to pay subcontractors until final resolution of all the job issues. By offering the subcontractor partial payment, plus conspicuous notice that the payment is intended as final settlement of the claim, you may be able to protect yourself from any future actions related to the claim. A subcontractor who accepts such payment will waive the right to pursue other, and potentially larger, claims against you.
About the Author: M.K. Holohan is an associatae in the firm’s Vienna, Viriginia office. She focuses her practice on government contract litigation, bid protests, and construction litigation. M.K. can be reached at 703-790-8750 or by e-mail at email@example.com.
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Indemnification Clause Unenforceable if Negligent Parties Are Indemnified
Where an indemnification clause in a construction subcontract was so broad as to require the subcontractor to indemnify a project owner and construction manager for their own negligence, a court held the clause could not be enforced during a summary judgment motion requested by the indemnities. The clause could only be saved if it were proved that the indemnitees were not themselves negligent, and that determination would have to await the outcome of the trial on the facts.
In Lanarello v. City University of New York, 774 N.Y.S. 2d 517 (2004), the court considered the enforceability of an indemnification clause that required the subcontractor to “indemnify the owner and construction manager [Morse Diesel] for any and all losses they sustain as a result of any or all injuries to any and all persons arising out of or occurring in connection with [subcontractor’s] work, excepting only injuries that arise out of faulty designs or affirmative acts of the owner or construction manager committed with the intent to cause injury.” The court concluded that this clause would indemnify the owner and construction manager for their own negligence and therefore “runs afoul of General Obligations Law section 5-322.1(1) of New York.
Morse Diesel, the construction manager (“CM”) was asking the court to enforce the indemnity clause by way of a summary judgment motion to grant it judgment against the subcontractor. It argued that to the extent that the clause did not require the subcontractor to indemnify the CM for the CM’s own negligence the clause would be saved by another clause in the contract providing that “each and every provision of law and clause required by law to be inserted in the Contract shall be deemed to be inserted therein.” In rejecting that argument, the court stated “Such language is not equivalent to language in the indemnification clause itself limiting a subcontractor’s indemnification obligation ‘to the extent permitted by law.’”
The Motion court that denied the summary judgment motion found that Morse Diesel had more than a mere general supervisory authority with regard to one of its subcontractor’s who had responsibility for cleaning up debris and providing temporary protection around openings. Since negligence in those respects may have contributed to the accident, it would be necessary to allow the matter to go to trail so that it could be determined based on all the facts whether or Morse Diesel was negligent or not.
Practice Note: It is important to include a “survival” or “saving clause” directly inside the indemnification article so that if for any reason a court finds the indemnity language to be in violation of public policy or a state anti-indemnity statute, the article will nevertheless survive as language that falls back to that which is permissible under public policy and state law. This is often accomplished by introducing the article with language such as, “To the fullest extent permitted by law, the Contractor shall indemnify the Client ….” This may be more persuasive with a court than was the general saving clause that the court declined to apply in this particular case.
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Insurance Carrier not Required to Treat CM as Additional Insured Under Contractor’s Policy
Where contractor was expected to make the construction manager (“CM”) an additional insured under its general liability policy, but failed to do so, the contractor’s insurance companies had no duty to provide coverage to the CM.
The contractor’s insurance policies provide additional insured status to those with whom the contractor enters into written contracts. Where the CM, Morse Diesel, had no written contract with the contractor, it would not be an additional insured pursuant to the terms of the policies. In the case of Lanarello v. City University of New York, 774 N.Y.S. 2d 517 (2004), the court found that even if the CM were a third-party beneficiary of the contracts between the contractors and the project owner, that would merely give the CM standing to sue the contractors for breach of their contractual duty to the project owner to name the CM as an additional insured under their policies. This would not, however, create any independent duty of the insurance carriers to rewrite their policies to name the CM as an additional insured. Moreover, the fact that the insurance companies had issued certificates naming a predecessor construction manager as an additional insured, did not require them to treat Morse Diesel as an additional insured since that firm had not been specifically named as such and since Morse Diesel did not show that it had relied on the certificates that had been issued to its predecessor.
Practice Note: As indicated in the court’s decision, a contractor’s general liability insurance policy may state that parties with which it enters into signed contracts will be considered “additional insureds” under the policies. According to that language, third parties that are not in direct contract with a contractor will not be given additional insured status. For such a third party to become an additional insured, a request will need to be made of the insurance carrier and a certificate of insurance will need to be issued by the carrier to make a special exception to name such a third party as an additional insured. Unless that is done, the third party has no recourse directly against the contractor’s insurance company. For these reasons, it is important to dot the I’s and cross the t’s when it comes to requesting and tracking certificates of insurance.
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