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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 was an associatae in Wickwire Gavin’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 mholohan@wickwire.com.

ConstructionRisk.com Report, Vol. 6, No. 6 (Sep 2004)

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