ConstructionRisk.com Report (Apr 2011)

Inside this Issue

• A1 - Working On Purpose - (My new book!)
• A2 - Battle of the Contract Forms: Subcontractor Bound to General Contract Terms
• A3 - Oral Contract for Remodeling Home May be Enforced
• A4 - Spoliation of Evidence May (or May Not) Justify Dismissal of Lawsuit
• A5 - "Pay when paid" Clause Excuses Prime from Paying Subcontractor Since Owner Didn’t Pay

Article 1

Working On Purpose - (My new book!)

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Get FREE copy of my new book - "Working on Purpose"

 

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Working on Purpose - An Introduction

Whether or not we acknowledge it to ourselves, each of us is in a quest to find a significant purpose for our lives and then fulfill that purpose.  We ask ourselves, either consciously or subconsciously, questions like:  "Am I doing all I can and should be with my life? Am I called to do something bigger and more meaningful?  Am I getting anywhere? Am I wasting my talents and my time?  What work and activities should I be doing so that I'm excited about life again?  What is my purpose?"

Looking Deeper

In this three part book (which may be used as part of a three part course), we discuss the importance of stepping back from our busy schedules to take a deeper look into our life's purpose, how to set and achieve goals, and manage time well.

The book is divided into three distinct parts:

 

Article 2

Battle of the Contract Forms: Subcontractor Bound to General Contract Terms

See similar articles: Battle of forms | Brand name or equal | Flow down | Incorporation by Reference | Specifications | Subcontract Dispute

It is not uncommon to see disputes between prime contractors and their subcontractors concerning whether terms submitted with the subcontractor proposal or subcontract form will take precedence over the broader terms of the prime contract that are incorporated by reference into the subcontract.  Where a wastewater treatment district specified certain holding tank liners by brand name or equal, the subcontractor did not effectively limit its subcontract bid to the prime contractor to be conditioned only upon acceptance of the “or equal” liner it intended to use.  When it submitted its proposal to the prime it indicated its intent to use the “or equal”.   But when it subsequently sent its subcontract to the prime contractor it inadvertently forgot to attach and incorporate its original proposal that would limit its scope of work to install only  the “or equal” liner.  A week after sending the subcontract without the proposal, the subcontractor realized its mistake and sent a revised subcontract with proposal attached.  Some time later, the prime contractor sent the subcontractor the signed subcontract – but without the limiting proposal attached.  The subcontractor, acted with apparent acceptance of the subcontract as executed by the prime contractor, and then proceeded to provide equipment submittals and information to the prime. The “or equal” liner was rejected by the design engineer and the prime contractor directed the subcontractor to install the more expensive brand name product.  The subcontractor refused to install the brand name without being paid extra for it – which the prime contractor refused to do.  The subcontractor’s attorney then wrote to the prime stating that the subcontractor was terminating the contract.  Ultimately, the prime contractor responded that this would be a default termination and provided an opportunity to cure, which the subcontractor refused to do.  A new subcontractor was obtained and completed the work with the brand name liner and the prime contractor successfully sued the original subcontractor to recover its costs.   John T. Jones Construction Co. v. Hoot Construction Company, 613 F. 3d 778 (8^th Cir, 2010).

In this case the Des Moines Metropolitan Wastewater Reclamation Authority (WRA) was updating one of its wastewater treatment facilities and retained the engineering firm of Black & Veatch (B&V) to write the specifications for the project.   B&V specified that the wastewater holding tank liner must be a particular system created by a company named Lindabond.  This was changed at the request of the WRA to add the words “or equal” at the end of the specifications.  As engineer, B&V had discretion to determine what to accept as “equal”, says the court.

Jones Construction, a general contractor, intended to bid on the overall project and invited Hoot Construction to submit a subcontract bid to install the liner.  Hoot, however, only installs liners made by a different manufacturer other than Linabond.  Hoot advised the prime that it would submit a proposal to use an “or equal” as the basis of its bid.  Hoot then contacted its “or equal” supplier and “and received assurances from the Company that Ameron systems are considered equal to Linabond in the industry.”  Hoot then conveyed that information to the prime and informed the prime that It had never had  Ameron rejected as “or equal” on a project.  Hoot then submitted a bid to the prime to install the liner and the prime used that bid in its main bid to the client, and was awarded the project.

The prime contractor (Jones) administrator mailed a standard subcontract form to the subcontractor and asked the sub to sign and return it within ten days.  The form required the subcontractor to perform the work as described in the main contract and incorporated the main contract as an exhibit.   The subcontractor altered the contract slightly by changing some payment terms, signed it, and returned it to the prime as requested.  It forgot, however, to include a copy of its bid proposal as an attachment to the subcontract.  The court states “Hoot’s company policy was to incorporate its original bid into any subcontract as a means of limiting the scope of its work to the contents of the bid.”  Before the prime responded to the subcontract submittal, Hoot realized it had forgotten to attach its limiting proposal and it consequently faxed a copy of it to the prime and asked that it be attached as “Exhibit B” to the contract.

There is evidence as reported by the court decision, that an individual with the prime contractor received the fax and had internal discussions with others at the prime and understood, and essentially agreed, that the proposal was to be an attachment B to the contract.  This fact, however, was found by the court to be irrelevant to the terms of the contract since it was not formally made a part of the contract and the “integration clause” of the contract stated that nothing outside the four corners of the  written contract would be deemed to be part of the contract terms.

What happened next is that B&V rejected the “or equal” submittal for the liner.  In response to the prime contractor’s suggestion that the subcontractor either install the brand name liner or hire another installer to do so, the subcontractor retained an attorney who wrote to the prime advising that the subcontractor had contracted only to install the “or equal” liner and that the “wrongful rejection of Ameron as equal” prevented the subcontractor’s performance.  The attorney further accused the prime of breach of the subcontract by failing to gain approval of the “or equal” system.  The prime wrote back explaining that the subcontractor was responsible under the terms of the subcontract to install a lining system in accord with the specifications and that the limiting provisions of the subcontractor proposal had not been incorporated into the contract.  Termination for default ensued.  The question then for the court was whether it was a proper default termination.

As an initial matter, the court found that when the subcontractor submitted the subcontract form (with its proposed changes to payment provisions) and returned it to the prime, that constituted an “offer.”  When the prime contractor signed the subcontract and returned it to the subcontractor without attaching the subcontractor’s limiting proposal as an attachment that constituted a “counter-offer.”  When the subcontractor sent submittals to the prime for performance under that subcontract, this constituted “acceptance.”    The court concluded from the evidence reviewed that the subcontractor intended to be bound to the subcontract and had assumed the risk of rejection of its “or equal” system – meaning that it bore the risk of having to perform the subcontract with the more expensive brand name system.

Since the limiting proposal was not attached to the subcontract and made a part thereof, the court held that the written contract supersedes any oral understandings the parties might arguably have had.  In particular, “the subcontract includes an integration clause stating the agreement ‘represents the entire integrated agreement between the parties hereto and supersedes all prior negotiations, representations, or agreements, either written or oral.’ ”   For this reason, the court found that the Exhibit B subcontractor proposal that had not been signed by the prime and returned attached to the subcontract that was returned to the sub by the prime, was not part of the contract and cannot be admitted into evidence for the purpose of varying the terms of the contract or attempting to make the terms ambiguous so that parol evidence could be used to clarify the intention of the parties.

For these reasons, the court found that the subcontractor was properly default terminated and that the subcontractor was responsible for paying the extra reprocurement costs incurred by the prime contractor.

Comment: There are several lessons to take from this case.  The ones I find of significant importance are (1) In the battle of the forms, the form sent last and on which the work begins, is generally going to be enforced as the final contract.  It is important, therefore, to be certain that the form in existence when work begins says what you intend it to say;

(2)  Incorporation by reference of the prime contract, with its scope of work and requirements pertaining to that scope, made applicable to the subcontractor, is a good management technique by a prime to secure the services needed by the subcontractor for that work.  I have numerous instances where the prime contractor attempts to re-state the scope and/or specifications applicable to the subcontractor’s work and then be stuck having to analyze the subcontract proposals to determine whether they actually include everything necessary for that aspect of the work – or whether there are gaps that will have to be filled by the prime or other subcontractors.

(3)  It is generally too risky for a subcontractor to refuse to do contested work and assert that the prime is in breach of contract excusing the sub from completing the work.  Too often, the termination of the contract that ensues is found to be a correct default termination.  This same principle applies to the prime contractor contesting an owner’s insistence on performance of work.  If the contractor is correct in its position, it can later prevail in a claim against the project owner to recover its costs.  If it loses in that litigation, at least it succeeded in mitigating and managing the excess costs that were paid during the performance in contrast to the higher costs that may be incurred if the project owner terminates the contractor and re-procures the work from another contractor and higher cost and with additional time – all of which gets charged to the contractor in the event that the termination is deemed to be a proper default termination.

About the newsletter and author: J. Kent Holland is a construction lawyer located in Tysons Corner, Virginia, with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners. He is also founder and president of ConstructionRisk, LLC, a consulting firm providing consulting services to owners, design professionals, contractors and attorneys on construction projects. He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932. This article is published in ConstructionRisk.com Report (2010) at www.ConstructionRisk.com.  This article is published in ConstructionRisk.com Report, Vol. 13, No. 4 (April 2011).

Article 3

Oral Contract for Remodeling Home May be Enforced

See similar articles: Breach of Contract | Oral contract

Where contractor entered into an oral contract with a real estate attorney to perform major renovations to the attorney’s new home which had previously been a small apartment building, the owner/attorney coxed the contractor (a friend who had performed work for him in the past) into performing work without pay while the project progressed, and at the conclusion of the work, refused to pay over $300,000 – asserting that the contractor was in violation of a state law requiring written contracts, and that the oral contract was null and void.  There didn’t appear to be any argument concerning the quality of the work.  The owner apparently just didn’t want to pay, and, being knowledgeable in the law concerning oral contracts, hoped to use the law as a sword to strike the contractor’s complaint down.   The appellate court held that the statutory violation does not automatically render the contract unenforceable.  In this case, there was no public policy requiring that oral contracts for home remodeling be held unenforceable.    Miller Construction Company v. McGinnis, 238 Ill. 2d 284 (2010).

The construction firm in this case was solely owned by one individual, a Mr. Keith Miller.  The initial oral contract for remodeling was $187,000.  Shortly after the work began, the owner told the contractor he wanted to “vastly increase” the work and that an architect would be developing new plans and specifications for the expanded project.  The modifications raised the total cost of the project to $500,000.

A few months later, the contractor submitted an invoice for $58,000 and the owner refused to pay it – saying he didn’t want to make any more payments until all construction work was completed.   Incredibly, the contractor financed the balance of the construction himself by obtaining a bank line of credit for $150,000 to complete the project.    The work proceeded to completion and the owner approved all the work with the exception of some minor floor issues that would cost about $300 to repair.     For that, the owner refused to pay $300,000 that was due!

At issue was an Illinois statute (The Home Repair and Remodeling Act), that required persons “engaged in the business of home repair or remodeling” to provide customers with “a written contract or work order” prior to beginning work on a project costing more than $1,000.  Another section of that Act states that it is “unlawful” to engage in home remodeling “before obtaining a signed contract….”  Since the contract in this case was not in writing, the owner moved to dismiss the contractor’s law suit on the basis that the contract was unenforceable and that the mechanic’s lien filed by the contractor could not be enforced on a void contract.

The trial court granted the owner’s motion and dismissed the contractor’s complaint with prejudice.  The intermediate appellate court affirmed the dismissal of the breach of contract claim, but held that the contractor had a viable claim based on quantum meruit to recover the value of what had been provided to the owner.   The state Supreme Court, held that the breach of contract should not have been dismissed, and that the contractor was entitled to pursue that cause of action.  In reaching that conclusion, the court examined the statute and determined that the statute provided a small penalty for failure to have a written contract, and that the legislature did not intend to a violation of the statute to render the oral contract unenforceable.

Risk Management Note: Contractors and design professionals should beware when working on homes or small commercial buildings owned by attorneys.  It is remarkable how much litigation arises out of contracts for construction of expensive homes for lawyers.   Even sophisticated architects and engineers have suffered at the hands of attorney/homeowners of expensive homes who sometimes seem to have a penchant for requesting numerous project changes that run up the costs, and then don’t want to pay for them.  If ever there was a class of project owner where a contractor is well advised to get a written contract that provides a well defined scope of work, good payment terms, and reasonable risk allocation clauses, this is one.    Another pointer from this case is to exercise caution when working for “friends.”  Because someone is a friend there can be a tendency to be more trusting and not adhere to normal business practices.    There is an old saying that strong fences make good neighbors.  Likewise, a good enforceable written contract for work can help preserve a friendship between an owner and a contractor.

About the newsletter and author: J. Kent Holland is a construction lawyer located in Tysons Corner, Virginia, with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners. He is also founder and president of ConstructionRisk, LLC, a consulting firm providing consulting services to owners, design professionals, contractors and attorneys on construction projects. He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932. This article is published in ConstructionRisk.com Report (2010) at www.ConstructionRisk.com.  This article is published in ConstructionRisk.com Report, Vol. 13, No. 4 (April 2011).

Article 4

Spoliation of Evidence May (or May Not) Justify Dismissal of Lawsuit

See similar articles: Evidence | Evidence Destruction | Spoliation of Evidence

A sanction for spoliation (destruction) of evidence must be carefully considered to impose only such relief as is reasonably necessary to level the playing field between the plaintiff and defendant.  Where a trial court barred a project owner from presenting expert testimony concerning window-related claims because the windows and been removed and discarded before the defendant could see them, the lack of expert testimony then led to a subsequent  motion for summary judgment for the defendant that was granted.  On appeal, the Supreme Court of New Jersey in the case of Robertet Flavors, Inc. v. Tami-Githens, Inc., 203 N.J. 252, 1 A.3d 658 (NJ 2010), did a comprehensive review of the appropriate remedies for spoliation of evidence in the context of complex commercial construction, and held that the action against the construction manager was properly dismissed because the CM was unable to evaluate the evidence.  But the action against the glass company that installed the curtain wall must be allowed to go forward to a jury – provided that the evidence to be used by the plaintiff against the contractor would be limited to conditions that were observable prior to removal and remediation of the curtain wall.    The court explained that when considering factors bearing on the appropriate remedy for the spoliation, courts  should consider (1) the identity of the spoliator, (2) manner in which spoliation occurred, (3) prejudice to the non-spoliating party, and (4) alternative sources of information that are available to the non-spoliator.

In this case, the building owner hired an architect to design a new corporate head quarters, and it acted as its own general contractor.  The Owner also retained the services of a construction manager (CM) to organize the bids and made recommendations to the Owner.   The Owner contracted directly with a glass company (Academy Glass) to install window and curtain wall systems manufactured by Kawneer Company.   After the building was completed, the Owner moved in and began experiencing leaking through the strip window system along the entire length of one side of the building.

Academy Glass was responded to warranty calls and attempted to correct the leaks – but eventually the Owner stopped trying to have Academy Glass solve the problem.  Owner decided to pursue litigation and hired a forensic architect, as well as an environmental consulting firm, to inspect the window to determine the cause of the problem.   The consultants recommended that a section of the strip windows be removed to inspect them.  Based on the findings, the Owner filed suit against Academy Glass and the CM.  Approximately a month after the suit was filed, the Owner removed a section of the strip windows and discovered moisture and mold.   Based on these findings, the Owner was advised by its consultants that it needed to replace the strip-window system and the Owner decided it  “had no choice but to remove and replace everything in the building that had been contaminated with mold, including interior walls, insulation, and carpeting.”

Before the Owner had taken the remediation action, however, the defendants filed their Answers to the Complaint, along with discovery demands.  The discovery demand of the CM included the following request:

“In lieu of a more formal notice to inspect, this party hereby demands that it be notified immediately of any intended, planned or ongoing remediation, replacements or other work that relates to the subject property. The property is evidence in this case and must be preserved in an unaltered condition so that this party may properly inspect the premises.”

It appears that the Owner’s attorney was advised by the Owner of its intent to tear out the window system and perform the corrective action work, but the attorney did not advise the defendants.   The Owner proceeded to tear out the window system and do the full remediation without advising the defendants.   Attorneys for the defendants spoke with the attorney for the Owner several months after the new window system had been ordered by the Owner (and before the remediation work was actually performed), but the Owner’s attorney did not advise them that the windows had been ordered and that the Owner intended to do the remediation once the windows arrived.

At some point the defendants moved to dismiss the complaint for failure to provided discovery.   It was not until counsel attended the court hearing on the discover motion that they learned that remediation had begun, and even then they were not told about the discovery of mold contamination.  Counsel for one of the defendants requested, in writing, that the Owner refrain from further remediation until defendant had an opportunity to evaluate the Owner’s claims of defective construction and related damage.   Owner advised the defense counsel that it would not suspend the partially completed remediation work because it would be impractical, if not impossible, to do so.   About a month later, the defendant, Academy Glass, and its attorney visited the premises and found that the strip-window system had been replaced and that all of the allegedly defective conditions related to the work had been remediated.   They were directed by the Owner to an off-site location where some of the components of the strip-window system had been removed and stored in a pile.

As the case proceeded to trial, there was expert testimony for the Owner stating that based on visual inspection, documented with photographs, the window system as originally installed was retaining water and it was possible that excessive moisture was also collecting on the inside of the mullions.   The expert acknowledged, however, that he did not photograph every window and did not document through photographs each and every one of the defects noted in his expert report.   As stated by the court:

“Munro [the expert] conceded that he did not photograph every window and therefore did not document through photographs each and every one of the defects noted in his expert report. He also acknowledged that after the remediation was completed one could not independently verify which of the defects he noted had caused the water infiltration, whether and to what extent the caulking had been deficient, and whether and to what extent expansion mullions or the sill extensions had contributed to the water infiltration. He further conceded that the particular components that he blamed for the water infiltration, including the gaskets, sill extensions, and caulking, were removed during the remediation and had not been preserved. He also conceded that a portion of the EIFS that abuts the windows was repaired, so that its effect, if any, on the leakage, could not be independently verified.”

The trial court granted motions by both defendants to exclude evidence relating to the window system installation.  In reaching that conclusion, the court found that:

"The plaintiff had never given notice to defendants about the proposed remediation prior to the commencement of the work; had failed to respond to defendants' initial requests to conduct an inspection; had first notified defendants of the remediation work on January 24, 2003, when there was insufficient time to permit them to perform an independent investigation; and had completed the repairs when there was no real emergency.”

The court thus concluded that the Owner had engaged in spoliation of the evidence and that there was clear prejudice to defendants because their expert had not been given an opportunity to fully investigate the leaks and their cause.   Subsequently, the defendants moved for summary judgment on the basis that without expert evidence the Owner would be unable to have the merits of its claim presented for consideration by a jury.  The court agreed and granted the motions.   The owner appealed, and the state supreme court, after very thoroughly reviewing the facts and the law, concluded that the decision was correct as the dismissal of the claim against the CM but that as to the glass company, a different remedy for addressing the evidence spoliation must be applied, and that the claim would be permitted to go forward against the glass company – as limited by the court’s holding.

The court noted:

“Although most of the published decisions relating to spoliation focus on the available remedies, selecting the one that is appropriate under the circumstances must be guided by the essential purposes that all of the sanctions are designed to achieve. As we have observed, the spoliation sanction serves three goals: “to make whole, as nearly as possible, the litigant whose cause of action has been impaired by the absence of crucial evidence; to punish the wrongdoer; and to deter others from such conduct.” [citation omitted]. Put another way, the focus in selecting the proper sanction is “evening the playing field,” or rectifying the prejudice caused by the spoliation so as to “place[ ] the parties in equipoise,” [citation omitted].  Achieving those sometimes competing goals calls for careful evaluation of the particular facts and circumstances of the litigation, in order that the true impact of the spoliated items can be assessed and an appropriate sanction imposed."

In its concluding analysis, the court explained the logic of its decision that, rather than paraphrasing, I will quote as follows:

“Our purpose is not to create a catalog of the many possibilities that may occur in commercial construction projects and the ways in which they may be pursued or may be lost due to spoliation, but to use this case as an illustration of how courts can address it both fairly and creatively. It will not always be possible to recreate the evidence that has been lost or to limit the claims so as to be fair to the non-spoliating party. In those circumstances, the severe sanction of dismissal may indeed be appropriate. Moreover, even after the claims are limited and the matter can fairly proceed, it will still be within the court's power to utilize other sanctions against the spoliator through the use of an adverse inference or the imposition of monetary sanctions designed to shift costs to the spoliator."

"We leave it to the sound discretion of the trial courts to make those decisions as justice requires. In the end, courts faced with spoliation claims should strive to impose a remedy that will serve the ends of justice by creating a level playing field, by ensuring that the consequence of the lost evidence falls on the spoliator rather than on an innocent party, and by using their considerable powers to deter future acts of spoliation."

"In this dispute, plaintiff has already lost claims as a result of the spoliation and its claim relating to the strip-window system has been limited significantly. There remains, however, one further step in our analysis, because defendants are not similarly situated. As to defendant Academy Glass, we agree with the Appellate Division that there is a sufficient basis on which to permit plaintiff to proceed, limiting its claims to the conditions that were observable prior to remediation and its experts to a review of only those conditions."

"However, we reach a different result as to defendants Tri-Form and Karabinchak. In spite of the fact that the wealth of evidence ordinarily generated during construction projects lends itself to leveling the playing field, in this case the opportunity to inspect the leaking windows before remediation was critical. Because plaintiff deprived defendants Tri-Form and Karabinchak of that opportunity, and because we therefore perceive them to have no independent source of evidence or testimony sufficient to permit them to mount a defense, the claims as to those defendants cannot proceed at all. As to defendants Tri-Form and Karabinchak, the only fair remedy for plaintiff's spoliation is to impose the sanction of dismissal.”

Comment: This is decision should become a valuable resource and guide to litigants and their counsel when making decisions about remediation of construction defects – and advising other parties before tearing things apart and discarding the evidence of the defective work.  For attorneys, this is an important reminder of how important it is to advise the client that they can’t dispose of evidence.  This “litigation hold” of evidence and documents germane to a matter is of great importance.  Attorneys are expected to know this and to advise their clients who may not understand that repair and replacement (particularly discarding the replaced materials) constitutes spoliation of evidence.   Even if a complaint has not yet been filed, a project owner is well advised that if there might be a possibility of later filing a complaint, it should create documentation of the problems with independent experts, video, photographs and other evidence, and save hard evidence of the defects themselves – and preserve that evidence to be used both for making its case as well as for potential defendants to be able to later analyze and use in their defense.

About the newsletter and author: J. Kent Holland is a construction lawyer located in Tysons Corner, Virginia, with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners. He is also founder and president of ConstructionRisk, LLC, a consulting firm providing consulting services to owners, design professionals, contractors and attorneys on construction projects. He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932. This article is published in ConstructionRisk.com Report (2010) at www.ConstructionRisk.com.  This article is published in ConstructionRisk.com Report, Vol. 13, No. 4 (April 2011).

Article 5

"Pay when paid" Clause Excuses Prime from Paying Subcontractor Since Owner Didn’t Pay

See similar articles: pay-when-paid | Payment Issues

Where a pay when paid clause in a construction subcontract unambiguously states that the subcontractor will only be paid for its work after the prime contractor has been paid by the project owner, the clause was ambiguous due to incorporation of the AIA form prime contract which provided the owner would reimburse contractor for payments made by the contractor to the subcontractor in accordance with the subcontract requirements.  Since the subcontract requirements were themselves quite plain that payment would only be made after receipt of the owner payments, the prime contract provision was deemed by the court to relate only to the amount of money to be reimbursed to the prime contractor for its subcontractor payments rather than to the timing of payment.  Applying Virginia law, the 4^th Circuit Court of Appelas in the case of Universal Concrete Products v. Turner Construction Company, 595 F.3d 527 (4^th Cir. 2010), held that the subcontractor was not entitled to be paid for its services since the prime contractor had not been paid by the Owner.

Case

Payment of $885,507 was the amount at issue in this case.  There was no issue over the performance of the work or the quality of the work.  Instead, as the court noted, “Like countless other construction ventures since collapse of the real estate market, the [  ] project ultimately fell through [  ]  when the owner could not longer finance it.”   Turner Construction had not paid the subcontractor for any of the work performed, because Turner had not yet been paid by the owner.  When the subcontractor sought payment for the work it had performed, Turner refused, citing the pay when paid provision of the subcontract.

The subcontractor argued that the subcontract, when read in light of Turner’s (AIA A121) prime contract with the owner is “patently ambiguous” as to when Turner was required to pay the sub.   The subcontractor cited two court decisions from other states that ruled in favor of subcontractors on almost identical contract language.  The court declined, however, to follow those decisions, finding instead that under Virginia law the courts would find in favor of Turner on the basis of the clear subcontract language which provided as follows:

“The obligation of Turner to make a payment under this Agreement, whether a progress or final payment, or for extras or change orders or delays to the Work, is subject to the express condition precedent of payment therefor by the Owner.”

The court also pointed out that another section of the subcontract stated that the agreement was intended to supplement the agreement between Turner and its sub, and that “any conflict between the two agreements will be read to impose the greater obligation on the subcontractor.”

Pay when Paid Contract

In arguing ambiguity between the prime and subcontracts, the subcontractor cited A121 section 6.1.3, which states that the costs for which the owner will reimburse Turner include “[p]ayments made by the Construction Manager to Subcontractors in accordance with the requirements of the subcontracts.”   The subcontractor emphasized the term “payments made” which it claimed demonstrated that Turner and the owner contemplated Turner’s paying the sub before invoicing the owner.  The balance of that same clause, however, states that the “payments made” are those payments made “in accordance with the requirements of the subcontracts.”  In view of that, the court found that the clause relates only to the reimbursement amount, and not to the question of when the amounts would be paid.  Other clauses in the applicable A201 contract, including sections 9.6.2 and 9.3.1, contemplate the likelihood that the general contractor and subcontractor would enter into a paid-when-paid contract.

For these reasons, the court affirmed the trial court decision, holding that the pay-when-paid clause was clear on its face and must be enforced in favor of Turner Construction against the subcontractor.  It should be noted that the Court included a footnote in its opinion stating that Turner was pursuing a claim against the project owner seeking payment of over $13 million, which includes the amount owed to the subcontractor.

Comment

In the current economically troubled times, the pay when paid clause has proven to be an important tool to protect a prime contractor against having to pay its subcontractor for work that the project owner itself has not paid to the general contractor.  On the other hand, it can create a terrible situation for the subcontractor that has properly performed its work and has no recourse to get paid.   If this clause is included in the contract, the subcontractor needs to pay special attention to including language in the contract to permit it to suspend or terminate work in the event that it is not being paid when its invoices are due.   It is also important to preserve the right to file liens on the property and to exercise that right.   The pay-when-paid clause is also becoming a problem for design professional subconsultants in manner similar to construction subcontractors.  When commenting on the pay-when-paid clause in design professional subconsultant’s contracts one suggestion I offer is to set an ultimate time limit on how long payment can be withheld.  For example, a sentence could be added to the effect that “In no event shall payment of uncontested amounts on invoices be paid later than 120 days from submittal of the invoice.”  Since that shifts the risk of payment back to the prime consultant, however, it may be difficult to obtain.

About the newsletter and author: J. Kent Holland is a construction lawyer located in Tysons Corner, Virginia, with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners. He is also founder and president of ConstructionRisk, LLC, a consulting firm providing consulting services to owners, design professionals, contractors and attorneys on construction projects. He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932. This article is published in ConstructionRisk.com Report (2010) at www.ConstructionRisk.com.  This article is published in ConstructionRisk.com Report, Vol. 13, No. 4 (April 2011).