January 2012

The proposition that a contractor can be terminated for non-performance is unremarkable and well understood. However, nearly all public project construction contracts and many large private project contracts contain language that permits a general contractor or owner to terminate the contract at any time without cause. Clauses that grant an owner or general contractor the right to terminate the contract without cause are known as “termination for convenience” clauses. Termination for convenience clauses typically spell out the amount of damages a contractor is entitled to if the clause is invoked, which may or may not include lost profits and other consequential damages.

 The idea that a party can terminate a contract without cause and without paying the full contract price traces its origins to the Civil War. The doctrine originated because it would be unreasonable for the government to continue wartime contracts after the war was over and continuing a wartime contract during peace time would be against the public interest. Concern for public interest has caused the doctrine to carry over into peacetime public works projects. As one can imagine, there are a variety of economic and political reasons that a government entity would terminate a public works project prior to completion. Generally, if a government contract is terminated for convenience recovery is limited to costs incurred, profit based on work done, and the cost of preparing the settlement proposal. Maxima Corp. v. U.S., 847 F.2d 1549, 1552 (Fed.Cir. 1988).

 Termination for convenience clauses have found their way into many private project contracts as well. The amount of damages recoverable when a termination for convenience clause is invoked on a private project is determined by the language of the contract. Contractors, therefore, should carefully review such clauses to see what damages will be recoverable in the event of termination. Often, the termination clause does not permit recovery other than the value of the contractor’s work performed up to the date of termination. Therefore, a contractor will not be permitted to recover lost profits that would have been earned had the entire contract been completed. Finally, these clauses may not clearly state how a terminated contractor will be compensated for work performed off-site or for stored materials. Therefore, a contractor anticipating performing off-site work or storing large quantities of material or pre-fabricated items should consider amending the language of a termination for convenience clause to spell out how it will be compensated for such work and material.

Although termination for convenience clauses suggest a broad set of circumstances which would permit termination without cause, such termination must still be done in good faith. In other words, a party cannot enter into a contract with the intention of not honoring it and avoid liability for breach by hiding behind a broad termination for convenience clause. Torncello v. United States, 681 F.2d 756 (Ct.Cl. 1982); Salsbury Indust. v. U.S., 905 F.2d 1518, 1521 (Fed.Cir. 1990).

Margins on a completed construction contract are tight. Therefore, it is critical to determine whether a contract contains language which permits a party to terminate a contract without cause and without compensating the contractor for lost profit.

 

 

For years construction lawyers in Pennsylvania have been taught that the requirements of the Mechanics Lien Law must be strictly followed or a mechanics lien claim will be stricken and lost.  In decades of precedent, it has been repeatedly stated that the Pennsylvania Mechanics Lien Law is a “creature of statute in derogation of the common law” and, therefore, in order for a lien claim to be valid it  must be filed in strict compliance with the Mechanics Lien Law.

Construction attorneys representing owners, whose property became subject to a mechanics lien, have used this well established principal to dismiss mechanics liens for any variety of deviations from the Mechanics Lien Law. Failing to attach a written copy of the construction contract to the lien; failing to properly identify the owner of the property; failing to properly serve the lien; and failing to give proper notice are some examples of deviations from the strict requirements of the Mechanics Lien Law that have resulted in mechanics liens being dismissed.

However, on January 6, 2012, the Superior Court in Bricklayers of Western Pennsylvania Combined Funds, Inc. v. Scott’s Development Company, 2012 WL 29299. overturned decades of precedent and held that “[p]ursuant to the plain language of 1 Pa .C.S.A. § 1928(a) and (c), the Mechanic’s Lien Law of 1963 cannot be strictly construed on the basis that it is in derogation of the common law. See 1 Pa.C.S.A. § 1928(a), (c).”  A copy of the decision is available here.

In Bricklayers, the Superior Court addressed the viability of mechanics lien claims that the trustees of employee benefit funds filed  for unpaid contributions owed to union members under collective bargaining agreements between a contractor and the unions.    The trial court concluded that the union members were not “subcontractors” under the Mechanics Lien Law because the collective bargaining agreements were not traditional subcontractor agreements, and the union members were employees and/or laborers of a contractor. The Superior Court overruled the trial court and concluded “that under the specific facts presented in this case, the unions are subcontractors and given the unique legal relationship that exists between the trustee and the union, the trustee has standing to assert a mechanics’ lien claim on behalf of the union.”

The Court refused to strictly construe the Mechanics Lien Law as it had done in the past because “the ‘derogation of common law’ precept violates the commands of 1 Pa.C.S.A. § 1928(a) and (c)”   Thus,  “[it] should no longer be used in connection with the Mechanics Lien Law of 1963.”    Moreover, the Court held  “[t]his is especially true since Sampson–Miller,the source of the strict construction rule, erroneously rested on case law interpreting the Mechanics’ Lien Law of 1901 and inaccurately transposed it to the successor statute, the Mechanics’ Lien Law of 1963.”  Therefore, the Court concluded, “the statute must be liberally construed to effect [its] objects and to promote justice.”  Based upon its holding, the Superior Court for the first time permitted unpaid unions – through their trustee fiduciaries – to assert a mechanics lien claim for unpaid benefit funds.

Obviously, the Bricklayer decision is groundbreaking simply because it creates a new class of lien claimants and another headache for owners of projects using union labor.  However, the Court’s decision that the Mechanics Lien Law should not be strictly construed is what will reverberate for years. Certainly, the Bricklayer holding will be used to counter any challenge to a mechanics lien claim based on a deviation from the requirements of the Mechanics Lien Law.  While the Superior Court seems to indicate that strict compliance with the notice and service provisions of the law are still required, it did so with a less than resounding endorsement stating “although strict compliance standard may be used to determine certain issues of notice and/or service, we conclude that a liberal construction of the definition of “subcontractor” is necessary to effectuate the Mechanics’ Lien Law’s remedial purpose of protecting pre-payment of labor and materials.”
Takeaway for Owners and Lenders
The Bricklayer decision impacts owners and lenders the most.  The decision combined with the 2006 Amendments to the Mechanics Lien Law, which outlawed (in most cases) pre-contract lien waivers , mean owners and lenders must be more proactive in order to insure a lien free project.  Owners and lenders should be requiring labor and material payment bonds from general contractors.  When a payment bond is posted, pre-contract lien waivers are still valid.  Also, owners and lenders should be obtaining affidavits from the benefit funds of the various trade unions working on the project attesting that a subcontractor is current on all fund contributions for members of the trades working on the project.    Proof of payment of benefit funds should be a condition precedent to payment.
Takeaway for Contractors
General contractors who have agreed to indemnify an owner against any lien claims should also be obtaining affidavits from the various trade unions attesting that all benefit fund contributions are current as a condition of payment.  Moreover, anyone who potential could classify as a “subcontractor” under the new broad definition of “subcontractor” should be filing liens for non-payment. The Bricklayer case probably clarified the unsettled question of whether equipment rental companies have lien rights and means equipment rental companies are probably clear to file a mechanics lien.
Will courts limit the Bricklayer’s liberal interpretation holding to certain areas of the lien law, such as the definition section?  Or will courts expand the liberally apply the lien law in other areas as well, such as with the potential need to file separate lien claims on condominium projects?   These issues will be sure to play out over the next few years as the courts determine the applicability of the Bricklayer decision to challenges to mechanics lien claims based upon deviations from the requirements of the Lien Law.  I would also not be surprised if the Legislature steps in at some point.  Of course, we will report on any decisions that we hear about on this issue.

 

 

 

Terms and timing of payment are critical. A subcontractor that cannot manage cash flow is doomed. For terms of payment, most construction contracts use either a pay-when-paid or a pay-if-paid clause. Understanding the often subtle difference between the two is important for understanding when a subcontractor can expect payment.

1. Pay-when-paid.

A pay-when-paid clause is a timing mechanism that states that payment is due to a subcontractor within a certain time period after a contractor receives payment from the owner. A pay-when-paid clause, however, does not condition payment to a subcontractor on the contractor’s receipt of funds from the project owner. Sloane Co. v. Liberty Mutual Ins. Co., 2009 WL 2616715 (E.D.Pa. 2009)(“pay-when-paid” clauses “merely create a timing mechanism for a contractor’s payments to a subcontractor and do not condition payments to a subcontractor on the contractor’s receipt of those payments from the project owner.”)

2. Pay-if-paid.

Conversely, under a paid-if-paid clause a contractor’s receipt of payment from the owner is a strict condition precedent on payment to a subcontractor. Courts hold that a pay-if-paid clause in a subcontract shifts the risk of loss, from non-payment by the owner, to the subcontractor. Id.; Fixture Specialists, Inc. v. Global Construction, LLC., 2009 WL 904031 (D.NJ. 2009). Depending on the jurisdiction, a contractor may have to wait indefinitely for payment to a contractor to happen before it is paid, or it merely must wait only a “reasonable period” of time before it pursues payment from a contractor.

3. Telling the difference between the two.

The differences in the language used in a pay-when-paid verse a pay-if-paid clause are often subtle and requires careful analysis of the subcontract’s language. Most courts agree that in order for a payment clause to be construed as the more onerous pay-if-paid clause, whereby payment to the contractor is a condition precedent to payment to the subcontractor, there must be clear language showing the intention of the parties to shift the risk of non-payment. Id.; Seal Tite Corp. v. Ehret, Inc. 589 F.Supp. 701 (D.NJ.1984); Lafayette Steel Erectors, Inc. v. Roy Anderson Corp., 71 F.Supp.2d 582, 587 (S.D.Miss.1997); Mrozik Constr., Inc. v. Lovering Associates., Inc., 461 N.W.2d 49, 51 (Minn.Ct.App.1990) ; Watson Constr. Co. v. Reppel Steel & Supply Co., 123 Ariz. 138, 598 P.2d 116, 119 (Ariz.Ct.App.1979).

Sometimes it is easy differentiate between to the two clauses. If words such as “condition,” “if and only if,” or “unless and until” are used in describing when payment to a subcontractor is due, then the clause is most likely a pay-if-paid clause. Sloan Co., supra, at *5. However, courts have also construed payment clauses as pay-if-paid clauses when less obvious language is used. For example, one court held that a payment clause that stated “disbursement will be processed as funds are received” constituted a pay-if-paid clause as payment was conditioned on the contractor’s receipt of the funds. LBL Skysystems (USA), Inc. v. APG-America, Inc. 2005 WL 2140240 (E.D.Pa. 2005). Moreover, some courts have held that key words such as “condition precedent” are not alone dispositive and the courts must look to the entire subcontract in order to determine whether the parties intended to shift the risk of non-payment to the subcontractor. Sloan Co, supra, at * 6. Therefore, while a majority of courts give heavy weight to key words such as “condition precedent,” it is important to review the entire subcontract before concluding that a clause is a pay-if-paid rather than the more forgiving pay-when-paid variety. Of course, if possible, the safest bet would be to not agree to any payment terms that use the words “condition,” “if and only if,” or unless and until.”

Knowing what your rights to payment are important. As you can see, the difference between waiting indefinitely for payment and being able to pursue payment immediately sometimes hinges on few key words. Therefore, you need to scrutinize each subcontract carefully. Next week we look at termination for convenience clauses.

 

Subcontractors need to make sure that they are aware of all of the terms they are agreeing to in the subcontract. Many subcontracts contain so called “flow down” or incorporation by reference clauses, which incorporate the terms of the general contractor-owner agreement and bind the subcontractor to the general contractor to the same terms that the general contractor is bound to the owner. Plum Creek Wastewater Auth. v. Aqua-Aerobic Sys., Inc., 597 F. Supp. 2d 1228, 1233 (D. Colo. 2009)(“Flow down clauses are designed to incorporate into the subcontract those provisions of the general contract relevant to the subcontractor’s performance.”)

Because flow down clauses incorporate language appearing in a separate document – the general contract – it is important for subcontractors to review the general contract in addition to the subcontract to fully appraise itself of the terms to which it is agreeing. A subcontractor is bound to obligations relating to the subcontractor’s work which appear in the general contract, although the terms do not necessarily appear in the subcontract itself.

Article 2 of AIA Form 401-2007, “Standard Form of Agreement Between Contractor and Subcontractor,” provide an example of a typical flow down clause.

 The Contractor and Subcontractor shall be mutually bound by the terms of this Agreement and, to the extent that the provisions of AIA Document A201-2007 apply to this Agreement pursuant to Section 1.2 and provisions of the Prime Contract apply to the Work of the Subcontractor, the Contractor shall assume toward the Subcontractor all obligations and responsibilities the Owner, under such documents, assumes toward the Contractor, and the Subcontractor shall assume toward the Contractor all obligations and responsibilities which the Contractor, under such documents, assumes toward the Owner and the Architect. The Contractor shall have the benefit of all rights, remedies and redress against the Subcontractor that the Owner, under such documents, has against the Contractor, and the Subcontractor shall have the benefit of all rights, remedies and redress against the Contractor that the Contractor, under such documents, has against the Owner, insofar as applicable to this Subcontract. Where a provision of such documents is inconsistent with a provision of this Agreement, this Agreement shall govern.

By not reviewing the general contract, a subcontractor through a flow down clause may unwittingly agree to terms that arguably have nothing to do with its work. Terms that an unsuspecting subcontractor may be agreeing to via a flow down clause include termination clauses, claims processing clauses, indemnification clauses, and dispute resolution clauses.

Therefore, before signing a subcontract that contains a flow down clause subcontractors should insist on reviewing the general contractor agreement which the flown down clause is incorporating by reference.