Limits on the ransom money.In the event that the Contractor raises the "good faith dispute" defense, the amount that the Contractor may withhold from payment can not exceed the difference between the two payment positions (or 110% of the difference on a residential project). (28.003). Thus, a Contractor may not withhold an entire Pay Application to coerce your concession of the disputed portion. The undisputed portion of the account survives as the subject of the remaining remedies.
- Interest accrues at 1½% per month, commencing on the day after payment becomes due (i.e. after either the 35th or 7th day).
- Suspension of Performance. I submit that the right (or even the threat) to legally suspend performance of your subcontract is a powerful antidote to any "slow pay" job. A Contractor or Subcontractor may suspend contractually all required performance 10 days after giving the Owner and its construction lender, if any, written notice of non-payment of an undisputed amount and its intent to suspend performance.
If the claimant is not paid within 10 days after giving the notice, it has no further obligation to perform the subcontract unless or until it has received payment of all sums due, i.e. the undisputed sum, plus interest plus the cost of de-mobilization and re-mobilization. A Contractor or Subcontractor is not responsible for damages resulting from suspending work if it has not been notified in writing before suspending performance that payment has been made or a "good faith" payment dispute exists.
A notice that a "good faith" payment dispute exists must include a list of specific reasons for non-payment. In this event, the sub is entitled to a reasonable opportunity to cure the listed defects or offer a reasonable back-charge to compensate for defects that can not be promptly cured.
PUBLIC WORK – Texas Government Code, Chapter 2251
This is the counterpart for Texas public work having some variations from the Property Code.
For example, payment by a governmental entity becomes past due on the 31st day after the later of:
- the date goods are received;
- the date performance is completed; or
- the date an invoice is received by the governmental entity
However, if the governing body of the governmental agency meets only once a month or less, the account is overdue on the 46th day after the later of those three events.
A vendor (i.e. a general Contractor) shall pay the appropriate share of a payment received to a Subcontractor within 10 days; and the payment of that share becomes past due on the 11th day after the date that payment was received from the public Owner.
A Subcontractor is obligated to pay a supplier its share within 10 days of receipt of payment from the vendor (GC) which becomes overdue on the 11th day.
Interest accrues on an overdue payment at the rate of 1% plus the prime rate published in the Wall Street Journal, effective as of certain dates that are too complicated to recount here. Interest is payable without request or calculation by the Claimant. Interest stops on the date when the overdue payment is wired or mailed. So, keep the government's envelope transmitting the payment to preserve the postmark date.
A Subcontractor may suspend performance of a contract with a governmental agency under the same conditions as described for private work above if the governmental agency fails to timely pay an undisputed account to the vendor; or the vendor, having been paid, fails to pay the Subcontractor's undisputed account.
The tactical significance of the Prompt Pay Act (both private and public versions) can be summarized as follows:
- The notice of non-payment and intent to suspend performance from a critical trade (high visibility and long lead-time) motivates Owners and architects to resolve payment problems.
- The notice triggers a new statutory obligation of the Owner or Contractor to make payment of the non-disputed portion of the account. This duty is separate from the contractual obligation to pay. Default by the Owner or Contractor after receipt of the notice creates a separate cause of action for violation of the statutory obligation in addition to breach of contract.
This statutory violation may trump a poorly drafted "Pay If Paid" clause. For example, if the obligation to pay your company is limited to the condition that the Contractor is paid "pursuant to its contract with the Owner", that condition does not nullify the Contractor's independent statutory obligation to pay. There is no case law to this effect yet. But, it is a plausible argument.
- Both laws impose interest on unpaid accounts when your subcontract may be silent.
- A default in payment by Owner or Contractor after notice enables the sub to walk the contract without further legal liability for non-performance on a job gone bad while preserving its lien and bond rights to secure payment for labor and material previously furnished.
- The wild card is, of course, the issue whether there is a "good faith dispute" on private work or a "bona fide dispute" on public work. The degree of confidence with which you can "walk the job" will require a detailed, candid analysis within the 10-day cure period whether your materials and installation conform to Contract Documents. The table for this analysis is set by the requirement that the Contractor specify the reasons for non-payment. Documents must be carefully scrutinized and job photos and records must be examined carefully to evaluate the outcome of the "good faith" or "bona Fide" dispute issue. If the stakes are high or the documents are ambiguous, experts should be consulted. If the cost of obtaining conformity to Contract Documents is modest, offer to reduce your claim accordingly and march off. If you have received many unaddressed demands to correct defects and non-conforming conditions or to adhere to the project schedule or suffer liquidated damages, suspension of performance may become a risky venture.
II.
SECURITY FOR PAYMENT OF CLAIMS
The second major remedy against non-payment is the securitization of your claim, whether by a mechanic's lien on private work or a bond claim on private or public work.
Mechanic's Liens and Payment Bonds secure the payment of claims much like mortgages secure the payment of promissory notes.
Requirements for Perfecting a Bond Claim on Texas Public Work
This check-list item refers to contracts awarded by Texas public agencies, not to agencies of the federal government.
Payment Bonds are required for all public work contracts in excess of $25,000.00 for the benefit of Subcontractors and suppliers of every tier.
A copy of this Payment Bond should be obtained by a Subcontractor from the prime Contractor at the commencement of the job.
Notices Required for all Subcontractors
In order to recover from a surety, a claimant (beneficiary) must post to the Contractor and surety a notice of claim by the 15th day of the 3rd month after each month in which unpaid labor or material was actually furnished to the project. The notice must be accompanied by a sworn statement in effect that "The amount claimed is just and correct; and all just and lawful offsets, payments and credits known to the affiant have been allowed." The account should state the amount of retainage that has not yet become due and payable. A copy of your contract and Pay Application evidencing percentage of completion are optional, together with the mandatory sworn statement.
Notice for Retainage
A Subcontractor or a sub-Subcontractor must provide written notice of retainage to the prime Contractor and the surety by the 90th day after the date of "final completion" of the public work contract.
Additional Notices by Sub-Subcontractors
A beneficiary that does not have a contract directly with the prime Contractor must also send an additional, preliminary notice to the prime Contractor by the 15th day of the second month:
- after the date of beginning of delivery of material or the performance of work that its subcontract provides for retainage and the general terms of retainage;
- after each month in which labor or material were furnished.
Notice for Specially Fabricated Materials
On Texas public work a claimant must provide to the prime Contractor written notice on or before the 15th day of the second month after the receipt and acceptance of an order for specially fabricated material. The portion of the claims for undelivered material may not exceed the reasonable value of conforming materials, less fair salvage value.
Requirements for Perfecting a Mechanic’s Lien or Bond Claim on Private Work
The perfection of a valid mechanic's lien or a claim against the general Contractor's payment bond, if available, on private commercial work requires the claimant to post timely notices of claim by certified mail and to timely record a lien affidavit in the county deed records. With one exception to be noted, these requirements for perfecting lien claims and bond claims on private work are identical.
I have deliberately avoided the treatment of notices and liens on residential projects, (i.e. single-family, duplex, triplex or quadruplex intended to be used as a dwelling by one of the Owners). This is a separate topic requiring a separate check-list of issues.
Notice – An unpaid Subcontractor must provide written notice of its claim with certain statutory formalities (a warning and a demand for payment) to both the Contractor and the Owner. This notice must be sent by certified or registered mail and be postmarked by the 15th day of the 3rd month following each month of unpaid performance. Performance is measured by months in which labor or material are actually furnished to the job, not the month that these are invoiced.
The trick here is that the notice must be sent timely to protect both progress and retainage. This can be a trap on jobs of three months or longer in which progress payments are received on a current basis. Even a careful sub may give no thought to protecting retainage when early progress accounts are timely paid. However, by the time that the job is completed several months later in the midst of payment problems, it is too late to double back and give notice for retainage on the first few month's performance.
To deal with this problem on lengthy jobs, the sub has two alternatives:
- Provide a recurring notice of its unpaid retainage account each month despite timely receipt of progress payments. This is awkward and annoying to everyone; or
- Provide an optional notice of your retainage account at the beginning of the job before any problems surface.
Optional Retainage Notice
A Subcontractor has the option of providing notice of its retainage agreement to the Owner and Contractor in lieu of giving the foregoing recurring monthly notices of unpaid retainage. This notice may be provided to the Owner by the 15th day of the 2nd month following the month in which labor or materials are first furnished to the job under a subcontract with a retainage agreement. Prop. Code, §53.057.
I always recommend consideration of an optional retainage notice on lengthy jobs.
Additional Preliminary Notice for Sub-subs
If your company has a contract with a Subcontractor (i.e. you are a sub-sub) then you have an additional preliminary notice to send to only the general Contractor. This notice must also be sent by certified or registered mail and be post-marked on or before the 15th day of the second month after each month of unpaid performance. No particular form is required; a copy of your unpaid invoices with a summary of your unpaid account is sufficient.
Notice of Specially Fabricated Materials
Architectural millwrights have an unique right to perfect mechanic's liens for materials reasonably unsuited for use elsewhere, even though the materials are never delivered to the job-site. (Property Code, §53.058)
To achieve this special treatment, a millwright must provide a notice to the Owner (and to the Contractor if the contract is with a sub-sub). The notice must be post marked on or before the 15th day of the 2nd month after the month in which the claimant receives an order for the specially fabricated material.
Affidavit - The statutory mechanic's lien affidavit must be recorded in the County Land Records where the Project is located no later than the 15th day of the 4th month after the last month in which the claimant has furnished labor or material.
Regardless of this 4th month deadline, if a claimant wishes to participate in the 10% statutory retainage account that the Owner should withhold from the general Contractor, the lien affidavit must be filed within 30 days of "completion" of the original contract.
This short duration is a serious problem, particularly, for early finishing trades who are unaware of the "completion date". However, millwrights' installation is typically late-finishing work with adjustments continuing until the "grand opening". Do not let that 30-day window pass without exercising lien rights in time to share proportionally with the few other trades who timely file their lien affidavits.
Bond Claims on Private Work
When required by an Owner on private projects, the Payment Bond, when recorded by the Contractor, has the legal effect of releasing all mechanic's lien rights on the project. The credit and assets of a commercial surety are substituted as collateral for the lien on the land and improvements of the Owner. The failure of the Owner and Contractor to record the Bond does not affect the surety's liability.
A claimant perfects its claim against the Payment Bond by either:
- giving all of the foregoing notices and filing an affidavit within the same time frames as required for fixing a mechanic's lien; or
- making a bond claim by giving the same notices within the same time frames as required for perfecting a lien, except that the Owner's notices are sent to the surety. A notice to perfect a bond claim need only be "fair notice" of the nature and the amount of the claim. An affidavit is not required to complete the bond claim.
Removables
The Priority for "Removables" – Typically, mechanic's liens are subordinate to lenders who record their deeds of trust before any Contractor does any work on the Project. Your mechanic's lien "relates back" to that first date of visible construction or delivery of materials by any sub or supplier. If the lender recorded its deed of trust before the common "inception date" for all Contractors' liens, then your lien will be subordinated regardless of any contractual subordination provision. The foreclosure of the senior lien has the legal effect of releasing all junior liens.
However, "specially fabricated materials" also catch a special break under Property Code, §53.123, if these materials are "removable", i.e. the materials may be removed without injury to the materials or to the portion of the structure to which it is attached and without opening the structure to the elements. See First Nat'l Bank in Dallas v. Whirlpool Corp., 517 S.W.2d 262 (Tex. 1974); Exchange Savings & Loan Ass'n v. Monocrete Prop., Ltd., 629 S.W.2d 34 (Tex. 1982).
The best authority that I have found for the recognition of millwork as a "removable" addresses "cabinets". In Orah Wall Financial Corporation v. Jordan & Nobles Construction Co. of El Paso, 84 B.R. 442 (Bkrtcy. W.D. Tex. 1986) a bankruptcy court found that "cabinets" are “removable” even though the removal may cause some minor damage to wall paper and the cost of removal will prove little or no benefit to the claimant.
While the "cabinets" are not described and the decision of a bankruptcy court affords little general application, this case is a toe-hold for fabricators of millwork to claim lien supremacy over everyone, including prior lenders, under the removable theory.
The outcome of this contest will turn in large measure on the ease with which your products can be removed, provided that you have not contractually subordinated your lien rights to the Owner's lender.
III.
CONTRACT ISSUES
The question of subordination of lien rights is a tester because Owners will insist on subordination clauses in construction contracts as required by their loan agreements. Try to strike these provisions – particularly, if you would otherwise be king-of-the-hill with a "removable" lien.
Also, it is foolish to sign a contract providing for the waiver of lien rights. Waivers of liens before performance are enforceable in Texas. Owners will typically back off this requirement.
Contingent Payment Clauses
The contingent payment clauses are (together with the broad-form indemnity clause) the biggest source of Subcontractor heart-burn. There are two categories of these clauses.
The "Pay When Paid" clause in a subcontract seeks to postpone the obligation of the Contractor to pay the Subcontractor until such time that Contractor receives payment from the Owner. However, this clause has been interpreted to permit postponement of the payment obligation for only a reasonable time.
On the other hand, the "Pay If Paid" clause legally forestalls the obligations of the Contractor only if the receipt of payment from the Owner is made a "condition precedent" to the Contractor's obligation to pay the Subcontractor. If those quoted 'magic words" are not recited, the clause is not enforceable.
The Pay If Paid clause does not interfere with your rights to perfect a mechanic's lien against the Owner and its property. If the Contractor has received payment from the Owner and failed to pay its sub, the essential condition for the clause has failed and the sub may proceed to sue the Contractor for breach of contract and the Owner for foreclosure of its lien.
If the Owner has failed to pay the Contractor, the properly drafted clause will protect the Contractor from suit by the sub. But it will not protect the Owner from liens by both the Contractor and the sub.
IV.
THE STATUTORY UNTANGLING AND
RE-TANGLING OF THE CONTINGENT PAYMENT CLAUSE
The hostility of Subcontractors to Contractors' unwillingness to delete the risk-shifting contingent payment provision has resulted in a sort of legislative compromise enacted as Texas Civil Practice & Remedies Code, §35.521(b), having these features:
- The contingent payment clause is not enforceable by a Contractor or its surety to the extent that an Owner's non-payment is the result of the Contractor's breach of contract – unless non-payment is the result of the sub's failure to meet Contractor's requirements. This is a significant improvement for subs whose payment was previously blocked by the clause for reasons having nothing to do with the sub's performance. However, the Contractor may re-introduce the obstacle by blaming the Subcontractor for non-payment.
- As a separate tactic, a Subcontractor may now aggressively provide written notice of its objection to the enforceability of the clause after the 45th day after the date that the sub submits a Pay Application in form conforming to the contract. The notice becomes effective subject to certain conditions:
- on the 10th day after the Contractor receives the notice;
- with respect to work or materials furnished after that 10th day;
- provided that within 5 days of Contractor's receipt of the notice, the Subcontractor does not receive Contractor's written counter-notice of the Owner's dispute under the Prompt Pay Act as a result of the sub's default and the continued enforceability of the clause.
These notices and counter-notices create a tic-tac-dough contest with serious consequences.
These are other considerations:
- The clause will not invalidate a mechanic's lien.
- The clause is enforceable to the extent that funds are uncollectible because the Owner successfully asserts the defense of sovereign immunity.
- The clause is not enforceable if: (i) the Owner and Contractor are in a sham relationship or (ii) its enforcement would be "unconscionable". A clause is not unconscionable if the Contractor exercised due diligence in ascertaining and communicating to the Subcontractor in writing before the contract is signed the financial viability of the Owner and the existence of adequate financial arrangements to pay for improvements and the Contractor made reasonable collection efforts or offered to assign a cause of action for collection of the Subcontractor's account.
Obviously, the "Pay if Paid" clause and this legislative reaction are complicated. Legal advice of your counsel is recommended when navigating these issues.
The simple, straightforward points to be gleaned from this complicated subject are these:
- Any contingent payment clause is legally enforceable against you only if the receipt of payment is subject to the "condition precedent" that the Owner has paid the Contractor.
- If your subcontract has such a clause, it is not enforceable to the extent that the Contractor breached its contract and your company did not breach its subcontract. However, this large dose of relief could be subject to potential dispute as to whether the Contractor or the Subcontractor caused the non-payment. Further, the clause continues to effectively shift all other risk of non-payment by the Owner (e.g. bankruptcy) to you.
- The enterprising sub may still try to navigate its way out of the strictures of the clause through the described notice procedure. But, success requires that there will be no counter-notice by a slumbering Contractor. That is a risk worth taking without any down-side.
Construction Trust Funds
Finally, remedies for non-payment must include the consideration of the Construction Trust Fund, Texas Property Code, Chapter 152, in appropriate cases where an Owner, Contractor or Subcontractor receives funds under a construction contract without paying its subs and suppliers. Those payments received are impressed with a trust obligation to pay those entitled to payment. The individual owner, officer, director or agent of the entity receiving trust funds or who has control of the direction of trust funds is the trustee of the trust funds. A trustee misapplies trust funds if he or she intentionally, knowingly, or with intent to defraud diverts trust funds without fully paying all beneficiaries.
Certain defenses to civil and criminal sanctions exist if the trustee uses trust funds to pay actual construction expenses or funds are retained pursuant to the lien statutes or the trust funds are paid to beneficiaries within 30 days after the trustee receives written notice of the filing of a criminal complaint.
This remedy requires careful investigation before any insinuation of a violation may be made.
CAVEAT
The foregoing check-list items and commentary are not intended to provide legal advice with respect to any pending or potential issue or controversy that you may face. You should always consult and rely only upon the advice of your legal counsel after disclosure of all applicable facts and documentation.
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