BLOC (www.bloccos.com) is dedicated to promoting ethical standards throughout the industries and markets we serve. Hiring an unqualified general contractor can cause an owner to lose a lot of money, to experience tremendous project delays, an untold number of headaches, and to become exposed to years of litigation.
Perhaps the biggest trap that owners and general contractors get entangled in is over payment issues. This is especially true when GC firms are mismanaged and end up being forced to get into the practice of “buying jobs.” “Buying jobs” is when a GC has gotten themselves into the business of being the lowest priced contractor on every proposal in an effort to simply get cash flow through the door.
Under this scenario the GC is getting into somewhat of a pyramid scheme. As long as he keeps getting new jobs he can keep the cycle of “kiting payments” from job to job. But, when the new contracts start drying up and “Peter” no longer has enough money to pay “Paul” the game is over.
A few popular tactics used by GC’s who are “buying jobs.”
Pricing jobs below cost in anticipation of forcing payment delays and squeezing margins from suppliers and subcontractors in order to keep their own doors open.
Holding payments from subcontractors and suppliers and agreeing to “make-it-up” to them on another job.
Over billing on progress payments by having subcontractors and suppliers charge services and supplies for one job to a different job.
Some of these GC’s even go so far as to hold projects hostage. They go into a job knowing the job cannot possibly be completed for the contracted amount and with the full intention of forcing the owner to agree to change orders and/or extra payments at the end. The owner is bullied into the realization that unless they agree to the GC’s demands the project will be delayed and riddled with countless liens from unpaid subcontractor and suppliers.
Who gets hurt? Who are the victims? Well, many people are…the subcontractors, the suppliers, GC’s employees, and the project owners.
Unfortunately, it’s the project owners who are usually left with the most liability (“holding the bag”). However, owners do have some limited options to reduce exposure. A few of these were recently discussed in an article written by Andrew Ness and Elizabeth Walsh at Jones Day in Washington (cited below).
“Joint Checks and Direct Payments to Subcontractors and Suppliers"
Written by Andrew Ness and Elizabeth Walsh
"On a troubled project, the Owner may start hearing complaints about non-payment of subcontractors and suppliers—your general contractor isn’t paying its subs consistent with what you’ve been paying the contractor. Signs of this problem can take several forms: Interim lien releases from certain subcontractors may be missing from monthly payment applications, the releases provided may contain significant qualifications for pending claims, or they may indicate lower-tier payments that are substantially less than what they should be based on your knowledge of the project. Preliminary lien notices or even actual lien claims may be starting to trickle in your door. Or you may be receiving direct calls and emails from the unpaid subcontractors and suppliers themselves.
Any of these trouble signs require your prompt attention and investigation. Simply continuing to pay the general contractor as usual after receiving notice of payment problems at lower tiers often just makes matters worse, and this may open the Owner to the potential for paying twice for the subcontractor’s work. Even worse, ignoring such complaints may bring project progress to a halt, causing crippling project delays. Subcontractors and suppliers with legitimate concerns as to whether they will be paid are not likely to perform at the pace needed to maintain the project schedule until adequate payment assurances are provided.
The Owner has several possible remedies available in this situation, short of terminating the troubled contractor for default (which, depending on the particulars, may well be counterproductive). Here we outline three basic strategies to consider in dealing with this problem.
Withholding from General Contractor
Quite likely, your construction contract entitles you to withhold payment to the contractor when you are aware of downstream payment failures. For example, the ConsensusDOCS 200 standard Owner/Contractor Agreement permits adjustments to payment applications to protect the Owner from loss resulting from the contractor’s failure to properly pay subcontractors or suppliers, per Section 9.3.3. In some states, you may also have a statutory right to withhold payment. In Maryland, for example, upon receipt of a subcontractor’s lien notice, checks and direct payments should be kept to only the minimum necessary, with a focus on those subcontractors and suppliers who are vital to the project’s successful completion. Joint Checks and Direct Payments to Subcontractors and Suppliers “the owner may withhold, from sums due the contractor, the amount the owner ascertains to be due the subcontractor giving the notice.” Md. Code Ann., Real Prop. § 9-104(f).
But withholding payments has a strong risk of making the problem worse – in all likelihood lack of cash flow is what is causing the contractor to skip paying subs and suppliers in the first place. Instead of not paying anyone, it is often preferable to make sure that subs are getting paid by paying them yourself, instead of paying the general contractor. But as Owner, you do not have any contract with those entities, so how do you accomplish this without creating a payment mess and a risk of paying twice?
Payment by Joint Check
Joint check arrangements are a time-honored practice that allows the Owner to assure payment reaches a subcontractor by issuing a check payable to both the contractor and the subcontractor/supplier. In order to deposit or cash the check, both parties must endorse it, so the subcontractor can keep the contractor from depositing the money in its own account by withholding its endorsement. The problem, however, is that just issuing joint checks without the contractor’s agreement may not protect the Owner.
Some form contracts include an advance agreement to the use of joint checks, in order to avoid this risk and enable them to be used when needed. For example, the AIA form A201 General Conditions provide for this (at Section 9.5.3) as follows:
… the Owner may, at its sole option, issue joint checks to the Contractor and to any Subcontractor or material or equipment suppliers to whom the Contractor failed to make payment for Work properly performed or material or equipment suitably delivered…
Inclusion of such terms is a good idea, as it allows access to this technique without delay when circumstances call for it. In the absence of such terms in the contract, however, what you need instead is the agreement of your contractor to accept payment in joint check form, either generally or on a case-by-case basis. This agreement needs to be in writing. While the contractor may be hesitant at first to agree (generally driven by its great need for cash from any source), usually By Andrew Ness and Elizabeth Walsh OP1207_Summer12. an agreement can be worked out once the Owner makes clear that the only alternative is withholding payment altogether, and the contractor is not going to get its hands on the money in any event.
Here are some basic guidelines for the use of joint checks:
The joint check itself should clearly designate the project to which the check applies, and better yet the specific lower-tier invoice being paid. The last thing you want is the subcontractor applying your jointly issued payment to its separate claim against the same contractor relating to a different project.
Any joint check agreement should explicitly state that the Owner is taking on no general obligation to pay by joint check, and avoid any possible implication that the Owner is taking on either an open-ended arrangement to make good on any debt of the general contractor to the subcontractor, or to make joint-check payments generally in the future.
Rather, the basic purpose of a joint check agreement is to set forth the contractor’s agreement to allow the Owner to make payments under the contract in the form of joint checks, at the Owner’s sole discretion, and nothing more.
As a condition to payment by joint check, you should always require both payees to release any claims or lien rights for the amounts being paid.
Payment by joint check is not necessarily a guarantee that once properly endorsed the check will ultimately be deposited into the subcontractor’s account. Even so, if your project is in a jurisdiction that abides by the “joint check rule,” just by endorsing the joint check the subcontractor will be deemed to have received the amount of the check.
Paying subcontractors or suppliers directly, without the use of joint checks and without the cooperation of your contractor, is another alternative, but generally a less desirable one. Again, many contracts permit this, at least once a lien claim has been asserted. The major practical obstacle, however, is determining exactly what is owed to the sub, when the contractor is not involved in the process, as it necessarily is when endorsing a joint check. The sub’s invoices and accounting records may not be agreed by the general contractor, and if you overpay, you may well be unable recover the excess payment. Verifying the accuracy of the sub’s accounting will often be difficult. At a minimum, you should require a copy of the sub’s complete agreement with the general contractor, including all amendments and change orders; confirmation of all prior invoices and payments received; and all prior lien or claim releases.
Once convinced that you know the amount properly due a specific subcontractor, or supplier, put your contractor on notice of your intent to pay that amount directly. Your notice should identify the work that is being paid for, the amount, and request the contractor to notify you immediately if it has an objection, along with the basis for any such objection. So long as you are not running afoul of a specific term of the general contract or subcontract (such as a subcontract provision that preconditions the subcontractor’s right to payment to receipt of the funds by the contractor), the contractor should not later be able to claim diversion of funds or tortious interference with the subcontract. A recommended precaution, however, is to obtain the sub’s agreement to defend and indemnify the Owner from any claims by the contractor that direct payment was improperly made. To be sure, this is not a risk-free process, and needs to be navigated carefully, but the particular circumstances of your project may warrant the risks involved.
Each of these strategies is subject to specific local requirements or limitations, so advance consultation with competent construction counsel is highly advised. Since the risk of making a costly mistake increases with the number of payments, the use of both joint checks and direct payments should be kept to only the minimum necessary, with a focus on those subcontractors and suppliers who are vital to the project’s successful completion. Properly executed, however, joint checks and direct payments can be the least disruptive means of keeping your project on track.”
BLOC's alliance partners are well screened and dedicated to doing business the right way. BLOC is dedicated to creating and improving higher ethical standards. We believe that better options should be available to all parties and are working everyday to improve industry standards and ethics.
Charles D. Clements, CEO/Mbr.
STOP PAYING YOUR GENERAL CONTRACTOR
June 26, 2015