Ashley J. Sherwood and Dan W. Ballesteros | Seyfarth Shaw
Clauses that can affect your right to payment in different U.S. states
In contracts that can sometimes be hundreds of pages, the provisions that contractors (and their attorneys) scrutinize the most concern payment. But it is not just the obvious payment application or interest clauses that can impact a contractor’s right to payment. Indemnity, no-damages-for-delay and pay-if-paid clauses can drastically impact when a contractor sees the money. Adding another layer of complexity are statutory nuances about which contractors need to be aware. Construction laws vary from state to state and can, in some cases, invalidate what would otherwise be enforceable contract language. Subcontractors, in particular, should safeguard themselves, as state-law protections do not always trickle down past the prime contractor level.
Most statutory payment provisions fall into three categories – (1) timing of payment; (2) conditions of payment; and (3) bases for non-payment. This article discusses typical contractual clauses impacted by statute and provides examples on how state law may apply to your project and impact your rights. While not every payment-related issue or state law is covered in this article, contractors and subcontractors of all sizes and specialties should come away with a better understanding of what to look for in their existing contracts, and what to push back on during their next negotiation.
Timing of payment: State statutes requiring prompt payment and interest
Prime contracts may contain clauses requiring the owner to pay the prime contractor within “X” days of receipt of a complete payment application or, in a subcontract, require a prime contractor to pay the sub within “Y” days of receipt of payment from the owner. Regardless of whether your contract contains such a clause, there may be a state law requiring an owner to pay the prime contractor within a certain period, or face penalties in the form of interest and/or liability for attorneys’ fees and costs. Subcontractors are almost always beneficiaries of these clauses.
Clauses mandating “prompt payment” vary from state to state. Public projects at the federal level, and in every state except one, are subject to prompt payment requirements for prime contracts and first-tier subcontractors. Certain states also have prompt payment provisions for private projects, and some states prescribe different deadlines for prime contractors and subs. For example, Texas requires payment from an owner to a prime contractor within 35 days of the invoice for private projects,1 and 31 days after an invoice or receipt of goods (whichever is later) for public projects.2 Offenders can be on the hook for anywhere from 1.5% interest on unpaid amounts and attorneys’ fees (private) to the prime interest rate + 1% and attorneys’ fees to the prevailing party (public). Prime contractors in Texas must pay subcontractors within seven days of receipt of payment from a private owner, and within 10 days after receipt of funds on a public job (this regime is common to many other states).
States that only have statutes governing prompt payment on public works projects often impose payment deadlines ranging from a week (e.g., Montana)3 to three months (e.g., Illinois),4 with penalty interest rates varying across the board. Not all states, including Arkansas and Idaho, provide prompt payment for subcontractors, however, so subcontractors and suppliers should check the laws of the state in which they are working. New Hampshire is the only state that does not have any prompt payment law for either private or public projects.
In contracts that omit a prompt payment clause or in a state that does not statutorily provide for the same, including a simple interest clause with a set rate (typically 6 to 12% per annum) is the most straightforward way to secure interest on unpaid amounts. An interest provision is particularly important for subcontractors who have to wait longer for payment to trickle down from the contractor.
To the extent your contract does not contain an interest clause, most states provide for recovery of pre-judgment interest as a matter of right based on either case law or codified in statute (e.g., North Carolina).5 Other states, like Tennessee, make an award of pre-judgment interest discretionary.6
Conditions of payment: Lien waivers and retainage
Most owners require lien waivers from prime contractors and their subcontractors, as a strict condition precedent to both progress and final payments. The substance of a lien waiver depends on the state. Eleven states prescribe what must be included in a lien waiver. These states7 provide that such a waiver is invalid if it does not “substantially” conform to that state’s requirements.8
The remaining states do not require any specific form be used. However, if worried about what you may be required to sign as a condition to payment, many owners or primes will agree to negotiate such language in advance and attach an exhibit or addendum to the contract with a sample waiver that must be included with each payment application.
Critical for both prime contractors and subcontractors is to check whether lien rights can be waived even prior to performing work. For example, in jurisdictions like Alaska and the District of Columbia, there is no express prohibition on waiving lien rights before performing work; thus, contractors in those jurisdictions should check their contracts carefully before starting a job. Other states like Georgia and New York expressly provide that lien rights cannot be preemptively waived.9
Retainage laws
Owners and prime contractors generally hold back funds as retainage – a safeguard if later issues arise. A 10% holdback for retainage is customary, but not uniform, and may be too high when today’s profit margins may be even less than the retainage percentage. The good news for contractors – and particularly subcontractors who face downstream payment pressures – is that many states have enacted laws that set retainage rates downward from 10%, and trending towards no more than 5% retainage on public projects. Massachusetts is one example, where retainage may not exceed 5% of the approved amount of the period payment.10
While poor performance or nonperformance is frequently the basis for the owner or prime to holdback payment, some states mandate that retainage be withheld from contractors on public projects even where there are no deficiencies in the work. Idaho,11 Ohio12 and Washington13 are examples of such states where contractors can expect 5% to 8% to be withheld from their earned funds, regardless of performance.
There appears to be a 50/50 split between states that have statutory retainage limits for both public and private projects. Nebraska caps retainage on private non-residential projects at 10% for the first 50% of the project, and no more than 5% thereafter.14 Louisiana does not cap retainage on private projects, but for most projects over $50,000, retained funds must be placed in an interest-bearing escrow account.15
Subcontractors, in particular, should safeguard themselves, as state-law protections do not always trickle down past the prime contractor level.
Bases for non-payment: Contingent pay clauses, anti-indemnity and prohibitions on delay damages
“Pay-if-paid” clauses impact whether a subcontractor is ever entitled to receive payment, while “pay-when-paid” clauses only impact the timing of payment. Most states distinguish between the two types of contingent pay clauses, while a small number of jurisdictions find they have the same legal effect. Laws in Georgia, Kentucky and Wisconsin provide a good sample of how states can vary.
Subcontractors in Georgia: beware. Payif-paid and pay-when-paid clauses are both enforceable, without exception, and bar recovery by the subcontractor until the condition (i.e., payment from the owner to the prime) is met.16
Kentucky law is representative of the majority rule. In those states, “pay-if-paid” clauses are enforceable if explicitly stated in the contract, while “pay-when-paid” clauses are interpreted to set a “reasonable time” for payment by the contractor to the subcontractor after receipt from the owner.17
North Carolina is protective of a subcontractor’s right to payment and invalidates any provision in a contract that purports to make payment by the owner to a contractor a condition precedent to payment to the subcontractor.18 While North Carolina courts have not squarely addressed the validity of “pay-when-paid” clauses, some courts have interpreted North Carolina’s law to be a blanket prohibition of any “condition precedent” clauses, and thus contractors can safely assume “pay-whenpaid” clauses will similarly be looked at with a wary eye.
Indemnity clauses are of particular importance to subcontractors because owners and prime contractors often shift their own liability and risk downstream. Both “hold harmless” language and additional insured requirements should be scrutinized by both your attorney and your insurance broker. The state in which the project is located could impact the scope of the allowed indemnity vis-à-vis “anti-indemnity” statutes.
Forty-three states have some law on the books that prohibits clauses requiring a contractor (both prime and sub) to indemnify another for its negligence; however, some of those states limit application of the law to public projects only. States like Alabama, Maine and Vermont, however, have no such anti-indemnity laws and the contract language will control.
Of the 43 states that do have some sort of anti-indemnity law, states (like Minnesota19 and Oklahoma20) prohibit a contractor from indemnifying another party for its sole or partial fault. Others (like Alaska,21 New Jersey22 and West Virginia23) only prohibit a contractor from indemnifying another party for its sole fault.
Even if the indemnity clause in your contract seems hopelessly broad, contractors should check the applicable state law to find out whether there is a statute that might render that clause partially or entirely invalid.
Turning to no-damages-for-delay clauses, it is common for an owner to try to limit a prime contractor to time, but no money, for delays on a project. Even if such a prohibition is not in the prime contract, the authors of this article often see general contractors try to impose such a limitation on subcontractors. Both prime and subcontractors should try to eliminate no-damages-fordelay language from their contracts.
Most state legislatures agree that nodamages-for-delay clauses are enforceable, with some exceptions. For example, some states hold such clauses are enforceable unless the delay is caused by the owner’s interference, a significant change in scope, in cases of intentional wrongdoing, gross negligence or misrepresentation.24 Other states, like California, differentiate between public and private jobs, finding such clauses unenforceable in public works contracts where the delay is “unreasonable under the circumstances involved and not within the contemplation of the parties” at the time of contracting, but that the same clauses are enforceable in private contracts so long as expressly and unambiguously stated.25, 26 States like Washington wholly ban such clauses as against public policy.27
Even if a prime or subcontractor finds the other contracting party is not willing to remove a no-damages-for-delay clause from the contract, they should check the state law applicable to their project to see if the clause will nonetheless be considered unenforceable.
Conclusion
Contract language, the applicable state law, the type of project (public or private) and where you fall in the contracting chain all impact your right to payment. Subcontractors do not always enjoy the same state law protections as prime contractors. They also often face two sets of contract terms vis-à-vis flow down of the prime contract, thus making their path to payment more winding.
Contractors at all levels should take a close look at their contracts and consult with their attorney to help make “cents” of their payment rights.
Footnotes
1. Tex. Prop. Code §§ 28.001–28.010.
2. Tex. Govt. Code §§ 2251.021-2251.055.
3. M.C.A. § 28-2-2101–28-2-2117.
4. 815 ILCS 603/1 et seq. (private projects), 30 ILCS 540/0.01 et seq. (state public projects), 50 ILCS 505/1 et seq. (local public projects).
5. N.C. Gen. Stat. § 24-5.
6. Tenn. Code Ann. § 47-14-123.
7. These states are Arizona, California, Georgia, Massachusetts, Michigan, Mississippi, Missouri, Nevada, Texas, Utah, and Wyoming.
8. See e.g., Cal. Civ. Code § 8132.
9. See e.g., Ga. Code Ann. § 44-14-366.
10. Mass. Gen. Laws c. 30 §39K.
11. Idaho Code § 54-1926.
12. Ohio Rev. Code Ann. § 153.12.
13. RCW 60.28.011.
14. Neb. Rev. Stat. Sec. 45-1204.
15. La. Rev. Stat. Ann. §9:4857.
16. St Paul Fire & Marine Ins. Co. v. Ga. Interstate Elec. Co., 187 Ga, App. 579 (Ga. Ct. App. 1988); Assoc. Mechanical Corp., Inc. v. Martin K. Eby Const. Co., Inc., 67 F.Supp.2d 1375 (M.D. Ga. 1999).
17. A.L. Pickens Co. v. Youngstown Sheet & Tube Co., 650 F.2d 118, 190 (6th Cir. 1981).
18. N.C. Gen. Stat. § 22C-2; Am. Nat’l Elec, Corp. v. Poythress Commercial Contractors, Inc., 604 S.E.2d 315 (N.C. App. 2004).
19. Minn. Stat. § 337.02.
20. Okla. Stat. § 15-221.
21. Alaska Stat. § 45.45.900 (exception for hazardous materials).
22. N.J. Stat. § 2A:40A-1.
23. W. Va. Code § 55-8-14.
24. Nev. Rev. Stat. § 338.485; State Highway Admin. V. Greiner Eng. G Scis., Inc., 577 A.2d 363 (Md. App. 1990).
25. Cal. Pub. Cont. Code § 7102.
26. K&F Constr. v. L.A. City Unified Sch. Dist., 176 Cal. Rptr 842 (Cal. Dist. App. 1981).
27. RCW 4.24.360.
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