Another Contractor Solution

Re: General Contractor Non-liability for Owner Non-payment

One of the serious risks of being a general contractor is that the general contractor is directly liable to the subcontractors and vendors, even if the owner fails to pay the general contractor. An owner may refuse to pay the general contractor or construction manager because of a defect in the work of one subcontractor, and the general contractor will remain liable to all of the other subcontractors and vendors whose work was properly performed. The general contractor can end up being the de facto banker and guarantor for the owner. In the case of Wm. Clarke Corp. v. Safeco Insurance Co. of America (95 C.D.O.S. 8031) the Court of Appeals for the Second Appellate District quoted the following contract language and expressed no skepticism or doubt regarding its validity and enforceability:

Receipt of funds by Contractor from Owner is a condition precedent to the Contractor's obligation to pay subcontractor under this Agreement, regardless of the reason for Owner's nonpayment, whether attributable to the fault of the Owner, Contractor, Subcontractor or due to any other cause. [Emphasis added in original.]

4. Nothing in this Addendum shall be interpreted as limiting Subcontractor's rights to enforce its statutory mechanic's lien rights or remedies, if any, against Project property and Subcontractor expressly agrees that such mechanics lien rights, if any, shall be its sole remedy and means for payment (regardless of whether the value [of] Project property is sufficient or insufficient, for any reasons, to satisfy Subcontractor's claim) on account of Work performed by subcontractor for which contractor has not been paid by Owner. [Emphasis added in original.]

In the Wm. Clarke Corp. case the general contractor who was really a construction manager had some doubts regarding the financial liquidity of the owner and its ability to make its payments on time, notwithstanding that there was plenty of equity in the property where the work would be performed. The purpose of the quoted language was to limit the subcontractors and vendors to their mechanic's lien rights and to eliminate their right to seek payment from the general contractor directly and leave the general contractor alone suing the owner on a mechanic's lien claims.

The general contractor also obtained a payment bond, and the issue resolved by the Court of Appeals was whether or not the language limiting the subcontractors remedies to enforcement of their mechanics lien claim meant that they could not enforce the general contractor's payment bond. The court held that the subcontractors could seek payment under the payment bond. Assuming that the surety company had a reimbursement indemnity from the general contractor, the end result was to substitute a direct claim by the subcontractors against the general contractor for a reimbursement claim by the surety company against the general contractor, for the contractor not much of an improvement.

We are recommending to our clients that the seriously consider adding language similar to that quoted from the Wm. Clarke Corp. case above in all of their contracts with subcontractors and vendors. Some subcontractors and vendors will refuse to accept such language. As discussed above, the language will provide little or no protection in situations where the general contractor is required to provide a payment bond. In most situations, such language will afford the general contractor significant protection against being squeezed between an owner who is slow to pay or is refusing to pay and a subcontractor who is entitled to payment from the general contractor even though the general contractor has not been paid.

If you would like language to add to your subcontract forms, would like to have your subcontract forms reviewed generally or have questions regarding construction contracting, mechanic's liens or performance and payment bonds, please call me.

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