New Legislation Affecting Payment Obligations
By Dean B. Thomson, Esq.
IntroductionFor several years, the Minnesota Chapter of the American Subcontractors Association ("MnASA") has been leading the efforts of a coalition of subcontractor organizations to pass a broad package of legislation governing the relationship between subcontractors and general contractors.2 Although these efforts have been largely opposed by the Minnesota Association of General Contractors ("MnAGC"), the MnASA and MnAGC were able to reach agreement on several significant aspects of the proposed legislation during the 1997 session, and a modified bill was passed into law on May 9, 1997. The new law, which applies to all construction contracts entered into after July 31, 1997, affects (1) the location of disputes and choice of law governing them; (2) lien waivers; (3) prompt payment to subcontractors; and (4) progress payment and retainages. This Briefing Paper discusses these new provisions in more detail.
Choice of Law and VenueOut-of-state general contractors entering into subcontracts with local subcontractors for projects constructed in Minnesota have, with increasing frequency, been requiring that disputes be resolved in court or arbitration hearings in the general contractor's home state. Typically, the specified venue was the general contractor's hometown. Moreover, the out-of-state general contractor often required that resolution of any dispute be governed by the laws of that general contractor's home state, rather than the laws of Minnesota.
To address this concern, the new legislation provides that: "Provisions contained in, or executed in connection with, a building and construction contract to be performed in Minnesota making the contract subject to the laws of another state or requiring that any litigation, arbitration, or other dispute resolution process on the contract occur in another state are void and unenforceable."
Although the intent of the new legislation is clear, it is debatable whether it will always be effective. Suppose a subcontractor enters into a subcontract for a Minnesota-based construction project with a New York-based general contractor, and the subcontract contains a provision requiring that any dispute be litigated in New York. If the subcontractor brings a claim in Minnesota against the general contractor, the Minnesota courts will likely hold that the requirement that the dispute be litigated in New York is void and unenforceable. On the other hand, if the general contractor initiates a suit in New York against the subcontractor, it is uncertain whether a New York court will determine that the choice of venue clause is unenforceable. While the New York court may give comity or deference to Minnesota's new law, it is not required to do so. In short, the new legislation controls only the decision of Minnesota courts, and not necessarily the decisions of courts in other jurisdictions. Thus, the location of a dispute and the law that will govern that dispute may be decided by whichever party to a dispute first files in its home state.
Even though the new legislation may not be effective in all situations, it nevertheless provides Minnesota subcontractors with significant arguments that they previously did not have to combat unfavorable venue and choice of law provisions imposed by out-of-state general contractors.
Waiver of Lien or Bond ClaimsOccasionally, lenders and large developers require that general contractors and subcontractors waive their lien rights before beginning work as a condition of obtaining a contract for construction of the project. Those involved in constructing the Mall of America will remember that such a condition was imposed in every contract and subcontract relating to that development. Of course, neither general contractors nor subcontractors appreciate being forced to waive their lien rights as a condition of obtaining work. Similarly, neither general contractors nor subcontractors favor contractual clauses that require them to waive mechanic's lien or payment bond rights before actually receiving progress payments for the services covered by the waiver.
The new legislation addresses both concerns by stating that any provision in a construction contract requiring a lien or bond waiver before being paid for the work covered by the waiver is void and unenforceable. Many third parties rely on lien waivers, however, without knowing whether or not the contractor has been paid for the work covered by the waiver. Both MnASA and MnAGC thought it was appropriate that lenders and other third parties could rely on these waivers, so the new legislation provides that: "This provision shall not affect the validity of the lien waiver as to any third party who detrimentally relies upon the lien waiver." In effect, therefore, the new legislation primarily affects the enforceability of lien and bond waivers between those making and receiving payments.
The new legislation also raises interesting questions in the context of unasserted or unresolved claims. For example, assume that in exchange for progress payments, a contractor signs full lien waivers (i.e. a waiver of all claims up to a certain date) throughout the course of a project. Also assume that the contractor's work was delayed throughout the entire duration of the project, and at the end of the project the contractor brings a delay claim against the owner. Historically, owners have argued that the full lien waivers waived the contractor's right to file a lien for this delay claim except for delay that occurred after the date of the last full lien waiver. Pursuant to the new legislation, it is not clear if the lien waiver could be enforced to bar the delay claim (as the owner would like) or if it is invalid because the contractor was not fully paid for the delay damages allegedly covered by the waiver. A carefully drafted lien release should be able to solve this problem; preferably, however, the statute should be amended to clarify the Legislature's intent.
Prompt Payment to SubcontractorsA continual complaint of subcontractors is that general contractors do not always pay subcontractors promptly after the general contractor receives payment from the owner. Accordingly, the new statute provides that any "building and construction contract must require the prime contractor and all subcontractors to promptly pay any subcontractor or material supplier contract within ten days of the prime contractor's receipt of payment from the owner or owner's agent for undisputed services provided by the subcontractor." The statute also provides that the contract require the prime contractor pay interest of 1-1/2 percent per month to the subcontractor on any undisputed amount not paid on time to the subcontractor. Finally, if the subcontractor prevails on a collection action for monies not paid according to the statute, the subcontractor "must be awarded its costs and disbursements, including attorney fees incurred in bringing the action."
The prompt payment provisions of this statute have some very sharp teeth and the potential to recover attorney's fees will ensure that they are vigorously enforced. Unfortunately, the statute's language is not a model of clarity. Note that the prime contractor and all subcontractors must promptly pay any subcontractor or material supplier within ten days of the prime contractor's receipt of payment from the owner. As a result, if the prime contractor pays its subcontractors within nine days of the prime contractor's receipt of payment from the owner, it would appear from a literal reading of the statute that the subcontractors would then only have one day to pay their lower-tier subcontractors and material suppliers. The intent of the statute presumably was to allow subcontractors the same ten-day window that is allowed general contractors after receipt of payment to make payments to lower-tier subcontractors and suppliers. Nevertheless, this presumed intent is not reflected in the statute's language.
In addition, the statute requires that every subcontract contain these payment provisions. If the subcontract fails to do so, it is unclear whether the remedy will be to impose the requirements of the statute into the subcontract or to hold that the subcontract is void. Hopefully, the statute will be amended to correct these two problems as soon as practicable.
An important exception to the legislation is that it does not apply to construction of or improvements to residential real estate consisting of one-to-four units or to construction of or improvements to structures consisting of fewer than thirteen attached single-family dwellings.
As a practical matter, the new statute does not impose any requirement different than the standard practice of most contractors. As an example, the new MnAGC standard Labor and Material Subcontract requires that the general contractor pay its subcontractors within 10 days of the general contractor's receipt of payment from the owner. Moreover, on public projects, Minnesota's prompt payment laws require that general contractors pay their subcontractors within 10 days or pay similar penalties. See Minn. Stat. § 471.425. Thus, the new statute merely imposes upon private projects the prompt payment requirements previously applicable only to public projects.
Progress Payments and RetainagesIn an attempt to make payment provisions more uniform, the new legislation requires that the owner or other persons making payments under a building contract must make progress payments monthly as the work progresses, unless the contract provides otherwise. In other words, if the parties expressly state a specific schedule of payments, the agreement will be enforced. If no schedule of payment is specified, then the owner or any other person making payment must make monthly progress payments. The amount of the payments "shall be based upon estimates of work completed as approved by the owner or the owner's agent." The statute also provides that any progress payment shall not be considered acceptance or approval of any work or waiver of any defects in the work.
The statute also limits the amount of retainage that can be withheld on a construction contract to an amount not to exceed five percent of the payment, unless the contract provides otherwise. In other words, a greater amount of retainage may be withheld if the contract expressly allows retainage of more than five percent.
These provisions highlight the importance of an effective flow-down clause in all tiers of contracts, subcontracts, and purchase orders. For instance, if the owner's contract with the general contractor specifies ten percent retainage, but the general's subcontract with the subcontractor does not contain an effective flow-down clause, then the general contractor may not be able to retain more than five percent from its subcontractor.
The statute does not expressly address whether or not more than five percent retainage can be withheld if the general contractor's or subcontractor's work is defective, behind schedule, or otherwise inadequate. Once again, this highlights the importance of an express contract provision allowing the withholding of greater than five percent if necessary to ensure proper performance. Of course, if the work is progressing satisfactorily, the statute allows the owner, at its option, to reduce the amount of retainage or eliminate the retainage altogether on any monthly contract payment.
As with the prompt payment provision discussed above, the provision regarding progress payments and retainages also does not apply to construction of or improvements to residential real estate consisting of one-to-four units or to construction of or improvements to structures consisting of fewer than thirteen attached single-family dwellings.
The laws affecting construction are constantly changing. Because the penalties for noncompliance are increasingly severe, it is important to obtain professional advice to ensure that your contract forms and business practices comply with the new requirements.
This discussion is generalized in nature and should not be considered a substitute for professional advice. © FWH&T