In This Issue

• "Pay if Paid" Provision Found Unenforceable in New York
• New ODOT Claims Procedure
• Statute of Limitations
• Surety Not Required to Mitigate Damages
• Subcontracts Battle of the Forms
• Form Subcontract Comparison
• Change Orders — Get It in Writing
• Asbestos Abatement Contractor Not Liable When Owner Sued by EPA
• Incorporation by Reference
• Firm Announcements

"Pay if Paid" Provision Found Unenforceable in New York

Donald W. Gregory
Construction
Law chair

"Pay When Paid" subcontract agreements are structured in a way that payment from the general contractor to the subcontractor is conditioned upon prior receipt of payment from the owner to the general contractor. Ordinarily, the subcontract will state that payment is due to the subcontractor within a certain period of time after receipt by the general contractor of payment from the owner. Such a conditioning of payment in a subcontract is known as a "Pay When Paid" clause.

Ohio courts have traditionally interpreted "Pay When Paid" provisions as an unconditional promise to pay, with the time of payment being postponed until the happening of a certain event, or after a reasonable period of time has elapsed if such event does not take place. Thomas J. Dyer Co. v. Bishop Int's Eng'g Co., (C.A. 6, 1962), 303 F.2d 655. That means that the general contractor must pay within a "reasonable time" if the triggering event does not occur —not that the general contractor need not ever pay the subcontractor in the event of non-payment by the owner.

However, recently many general contractors have begun inserting "Pay If Paid" provisions in their subcontracts, stating something to the effect that the subcontractor assumes the risk of non-payment by the owner and payment by the owner to the general contractor is a condition precedent to payment by the general contractor to the subcontractor. In this way, the general contractor is attempting to insulate himself from any liability to the subcontractor at any time in the event of non-payment by the owner.

Court decisions in other states have upheld the validity of "Pay If Paid" provisions if they unambiguously express the intention of the parties to shift the credit risk to the subcontractor. Southern States Masonry v. J.A. Jones Construction, (LA. 1987), 507 So. 2d 198, 206; Gulf Construction v. Self, (Tex. App. 13 Dist. 1984) 676 S.W.2d 624, 627; Statesville Roofing & Heating v. Duncan, (W.D.N.C. 1988), 702 F. Supp. 118, 121. Although no Ohio court in a reported case has yet ruled on such a "Pay If Paid" provision, it is likely that it would be found enforceable in view of the decision in the Dyer case if it clearly stated that the credit risk of the possible insolvency of the owner was being transferred from the general contractor to the subcontractor.

However, the New York District Court for the Southern District of New York recently found that such a "Pay if Paid" clause in Gilbane's subcontracts was unenforceable under New York law on a project where a payment bond was provided. This case has been appealed and is being closely watched by the industry.

Both general contractors and subcontractors must pay particular attention to the wording of these contingent payment provisions.

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New ODOT Claims Procedure

The Ohio Department of Transportation ("ODOT") is in the process of instituting a new claims process through the imposition of a new specification - Section 105.17. Pursuant to this new claims procedure, contractors will have to give the Engineer early written notice of the claim. Once the Engineer responds in writing, the contractor has ten (10) days to submit a notice of claim with the basis and nature of claim, or is deemed to waive the claim. Within ten (10) days of the notice of claim, the Contractor is to give the Engineer the estimated additional time and cost of the claim or is deemed to have waived the claim.

No later than sixty (60) days after substantially all of the Contractor's costs are known, the Contractor is to submit a detailed claim to the Engineer, or again the claim is waived. The Engineer is to then decide the claim within sixty (60) days after submission.

If the Contractor is unsatisfied with the Engineer's decision, he must appeal to a newly created Director's Claim Board within twenty (20) days who shall make a decision, in most cases, within thirty (30) days after the hearing. Only after the Claim Board decision can the Contractor file suit in the Court of Claims.

The time and notice restraints of this new procedure provide significant procedural traps for unwary highway Contractors.

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Statute of Limitations

Under Ohio law, there is considerable confusion as to what period of time a person has to file suit (the "statute of limitations") for construction defects. In Drater v. Willard Constr. Co. (1994), 93 Ohio App.3d 443, the Court of Appeals for Lorain County struggled with this issue and found that the owner had only:

1. Two years from the date the claim arose for damage to personal property; and

2. Four years from the date the claim arose for damage to real estate to file a lawsuit, even if the suit was filed timely within Ohio's 10 year "statute of repose."

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Surety Not Required to Mitigate Damages

In a case favorable to bonding companies and unfavorable to contractors or subcontractors providing bonds, the Court of Appeals for Hamilton County held that a surety had no obligation to mitigate its principal's damages under an indemnity agreement by attempting to collect payment for work performed prior to the principal/contractor's default. Four Seasons Environmental v. Westfield (1994), 93 Ohio App.3d 157.

This case gives bonding companies considerable latitude in deciding what action to take or not when a contractor defaults, while still retaining the ability to recoup its loss from the contractor and its owners who signed the indemnity agreement.

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Subcontracts Battle of the Forms

There are several forms of subcontracts commonly used by general contractors and subcontractors in the construction industry. Starting with the most favorable to subcontractors and moving to the least favorable would be:

1. AIA A401 - Endorsed by ASA, but has never been accepted by AGC. Envisions important role but little liability exposure for architect.

2. AGC 640/ASA 4100/ASC 52 - Endorsed by all 3 of these organizations, it is a reasonable compromise between contractor and subcontractor interests.

3. AGC 600 - This subcontract formerly endorsed by AGC, has never been accepted by ASA.

4. Proprietary forms - These in-house proprietary forms are typically used by large general contractors whenever possible and are generally the least favorable to subcontractors.

A summary of the key components of the three generally accepted trade association subcontracts is as follows:

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Form Subcontract Comparison

*All cites refer to sections in form contract except those marked A201 which refers to A201 general conditions which may be incorporated into the AIA 401.

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Change Orders — Get It in Writing

A constant source of disagreement between owners, contractors and subcontractors is entitlement and amount of change orders. The following issues need to be kept in mind from the initial contractual negotiations through to contract close-out.

1. What does the contract provide with respect to advance notice, in writing, etc.?
2. Can you be forced to perform extra work without an agreement?
3. Who has the authority to sign a change order?
4. Are you, if a subcontractor, limited to the contractor's remedies against the owner?
5. By receipt of a change order, have you closed out any delay claims for the cumulative effect of multiple changes?

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Asbestos Abatement Contractor Not Liable When Owner Sued by EPA

In a case of great concern to property owners and managers, a trial court in Montgomery County has ruled in the case of Beerman Realty Co., v. Alloyd Asbestos Abatement Co. (Case No. 93-3440) that an owner has no right to recover attorney's fees and its EPA fine against a contractor who allegedly failed to abate asbestos consistent with the Clean Air Act. The Court ruled that each party was responsible for its own attorney's fees and fines, and interestingly, that any indemnity provision shifting this risk to the contractor would be unenforceable. It is the latter position that is most troubling to owners, who have traditionally attempted to shift the risk of regulatory compliance to the person actually performing the work by such an indemnity provision in the prime contract. The case is currently on appeal.

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Incorporation by Reference

It has become typical in the construction industry for prime contract terms to be incorporated into subcontracts by reference, thereby binding the subcontractor to the prime contractor's obligations. This practice has been upheld by many courts recently, resulting in occasional hardship to subcontractors. In a case out of Mississippi, the appellate court determined that when the owner made final payment to the contractor, the subcontractor's claims were also released because of a provision in the prime contract (incorporated into the subcontract by reference) which stated that final payment to the prime contractor constituted a release of all claims.

In a case from Washington, the appellate court ruled that an incorporation clause meant that a subcontractor was bound to arbitration as a remedy if the prime contractor was bound to arbitrate its disputes with the owner.

In view of these decisions, it is more important than ever for subcontractors or suppliers to become familiar with the terms of the prime contract governing the project.

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Firm Announcements

Congratulations to Ted Scott and Jud Scheaf of the Construction Law Area who have become directors with the firm.

The net proceeds of the Construction/Labor Law Seminar held in the Spring have been donated to the Columbus Housing Partnership, a non-profit association providing housing for low income families.

Congratulations to Don Gregory who was the only attorney named to Business First's 1994 list of "Who's Who in Central Ohio Construction, Architecture & Engineering."

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Credits

Kegler, Brown, Hill & Ritter's Construction Law Newsletter is prepared by Donald W. Gregory for the Construction Law practice group.

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