by Michael L. Chapman

Allocating the Risks of Nonpayment

Experienced contractors know that one of their primary risks is nonpayment from the owner. There are many reasons why contractors experience this risk, ranging from dissatisfaction with the contractor's work, untimely performance, owner insolvency, as well as a host of other reasons.

Recognizing that this risk as a real one, contractors attempt to share this risk with their construction partners by allocating the risk of nonpayment to their subcontractors and suppliers. This allocation can take a variety of forms, and includes such common devices as pay-when-paid clauses and liquidating agreements which limit a subcontractor's right of recovery against the general contractor.

Public policy considerations also play a role, and subcontractors and suppliers have not hesitated to use their clout with the Georgia General Assembly to obtain favorable prompt payment legisations and statutory interest and penalties for the refusal to promptly pay undisputed pay applications.

The General Assembly has responded to the corresponding need of general contractors to protect themselves from unforeseen claims by requiring the use of standard lien waiver forms for both public and private construction projects.

A useful introduction into the various issues raised by payment allocation clauses is a review of the standard AIA and AGC payment clauses.

Contingent Payment Clauses

Contingent payment clauses make the right to receive payment for work performed contingent upon the happening of some event, usually the receipt of full payment by the party making payment. Problems occur when the party making payment does not receive payment through no fault of the party expecting to receive payment. For example, a subcontractor who has fully and properly performed may not receive payment from a general contractor due to the fault of the general contractor, another subcontractor or supplier who have defaulted on some aspect of their performance, thereby authorizing the owner to withhold payment from the general contractor. Thus, the innocent subcontractor suffers non-payment due to the performance problems unrelated to their own work.

The courts in some jurisdictions interpret contingent payment clauses to mean that the contractor must make payment within a reasonable time, but the Georgia courts have not followed this liberal trend. In Georgia, a pay-when-paid or pay-if-paid clause is fully enforceable. Sasser & Co. v. Griffin, 133 Ga. App. 83, 210 S.E.2d 34 (1974).

A pay-when-paid clause in a subcontractor's contract may be circumvented where the court finds that a oral agreement apart from the written contract supports the claim. Excavators and Erectors, Inc. v. Bullard Engineers, Inc., 489 F.2d 318 (5th Cir. 1973).

Dealing with contingent payment clauses is a frequent headache for subcontractors. Contingent payment clauses, sometimes called "pay when paid" clauses, make payment provisional upon some contingency, usually the owner's payment to the general contractor. In their worst form, payment is due to the subcontractor "if and only if" or "upon the express condition precedent" that the general contractor has been paid by the owner.

In effect, contingent payment clauses make subcontractors bear numerous risks completely unrelated to their own performance. Delayed approval of applications for payment by the architect, cash flow problems, pending and unpaid claims, and defective performance by other subcontractors all may prevent payment to the general contractor through no fault of the subcontractor. The resulting delay in payment impairs the subcontractor's credit rating, depletes operating capital and lines of credit, and hurts the subcontractor's relationships with its own trade creditors. Even worse, contingent payment clauses compel subcontractors to continue to work even though they have not been paid.

Contingent payment clauses also raise many practical problems. For example, how is a subcontractor to know when or how much the general contractor has been paid? What happens if the general contractor is paid only part of its last application for payment? If a contingent payment clause gives the general contractor a choice, will the general contractor pay the subcontractor who already has performed or the subcontractor who still has work left to do on the project?

Fortunately, most courts hold that contingent payment clauses only permit the postponement of payment for a "reasonable time." Such rulings are based on the belief that the parties did not intend to make payment to the general contractor an express "condition precedent" to the subcontractor's payment. For the most part, however, courts have not held that these clauses are void as "unconscionable" or "against public policy." Indeed, the courts in a number of jurisdictions routinely enforce contingent payment clauses, particularly when the parties clearly express their intention to make the subcontractor's entitlement to payment conditioned upon the general's own payment from the owner. Even worse, the general contractor or its surety may use a contingent payment clause as an excuse not to pay a subcontractor, even if the clause wouldn't hold up in court.

What should you do when you encounter a contingent payment clause in a proposed subcontract? Entirely avoiding contingent payment clauses obviously is the best approach, so strike the clause from your subcontracts wherever possible. Most standard form subcontracts do not contain contingent payment clauses, so another approach is to suggest the use of one of these forms as an alternative to the general contractor's own form subcontract. Describing how the clause could be abused is often a useful method for illustrating your concerns. Try to negotiate the clause out of the deal by stressing the importance of a neutral and reasonable subcontract. Emphasize the desire for a long-term relationship with the general contractor. If appropriate, try to negotiate a standard form of agreement with the general contractor for use on all future work with that contractor.

A slightly different approach is necessary for contingent payment clauses in subcontracts attached to a bid package. One option is to submit a request for a modification of the clause prior to bidding the job. Another option is to submit the bid subject to a mutually agreeable modification of the contingent payment clause. Careful phrasing of any exception to the standard bid package is necessary in order to avoid rejection of the bid as non-responsive.

In either bid or negotiated work, if you are not successful in striking out the clause entirely some other modifications of the clause may be helpful. The simplest modification is to state that the contingent payment clause applies only for a limited period of time, perhaps up to thirty or sixty days. Any limit is better than an open-ended clause. Try to add a specific date when payment normally is due, even if payment on that date is contingent upon payment from the owner to the general contractor. Try adding a proviso that the clause may be enforced only if there is some defect in your own performance which causes the payment to the general contractor to be withheld. Create an exception to the contingent payment clause for suitably stored materials delivered to the site.

If all else fails, try to negotiate the insertion of a clause stating that payment will be made within a "reasonable time." This preserves your entitlement to payment and makes clear that the parties do not intend to completely foreclose payment in the event that the general contractor is not paid by the owner.

Carefully check other provisions of the subcontract to see that your lien and bond rights are preserved. Add a clause permitting you to stop work if you have not been paid. Be sure that your final payment is not conditioned upon the architect's approval of the entire project. Obviously, you do not want your final payment delayed or even entirely eliminated due to problems caused by others.

Despite your best efforts you may be forced to live with a contingent payment clause. In those circumstances, you should carefully review your projected cash flow and look for opportunities to front-end load the project. Check out the reputation of the owner through Dun & Bradstreet or other credit reports. Some other helpful sources of information which are often overlooked include the "suits filed" index and the mechanic's lien index at your local courthouse. Ask the general contractor to verify financial information from the owner pursuant to Article 2.2.1 of the AIA General Conditions A201, if that form is applicable to the project. Even if the general contractor doesn't comply with your request, the fact that you asked could be helpful to your case later on.

What if the general contractor attempts to enforce the contingent payment clause against you? You have several options. Obviously, you should strongly argue that the contingent payment clause was not intended to completely foreclose your right to be paid. Argue that this interpretation of the clause violates prompt pay or unfair business practices acts, if either or both exist in your state and apply to your contract. Also, try complaining about any unfair application of the clause to the appropriate licensing board, MBE board, the architect, or the owner. When you get to this stage it is time to be a "squeaky wheel."

Fortunately, even with a contingent payment clause in the subcontract most states allow a subcontractor to file a lien or assert a claim against the general contractor's payment bond. If, however, the contingent payment clause makes the general contractor's payment obligation to you expressly conditioned upon receipt of payment from the owner, then you may be out of luck. In that situation, an unjust enrichment or quantum meruit suit for the value of labor and materials provided to the project may be an option. These claims are equitable in nature and thus may not be subject to the contingent payment clause defense.

Contingent payment clauses are a fact of life for most subcontractors. Dealing with them successfully may mean the difference between survival and death of your business. Treat them with the respect that they deserve.

Liquidating Agreements

A liquidating agreement is an agreement between a general contractor and a subcontractor which provides for the payment of the subcontractor's claim from a recovery made from a third party, usually the owner. These agreements sometimes permit the subcontractor to assert the claim against the owner in the name of the general contractor, but more often they provide that the general contractor will assert the claim and will pay the subcontractor such amounts as the general contractor recovers from the owner on the claim.

In Georgia, the principal problem with such agreements is the issue of whether the obligation to the subcontractor is actually owed as a result of the liquidating agreement. The Georgia courts have disallowed liquidating agreement which do not clearly make the general contractor liable to the subcontractor for the claim asserted against the owner.

Claims are sometimes settled by the use of "pass-through" or "liquidating" agreements. Often, these agreements permit a subcontractor to assert a claim in the name of the general contractor against the owner, or require the general contractor to assert claims on behalf of a subcontractor, or assign contract rights or causes of action. In exchange for the agreement to prosecute the claim, the subcontractor usually agrees to accept whatever is recovered by the general contractor in satisfaction of the claim.

The legal basis for these agreements has been challenged where the pass-through agreement makes it uncertain whether the general contractor is actually responsible to the subcontractor for the damages asserted in the pass-through claim. It is not sufficient for a general contractor to show that its subcontractor has sustained damage without going further and showing that the general contractor has some responsibility to the subcontractor for those damages. Department of Transportation v. Claussen Paving Co., 246 Ga. 807, 273 S.E.2d 161 (1980).

This is to be distinguished from pass-through agreements where the general contractor's obligation to pay the recovery on the claim to the subcontractor is made clear. In such cases the pass-though claim may be properly asserted by the general contractor on behalf of the subcontractor. Raymer v. Foster & Cooper, Inc., 195 Ga. App. 200, 393 S.E.2d 49 (1990).
 

Payment on Public Projects

Due to the bureaucratic nature of contract administration on public projects contractors frequently encounter serious delays in receiving payment from public owners.
 

--Prompt Payment Legislation

In 1994 Georgia adopted prompt pay legislation which is expected to significantly affect the way in which payment is made on public projects in Georgia.

The General Assembly had earlier passed legislation providing for prompt payment for Utility Contractors under certain limited sets of circumstances.
 

 --Retainage Regulation
 

The Right to Withhold Payment
 

Joint Payment Rights

Suppliers frequently encounter situations in which joint checks (sometimes called "two-party" checks) are issued payable to both the supplier and a subcontractor. Joint checks also may be used where a contractor is faced with a thinly capitalized subcontractor, and the sub's bank insists on the issuance of check made payable jointly to the sub and the bank. Occasionally, a surety may require that checks be made payable both to the surety and its principal, or may itself issue joint checks to third parties making claim on a payment bond. Although the use of joint checks is common, surprising results may occur if care is not used to properly handle a joint check.

What is a joint check? A joint check is considered to be any check made payable to two or more parties (called "payees"). The effect of a joint check differs depending upon how the check is made out. A check payable to "John Doe and John Smith" is a check made payable to joint payees and must be endorsed by both of them before being cashed. A check made payable to "John Doe and/or John Smith" is made payable to alternative payees, and may be cashed by either of them without the signature of the other. Most contractors will be surprised to know that a check made payable to "John Doe/John Smith" also is made payable to alternative payees and may be cashed by either one of them. Ryland Group, Inc. v. Gwinnett County Bank, 151 Ga. App. 148, 259 S.E.2d 152 (1979).

Joint checks normally are issued pursuant to a formal joint check agreement. The joint check agreement may be made by a contract (Williams v. McCoy Lumber Industries, Inc., 146 Ga. App. 380, 246 S.E.2d 410 (1978)); by letter agreement (Century Engineering and Construction, Inc. v. American Olean Tile Co., 172 Ga. App. 769, 324 S.E.2d 591 (1984)); or by an oral agreement (All-Phase Electric Supply Company v. Transamerican Insurance Company, 162 Ga. App. 104, 290 S.E.2d 208 (1982)).

It is important to remember that a joint check agreement must have consideration in order to be valid. A mere "naked promise" to include a party on a joint check does not create a valid obligation to comply with the promise. Trust Company of Columbus v. Rhodes, 144 Ga. App. 816, 242 S.E.2d 738 (1978). Forbearance from rescinding a contract or forbearance from suing for a breach of contract does, however, constitute sufficient consideration for a joint check agreement. Mann Electric Co. v. Webco Southern Corp., 194 Ga. App. 541, 390 S.E.2d 905 (1990).

A joint check agreement does not automatically make the party agreeing to issue the joint check a surety or guarantor of payment for labor and materials delivered to a job. Century Engineering & Construction, Inc. v. American Olean Tile Company, 172 Ga. App. 769, 324 S.E.2d 591 (1984); All-Phase Electric Supply Company v. Transamerican Insurance Company, 162 Ga. App. 104, 290 S.E.2d 208 (1982); Williams v. McCoy Lumber Industries, Inc., 146 Ga. App. 380, 246 S.E.2d 410 (1978).

What should be considered before a joint check agreement is signed? First, the prudent contractor or supplier should remember to preserve all lien rights. A joint check agreement should be carefully reviewed to determine whether it contains a lien waiver, lien release, or lien subordination limiting the right to file a lien. Certainly consider filing a lien unless adequate assurance of payment is received from the co-payee or suitable arrangements are made for direct payment by the owner before your lien rights expire.

Second, be sure to check every joint check agreement for time limits, notice requirements, or any dollar limit on the total amount of joint checks which will be issued.

Third, from the contractor or supplier's standpoint, it is beneficial if the joint check agreement contains a guaranty arrangement assuring the joint payee of payment in the event of a default by the co-payee. Owners usually will object to such an arrangement on the grounds that they have no effective control over the co-payee. Despite that objection, a guaranty agreement may be negotiated where the owner has need of specially fabricated equipment, material, or labor, or where timely delivery is possible only from a particular contractor or supplier. Negotiating leverage is much stronger before delivery than after.

Another frequently encountered problem is the endorsement of joint checks. There are numerous endorsement problems, including forged endorsements, missing endorsement of a joint payee, or obliteration of the joint payee's name from the check.

A forged endorsement occurs when the joint payee's name is fraudulently signed by the co-payee of a joint check. Falsely endorsing a joint check in this fashion constitutes the criminal act of forgery. Oldham v. State, 179 Ga. App. 730, 347 S.E.2d 698 (1986).

A more common problem is the attempt to cash a check without the endorsement of one of the joint payees. A check payable to joint payees must be endorsed by all of them. O.C.G.A. § 11-3-116(b). A bank which is presented with a joint check endorsed by only one of the payees normally will refuse payment of the check. Where, however, a bank cashes a check endorsed by only one of two joint payees, then the bank, the payor, and the payor's surety (if any) all are liable to the non-signing payee. Insurance Company of North America v. Atlas Supply Company, 121 Ga. App. 1, 172 S.E.2d 632 (1970); Refrigeration Supplies, Inc. v. Bartley, 144 Ga. App. 141, 240 S.E.2d 566 (1977); Citizens and Southern National Bank v. Sun Belt Electrical Constructors, Inc. (In re Sun Belt Electrical Constructors, Inc.), 64 B.R. 377 (N.D. Ga. 1986). See Annot., 47 A.L.R.3d 537 (1973). A bank does, however, have the limited right to add an endorsement of its own depositor where the check is being deposited to that depositor's account. See O.C.G.A. § 11-4-205.

What happens if the names of joint payees are scratched off by the depositor? Again, if all of the payees on a joint check have not endorsed the check, then the bank should refuse to pay the check. It makes no difference that one of the names on a joint check has been scratched off by the depositor. Where a bank accepts a check where the name of a joint payee is obliterated from the check, then the bank accepting the check will be liable for its failure to dishonor the check. First National Bank of St. Paul v. Trust Company of Cobb County, 510 F.Supp. 651 (N.D. Ga. 1981).

What if you are the issuer of a check that is improperly cashed without proper endorsement? The issuer of a joint check has a duty to examine the joint check when it is returned by the bank in order to verify that it is properly endorsed. In most states, there is a one-year limitation period on reporting improper payment due to a missing endorsement. Claims made against the bank after that one-year period are untimely. Trust Company Bank v. Atlanta IBM Employees Federal Credit Union, 245 Ga. 262, 264 S.E.2d 202 (1980).

The issuer of a joint check also should issue remittance instructions indicating how the funds paid by the joint check are to be allocated. Without such instructions, the payee may apply the funds received to any debt of the payor. Piedmont Engineering & Construction Corp. v. Hanna Paint Company, 95 Ga. App. 605, 98 S.E.2d 137 (1955). This could mean that the payment could be directed to a debt other than the one for which the check was intended. This leaves open the possibility of double payments due to mechanic's liens or claims against a payment bond.

Similarly, if the joint payee does not object, the co-payee may allocate funds (as between the two) in any manner he wishes. Lewis v. Sherwin Williams Company, 141 Ga. App. 53, 232 S.E.2d 392 (1977). Thus, the payment could be directed to old invoices, interest, or to debt on unrelated projects. This could expose the joint payee to liability to the issuer of the joint check, particularly where the co-payee asserts valid lien or bond rights against the issuer of the joint check.

As a result of these problems, many jurisdictions follow the "Joint Check Rule." Under the Joint Check Rule, a supplier endorsing a joint check without collecting the proceeds of the check is barred from asserting a lien or bond claim based on that debt. This rule is based on the understanding that a joint check arrangement is designed to protect the issuer of the joint check from the supplier's claim, to protect the supplier by ensuring payment, and to protect the owner from potential lien claims. The reasoning behind the rule varies from jurisdiction to jurisdiction, but usually is based upon the legal defenses of payment, release, waiver, or estoppel.

In contrast, a refusal to accept a joint check usually does not bar the subcontractor from filing a lien or asserting a claim against a payment bond. This is because the mere issuance of the check does not constitute payment. Without both endorsements, a joint check is for all practical purposes a non-negotiable instrument. Piedmont Engineering & Construction Corp. v. Amps Electric Co., Inc., 162 Ga. App. 564, 292 S.E.2d 411 (1982).

What is the effect of the bankruptcy of one of the joint payees? Difficulties frequently encountered in this are include possible preference problems for payments received within ninety days of the filing of the bankruptcy petition, the problems of handling checks which the bankrupt joint-payee has not yet signed, and the problems associated with a two-party check issued in satisfaction of pre-petition shipments.

With respect to preference problems, a debtor filing for bankruptcy is presumed to be insolvent during the ninety-day period preceding the bankruptcy filing. Joint checks cashed during this period may be challenged as preferential payments, and a joint payee may be asked to return money received from joint checks to the debtor's bankruptcy estate. In jurisdictions with construction trust fund statutes, or in jurisdictions where courts recognize the construction trust fund theory on equitable grounds, the joint payee usually will prevail against the trustee. Bethlehem Steel Corporation v. Tidwell, 66 B.R. 932 (M.D. Ga. 1986).

In states without the protection of an express or implied construction trust fund doctrine, this result is much less certain. In those states, the joint payee must establish an exception to the preference or else return the funds to the bankruptcy estate. Accordingly, in these states a party receiving a joint check should always be mindful of the fact that funds received by way of a joint check may be lost as an avoidable preference at a later date.

A related problem occurs where a joint check has been issued but where it has not been signed by the debtor. The courts in trust fund jurisdictions have treated the obligation to sign a joint check as an "executory contract" which the debtor must either accept or reject. In this situation the debtor usually will be encouraged or even directed to sign the joint check, particularly where payment of the check will result in the satisfaction of a claim against the bankruptcy estate. In re Sun Belt Electrical Constructors, Inc., 56 B.R. 686 (N.D. Ga. 1986). Jordan Company v. Bethlehem Steel Corporation, 309 F. Supp. 148 (S.D. Ga. 1970).

With respect to the problem of post-petition payments made by a joint check, the bankruptcy court normally will have to deal with the tension between the cash collateral security interest of the debtor's bank as opposed to the claims against the bankruptcy estate by the co-payee. The debtor's bank normally secures loans to the debtor through a security interest taken on the debtor's inventory. Joint checks issued by an owner thus will be considered by the debtor's bank as "cash collateral" arising from the sale of inventory on which it has a security interest. In this situation, most courts find that the bank cannot claim a cash collateral security interest in these proceeds because the funds never become part of the debtor's bankruptcy estate. First Bulloch Bank & Trust Company v. Inca Materials, Inc. (Inca Materials, Inc.), 880 F.2d 1307 (11th Cir. 1989).

Problems associated with joint checks can be avoided if they are anticipated and handled properly when they arise. Joint checks are a useful device to assure payment is received by the proper parties and is not diverted for improper purposes. Proper preparation, endorsement, and the use of allocation instructions will avoid most joint check problems.
 

Bankruptcy Implications

Bankruptcy of the owner, general contractor, subcontractor or supplier may complicate or defeat the payment rights of the various parties. The two primary vehicles for bankruptcy filings which are usually encountered on a construction project are a Chapter 11 Reorganization or a Chapter 7 Liquidation. In either case, the filing of bankruptcy by a party results in the entry of an automatic stay which severely restricts the opportunity to take legal action against the filing party, called the "debtor."

When a subcontractor or supplier files bankruptcy, the general contractor usually seeks to lift the automatic stay in order to terminate the debtor's contract or to seek adequate assurance that the debtor can complete the contract.

When a general contractor files bankruptcy, the owner usually looks to the general contractor's performance and payment bond surety, if the work has been bonded. If the work has not been bonded, the owner may seek to lift the automatic stay or seek adequate assurance of performance.

Under these circumstances, subcontractors and suppliers who have not been paid usually protect their right to payment by filing a lien claim. Such filings do not violate the automatic stay because under Georgia law the filing of a lien claim merely perfects an inchoate right existing prior to the filing of the bankruptcy, and federal law permits such perfection of preexisting security interests.

What does it mean when a company "goes bankrupt"? The right to declare bankruptcy is protected in the U.S. Constitution, and federal law controls all aspects of the process. There are three main types of bankruptcy that are relevant to contractors. Chapter 13, or "wage earner" bankruptcy, is the most common type of bankruptcy, but more than likely it will not be relevant to your situation since most contractors are incorporated. Corporations can't "go Chapter 13." Instead, corporations declare bankruptcy through Chapter 11 "reorganizations" or Chapter 7 "liquidations." As their names imply, the Chapter 11 reorganization is intended to keep the bankrupt company in business by reorganizing or restructuring the company's debt. Unfortunately, most Chapter 11 proceedings end up being converted into Chapter 7 liquidations, where the company simply portions out its assets to its creditors and shuts down.

With this background in mind, the first thing you should do after learning your customer has declared bankruptcy is to determine the case number of the bankruptcy proceeding and the bankruptcy court in which the proceeding has been filed. Your attorney can then determine whether the bankruptcy is a Chapter 11 or Chapter 7 proceeding.

Resist the temptation to immediately send your customer a default letter. Many construction contracts have bankruptcy provisions stating that bankruptcy constitutes an automatic default under the contract, but these contract terms are not enforceable and are void under federal law. If you place your customer in default, seize the company's tools, equipment and stored materials, or throw the company off the job, you probably have violated the "automatic stay" provisions of the bankruptcy code and are subject to severe penalties.

You can seek relief from the automatic stay by applying to the bankruptcy court. You also may file an application with the bankruptcy court for the bankrupt company (called the "debtor") to assume the remaining portions of your contract and to provide you with "adequate assurance" of future performance. If your contract is assumed by the debtor it becomes a "post-petition obligation" of the debtor and may be treated like any other contract.

While it sounds complicated, the logic behind all of this is simple. The main objective of bankruptcy proceedings is to see that what is left of the debtor's assets is put to the best possible use. A Debtor's assets could include cash (if any), as well as contracts in progress, tools and materials necessary to complete those contracts, and claims against third parties (hopefully not you). The debtor will propose a plan to the bankruptcy court about how to best use the assets of the bankruptcy estate, and the debtor normally will be given the right to continue to use the assets as a "debtor in possession" of the assets. Your unilateral attempt to take any of the assets of the debtor's estate possibly would disrupt the plan, particularly if the debtor was looking to the juicy profit in your contract as one of the main assets of the bankruptcy estate.

A liquidation under Chapter 7 contains a few additional twists. Here, the main objective of the bankruptcy is to distribute the available assets of the debtor in the fairest way possible. Since the debtor is liquidating assets and not attempting to continue in business, your main objective should be to secure your claims by filing a "proof of claim" in the bankruptcy court and by protecting any "security interest" you may have in the assets of the debtor's estate.

It helps to anticipate the possibility of bankruptcy beforehand. Knowing of this risk, you should place a bankruptcy clause in your contracts and purchase orders which is enforceable. This clause must set out objective grounds for a default other than the mere declaration of bankruptcy. Thus, while you cannot throw a company off the job simply because it declares, bankruptcy, you can take steps to do that through the bankruptcy court where your contract permits a termination for failure to properly man the job, to make adequate progress, or to pay its subs and suppliers. Spelling out these actions as grounds for default in your contract makes life much easier after a bankruptcy filing.

If your general contractor declares bankruptcy, similar rules apply. Ideally, you will be able to look to the general's bonding company for payment, and you should put the bonding company on notice just as soon as possible. Likewise, don't forget your lien rights against the property. This remedy is particularly helpful if an owner declares bankruptcy. Similarly, remember that the owner's bankruptcy may not prevent you from collecting your applications for payment from the general contractor. Your success will depend on whether the general contractor placed a contingent payment clause in your contract and whether such clauses are enforced in your state. Your lawyer can help you work out the best approach to collect your money in this situation.

If a key supplier files bankruptcy, the question that will be before the bankruptcy is whether the contract is a "executory contract." Executory contracts are not defined in the bankruptcy code, but may generally be considered to be contracts which have yet to be performed by the debtor and which will be assumed or rejected by the debtor in the course of the bankruptcy proceeding. The option of rejecting the contract purely on the grounds of the bankruptcy is not available to you because this action would violate the automatic stay.

Unless you seek relief from the automatic stay, the debtor may wait until its final plan of reorganization is confirmed before your contract is accepted or rejected. This delay may be unacceptable to you, and for this reason the bankruptcy code provides for relief from the automatic stay in order to terminate the contract.

Unfortunately, you may find yourself in the situation where the contractor has not yet reached the point where its performance is due. Nevertheless, you know that because of the bankruptcy the probability of receiving the goods you ordered is remote. In that event, the bankruptcy code allows you to seek assumption of rejection of the contract within a reasonable time. if the contract is assumed, the debtor must secure past defaults and provide adequate assurance of future performance.

Remember that the debtor may be viewing your contract as a source of considerable profits for the reorganized company. Likewise, do not assume that just because your supplier has declared bankruptcy there is no opportunity for the debtor to perform its contract. Accordingly, do not make the mistake of terminating the contract purely on the basis of the bankruptcy. If you do so, you are exposing your own company to a suit for damages by the debtor in addition to the risk that you will be held in contempt for violating the automatic stay.

In the event that your supplier is dissolving under Chapter 7 of the bankruptcy code, executory contracts will be assumed or rejected by the bankruptcy trustee within sixty days. If no action occurs, the contract is deemed rejected and you may file a proof of claim with the bankruptcy court for your damages. Unless the estate of the debtor is substantial, you will not receive much money from such an unsecured claim.

Regardless of whether the case is proceeding under Chapter 7 or Chapter 11, you certainly should file a proof of claim in the case, even if you do nothing further. Unless the proof of claim is disputed by the debtor, your claim will be accepted by the bankruptcy court. Depending on whether your claim is secured or unsecured, various options are available to the bankruptcy court. Secured creditors are ordinarily in a better position than unsecured creditors, but that is not always the case. The bankruptcy court has broad powers to take action on proofs of claim in order to secure the best interest of all concerned.

In large cases, it is common for the bankruptcy court to create creditors committees to determine how various categories of claims should be treated. There are certain advantages to serving on the creditors' committee, particularly if your claim is large. Under certain circumstances, professional fees associated with work on a creditors' committee may be reimbursed as an administrative expense out of the estate of the debtor. In order to recover such expenses, the bankruptcy court will ordinarily insist on proof that participation in the creditors' committee has resulted in a substantial contribution to the proceeding. Various legal issues are crucial in determining whether participation in the work of the creditors' committee is advantageous. Compensation is not automatic, and participation in the work of the committee can result in legal conflicts of interest and the possibility of waiving attorney/client privilege. These factors must be carefully waived before making a decision about participating on a creditors' committee.

The practical concerns of a bankruptcy filing require immediate action on the part of a prudent contractor. Depending on the type of bankruptcy filing involved, the contractor has many options available in the wake of a bankruptcy filing by its customer/supplier. Great care should be taken to avoid violating the automatic stay provisions of the bankruptcy code, but even within the limitations of the automatic stay, steps can be taken to protect the interest of the contractor. These steps will enable the contractors to secure the best result in a bad situation.
 

Supplier Rights and Remedies
 

Bad Faith Refusal to Pay
 

Allocating Payments Among Debts

A common dispute which arises on construction projects is the question of how payments are to be allocated among debts. For example, if several invoices are owed and a partial payment is received, which of the invoices are deemed paid? Similarly, may claims on one project be offset against amounts owed on another projet?
 

Lender Liability

Lenders have been sued with great frequency in Georgia, but few victories have been achieved by the claimants. Under a variety of circumstances, lenders have been alleged to be liable to unpaid contractors, general contractors, and suppliers. See Malloy v. Planters Warehouse & Lumber Company, Inc., 142 Ga. App. 69, 234 S.E.2d 807 (1977); Williams v. Chatham Real Estate Company, 13 Ga. App. 42, 78 S.E. 869 (1913); Gillis v. B.L.I. Construction Company, Inc., 148 Ga. App. 527, 251 S.E.2d 800 (1978); First Florida Building Corporation v. Smith, 530 F. Supp. 496 (N.D.Ga. 1982). For the most part, such suits have been unsuccessful in Georgia.

Claimants should consider the possibility of requiring lenders to "marshall assets." See Annot., 76 A.L.R.3d 326 (1977).

Cases in other jurisdictions raise the issue of whether the lender has a duty, in disbursing funds, to protect the mortgagor against outstanding or potential liens against the mortgaged property. See Annot., 30 A.L.R.4th 134 (1989).

Lenders are most often sued for unjust enrichment caused by their foreclosure on projects which have been fully or partially completed but for which payment has not been received by the general contractor. For the most part, these suits have been unsuccessful unless the lien rights of the general contractor protect the general contractor's recovery.

Subcontractors are restricted to their lien rights and cannot sue a foreclosing lender for unjust enrichment, even if the subcontractors have not been paid.

One key to a successful lien recovery is determining the date upon which the contractor begain work on the project. Georgia law provides that the priority of a lien claim dates from the time the lien claimant begain work on the project, not the date of the filing of the lien. If the lien claimant begain work before the lender recorded its security deed, then the lien claim may take priority over the interest of the foreclosing lender.

Lender may be sued on other grounds. One common suit arises from the alleged promise to pay the general contractor if a troubled project is completed. The lender typically will defend against such claims by claiming that the suit is barred by the statute of frauds, which prohibits the enforcement of a promise to pay for the debt of another unless such promise is in writing. The lender will assert that the bank's promise to pay is really an agreement to pay for the debt of the developer, not a promise by the bank to pay for its own independent obligation.

If an authorized agent or officer of the lender has expressly agreed to pay a general contractor if a project is completed, then the lender may be estopped by its conduct from denying the obligation to pay the general contractor.
 

Insurance Claims

Receiving payment for insurance claims can be a frustrating experience for contractors. Complex claims forms, coverage disputes, and arguments over the valuation of claims can result in protracted delays in settling insurance claims.

Proper processing of an insurance claim requires the verification of coverage, a determination that there are no applicable exclusions under the policy, and compliance with the procedural requirements of the insurance contract.

When filing an insurance claim, the first step is to examine the policy for coverage. Insurance policies are often issued with a cover page, often called a "delarations page," which sets out the insurance coverage available under the policy. The basic coverage set out in the policy may be supplemented by "endorsements" to the main policy which provide additional insurance protection in exchange for an additional premium.

Next, the exclusions of the policy should be closely examined. Insurers must carefully define the risk they bear in order to determine what premium must be charged to cover the exposure to that risk. Exclusions are an attempt by the insurance company to more precisely define and limit the scope of the insurance coverage. In certain policies, exclusions may be removed by the addition of an endorsement which removes that exclusion from the policy.

If the policy contains insurance coverage for the event giving rise to the loss, and this coverage is not removed by an exclusion, then the policy conditions should be reviewed and followed when submitting the claim. Policy conditions usually define the circumstance under which the claim will be processed. The policy conditions may require the claim to be submitted in writing, and may define the outside time limit for a claim filing, which often is one year from the date of the occurance giving rise to the claim. Prompt reporting of the claim is a requirement of most insurance contract. This provision is included in the policy so that the insurer can be given notice of the claim in time for a timely investigation of the claim to occur. A delays in the reporting of a claim may give an insurance company grounds to deny coverage.

Most claims are reported by telephone to the agent who issued the insurance policy, although the policy should be checked to see if a different form of reporting is required. The agent usually will send forms to the claimant which must be filled out and filed in order to process the claim. Most policies give the insurance company the right to take a recorded statement from the insured. This statment may or may not be taken under oath. Often the statement is taken over the telephone, but in serious cases a formal deposition may be scheduled.

The insurer usually will investigate the claim, and may send an adjuster out to the site to take pictures and interview witnesses. It is important to cooperate with the insurance company's investigation. A failure to cooperate with the insurer may give the company the right to deny coverage.

Investigation of a serious claim may take weeks or months to complete. During the investigation the adjuster may collect reports from police or fire departments, bills for medical expense or property damage, hospital records and other such data. These records will be carefully reviewed in an effort to determine the value of the claim and the likelihood that the claim can be resolved without litigation.

During this investigation period, the adjuster also may send out the claim to an attorney specializing in insurance coverage disputes for an evaluation of whether the claim is covered by the policy. If a recommendation is made to deny coverage, then the adjuster may send a letter to the insured advising that the insurer has determined that all or part of the claim is not covered by the policy.

At this point the insured should review the policy to determine whether the grounds for the denial of coverage are valid. If they are, then the insured may decide to drop the claim.

Another option available to the insurer is the filing of a declaratory action against the insured seeking a court determination of the coverage available under the policy. Such actions may be filed where the insurer believes that the state of the law is not sufficiently clear to permit a denial of coverage. If the insured determines that the grounds for denial of coverage are not valid, then the insured also can file an action against the insurer for a declaration that the policy covers the loss.

Reporting the claim is not the same thing as making demand for payment under the policy. Where the amount of the claim is known, the insured normally should to demand payment of the claim at the same time as the claim is reported to the insurer. A demand for payment of the claim may not be possible at the time the claim is reported due to problems with valuation of the claim. In such cases, the insured may wish to delay making demand for payment until the amount of the claim is determined. Once the amount of the claim has been determined, the insured should demand payment of the claim in writing.

In the case of third-party claims against the insured, there may be disputes over the fact and amount of the liability of the insured to the claimant. These disputes may be resolved by the adjuster, or may escalate into litigation. If a lawsuit is filed, the insurer normally appoints a lawyers of its own selection and pays for the cost of the defense of the insured. Payment of the cost of the insured's legal defense is one of the most important coverages available under most liability policies.

Georgia law provides that an insured who has not been paid within 60 days after the date payment of a claim has been demanded may file suit against the insurer for bad faith penalities and attorneys' fees.
 

Laborer Payment Rights

Georgia law defines a "mechanic" as one who works with his head and not just with his hands. By implication, a laborer is one who works with his hands and not primarily with his head.

Georgia law provides a special lien for laborers who have not been paid.
 

Checklist: Assessment of Contract Payment

Provisions

--Is there a pay-when-paid or pay-if-paid clause in the contract?

--Is there any restriction on the period of time for which such rights may be enforced?

--Is such a restriction limited to payments which are only withheld due to performance problems of the payee?
 

Payment Applications and Partial Lien Waivers

Payment applications usually contain language which require a contractor or subcontractor to waive any claim of lien. Such lien waivers can waive the right to assert liens for the amount represented by the payment application, or they can waive all claims through the date of the lien waiver.

In Georgia, there is a statutory form which is required for all partial lien waivers. Any other form which does not substantially comply with the statutory form is invalid under Georgia law.
 

Form: Sample Interium Lien Waiver Language

STATE OF GEORGIA

COUNTY OF _____________
 

The undersigned mechanic and/or materialman has been employed by [name of contractor] to furnish [describe materials and/or labor] for the construction of improvements known as [title of the project or building] which is located in the City of [name city], County of [name county], and is owned by [name of owner] and more particularly described as follows:
 

[DESCRIBE THE PROPERTY UPON WHICH THE IMPROVEMENTS WERE MADE BY USING EITHER A METES AND BOUNDS DESCRIPTION, THE LAND LOT DISTRICT, BLOCK AND LOT NUMBER, OR STREET ADDRESS OF THE PROJECT.]
 

Upon the receipt of the sum of $______________, the mechanic and/or materialman waives and releases any and all liens or claims of liens it has upon the foregoing described property through the date of [date] and excepting those rights and liens that the mechanic and/or materialman might have in any retained amounts, on account of labor or materials, or both, furnished by the undersigned to or on account of said contractor for said building or premises.
 

Given under hand and seal this _____ day of __________, 19___.
 

___________________(Seal)
 

________________________
 
 
 

__________________________

[Witness]
 

_________________________

[Address]
 

Final Payment

Receipt of final payment, including payment of contract balance and retainage, is a critical element in the construction senario since it eliminates payment as leverage to assure performance by the contractor, subcontractors and suppliers.

Final payment is also a triggering event for the execution of final lien and bond waivers.

Final payment usually indicates that any punchlist work remaining on the project has been completed to the satisfaction of the owner or general contractor.

In some contracts, final payment is the triggering event for the start of contract warranty, and receipt of final payment is sometimes made a condition for the enforcement of any warranty provided by the contract.

In Georgia, final payment does not automatically waive claims which were not known to the paying party at the time of final payment.