Tuesday, February 24, 2009

Construction Contingent Payment Act–The Legislature’s Modifications to the Rules of the Game

Contingent payment clauses (also known as "pay when paid" or "pay if paid" clauses) have long been a tool used by contractors to shift the risk of nonpayment. In short, the payor's payment to the payee is contingent on the payor itself being paid by another party (usually the owner). Under these clauses, if the payor is not paid, it has no obligation to make payments to the payees (subcontractors). These clauses effectively shift the risk of nonpayment from the general contractor to the subcontractor (or from subcontractor to sub-subcontractor).

For more on crafting enforceable contingent payment clauses, see my previous blog article.

In 2007, the Texas Legislature stepped in and placed some additional rules on these clauses through Section 35.521 of the Texas Business & Commerce Code (you can read about the Legislature’s labor here, or you can just see the "baby" here--to borrow a line from Bill Parcels). In a nutshell, the Act established certain situations where a contingent pay clause cannot be used as a defense for not paying subcontractors. A payor may NOT avoid payment in the following situations:

  • When the owner’s nonpayment to the GC is the result of the GC not meeting its own obligations, unless the non payment is the result of the subcontractor’s failure to meet its requirements.
  • When the owner fails to pay the GC because of the work of another subcontractor, the contingent pay clause is not effective as to the innocent subcontractor.
  • When, after a subcontractor has not been paid for past work, it gives notice to the GC objecting to the further enforceability of the contingent pay clause, the GC may not then enforce the clause on work or materials provided after the notice.
  • When the owner and GC are essentially the same.
  • When enforcement of the clause would be "unconscionable."
  • A contingent pay clause may not be used as a basis for invalidation of the enforceability or perfection of an otherwise valid lien.

The requirements of the Act cannot be waived. However, the Act does allow for the assertion of a contingent pay clause as an affirmative defense to a lawsuit for payment under a contract. Finally, the Act does not apply to design services, civil engineering construction (roads, utilities, water supply projects, etc.), and most residential construction.

What is the lesson to be learned from this statute? First, good faith is generally required on the part of the general contractor to avoid one of the exceptions to enforceability of an otherwise valid contingent pay clause. Second, it is evidence that the Legislature has made increased efforts to protect subcontractors from heavy handed contractual provisions. A contingent pay bill was first introduced (unsuccessfully) in the 2003 Legislative session. Four years later, in 2007, the current version was passed. It will be interesting to see if this year’s legislative session results in any new measures.

Monday, February 16, 2009

Personal Liability Under the Texas Construction Trust Fund Act: The 800 Pound Gorilla You Never Knew Existed

Most people in the construction industry have at least some awareness of the Texas Construction Trust Fund Act. For an overview of the Act, I recommend my blog article here.

What many contractors may not realize is the potential personal liability that the Trust Fund Act creates. It is very important to be aware of this fact in advance to avoid potentially serious mistakes down the road.

In a nutshell, the Act deems construction payments and loan receipts "trust funds." The corollary is that a "contractor, subcontractor, or owner or an officer, director, or agent of a contractor, subcontractor, or owner, who receives trust funds or who has control or direction of trust funds, is a trustee of the trust funds." What does that mean? It means that the individual owner, officer, director, or agent may personally be a trustee. Trustee status does not simply stop at the corporate veil.

If an individual is a trustee, he or she owes the beneficiary of the trust funds a fiduciary duty. This means a duty of loyalty, and the utmost good faith, candor, integrity of the highest kind, and fair and honest dealing. The fiduciary duty is basically the highest standard of care in our legal system.

Because the Act confers "trustee status" on individuals and not just companies, personal liability can also fall to the individual–even if they were acting solely in the course and scope of their employment and in furtherance of their employer’s business.

In Herbert v. Greater Gulf Coast Enterprises, Inc., 915 S.W.2d 866 (Tex.App.–Houston [1st Dist.] 1995), the Houston Court of Appeals found personal jurisdiction for Trust Fund Act violations over someone who had no individual contact with Texas. In that case, the plaintiff, a subcontractor, sued the Connecticut general contractor and its president individually. The court rejected the defendant’s argument that he individually had no contact with Texas. In its ruling, the court noted that the Legislature enacted the Construction Trust Fund Act as a special protection for contractors and subcontractors "to avoid the injustice of owners and contractors refusal to pay for work completed."

The plaintiff in Kelly v. General Interior Construction, 262 S.W.3d 79 (Tex.App.–Houston [14th Dist.] July 3, 2008) sued the two sole shareholders of an Arizona GC individually for breach of contract, violations of the Construction Trust Fund Act, and fraud. The defendants argued that Texas courts did not have personal jurisdiction over them individually because they acted solely in their corporate capacity. The court ruled that there was no jurisdiction on the breach of contract claim because the individuals had, in fact, acted on behalf of their company. However, they found jurisdiction on the Trust Fund Act claim. The court noted that the Trust Fund Act essentially allows subcontractors to pierce the corporate veil. The Act creates personal liability if (1) the party breaches the Act’s duties with the appropriate intent, and (2) the claimants are within the class of people the Act was designed to protect.

C&G, Inc. d/b/a Fox Rental v. Jones, 165 S.W.3d 450 (Tex.App.–Dallas 2005) is a very interesting case (particularly if you want to give yourself a little heartburn). Fox Rental sued CCG supply company, including officers Jones and Duncan under Trust Fund Act. Jones and Duncan had signatory authority on CCG's checking account. Neither of them personally received any trust funds, nor did they "independently" determine to whom the trust funds should be paid. In fact, they simply disbursed such funds as they were directed by the officers of American Eco, which owned CCG. Over time, Jones and Duncan objected to American Eco’s use and direction of the funds; in fact, they were eventually asked to leave their employment in large part because of their objections to the way American Eco handled the funds. By all accounts, these guys were doing the "right thing" and objecting.

Nevertheless, court of appeals held that they participated in both the decision to divert the funds and the actual diversion of the funds. As such, they were held personally liable. Their objections were not a defense, and the court did not accept the "just following instructions" justification either.

The point of this discussion is that construction trust funds are a serious matter that can bring serious personal liability. There are defenses to claims of violations of the Act, but with the potential for personal liability, these defenses should be particularly well documented. In any event, construction trust funds are not something to play fast and loose with. Knowing the Act’s requirements and potential for liability in advance will, however, help minimize liability down the road.