Subcontractors to receive more legal protection for some jobs

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by Mike Scott
Legal News

Subcontractors in the construction business will have more payment rights thanks to an amendment that goes into effect on January 1.

Both the “pay when paid” and “pay if paid” clauses applied to subcontractors for publicly funded projects will be prohibited in the state of Michigan. Senate Bill No. 1319 ensures that provisions providing labor, supplies, equipment or materials in a governmental contract will get the money that's owed to them – on time and not when the contractor gets paid.

The “pay when paid” clause essentially serves as a timing mechanism that will impact the timing mechanism for when a subcontractor is owed for payment, said Richard Rozycki, a construction attorney with Plunkett Cooney, P.C., in Bloomfield Hills.

That clause currently has the effect of possibly shielding the subcontractor in the event funding for the project evaporates.

Some states have determined that both types of clauses are unenforceable for public and/or private projects. Michigan has not taken any such action against private projects. In general courts around the country have been more willing to enforce the “pay when paid” clause because it is a timing mechanism.

“Pay when paid has been a major bone of contention during contract disputes in recent years,” Rozycki said. “Some states have previously eliminated both types of provisions.”

The Michigan Legislature most likely was attempting to provide some protection for subcontractors with this law, Rozycki said, especially in the wake of a sagging economic outlook for the state’s construction industry.

“My assessment is that this was a way for the legislature to deal with subcontractors not getting paid on public projects,” he said. “In many ways this is a good public relations move because subcontractors might (be unhappy) about not getting paid for a publicly funded project that involves the state or municipalities. The state has an interest in making sure a subcontractor is paid for projects (he or she) worked on.”

Performance and payment bonds are required, at the expense of the proposed contractor, to provide external funds to finance expenditures. A performance bond is used to protect the governmental unit from paying the awarded amount for a construction, alteration, demolition or repair contract. The payment bond is solely for the protection of the people providing services, supplies or equipment.

“I think economic conditions probably do have something to do with this,” Rozycki said.

Some states have upheld the enforcement of such clauses if the clause is unambiguous. And some states, including California and New York, have made such clauses illegal for private construction projects as well. If such clauses are determined as unambiguous, Michigan courts will generally enforce the contract’s language governing private construction projects.

With the makeup of the current Michigan State Supreme Court, Rozycki does not expect any judicial rulings to ban the use of “pay when paid” or “pay if paid” clauses for private construction projects in the near future.

“Just because this bill was passed does not mean the next logical step is to apply it to private contractors,” Rozycki said. “The clause (serves) as a ‘shield’ for the contractor, who does not get paid by the owner and who faces multiple lawsuits from subcontractors but (assessing it) to the private sector may or may not occur.”

“Pay-when-paid” clauses in construction contracts are quite common. Under this provision, a subcontractor will be paid when the contractor is paid by the owner. These types of clauses deal only with the timing of payment and are construed merely as timing mechanisms, rather than as waiver or forfeiture clauses, Rozycki said.

They are referred to as “pay-when-paid” clauses, but they do not operate to preclude payment indefinitely. In other words, the clauses merely provide a general contractor with some reasonable period within which to make payment.

These clauses serve as both a sword and shield with respect to payment of subcontractors on construction projects. If a general contractor fails to pay a subcontractor after it gets paid, the general contractor can be liable for interest and attorney’s fees to the subcontractor.

This “sword” is used to force prompt payment, Rozycki said.

Yet Rozycki doesn’t believe the law was designed to limit the number or size of companies bidding on a public construction project, largely because the law was written for public projects that cost just $50,000 and up.