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Construction In Brief: Fall 2011

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Alert: New Law on Pay-if-Paid Provisions

By Jason A. Copley

In Sloan v. Liberty Mutual Insurance Company, the United States Court of Appeals for the Third Circuit recently issued a precedential decision interpreting construction contract payment provisions - specifically, a "pay-if-paid / pay-whenpaid" provision. As discussed below, the Sloan decision has broad implications for both general contractors and subcontractors to be considered when negotiating and drafting construction contracts.

A Primer on "Pay-if-Paid / Pay-when-Paid" Provisions

The widely used construction contract term "pay-if-paid" means that a subcontractor only is entitled to payment from a general contractor if an owner pays the general contractor for work on a project. The practical result of this type of provision is that the risk of an owner's non-payment is shifted from the general contractor to the subcontractor.

In contrast, a "pay-when-paid" provision does not establish payment by an owner to a general contractor as a condition precedent to a general contractor's obligations to pay its subcontractor. Rather, a "pay-when-paid" provision merely creates a timing mechanism for a general contractor's payment to a subcontractor. The practical result of this provision is that a general contractor must pay a subcontractor after it has been paid by an owner. If the payment from the owner to the general contractor is not made timely, or at all, the subcontractor can argue after a reasonable period of time that the general contractor nevertheless must make payment to the subcontractor for the work.

Pennsylvania courts routinely have found that if any doubt exists as to whether a construction contract payment provision is a "pay-if-paid" or "pay-when paid," the provision will be interpreted as a "pay-when-paid" clause. In the case of Sloan, the Third Circuit enforced the "pay-if-paid" clause as a risk-shifting provision in the construction contract at issue.

A Brief Explanation of the Sloan Decision

In Sloan, the Isle of Capri Associates, LP ("IOC") owned and developed condominiums in Philadelphia. As the owner of the condominium project, IOC entered into a prime contract with general contractor Shoemaker Construction Company ("Shoemaker"). Shoemaker, in turn, entered into a subcontract with Sloan & Company ("Sloan") to perform drywall and carpentry work on the project. Liberty Mutual Insurance Company ("Liberty") issued a payment bond to Shoemaker, insuring payment to Shoemaker's subcontractors on the project.

After the project was completed, IOC refused to pay Shoemaker $6.5 million in contract balance, withholding the money for several reasons, including alleged untimely and defective work on the part of certain subcontractors. Shoemaker then refused to pay Sloan the $1 million balance on the subcontract.

Shoemaker sued IOC to recover the contract balance owed under the prime contract. Sloan sued Liberty under the payment bond seeking to recover its contract balance under the subcontract. After some investigation into the Owner's alleged financial problems, Shoemaker settled all of its claims against the Owner for approximately $1 million. Shoemaker then offered all of its subcontractors, including Sloan, their pro rata share of the settlement. However, Sloan refused to accept the settlement proceeds and continued to pursue its claim against Liberty.

Liberty denied Sloan's claim under the payment bond, citing the final payment provision in paragraph 6.f of the subcontract, which conditioned payment to Sloan on the Owner's payment to Shoemaker. Specifically, paragraph 6.f of the parties' subcontract provided, in relevant part: "Final payment shall be made within thirty (30) days after the last of the following to occur, the occurrence of all of which shall be conditions precedent to such final payment."

Shoemaker argued that paragraph 6.f constituted a "pay-if-paid" provision. Sloan argued that it was a "pay-when-paid" provision, pointing to a second paragraph of 6.f, which provided that Sloan could make a "claim" against Shoemaker for "any remaining final payment in the event that IOC failed to make final payment within six months."

The Third Circuit found that paragraph 6.f "unequivocally" stated that "IOC's payment to Shoemaker is a condition precedent to Shoemaker's obligation to pay Sloan." The Third Circuit then considered the meaning of the phrase "any remaining claim for final payment." In considering the meaning of this phrase, the Court looked to the "Dispute Resolution" paragraph of the Subcontract, which provided a procedural mechanism for passthrough claims. The Dispute Resolution paragraph also contained a "liquidating agreement," whereby Sloan could submit a claim to Shoemaker to be passed up to IOC. Sloan agreed to be bound to Shoemaker to the extent IOC made a decision on Sloan's pass-through claim.

The Court found that its interpretation of the "pay-when-paid" and liquidating agreement paragraphs were consistent with the parties' intent to "share the risk of IOC's non-payment." Thus, the Court held that Sloan was bound to Shoemaker's settlement with IOC and that Sloan only could recover its pro rata share of the settlement proceeds.

What Does this Holding Mean for You?

There is no doubt that the Third Circuit and federal district courts will strictly enforce "pay-if-paid" provisions against subcontractors in Pennsylvania pursuant to the Sloan decision. Generally speaking, although state courts are not required to follow federal law interpreting state law, state courts tend to follow well-reasoned federal court decisions interpreting state law and it is reasonable to expect that a state court would follow the Sloan decision if the facts were similar.

General contractors will be pleased with in this ruling and subcontractors should have serious concerns about the risk they may be accepting in a construction contract. Regardless of where you stand, the Sloan decision does not address or answer other important questions impacting all parties to a construction contract:

What happens if a construction contract contains a "pay-ifpaid" provision similar to that in Sloan, but the reason for an owner's non-payment to a general contractor it not because of a subcontractor's work but, rather, because of deficient work or delays caused solely by the general contractor?

In such a case, would a subcontractor still be bound to the "payif- paid" provision and any pro rata share of settlement proceeds? In other words, if a general contractor's actions are the sole reason for an owner's non-payment or eventual settlement of an action for considerably less than the full contract balance owed, would a subcontractor still be entitled to pursue a claim against a general contractor and/or owner for its full contract balance?

Notwithstanding these unanswered questions, the most important lesson to take away from Sloan is to always be mindful of the precise contractual terms of payment provisions when negotiating, drafting and executing construction contracts. If you have any doubt as to how payment provisions will impact your company on a particular project, consult with legal counsel to help you decipher and negotiate your contracts.

 

A Brief Note

We are excited to serve as the new Co-Editors-in-Chief of Construction in Brief. In this issue, we continue to explore the ever-evolving laws impacting the construction industry. Specifically, you will read about the Third Circuit's recent decision on pay-if-paid provisions, as well as the significant tort reform legislation passed in Pennsylvania. Have you ever had to make or defend a bond claim? Are you interested in seeing how municipalities are building up their coffers through tax? All this and more is in this issue.

In addition, we welcome your feedback and hope that you will take a moment to respond to our Survey, on this page, regarding the content and delivery of this Newsletter. We wish you and your families a wonderful holiday season!

Kathleen J. Seligman, Esq.
Co-Editor-in-Chief

Ashling A. Ehrhardt, Esq.
Co-Editor-in-Chief

What's New

New Faces

Cohen Seglias is pleased to welcome Kerstin Isaacs to the Firm. As the new Marketing Director, she will be responsible for executing the Firm's marketing strategy across all eight offices, including attorney marketing plans, advertising, events and sponsorships. Prior to joining Cohen Seglias, Kerstin served as the Director of Annual Giving and Special Events for a large non-profit organization.

In the Media

Our attorneys have been actively publishing this fall. Among recent mentions are:

Edward DeLisle authored the article, "Preparing for Big Changes with HUBZone Program," which appeared in Government Contracts Law360. Pat Sorek authored the article "Health Care Competition: Beware the Middleman," which appeared in Health Law360. Marc Furman was quoted in the article, "Unions Factor into the Profitability & Competitiveness of Enterprise," which appeared in Area Development magazine.

For copies of any of these articles, please e-mail zklein@cohenseglias.com.

At the Podium

On October 19, 2011, Cohen Seglias hosted a seminar in Philadelphia titled, "How to Win Federal Construction Contracts and Make a Profit." Federal Construction Contracting Practice Chair, Michael Payne, and partner Edward DeLisle covered topics including:

  • Protecting your rights in the bidding and proposal process and knowing when to file a bid protest
  • How to submit a winning request for proposal (RFP) on a negotiated procurement contract
  • How to effectively create teaming arrangements for federal construction projects
  • Best practices for communicating and negotiating with the federal government
  • Protecting your rights through alternative dispute resolution and litigation
  • How to ensure prompt payment
  • How to successfully prepare and submit claims

If you would like to obtain a copy of the seminar materials, please e-mail rmcnally@cohenseglias.com.

Legislative Update

On October 5, 2011 the National Labor Relations Board finalized a new rule that requires private employers to post a notice of employee rights under the National Labor Relations Act (NLRA). By January 31, 2012, all employers covered by the NLRA must post the notice developed by the Board in each workplace, and also post the notice electronically on any internet or intranet sites where other personnel rules or policies are posted. This new rule applies to all private-sector employers, with the sole exception of agricultural employers and several other employer types not subject to the NLRA. While some business organizations and legislators are seeking to overturn the rule, employers should prepare to post the notice by January 31, 2012. We will advise clients of any changes to the rule or deadline, and will also post any changes on our Construction Law Signal blog, www.constructionlawsignal.com.

In the Courtroom

Roy Cohen and Jennifer Horn were successful in the Maryland Court of Special Appeals on behalf of Audio Visual Innovations when the appellate court, after argument, upheld its victory at trial. Roy and Jennifer persuaded the appellate court to find that the sensitive audio visual equipment supplied and installed at the NIH Biomedical Research Center at the Johns Hopkins Bayview campus were lienable fixtures under Maryland's mechanics' lien statute. The appellate court also agreed with Cohen Seglias' argument that the Johns Hopkins shell entities - not the tenant, the NIH - were "owners" subject to Maryland's mechanics' lien statute. A case of first impression, this decision has far reaching implications.

We Want to Hear from You

We would like to ensure that Construction in Brief is meeting your needs. Below are two questions we have asked in an e-mail survey sent to our readership to help us improve the content and delivery of our Newsletter.

If you have not already responded to the e-mail survey, please contact Zoë Klein, at (215) 564-1700 or zklein@cohenseglias.com, with your feedback.

1. Check the practice areas that interest you:

  • Construction
  • Federal Construction Contracting
  • Labor & Employment
  • Business Transactions & Real Estate
  • Commercial Litigation
  • Wealth Preservation
  • Insurance Coverage & Risk Management
  • Creditors' Rights
  • Healthcare

2. Would you prefer to receive the Newsletter in electronic format?

What Constitutes an "Indirect" Payment Under an AIA Labor and Material Payment Bond?

By Jason A. Copley

Have you ever had to make or defend a bond claim under an AIA A312 1984 labor and material payment bond? This bond form states that if the contractor makes payment "directly or indirectly," any payment obligation under the payment bond is null and void. Even though this payment bond form is widely used, until recently there has been no legal authority on what constitutes an "indirect" payment. However, this summer, the Superior Court of New Jersey, in a case of first impression, rendered a decision that defined the meaning of "indirect" payment.

The court ruled that payment from a contractor to a subcontractor that includes sums due to sub-subcontractors/suppliers constitutes indirect payment to the sub-subcontractors/suppliers under the AIA A312 1984 Bond Form. The court also found that once a contractor makes such an indirect payment, there is no further payment obligation for the contractor or the contractor's surety. In other words, a contractor is not required to pay twice for the same labor or materials.

In this case, a building materials supplier filed suit for unpaid materials supplied to a subcontractor. The supplier made claims against the subcontractor and the surety that issued the AIA A312 1984 labor and material payment bond on behalf of the contractor. The supplier argued that it was entitled to payment under the payment bond because the supplier had never received payment either "directly or indirectly" for the materials provided to the project. The surety countered that if payment from the contractor to the subcontractor did not constitute an indirect payment to the subcontractor's material suppliers, then the contractor would end up paying twice for those materials – once to the subcontractor that included the supplier's materials in its invoices and a second time to reimburse the surety for paying the supplier's payment bond claim.

While both the supplier and the surety made numerous arguments in support of their definition of "indirect payment," the court ultimately relied on Black's Law Dictionary to determine that the only logical interpretation of "indirect payment" is a payment made through an intermediary – such as a payment made by the contractor through a subcontractor to a sub-subcontractor/ supplier.

Once the court determined the definition of "indirect payment" it then considered whether the timing of the supplier's notice to the contractor of nonpayment had an impact on the supplier's payment bond claim. The court held that if the contractor made payments to the subcontractor after receiving notice that the supplier was not being paid, then the surety may not be able to raise the contractor's "indirect payment" as a defense to the payment bond claim. The court reasoned that once a contractor receives notice of a supplier's claim it should withhold payment from the subcontractor or make arrangements to pay the supplier directly. Any payments made by the contractor after it received notice of the nonpayment would be at the contractor's own risk.

Although this decision is not published, it still provides guidance to contractors, sub-subcontractors and suppliers on projects utilizing an AIA A312 1984 labor and material payment bond form. Contractors with sureties making use of this bond form should ensure that once a sub-subcontractor or supplier provides notice of nonpayment, no further payments to the subcontractor are made until the payment issue is resolved. Sub-subcontractors and suppliers on projects using this form should provide notice of nonpayment to contractors as soon as possible to maximize the possibility of recovery on any future payment bond claims.

Good News for Business: Pennsylvania Passes Tort Reform Legislation

By Jason A. Copley and Kathleen M. Morley

On June 28, 2011, Governor Tom Corbett signed into law Senate Bill 1131, better known as the "Fair Share Act," reforming the manner and extent to which damages are recoverable in civil tort lawsuits (i.e., personal injury or property actions). This new law is good news for construction businesses in the Commonwealth, as Pennsylvania now joins the majority of other states in limiting the liability of defendants to their "fair share" of a loss. In negligence actions involving multiple defendants, such as an action against a property owner and multiple contractors for personal injuries sustained at a construction site, the Fair Share Act means that each defendant is liable only to the extent of its share of responsibility for the damages awarded by either a judge or jury. Before the Fair Share Act, if multiple defendants were found to have caused a loss, a plaintiff could force any "guilty" defendant to pay the full amount of the judgment without consideration for the percentage of fault attributed to that defendant.

Consider the following example under the "old law" (prior to June 28, 2011) and the new law:

A plaintiff is awarded $10,000 in damages in a negligence action involving three different defendant contractors. The jury found Contractor A 70% at fault, Contractor B 25% at fault and Contractor C 5% at fault.

Under the old law, even though the extent of each contractor's fault varied considerably, each contractor was liable to the plaintiff for the full amount of the $10,000 judgment in the event the other defendants refused or were unable to pay – a concept known as "joint and several liability." Thus, even though Contractor C was only 5% at fault ($500), that contractor, or its insurance carrier, might be forced to pay the full $10,000 under the old law. In contrast, under the Fair Share Act, liability is "several," but not "joint," meaning that each defendant is liable to the plaintiff only for its percentage of liability. Therefore, under the new law, Contractor C would only be liable to the plaintiff for $500 of the $10,000 award, even if Contractor A and Contractor B were bankrupt and unable to pay.

Like most laws, there are exceptions and limitations to the application of the Fair Share Act. Most notably, under the Fair Share Act, any defendant found to be 60% or more at fault for a plaintiff's injuries still can be forced to pay the entire judgment, just like under the old law. Additionally, the Fair Share Act only applies to claims arising after June 28, 2011, the date that it went into effect. Thus, it does not apply to currently pending or newly instituted negligence actions that involve losses that occurred prior to that date. Importantly, the Fair Share Act does not limit a company's right to demand contractual indemnification and essentially contract away the reduced liability established by the Fair Share Act. Therefore, where a subcontractor contractually agrees to indemnify a general contractor for losses that are caused "either in whole or in part by the subcontractor," the Fair Share Act will not benefit the subcontractor. Nevertheless, there are many instances where lawsuits are filed against multiple parties not involving contractual indemnification and in these instances the Fair Share Act will be of great benefit to anyone that was not the primary cause of the loss.

It is too early to predict with certainty what effect the Fair Share Act will have on contractors, subcontractors and Pennsylvania businesses in general and, like any new law, the Act is subject to judicial interpretation. Despite this uncertainty, the Fair Share Act appears to be a victory for Pennsylvania businesses and their insurance carriers. Many Pennsylvania business groups, including the Pennsylvania Chamber of Business and Industry, supported the passage of the Fair Share Act and view the Act as favorable and necessary tort reform legislation that will improve the Pennsylvania business climate, foster job creation, and reduce the cost of goods and services.

Supporters of the Fair Share Act believe that the old law wrongly promoted frivolous litigation and lawsuits aimed at "deep pockets" with tenuous liability. In this regard, the Fair Share Act relieves unwarranted pressure that previously existed on solvent businesses to settle frivolous lawsuits out of fear of having to pay damages disproportionate to their share of fault. Supporters also believe that the new law will reduce the number of businesses being driven out of the Commonwealth as a result of frivolous lawsuits.

For contractors and subcontractors in the Commonwealth, the Fair Share Act means that in many instances a party's obligation to pay will be limited to their share of responsibility, rather than be determined by its financial assets. Overall, contractors and subcontractors and any business associated with construction in Pennsylvania, should be pleased with the new law and look forward to positive changes in the Commonwealth's future economic climate.

Municipalities Can Be Taxing – In More Ways Than One

By Lonny S. Cades

Across the nation, businesses and individuals are not the only ones suffering from the effects of the poor eonomy. Federal, state and local governments also are struggling, each desperate to build up their respective coffers. In an attempt to raise much needed funds, municipalities have been increasing their efforts to collect taxes from all sources, including from individual residents and businesses with offices located in the particular municipality, as well as from any entity conducting business within its borders. In order to collect these taxes, local districts are enacting new tax laws and enforcing existing laws that have not been diligently enforced.

Examples of taxes being assessed by municipalities as part of the recent heightened enforcement efforts include business privilege taxes, taxes on labor and services, earned income taxes, gross receipt taxes and sales and use taxes. Municipalities also have begun to more ardently assess occupational taxes, which usually are broadly defined as being based on the number of employees doing work in and/or from the employer's place of business in the municipality. Specifically, as to sales and use taxes, if the property is presumed to become part of the real estate, then it is subject to these taxes. However, each state's regulations set forth exceptions for work done for utility companies, which need to be analyzed before a contractor enters into a contract. Moreover, in construction projects, it is often the case that both general contractors and subcontractors are taxed for work performed by the subcontractors. Thus, a careful review of the municipality's regulations before entering into a contract would be beneficial for both general contractors and subcontractors.

As part of municipalities' efforts to increase their collection of taxes, they are hiring firms, usually on a contingent fee basis, to go back as many years as permitted by the applicable statute of limitations to conduct taxpayer audits. The audits invariably result in a tax increase for each of the years assessed, as well as significant penalties, interest and attorneys' fees. Quite often, the penalties, interest and attorneys' fees assessed exceed the amount of the taxes determined to be due.

The definitions and rules contained in these municipal tax laws vary greatly across jurisdictions. Accordingly, it is important that contractors be aware of all taxes that could be assessed for work done in a particular municipality prior to submitting a bid or negotiating an agreement. Contractors would be wise to factor these potential taxes into the cost of the work. Individuals and businesses should consult with counsel to review their specific situations.

Think you are okay because you are doing work for a tax exempt entity? Think again. Contractors must be cautious even if they are doing work for a tax exempt entity, as there still may be taxes due on a portion or all of the work. It is important to review the requirements for the entity maintaining the tax exempt status, as well as any filing requirements, and strictly adhere to these requirements in order to utilize any available tax exemption.

With increased scrutiny and enforcement by municipalities, it now is more important than ever to maintain and retain detailed records for both the business, and for individual projects. For businesses doing work in more than one state, there may be some tax planning alternatives to consider. The attorneys in our Business Transactions Group are well versed in these issues and here to help you explore these alternatives.

Managing Tax and Liability Consequences Surrounding Marcellus Shale Land

By Wayne C. Buckwalter

Cohen Seglias Partner Wayne Buckwalter has been avidly following the developments surrounding the Marcellus Shale boom, and has been advising Marcellus Shale land owners on how to best plan for their futures. We caught up with Wayne to ask him a few basic questions about what land owners with new or existing leases should do to make sure their families are protected.

Q: What is Marcellus Shale land?
A: It is property where natural gas is extracted from coal located under ground through a process called fracking.

Q: If you own Marcellus Shale land, what is the first thing you should do?
A: If you have a lease with a utility company, review it to determine what rights, if any, the gas company ultimately has and whether you are able to renegotiate payment terms and conditions.

If you do not have a lease, you need to speak with counsel before signing a utility company's standard contract.

Q: What is the economic benefit of owning Marcellus Shale land?
A: Upfront bonus payments based on acreage and royalty payments.

Q: What are the liability consequences of owning Marcellus Shale land?
A: Your gas rights may be attached by general creditors. Other non-gas assets may be put at risk by gas-related activities. Proper planning and structuring of the ownership of your gas rights can limit your liability exposure.

Q: What are the tax consequences of owning Marcellus Shale land?
A: Gas rights held at death are subject to Pennsylvania inheritance tax and may be subject to a substantial federal estate tax depending upon the value of your estate, including gas rights. Proper planning can eliminate, or greatly reduce, death taxes for future generations.

Q: What can you do to best protect yourself and your family?
A: Gas ownership should be separated from land ownership and often owned by a Limited Partnership. Limited Partnership interests may be owned by a Trust to protect beneficiaries from creditors and unnecessary taxes.