Paying subcontractors during difficult financial times is more worrisome and complicated than in a healthy economy. Many subcontractors are undercapitalized and subcontractor insolvency is a real concern. Accordingly, general contractors and owners are rightfully concerned that downstream suppliers and sub-subcontractors receive payment for work performed and materials supplied to Idaho construction projects.
Should a sub-subcontractor or a material supplier go unpaid, mechanics lien claims and payment bond claims inevitably ensue. The likelihood of paying twice for work performed or materials installed is increased as subcontractors become less and less solvent. In order to ensure that sub-subcontractors and material suppliers receive payments for their services and materials, contractors (and owners) commonly issue joint checks payable both to the subcontractor and the sub-subcontractor/material supplier. By making a payment by way of a joint check, the general contractor (or owner) can rest assured that so long as the amount of the payment is equal to or exceeds the sum due, potential lien and bond claims are discharged.
Numerous courts, although no Idaho decisions, have held that per the “Joint Check Rule” a check made payable jointly to two payees is presumed to be satisfactory of the amount due the lower-tier payee. The “Joint Check Rule” is enforceable even where the material supplier/sub-subcontractor does not actually receive full payment from its subcontractor. For example, in circumstances where a supplier endorses a joint check but the subcontractor nevertheless fails to provide any of the check proceeds to the supplier, courts have held that by endorsing the check and turning the same over to the subcontractor, the payor has satisfied the payee’s lien and bond claim rights.
Naturally, it is very tempting to simply start writing joint checks to subcontractors and their lower-tier suppliers and sub-subcontractors when a subcontractor’s credit becomes questionable. Absent an agreement to accept joint checks, however, a subcontractor is not obligated to accept payment by way of joint check. Rather, the subcontractor can simply refuse the joint check tender, and demand that payment be made directly to the subcontractor without any other payees on the check. For that reason, joint check arrangements have become more widespread, even at the outset of the project.
For example, a joint check arrangement at the owner’s sole option is provided in the 2007 edition of the AIA general conditions (the A201 document). The language of the AIA joint check arrangement may not be ideal, as it requires action on the part of the architect and a prerequisite failure on the part of the contractor to make payment prior to the contemplated issuance of joint checks. The AIA language may not be satisfactory in a circumstance where a subcontractor’s (or contractor’s) insolvency is imminent, but the subcontractor (contractor) has not yet failed to make a downstream payment. Moreover, the AIA language may not be satisfactory where the project architect is not involved in progress payments. Additionally, the AIA language directly pertains to owner joint checks to a contractor. The language does not specifically pertain to contractor joint checks to a subcontractor.
From the payor’s standpoint, most joint check arrangements should eliminate an architect’s involvement, and eliminate the failure to make a downstream payment as a prerequisite. Like the AIA document, join check arrangements should be optional on the part of the payor, and not mandatory. Adequate join check arrangements are fairly easy to draft.
Writing joint checks is a drastic measure on any project and is generally disfavored by all upper-tier payees. Nevertheless, it may be wise to include optional joint check arrangements in contracts as a matter of course because it may be quite difficult to obtain the consent of a nearly-insolvent upper-tier payee at a time when a joint check arrangement is most needed. For example, it is not hard to foresee that a nearly-insolvent subcontractor may be very motivated to apply progress payments to discharge lines of credit for which the company owner is personally liable rather than make payments to suppliers and sub-subcontractors. A nearly-insolvent subcontractor may be very reluctant to execute a joint check agreement at a time when lower-tier lien and bond claims are most likely.
Under circumstances in which a subcontractor is unwilling to accept joint checks, the contractor (or owner) may still protect the project from lien claims and bond claims by making direct payments to the lower-tier sub-subcontractors and material suppliers, and obtaining a release of the lien/bond claim in return. This practice will not prevent a potential claim from the subcontractor that the contractor (or owner) overpaid but it may have the desired result where there is no bona fide claim about the adequacy of the work performed (or material supplied). A subcontractor can certainly claim that the amounts paid to the lower-tier payee were not due, and therefore this practice is not without risk. Nevertheless, in the case of a subcontractor teetering on the brink of insolvency, it may be a better practice to be potentially liable for paying some of the bill twice than being potentially liable for paying all of the bill twice.
During periods of a difficult economy, think about whether you should incorporate a joint check arrangement into subcontracts. If you find yourself in a situation with an insolvent subcontractor and no joint check arrangement, your choices are not great. In that situation, contractors (and owners) may consider making direct payments to lower-tier payees to minimize lien and bond claims.
Geoff McConnell is a partner at McConnell, Wagner, Sykes + Stacey PLLC, focusing his practice in the areas of construction law, commercial litigation and business law. He has been recognized each year since 2008 by Best Lawyers in America and Mountain States Super Lawyers for his legal expertise in construction law, litigation and government contracts. Mr. McConnell can be contacted at (208) 489-0100.
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