PCCA Journal|4
th
Quarter 2010
24
liability therefor. (This is usually a
moral victory only inasmuch as, if
the subcontractor was financially
flush enough to cover the indemnity,
it likely would have paid its sub-
subcontractor in the first place.)
Certified Payrolls
In addition, as a condition of pay-
ment to your subcontractors, your
subcontracts should require your
subcontractors to provide certified
payrolls, which include a state-
ment under oath that all taxes and
fringe benefits have been paid. If the
subcontractor is willing to lie under
oath, you will get no protection from
this, but it is at least a filter through
which most subcontractors will not
pass. In other words, most people
will not out and out lie, but many
would fail to volunteer the informa-
tion if they are not asked. Remember
though, once you obtain this infor-
mation from the certified payrolls,
you need to use it. Verify that the
certified payrolls are current, and do
not just stick them in a file drawer.
Direct Payment and Joint Checks
Next, if you have reason to believe
that one of your subcontractors
is not passing on payments to his
lower-tier subcontractors, pay the
sub-subcontractors directly or use
joint payee checks for payment.
The problem with direct payment
to the lower-tier subcontractors
is that it requires an agreement
on what is owed among the
lower-tier subcontractor and your
subcontractor. If your subcontractor
has claims against the lower-tier
subcontractor or disagrees with
the lower-tier subcontractor’s
payment request, you run the
risk of overpayment. Therefore,
unless you have an agreement with
your subcontractor to make direct
payments to its subcontractors
and suppliers, this can be a risky
strategy.
Joint payee checks avoid the
problem of resolving any dispute
between your subcontractor and its
lower-tier subcontractors. If these
parties are unable to resolve the
dispute over what is owed, neither
gets paid because it will take the
signature of both to negotiate the
check. This method of payment does
require you to know to whom the
payments should be made in order
to make each entity a joint payee.
If you decide to issue joint checks,
notify both the subcontractor and
the lower-tier subcontractor or sup-
plier of your intention to issue a
joint payee check. In order to avoid
a false signature, if possible, person-
ally deliver the joint payee check to
representatives of both the subcon-
tractor and the supplier or make a
representative of each pick up the
check from your office. On the check
stub or voucher, type a directive
that the proceeds of the check are
to be applied solely and exclusively
to debts arising from your project.
(In some states in the absence of
an express direction, creditors are
free to apply payments to any debt
owed. It is therefore a good practice
to put the project to which the debt
should be applied in the memo line.)
Then, type on the back of the check
an appropriately worded release of
claims that becomes effective upon
endorsement. This has the added
benefit of wiping the slate clean as
between the general contractor and
the two joint payees upon the nego-
tiation of the check.
Another option you might con-
sider for a subcontractor who may
be on the verge of bankruptcy is
to enter into a formal Joint Payee
Check Agreement to memorialize the
parties’ intentions. This agreement
should expressly state (1) the pur-
pose of the payment, (2) its alloca-
tion toward the project-specific debt,
(3) the assent of the general contrac-
tor, subcontractor, and supplier, and
(4) a partial waiver of the lien rights
for the value conveyed in the agree-
ment. That way, if the payment were
subsequently scrutinized by a bank-
ruptcy trustee, the Joint Payee Check
Agreement will be evidence that the
subcontractor was a joint payee for
the purpose of holding the funds in
trust for the lower tier subcontractor.
(Trust funds are usually not a part
of the bankruptcy estate.)* This will
provide some protection against the
bankruptcy of your subcontractor
and right of the bankruptcy trustee
to recover payments made within 90
days of the bankruptcy petition be-
ing filed.
Conclusion
There is no complete answer to
the problem discussed here, just as
there is no complete answer to the
question of what is the right sub-
contract, what is the right insurance
policy for a contractor, what is the
right price to bid, how to eliminate
OSHA citations, how to reduce your
workers’ compensation modifica-
tion, or a myriad of other questions
contractors face daily. If there was
a complete and definite answer, it
would be known by now, given the
fact that construction contracting
is one of the oldest professions in
the world. The truth is that you can
implement processes to decrease
many of these risks. The balance of
the problems can be dealt with on
a case-by-case basis as they arise.
Contracting is all about risk broker-
ing, shifting, avoidance, and balanc-
ing; it is not about risk elimination.
Implementing the procedures noted
above, however, will go a long way
to place you “behind the fan” when
the stuff hits.
* Note:
This is a gross oversim-
plification of the trust fund theory
in bankruptcy, the explanation of
which would take many pages of
text.
Greg Spalj is a member of the PCCA
and represents many of its members.
He has a national law practice repre-
senting construction contractors. He
can be reached at (612) 359-7631 or
gspalj@fwhtlaw.com.Legal Watch
Continued from page 23