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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