eNews March 14, 2019

In the News

March 14, 2019


What Goes Into a Protective Subcontract?

Two Colorado Construction Projects in Peril

Beyond Financial Statements: How Societal Injustices Can Play Into Credit Decisions

The Often-Overlooked Protection Provided By a Statutory Payment Bond Under Chapter 53 of the Texas Property Code

What Goes Into a Protective Subcontract?

A solid business relationship in the construction industry begins with a subcontract that establishes clear parameters between all involved parties. Before any general contractor (GC) or subcontractor (sub) moves forward with a collaborative project, each party must define their objectives and duties throughout the course of the project in addition to procedures should one of the parties not fulfill its obligations. A sound subcontract can alleviate potential problems before or if they arrive, but how do you get there?

As discussed in NACM’s March 7 eNews article, “A Two-Way Ripple Effect: What Happens When a Sub’s Legal Woes Divert Finances,” conducting proper due diligence is the first element in creating a protective subcontract. Chris Ring, of NACM’s Secured Transaction Services, said GCs must investigate whether subs are licensed in their respective states—information that is available in some states through online databases. In her article, “The Dotted Line: How to effectively manage an underperforming sub,” on Construction Dive, Kim Slowey takes things one step further by noting GCs should review a sub’s ability to secure a payment or performance bond.

“Bonding capacity is another indication of a sub’s financial and operational health,” Slowey wrote. “The fact that the sub can secure one if needed is a nod to that company’s stability.”

Another method of protection lies within the termination clause, Slowey noted—more specifically, the differences between Termination for Cause and Termination for Convenience—both of which can protect GCs. When the quality of a sub’s work isn’t up to the agreed standard or it exceeds the project’s timeline, the Termination for Cause supports a GC’s decision to relieve the sub. She added that impending problems can be handled with convenience terminations.

“The most significant difference between the two is what each party is entitled to—or must pay—when a termination happens,” the article states.

While subs are typically responsible for fees during cause terminations, she explained, GCs may have to pay “demobilization costs and perhaps a termination fee” in a convenience termination.

Ring said parties must also be extra thorough when dealing with large contracts in order to understand how the terms and conditions pertain to them.

“If you have a contract with a subcontractor versus a contract with the general contractor, sometimes, that subcontract ties you into terms and conditions of the general contract,” Ring said. “For instance, if the material supplier receives a purchase order from the subcontractor and that purchase order gives an indication and says, ‘per plans and specifications,’ that could mean ‘per plans and specifications of the general contract.’ By accepting that purchase order, you’re tying yourself to terms and conditions of the contract that you’re not even privy to. You have no idea what you’re accepting.”

—Andrew Michaels, editorial associate

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Two Colorado Construction Projects in Peril

A pair of Colorado construction projects hundreds of miles apart are coming under fire as is the case with many construction projects no matter the location. One is facing thousands of dollars in unpaid bills and is set for the courtroom, while the other recently had its noteholder withdraw foreclosure.

According to the Longmont Times-Call, there is a back-and-forth situation for the Mead Towne Center, a mixed-use facility set to open later this year. The attorney for the property owner said in the Times-Call businesses are unpaid because of shoddy work and the need to make necessary repairs, yet the parties were “more than fully paid.”

Crosslands Construction Co. is owed roughly $300,000, and subcontractors D.A.S.H. Concrete and Stout Brothers are owed nearly $50,000 combined from Crosslands. “This is a fairly typical process in a construction dispute,” said Crosslands’ attorney in the article. “What normally happens is the owner will stop paying the general contractor who then in turn doesn’t pay the subcontractor. Everybody has the right to file a mechanic’s lien.”

Meanwhile, in Aspen, The Aspen Club project has been at a standstill since August 2017 when subcontractors left the job due to nonpayment, states the Aspen Times. The original noteholder of the project foreclosed in November 2017 after contractual agreements were violated when millions of dollars in mechanic’s liens were filed. Current noteholder GPIF Aspen Club withdrew its foreclosure earlier this month. Construction is expected to resume in April with new financing.

With all the uproar that can happen during a construction project between the owner and the general contractor or the general contractor with its subcontractors, material suppliers need to stay focused and keep their eye on the prize—getting paid for products, services and labor—as do other potential mechanic’s lien claimants.

Colorado is one of the states that does not require a preliminary notice before providing labor or material; however, it is still not direct-to-lien either for private, commercial projects. Certain parties, including subcontractors and suppliers, have the option to give the owner, among other entities, a written notice that they are on the job, giving them additional protection under the law. Once the notice has been given, “it is the duty of the person who contracted with the principal contractor to withhold from such principal contractor … sufficient money due or that may become due to said principal contractor … to satisfy such claim and any lien that may be filed,” states the Colorado Revised Statutes.

Before a lien can be preserved, a notice of intent to file a lien statement must be served to the owner and prime contractor at least 10 days before filing the lien statement. The lien expires four months after last furnishing. If still unpaid, claimants have six months from last furnishing or completion of the project, whichever is later, to foreclose.

—Michael Miller, managing editor

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Beyond Financial Statements: How Societal Injustices Can Play Into Credit Decisions

Amid bold marketing in the retail world, social issues have entered the forefront of the business-to-business (B2B) field. From Nike’s support for Colin Kaepernick to Gillette’s campaign for better men, consumers have been paying attention to social stances of large corporations, which has directly impacted how creditors in the B2B world handle their business. But according to a recent analysis by Moody’s, these social issues are not the “primary driver” of credit quality.

Moody’s defined social issues in their study as, “The risks to, and potential benefits for, a private issuer’s credit quality as a result of its interactions with key stakeholders including its employees, customers, supply chain partners, counterparties and society at large.” The study found risks within credit often derive from an issuer’s interaction with “core stakeholders” of companies.

“A company fighting with its employees or their union will start to see losses. A company that becomes part of a social movement may lose customers or they might gain them,” said NACM Economist Chris Kuehl, Ph.D. “The decision to buy or not buy something is not always about price—it is often affected by how the consumer reacts to a company, and controversial stands will have consequences.”

Keeping up with volatiles of specific markets, analyzing financial statements and other methods contribute to sound credit decisions, but these analytical, black-and-white methods of synthesizing information only provide part of the picture of a company’s risk.

The Moody’s study cites the Canadian energy infrastructure company TransCanada PipeLines Limited’s project on the Keystone XL pipeline, which was threatened by public protest over climate change. Amid the controversy surrounding environmental concerns, the pipeline company likely had trouble paying its creditors back: A burden the company will carry for many years for acting irresponsibly.

Moody’s and Kuehl note despite consumers holding companies to humanitarian standards, this factor is still not a primary driver of credit quality. Social considerations still remain a piece of analyzing a company’s line of credit, but these issues are not the only circumstances creditors should keep in mind when doing business with a customer.

Despite efforts in marketing to appear more socially aware, many companies still donate to causes and support political campaigns that do not mirror the same beliefs of their public actions. While on the surface a company may be proactive in combating societal injustices, it may not reach deeper than said surface, which creditors should take into consideration.

“Be aware that perception is reality for most consumers and businesses. If a company gets a reputation for discrimination, they will be subject to criticism and perhaps even boycotts,” Kuehl said. “A decision that alienates the consumer base may send a company into crisis very quickly. The credit manager really wants their creditors to stay focused on conducting their business successfully and less on trying to impact some political or societal norm.”

—Christie Citranglo, editorial associate

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The Often-Overlooked Protection Provided By a Statutory Payment Bond Under Chapter 53 of the Texas Property Code

Owners of construction projects are often surprised to learn that they are required to withhold 10% retainage on private construction projects in Texas. Failure to withhold 10% can result in liability up to that amount.[1] Similarly, owners often continue to pay the general contractor after receiving a lien notice with fund-trapping language which can create “fund-trapping” liability. If fund-trapping liability is established, the owner could end up paying for the same work twice—once to the general contractor and again to the subcontractor.[2]

But an owner can avoid these pitfalls by requiring that the prime contractor[3] on a private construction project provide a statutory payment bond. A statutory payment bond under Texas Property Code § 53.202 is not just any bond. To provide the protection contemplated by the statute, the bond must:[4]

  1. be in the original contract amount;
  2. be in favor of the owner—as obligee;
  3. have the written approval of the owner endorsed on it;
  4. be executed by:
    1. the original contractor as principal; and
    2. a corporate surety authorized, admitted and licensed to do business in Texas;
  5. be conditioned on prompt payment for all labor, subcontracts, materials, specially fabricated materials and normal and usual extras not exceeding 15% of the contract price; and
  6. clearly and prominently display the contact information for the surety.

If the owner obtains a bond that is consistent with these requirements and records it in the applicable real property records,[5] the owner is relieved of the requirement to withhold retainage and cannot be held liable for failing to trap funds.[6] Subcontractor liens no longer attach to the owner’s property and as a result, the subcontractor has no lien foreclosure action against the owner. In other words, the subcontractor’s remedy is provided by the bond and is not against the owner. This is a win-win for owners and subcontractors because the subcontractor’s remedy is not limited to its proportionate share of retainage plus any trapped funds and the owner is not subjected to a multiplicity of often conflicting subcontractor claims if bankruptcy, termination, or abandonment occurs at the prime contractor level.

Tips for making sure you actually receive a statutory payment bond when one is requested:

  1. The original contractor must provide the bond. In connection with an engineering, procurement and construction (EPC) contract, the EPC contractor often attempts to argue that the lead subcontractor performing the construction work should provide the bond. If the owner acquiesces, the owner does not have a statutory payment bond.
  2. The owner should require a bond compliant with § 53.202 in the contract.
  3. The bond should be in the amount of the contract, not an amount less than the contract.
  4. Once the contractor obtains the bond, the owner should review it for compliance with § 53.202.
  5. The owner should not be persuaded by the surety or the general contractor that the surety can only use its noncompliant form.
  6. The owner should make sure that it is named as the “obligee”—and not a contractor or some other party.

Reprinted with permission.

Amy Wolfshohl is a partner in the construction practice group of Porter Hedges. She represents companies in negotiating and analyzing risk in connection with highly complex construction transactions with an emphasis on industrial construction and EPC contracts.

[1] Tex. Prop. Code § 53.105.
[2] Id. § 53.084.
[3] General contractor here means the party contracting directly with the owner to perform the work.
[4] To make the intent of the parties clear, the owner should also consider including language in the bond that it is in attempted compliance with Texas Property Code § 53.202. The requirements in this blog post are paraphrased from the statute.
[5] Tex. Prop. Code § 53.203.
[6] Id. § 53.201.

mechanics lien, bond services, mechanics's liens

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