eNews May 21
In the News
May 21, 2020
Reviewing Construction Contracts in the Time of COVID-19
—Andrew Michaels, editorial associate
As several industries adjust to their altered operations due to COVID-19, some are looking ahead to assess their options financially, specifically how to keep business afloat until work ramps up again. Almost everything with a schedule is either delayed or canceled altogether, including movie theater releases, sports events and even construction projects. The latter was discussed in a webinar from American Institute of Architects’ (AIA) Contract Documents and Risk Management Director and Counsel Michael Kroger and Manager and Counsel James Germano, both of whom highlighted the importance of construction contracts during these uncertain times.
In an interview with Construction Dive, Kroger and Germano’s No. 1 takeaway for construction professionals who were impacted by the pandemic was “defining force majeure clauses.” Chris Ring, of NACM’s Secured Transaction Services, said force majeure clauses are generally written into contracts and free a party from a scheduled obligation of the contract based on an unforeseeable event or circumstance (act of God). If an owner suffers a loss because a construction contract cannot be completed on time and/or on budget, the owner may sue the general contractor for delay if there was no force majeure clause.
“During this time of a pandemic, the general contractor will most likely try to use the force majeure rights as a defense for why the contract could not be completed on time and/or on budget,” Ring said. “A subcontract agreement between a general contractor and a subcontractor typically has force majeure provisions as well. And, purchase orders between subcontractors and material suppliers may also contain force majeure provisions.”
All parties will be attempting to use their force majeure rights to defend against delay claims, he added, as parties upstream try to mitigate their losses.
Exposure to delay damages resulting from COVID-19 depends, to a large extent, on the wording of existing contracts, said James Fullerton, Esq., of Fullerton & Knowles, P.C. Do you have a good force majeure clause? Do you have an unconditional definite completion date or, even worse, a unilateral amendment clause? What are the notice requirements in your contract and did you provide notice of the delay, within the time and in the manner required by the contract?
Notice to the general contractor and owner are important mitigation tools. It is also important to alert suppliers and subcontractors about anticipated delays or other problems. Contractors, subcontractors and material suppliers should promptly inquire as to the status of pending orders and ability of substitute suppliers to fill orders. Consider substitution or alternate suppliers if supply delivery delays are expected. Problems with labor availability may be even more likely. Prepare to use temporary labor sources, if necessary. Give the general contractor and owner these options. Keep careful records of all these notices and inquiries.
NACM’s 2020 Credit Congress and Expo approaches its online debut in June with numerous educational webinar sessions, including the “Supplier’s Guide to Navigating Force Majeure Issues” (Session #29098) from construction expert and attorney Christopher Ng. In this session, participants will learn about the various types of force majeure provisions that exist in contracts and in state statutes and how these provisions are interpreted by the court. They will hear about how these contract and statutory defenses may impact their business and how to favorably update the terms and conditions of sale and contracts to ensure that force majeure provisions work in their favor in the future.
Joint Check Agreement Basics
—Michael Miller, managing editor
COVID-19 has turned the world upside down in more ways than one, leaving different parties stuck and hung out to dry through no fault of their own. This black swan has crippled many businesses and individuals, with still many outcomes left to be known. While some larger companies such as Under Armour, Nike and Adidas have come out and said they will pay manufacturers and suppliers in full, many companies, large, small and everywhere in between, do not have the ability to be so generous.
The downstream flow of money and payments has no doubt been affected by COVID-19 with bankruptcy filings and the lot. Businesses have closed, supply chains have been broken and payments have slowed and fallen by the wayside. One industry, while shutdown for a small period of time has started to reopen, if it was ever stopped to begin with. As spring continues into summer, construction will pick up in parts of the U.S. slowed down due to seasonality. Though construction payments are typically slower than other sectors, the impact of COVID-19 was still felt.
Depending on the type of construction project, there are certain mechanisms that can be used to help secure payment, especially for those lower in the supply line. Suppliers and lower-tier subcontractors can rely on mechanic’s liens and bond claims to try and lock down payment. Another tool credit professionals and potential lien and bond claimants can use is the joint check agreement (JCA).
“It’s even more important now than ever to have contracts in order to protect you for payment given the rough seas we’re experiencing and will continue to experience,” said Karen Hart, Esq., partner with Bell Nunnally & Martin LLP, during a recent NACM webinar on JCAs.
JCAs are a check payment with typically one issuer made payable to two or more parties as co-payees and is a device used frequently in the construction industry. There are several main purposes for JCAs depending on the viewpoint. Among them are to protect the general contractor (GC) or surety from making double payment; protect the subcontractor’s payment rights; and to keep the money and project moving forward. JCAs make sure money goes where it’s supposed to go and helps up and downstream contractors get paid at the same time, in theory.
Without a formal agreement, there are risks including checks being deposited without proper endorsements and forcing owners and GCs to pay twice. There is also the “Joint Check Rule” that discharges the GC or surety from liability to lower-tier subs and suppliers once the joint check is issued. However, this rule depends on where the project is located. This can be “very scary” for lower-tier subs and suppliers, Hart said, if the project is located in a state that follows the rule.
It is better to enter a formal JCA since they are more predictable, certain and manageable. “The more control you can have, the better,” she said. It is important to note that there are no standard JCAs, and they can vary widely depending on the project and the needs of the parties involved.
Some tips to remember for JCAs are:
- Clearly identify the parties and project
- Identify if the JCA is part of the subcontract
- Have a clear statement of consideration—extending credit/materials to the project in exchange for payment
As a lower-tier sub or supplier, some items to look for in JCAs are to have GCs required to issue joint checks; have the power of attorney to endorse the joint check on behalf of the sub; require the GC to deliver the joint check directly to the supplier; and to preserve lien or bond rights if funds are not received.
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Defending Your Business Against the Enforcement of a Personal Guarantee in Massachusetts
—David Katz, Esq.
In a recent case, I represented both a trucking company from Western Massachusetts and its owner against a civil action for breach of contract and breach of personal guarantee filed by a regional truck rental and sales company. In connection with the contract, my corporate client signed a truck rental /purchase contract, and the owner signed a “purported” personal guarantee. After only a few months into the contract, my corporate client could no longer afford to make payments and later defaulted. Subsequently, the rental company brought a breach of contract action in Middlesex Superior Court against my corporate client and a claim for breach of personal guarantee against the owner. As a means of securing its claim, the rental company moved to attach the personal real estate of the owner, as a personal guarantor, on the basis of the personal guarantee. On behalf of the owner, I filed an opposition, affidavit, memorandum of law and a motion for attorney’s fees. After the oral hearing, the Court found that there was absolutely no basis to attach the owner’s personal residence and awarded reasonable attorney’s fees to the owner on the basis of the following considerations:
1. The guarantee, in this case, was insufficient under the Massachusetts Statute of Frauds, G.L.c.259, section 1. The Statute of Frauds is an ancient Massachusetts law that requires all guarantees to be in writing in order to be enforceable. In this case, the guarantee consisted of only one line which stated that “The Defendant agrees to personally guaranty the payment of the amounts due in the purchase” with the signature of the owner appearing below that one line. This was held by the court to be insufficient. Massachusetts case law requires that several things need to exist in order to establish an enforceable guarantee. They are as follows: (a) The existence of a primary obligation; (b) The guaranty must be in writing; (c) That there was a default; and, (d) That the guarantor acted in accordance with the terms of the guarantee.
2. Under Massachusetts law, it is required that a guaranty be a separate enforceable contract in order to establish liability against a guarantor. Where the guarantee, in this case, was comprised of only one sentence, it was impossible for the Court to ascertain the intentions of the parties as to when and how the guarantee would be enforced. The Court concluded that more than just a label of a “guarantee” was needed in order to create an enforceable guarantee. In addition, the Court admonished the creditor’s counsel that he should have known that the guarantee was not enforceable on its face under Massachusetts law and that any motion to attach was nothing more than an exercise in wasting the Court’s time, coercive and frivolous. As a result, and after hearing, the Court allowed my motion for reasonable attorney’s fees. The fees were remitted to my client within two weeks of the Court’s order.
3. In this case, the underlying contract made no reference to the existence of any personal guaranty either. By not having any language in either the contract or the “purported” guarantee was found to be a violation of the Statute of Frauds and because it contained no specific language, it did not permit the Court the basis for any enforcement. For example, an enforceable guarantee has a provision for when it can take effect. Enforceable guarantees must either be conditional or unconditional. A conditional guarantee permits a creditor to enforce its guarantee against an individual only after it has exhausted its claims against the corporate debtor. An unconditional guarantee, on the other hand, permits a creditor to go after both the corporate debtor and the individual at the same time. In fact, some guarantees allow a creditor to enforce its rights against a personal guarantor without having to first seek legal action against a corporate debtor.
4. In Massachusetts, personal guarantees can be absolute, conditional, continuing or based on performance or payment. Massachusetts courts will enforce each guarantee in accordance with the “plain” language used in each guarantee. The elements of a well-structured guarantee unlike the guarantee, in this case, must be clearly separated from any underlying contract, contain the signature of the guarantor, and include language as to specifically when the guarantee will take effect.
Not every guarantee is enforceable, and just because it is labeled as a guarantee, does not automatically make it enforceable under Massachusetts law. Many guarantees are poorly drafted and create far more questions than they provide answers.
David Katz, Esq., is the founder and managing partner of the Katz Law Group, P.C., located in Marlborough, Massachusetts. His practice includes but is not limited to complex real estate litigation, employment disputes, premises liability defense, franchise and business litigation matters.
May 29, 2020
For CBA, CBF and CCE designation candidates to test on July 27, applications must be received by May 29.
The COVID-19 Potential Impact on Contract Surety
—Michael J. Weber, Esq. and Grace Winkler Cranley, Esq.
The COVID-19 pandemic raises a series of unknowns for contractors, owners, subcontractors, suppliers and sureties. Much is being written about whether construction is deemed an essential infrastructure exception to governors’ various executive stay-at-home orders. Surety practitioners are facing novel legal issues raised by the pandemic as they analyze parties’ rights and obligations under surety bonds and underlying construction contracts. As the legal industry and construction organizations work to understand the nuances of their governors’ executive orders, the health and safety of the labor force on jobsites is the absolute priority.
All construction projects must adhere to the Centers for Disease Control (CDC) safety protocols addressing COVID-19 health concerns. Social distancing and adequate spacing between laborers are difficult. Tight jobsite quarters, sharing of tools and equipment, and the requirement to routinely disinfect hands and surfaces raise concerns. Diligent contractors find their scope of work and specific trade can make it impossible or impractical to adhere to the CDC protocols.
Even when deemed an essential infrastructure exception to an executive stay-at-home order, construction on a particular job may still come to a halt. If a construction project is bonded, the surety may encounter its own challenges when faced with an interruption on a job due to the COVID-19 pandemic. The plain language of surety bonds often does not specifically address interruptions due to acts of God, disasters, national emergencies, etc. It is essential the parties understand the terms and provisions of the underlying construction contracts addressing force majeure, time extensions, damages and the safety rights of the labor force. Construction industry contracts may address the parties’ rights upon the occurrence of an epidemic, but not necessarily a pandemic occurring over a wider geographic area affecting more people.
Sureties will face new issues during this pandemic. Business relationships are a more significant factor than ever when working through best practices to address work stoppages under emergency situations. The surety’s bonded contractor/principal may be unable to keep its doors open if it is unable to remain on budget, or if the loss of work becomes too severe due to the pandemic. Construction financing can be withdrawn or modified, severely impacting the principal’s ability to perform or bid on future work. The principal and surety need to assess insurance coverage, the impact of work stoppages, inability to perform, and delays in completion requiring policy extensions and cost increases.
A surety faced with bond claims due to a declared default of its principal or interruption of performance due to the pandemic needs to address additional issues beyond the more traditional decisions made to assess the liability of its principal and the surety’s bonded obligations. Examples to consider include if this pandemic is an act of God or a national emergency. Is the surety’s principal entitled to time extensions or adjustments to its contract price due to the pandemic? Did the work stop due to a national or state executive order? Is the pandemic the sole cause of the stoppage, and there are no unrelated reasons why the principal is unable to proceed? Was workers’ safety at risk due to the pandemic?
It is essential for the surety to understand the multitude of pandemic-related challenges construction projects will encounter. The surety’s preparedness to deal with issues impacting its principals is key.
Communication is essential. The parties should work collaboratively to reach a mutual understanding as to whether any work stoppages are temporary or will continue through the duration of the project. Issues should be addressed as early as possible regarding financial obligations to contractors for work in place, including overhead and profit, as well as the respective parties’ anticipated losses, costs, potential damages and rights to time extensions.
The surety should continually communicate with its principal about the ability to remobilize as well as the principal’s financial capability to absorb associated costs due to work stoppages. The surety needs to evaluate the principal’s ability to absorb potential losses, costs and damages due to the pandemic (e.g., loss of work on current and future jobs, inability to supply adequate manpower, obtaining materials and supplies, etc.). Confirming the principal’s capacity to withstand the pandemic will directly impact the surety’s ability to determine what obligations it has in response to anticipated performance and payment bond claims.
The challenges caused by the pandemic are unforeseeable but will have a significant impact on the construction industry. It may take years for the courts to determine how to address the fallout from failed construction projects. It remains imperative parties understand the terms of the bonds and the construction contracts when evaluating how to proceed legally and equitably during unchartered waters.
Michael J. Weber, Esq. is a partner in the Commercial Litigation group with Dinsmore & Shohl in Chicago, Illinois. He is licensed in Illinois and Michigan and has a national litigation practice, which includes construction, contract and commercial surety, fidelity bond litigation, as well as general litigation and transactional matters.
Grace Winkler Cranley, Esq., is a partner in the Commercial Litigation group with Dinsmore & Shohl in Chicago, Illinois. She is an experienced commercial litigator who focuses her practice in the areas of surety, fidelity, transaction and general litigation matters. She also assists clients in all aspects of the construction process from the drafting and negotiation of construction contracts through post-project issues.
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