Agreement for Payment of Construction Contractor: The New Contingent Payment Statute

by Anthony D. Whitley

Whitley discusses the new contingent payment statute, passed by the Texas Legislature in June

Whitley is an attorney at the Dallas office of Ford Nassen & Baldwin P.C.. He can be reached at adwhitley@fordnassen.com.

Courts have long scrutinized contingent payment clauses which shift the risk of an owner’s non-payment to a subcontractor, but they have nevertheless held them enforceable when properly drafted. However, until now, the legislature remained silent on the issue. On June 16, 2007, Senate Bill 324 became law creating §35.521 of the Texas Business & Commerce Code. Section 35.521 becomes effective on September 1, 2007. In the Bill Analysis, it is stated that this new statute was enacted to clarify circumstances in which contingent payment clauses will not be enforced in Texas. The statute still requires the contractor to properly draft the clause, but places additional burdens on the owner and contractor to provide certain project-related information, on the subcontractor to provide statutory objections to its enforcement, and on the contractor to maintain the enforceability of the clause in different situations.

Contingent payment clauses must be properly drafted In five of the seven Texas appellate cases considering contingent payment clauses, the courts have held against the contractor where the clauses fail to clearly express the intent to shift the risk of the owner’s non-payment to subcontractors. If the statute does one thing well, it defines a “contingent payment clause” in such a way that the definition should provide the “magic” language courts have long looked for. The new statute defines a contingent payment clause as a provision in contracts for construction management or for the construction of improvements to real property, including the furnishing of materials, where “the contingent payor’s receipt of payment from another is a condition precedent to the obligation of the contingent payor to make payment to the contingent payee for work performed or materials furnished.” In a typical situation, the contingent payor is the contractor and the contingent payee is the subcontractor.

The owner and contractor must provide project-related information Once a valid contingent payment clause is drafted, the contractor must request information from the owner including the owner’s contact information, a description of property on which the project is constructed and detailed information regarding source of owner’s funds sufficient to pay for the improvements. The owner must provide this information to the contractor who then must pass it on to the subcontractor, along with information regarding the surety, prior to the date on which the subcontract becomes enforceable. If the owner fails to furnish this information to the contractor within thirty days, the contractor and subcontractor are relieved from their obligations to perform. The statute places similar requirements on a contractor and an owner on government-owned projects.

The subcontractor must object to the enforcement of the contingent payment clause The statute prohibits a contractor from enforcing a contingent payment clause after the contractor receives written notice from the subcontractor objecting to any further enforcement of the clause as it relates to the subcontractor’s most recent payment application. The subcontractor must wait forty-five days after submitting its payment application before sending this notice of objection. The statute does not state what the subcontractor should include in its notice. Logically, the notice would at least state that the subcontractor did not receive payment and that the contractor has no contractual or statutory support for withholding the same. If payment is later received, the notice requirements are reinstated for future payment applications.

However, in some situations, the subcontractor’s notice of objection will not prevent the enforcement of the contingent payment clause. For instance, the notice of objection will not:

1. prevent the enforcement of the clause if the reason for non-payment is the subcontractor’s failure to meet its own financial obligations to promptly pay its sub-tiers with monies received through previous payment cycles; or

2. prevent the enforcement to the extent the owner successfully asserts sovereign immunity and the contractor has exhausted all remedies available to it against the owner under the prompt payment statute in Chapter 2251 of the Texas Government Code.

Requirements for contractors to maintain the enforceability of contingent payment clauses The contractor must fulfill its obligations to the owner so that its defaults are not the reason for the owner’s non-payment, and it must not act in an “unconscionable” manner; otherwise, the statute will prevent the enforcement of an otherwise properly drafted contingent payment clause. The statute does not define what is “unconscionable.” Rather, the statute states it is not unconscionable if

1. the contractor made reasonable efforts to collect from the owner and/or made or offered to make an assignment of the right to do so to the subcontractor along with an offer to cooperate, and

2. the contractor proves that it exercised diligence by providing the subcontractor with the information described above related to the owner and its financing of the project.

The statute places an additional burden on the contractor to respond in writing to the subcontractor’s notice of objection to the enforceability of the clause. If the reason for non-payment is the subcontractor’s failure to comply with an applicable prompt payment statute, then the contractor’s timely response to the subcontractor’s notice of objection must specifically state that reason.

Miscellaneous provisions in the statute The statute lists numerous miscellaneous provisions that will assist the parties and courts in the future to interpret and apply the statute, including:

1 the statute cannot be waived;

2. an owner cannot prevent a contractor from using contingent payment clauses;

3. the statute cannot be used to invalidate the enforceability or perfection of a materialman’s or mechanic’s lien;

4 the statute does not affect contract clauses related to the timing of payment so long as payment is to be made within a reasonable period of time;

5. the statute prevents the enforcement of a contingent payment clause where the contractor and the owner are involved in a “sham contract”; and

6. the statute is inapplicable to contracts solely for design services; construction or maintenance of certain types of projects associated with civil engineering or construction; or for the construction of or improvements to a detached single-family residence, duplex, triplex or quadruplex.

Suggestions for contractors in enforcing contingent payment clauses after September 1 For contractors who wish to include and enforce contingent payment clauses in their subcontracts, they should first ensure they properly draft valid contingent payment clauses. Tracking the language in the statute’s definition of such clauses will help overcome the scrutiny of a court. Second, a contractor must seek the necessary information from the owner and pass it on to the subcontractor before the subcontract becomes enforceable. Third, a contractor must make it a business practice to keep track of the deadlines imposed by the statute to ensure that it fully complies with the statute’s requirements and so that the contractor may monitor a subcontractor’s compliance. Finally, a contractor must diligently to perform its own obligations on the project, and, if non-payment occurs, exhaust all remedies to recover payment from the owner or assign that right to the subcontractor.