By Wally Irvin | March 13, 2019

Come senators, congressmen please heed the call

Don’t stand in the doorway don’t block up the hall

For he that gets hurt will be he who has stalled

There’s a battle outside and it is ragin’.

It’ll soon shake your windows and rattle your walls

For the times they are a-changin’.

-Bob Dylan-

A battle is raging in Tennessee as Senator Jack Johnsonpushes a bill that seeks to significantly alter the way construction payments are processed and enforced. Senate Bill 324(HB271), as introduced, seeks to invalidate contingent payment provisions, extend the time for subcontractors to record a lien, and shorten the time retainage may be withheld, among other changes.

Contingent payment no more

First, the bill seeks to eliminate so-called “pay-if paid” clauses.  Under these provisions, a contractor’s payment obligation to a lower-tier contractor is not due unless and until the contractor receives payment.  Said another way, I will pay you ifI get paid.  Slightly different is a pay-when-paid clause, which relates more to the timing of payments.  A pay-when-paid provision requires the contractor to make payment when he receives payment. Although this allows the contractor to delay payment for a while, the contractor must still make the payment within a reasonabletime.  

Historically, Tennessee courts have enforcedboth provisions.  For a pay-if-paid clause to be valid, the contract must have been explicit that the lower-tier contractor assumed the risk of non-payment.   For instance, the following passed as a valid pay-if-paid clause:

“Receipt of payment by Contractor from Owner for Subcontractor’s Work is an express condition precedent to Contractor’s obligation to make payment to the Subcontractor. Subcontractor hereby acknowledges that it relies on the credit of Owner, not Contractor, for payment of Subcontractor’s Work.”

However, if the provision did not expressly condition payment to a subcontractor on receipt of payment by the owner, courts found the provision to relate only to the timing of payment, akin to a pay-when-paid clause.

The debate between contractors and subcontractors over who should bear the risk of nonpayment has worn on for years.  Contractors contend they should not be obligated to make payment to a subcontractor with funds they never received.  Subcontractors argue that because they have paid for the labor and materials furnished to the project, they are unwillingly financing the owner’s project.  What both sides agree on is the owner or the lender are the proper party upon whom the payment obligation should ultimately fall.  Both would prefer an avenue to reach the designated, but unpaid, construction loan proceeds.  However, the banking and lending industry has to date avoided any obligation to make payments to contractors in the event of an owner default. This problem is compounded by the fact the lender’s foreclosure of a project eliminates any mechanics’ liens filed by the contractor or the subcontractor.  

Change comes slowly and it appears the legislature’s first step toward remedying the problems of an owner default is invalidating pay-if-paid clauses as between contractors and subcontractors.  Whether it presses onward to shift some of the risk to the lender will be left to another day, another time. 

New notice requirements; Extension of notice and recording deadlines 

Another important change proposed by the bill is the imposition of a pre-work notice and the extension of service and recording deadlines for the enforcement of subcontractor liens. Not currently required, several states, such as Florida, require contractors and subcontractors to provide an initial notice to the owner advising them that they will be furnishing labor or materials on the project.  Tennessee does not currently require such notice and it is interesting that Senator Jackson’s bill imposes this additional hurdle on subcontractors while removing others.

Instead, Tennessee’s current lien law, a subcontractor must serve a Notice of Nonpaymentwithin 90 days of the last day of each month in which the subcontractor provided labor or materials to the project, but was not paid.  Additionally, the subcontractor must record and serve a Notice of Lien within 90 daysfollowing the completion of the project.   Finally, the subcontractor must file a lien enforcement suit within 90 daysof serving the Notice of Lien a/k/a the 90 Day Rules.

Although the current statutory requirements are relatively straightforward to remember, subcontractors have contended the 90 Day Rules did not give them enough time to assert and enforce a lien.  Depending upon the number of contracting tiers on a project, it is not uncommon for a subcontractor to wait more than 60 days after submission of its invoice before it receives payment.  At that point, two-thirds of the time a subcontractor has to serve a notice of non-payment has passed.  If the subcontractor misses this important deadline, it immediately takes away the subcontractor’s ability to assert a lien.  

In an attempt to gain some relief, the bill extends the time for a subcontractor to serve a notice of nonpayment, record a lien, and file a lien enforcement action to 12 months after the project is complete.  But this additional time could cause problems for lenders, owners, and general contractors that seek to close a project out well before the expiration of a year after completion.

Reduction of time before retainage is due

Finally, the bill seeks to reduce the amount of time retainage may be withheld on a project. Tennessee allows upstream parties on a construction project to withhold up to 5% of the contract price as “retainage.”  Retainage may be withheld from each progress payment until the project is complete to ensure a contractor or subcontractor complies with all of the terms of the construction contract.  However, retainage must currently be paid by the owner to the general contractor within 90 days of substantial completion.  A general contractor, and subcontractors, must thereafter release retainage to lower-tier subcontractors within 10 days of receipt. Senate Bill 324 seeks to reduce the time retainage may be withheld from the general contractor to 30 days after substantial completion while maintaining the 10-day rule applicable to lower-tier subcontractors.  Accordingly, the bill would reduce the time a subcontractor’s retainage could be withheld from 100 days to 40 days after substantial completion.  

Likely compromise

Obviously, general contractors and subcontractors do not view these changes from the same lens.  But like they do with contracts, the parties appear to be negotiating somewhat of a compromise.  After a number of proposed amendments, it is likely the final bill will be a mixed bag.  For instance, the time for subcontractors to assert a lien will likely increase to 120 days from 90 days, but subcontractors may be required to serve a pre-work notice. Similarly, pay-if-paid clauses may be rendered unenforceable, but the timing provisions for the payment of retainage could be left unchanged.  The final product remains to be seen but the Tennessee construction industry is certain to see some Ch-ch-ch-ch-Changesthis legislative session.

Photo:Ken Lund

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