Pay-if-Paid – What It Means for Subcontractors

Subcontractors Unite!  Do not sign a subcontract that shifts the risk of non-payment by the owner on you.  My advice is to strike out such provisions in any proposed subcontract and negotiate a reasonable time in which the Contractor has to pay regardless of whether the Owner pays.

Contractors are always trying new ways to “shift the risk” of non-payment by the Owner.  What this means is that General Contractors do not want to pay a subcontractor or supplier unless the Contractor has received payment from the Owner.

This is true even when there is no objection to the work performed or material supplied.

Contractors first tried inserting “pay-if-paid” and “pay-when-paid” provisions in their subcontracts.   The provision can be as simple as stating: “Contractor will pay Subcontractor within 7 days of Contractor’s receipt of payment by the Owner”, or as specific as, “It shall be a condition precedent to Contractor’s obligation to make each payment to Subcontractor (including but not limited to progress payment, final payment, payment for extra work or changed work), if the funds for such payment have first been paid by the Owner to Contractor.”

The Legislature took care of the “pay-if-paid” provision with the contingent payment clause statute that allows an unpaid Subcontractor to reject the enforcement of the provision when the reason for non-payment by the owner has nothing to do with the work of the Subcontractor.  Knowledge of Chapter 56 of the Texas Business and Commerce Code is essential.

Chapter 56 does not apply to a “pay-when-paid” clause if the payment is to be made within a reasonable time.  The problem is that “reasonable time” is not defined in the statute.

To get around the “pay-when-paid” reasonable time standard, Contractors are now defining “reasonable time” in the subcontract.  A typical definition might be as follows:

In the event of non-payment by the Owner, the parties agree that Contractor shall pay Subcontractor within a reasonable time.  For the purposes of determining the timing of payment under these circumstances, the parties acknowledge and agree that a reasonable time for payment to Subcontractor is within 30 days after Contractor has exhausted all available rights and remedies in connection with recovery of payment from the Owner.

When considering how long the litigation process can take including appeals, Subcontractors could be waiting up to 10 years for payment under this definition.  When negotiating the timing of payment, I would suggest the following:

In the event of non-payment by Owner, Contractor acknowledges it will be obligated to pay Subcontractor with a reasonable time for work completed in accordance with the Contract Documents, and for which Owner has no complaint.  A reasonable time period for non-payment to Subcontractor shall be 120 days from the date Subcontractor submitted its application for payment, or 90 days from the date the project reaches substantial completion, whichever occurs first.

However, Contractors have devised an even more sinister way to avoid payment.  They are now getting the Subcontractor to assume the risk of non-payment by the Owner and accepting the risk that the Owner may not pay for the work performed.  This language could be devastating in a suit to collect the amount owed for canopies installed at a project.  A typical provision might say:

It is agreed by the parties that, if payment from the Owner for all or a portion of the Subcontract work is never received by Contractor, then Contractor will never have any obligation to pay the Subcontractor for such portion of the work not paid by Owner.  Subcontractor expressly assumes the risk of Owner nonpayment.

Never agree to such a provision.  The Contractor is always in the best position to determine the financial strength of the Owner, or the Owner’s creditworthiness.  It is the Contractor who has met with and worked with the Owner concerning the plans and construction budget.  The risk of non-payment by the Owner should always fall on the Contractor because it is the Contractor who can elect not to contract with the Owner if the Owner lacks funds or credit.

In many instances a Subcontractor elects whether or not to subcontract on a job because of the Contractor’s reputation.  Most Subcontractors do not elect whether or not to subcontract on a job because of the reputation of the Owner.  Most often the Subcontractor has no intimate knowledge about the Owner.

Murray | Lobb, PLLC. represents subcontractors in their negotiations with contractors and helps in collecting payment for work performed and materials supplied to a construction project.

Sweeping Changes on the Horizon: Fiduciary Duty of Employers & Others Managing 401K Plans

The statute governing the conduct of plan sponsors and advisors to 401(k) plans is the Employee Retirement Income Security Act of 1974 (ERISA).  Section 404 of ERISA imposes a prudent man standard of care on the employer and other plan fiduciaries, comprised of five standards:

  • Duty of Loyalty – A fiduciary must discharge his duties solely in the interest of the plan participants. This means the fiduciary must avoid conflicts of interest when managing plan assets.
  • Exclusive Purpose Rule – A fiduciary must discharge his duties for the exclusive purpose of providing benefits or defraying reasonable expenses only. The plan must not pay excessive compensation to its investment and service providers.
  • Duty of Care – A fiduciary must discharge his duties with the care, skill, prudence and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims. This is also known as the “prudent expert” standard.
  • Duty to Diversify – A fiduciary must diversify the plan’s investments so as to minimize the risk of large losses, unless under the circumstances it is clearly prudent not to do so.
  • Duty of Obedience – A fiduciary must discharge his duties in accordance with the documents and instruments governing the plan insofar as they are consistent with ERISA.

ERISA in § 1113(1) provides that claims brought against fiduciaries under the Act must be brought within six years from the initial breach.

On February 24, 2015, the U.S. Supreme Court heard oral arguments in the case of Tibble vs. Edison International.  This was the first case involving litigation over excessive 401(k) fees heard by the Supreme Court.

The Plaintiffs sued Edison International (Edison) in the U.S. District Court for the Central District of California (district court) to recover losses from alleged breach of fiduciary duty in management of their 401(k) plan based on two theories: 1) that Edison violated certain ERISA provisions by participating in revenue sharing with the funds to offset plan costs (essentially using a portion of the revenue from the participants’ funds to pay administration costs); and 2) that Edison violated ERISA provisions by imprudent handling of plan investments.

The district court granted summary judgment for Edison noting that Edison initially chose the higher-fee retail-class mutual funds for plan investments more than six years before the claim resulting in the plaintiffs’ claim being barred by the ERISA limitations period.

On appeal to the Ninth Circuit, Tibble counsel argued a continuing violation theory proposing that Edison continually breached their duty of prudence by failing to identify on an ongoing basis alternative lower cost fund options for plan participants through 2007.  If this theory was accepted, the last breach would have been in 2007 resulting in plaintiffs’ claims falling within ERISA’s six-year statute of limitations.  The Ninth Circuit affirmed the district court’s ruling.  Tibble petitioned the Supreme Court which granted certiorari to review the case.

While the underlying claim asserts that Edison breached its fiduciary duty in the management of the employee 401(k) Savings Plan, a defined contribution plan sponsored by Edison, the Supreme Court limited review to the limitations issue.

Edison initially claimed it had no continuous duty, and those claims were barred by the six-year statute of limitations, but at oral argument both sides agreed that the duty to monitor was a continuing one. They disagreed on the scope of that duty.  Edison International contended it had no obligation to switch to the less expensive share class, because this was not the type of issue significant enough to warrant “full due diligence.”  The position of the plan participants was that Edison International, as a fiduciary for the plan, had an obligation to make changes that any prudent investor would, which included switching to the lower-fee share class, as part of its continuing duty to monitor investment options.

In response to Justice Kagan’s question as to what a trustee is supposed to do under the prudent person’s standard, Tibble counsel advanced a three-part standard: 1) look at performance on a regular basis, a periodic basis; 2) look at the expenses and determine if there is a cheaper way to get the same investment for less money that’s coming out of the beneficiaries’ assets; and 3) has there been an alteration in the fund management that one ought to look further into.

On the other hand, Edison counsel argued that ongoing, periodic monitoring for anything other than more significant changes such as change in value and risks of the investments is not required.  In response to his contention that all of the changes required to sell retail shares and buy new institutional shares creates disruptions that employees don’t like which is why the monitoring process is usually limited to looking for significant changes.  Justice Kagan was rather incredulous at this proposition by Edison when she observed that, for people who have invested in funds for 30 to 40 years, this would not be much of a disruption at all.  At another point in oral argument, Justice Roberts chimed in questioning how there could be investor confusion.  Justice Roberts proposed that one sentence saying we have been paying .3 percent, and by changing funds, now we’re paying .2 percent, will not have people running out screaming that they’re confused about it.  Justice Kagan responded again with incredulity challenging Edison counsel “They don’t like changes.  They would rather have fees?”

Edison counsel also suggested that all that should be required of the prudent trustee is a periodic review to look only for changed circumstances.  He argued against the Supreme Court endorsing Tibble counsel’s position that the prudent trustee should also look and scour the market for cheaper investment options.  Interestingly, Justice Kennedy seemed to be endorsing the Tibble position when he responded that you certainly would scour the market for cheaper investment options if that’s what a prudent trustee would do.

The Justices focused much of their questioning first as to what kind of monitoring Tibble’s counsel was proposing, what kind of standard he was suggesting.  Then they looked to whether that was what a prudent trustee would do, and what kind of burden this would create for Edison in managing the plan, and finally what effect it would have on the plan participants.

The Justices appeared to support the Tibble plaintiffs’ new “prudent” investor standard.  This Supreme Court was also urged by the government attorneys from the Labor Department to accept this new standard as well.  If the high court adopts this new standard, which appears likely, it could have sweeping effects on companies and employees.  According to the Investment Company Institute, 401(k) plans held $4.4 trillion in retirement assets as of March, 2014.  Some of the funds offered to Edison employees had fees 37% higher than comparable institutional funds.

The Supreme Court’s decision is expected to be out sometime this summer.  It could change how companies fundamentally handle the way they invest for 401(k) plans.  They could move away from mutual funds to lower-cost methods such as collective trusts or separately managed accounts.  One option would be to appoint a “3(38)” fiduciary under ERISA, typically a registered investment advisor (RIA), to transfer the responsibility for managing the plans from themselves to the RIA.  Aside from potential changes in how such plans are managed, there is a lot at stake for both employers and employees in terms of potential litigation.  The Supreme Court’s decision could open a floodgate of litigation regarding the fiduciary duties of trustees for 401(k) plans sponsored by companies across the nation.  This is definitely one decision to keep on your radar.

References

Employee Retirement Income Security Act of 1974 (ERISA), Pub. L. No. 93-406, 88 Stat. 829 (codified as amended in scattered sections of 5 U.S.C., 18 U.S.C., 26 U.S.C., 29 U.S.C., and 42 U.S.C.).

Employee Retirement Income Security Act of 1974, 29 U.S.C. § 1113(1).

Tibble v. Edison International, 711 F. 3d. 1061 (9th Cir. 2013), cert. granted in part, 2014 U.S. LEXIS 4901 (U.S. Oct 2, 2014).