Construction Law Blog
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Washington Supreme Court Overturns 30-Year Law Protecting General Contractors From Trust Fund Liens on Public Works Projects
Under Washington’s Public Works Statutes (RCW 39.08 and 60.28), general contractors who perform public works are legally required to post payment bonds and have retainage withheld from progress payments. The purpose of these laws is to protect the public entity (owner) from subcontractor and supplier claims against the public project, while preserving the interests of mechanic’s lien rights (subcontractors and suppliers are provided bond claim and retainage rights, but have no lien rights in the public property).
We regularly report on major construction projects in the Pacific Northwest to keep our readers informed of upcoming opportunities in the region. Two upcoming projects fit this category:
Recently, Division III of the Court of Appeals reversed a jury verdict in favor of a general contractor in a case where a subcontractor's employee was killed on the job.
Readers of our blog likely already know that a pay-if-paid clause provides that payment by the owner to the contractor is an express condition to any payment due subcontractors or suppliers. In contrast, a pay-when-paid clause typically provides that payment from the contractor to subcontractor or supplier must occur within a reasonable time after the contractor receives payment from the owner, regardless of whether the owner ever actually pays the contractor. Pay-if-paid clauses shift the risk of non-payment to the subcontractor, while pay-when-paid clauses place the risk of non-payment on the contractor.
While Washington courts have not yet dealt with the pay-if-paid versus pay-when-paid distinction, some other jurisdictions have legislatively or judicially declared that pay-if-paid clauses are unenforceable as a matter of public policy. These jurisdictions reason that a pay-if-paid clause is against public policy because, they believe, a contractor is in a better position to know the financial dealings and likelihood of payment from an owner, as compared to a subcontractor or supplier who does not deal directly with an owner.
Recent Ohio Court of Appeals' Decision
The Ohio Court of Appeals recently interpreted whether a clause in a construction contract was a "pay-if-paid" or a "pay-when-paid" provision.[i] In that case, the parties entered into a subcontract for electrical work for a swimming pool in a hotel. After performing the job, the subcontractor sued the general contractor for $44,088.90 for work that it completed, but did not get paid (the subcontractor had received $142,620.10 in partial payment for its work). The general contractor filed a motion for summary judgment, asserting that the subcontract contained a "pay-if-paid" clause and, therefore, the general contractor did not have to pay because the owner had not paid the general contractor. The subcontractor filed a cross motion for summary judgment, asserting that the subcontract's "pay-if-paid" clause was actually a "pay-when-paid" clause because the condition of payment from the owner to general contractor was not clear and explicit.
The provision of the subcontract reads as follows:
The Contractor shall pay to the Subcontractor the amount due [for work performed] only upon the satisfaction of all four of the following conditions: (i) the Subcontractor has completed all of the Work covered by the payment in a timely and workmanlike manner, (ii) the Owner has approved the Work, (iii) the Subcontractor proves to the Contractor's sole satisfaction that the Project is free and clear from all liens, and (iv) the Contractor has received payment from the Owner for the Work performed by Subcontractor. Receipt of payment by Contractor from Owner for work performed by Subcontractor is a condition precedent to payment by Contractor to Subcontractor for that work.
(Emphasis added). The trial court agreed with the general contractor and held that the above clause was a valid pay-if-paid clause and ruled in the general contractor's favor. The subcontractor, however, appealed the trial court's ruling contending that the trial court incorrectly concluded that the provision was pay-if-paid because it was not clear that the subcontractor bore the risk of nonpayment. The Ohio Court of Appeals addressed the issue by first stating that the risk of insolvency of the owner is ordinarily borne by the general contractor, and that pay-if-paid provisions are generally disfavored.
In Ohio, to enforce a pay-if-paid clause it "must clearly and unambiguously condition payment to the subcontractor on receipt of payment from the owner."[ii] In particular, a pay-if-paid clause must expressly state that: (1) payment to the contractor is a condition precedent to the subcontractor, (2) the subcontractor is to bear the risk of the owner's nonpayment, or (3) the subcontractor is to be paid solely from the owner.[iii]
In this case, the court held that the "condition precedent" language in the clause was not plain and clear enough to sufficiently shift the risk of the owner's nonpayment to the subcontractor. The court provided that a pay-if-paid clause requires a "clear, unambiguous statement that the subcontractor will not be paid if the owner does not pay" and that this clause was not sufficiently clear in this respect, despite the fact the provision contained the "condition precedent" language. The court found that "condition precedent" was not sufficiently defined to inform both parties that the subcontractor would bear the risk of nonpayment by the owner. Thus, the Court of Appeals reversed the trial court's ruling, and ruled in the subcontractor's favor that the clause was actually a pay-when-paid clause because it was not sufficiently clear to transfer the risk of nonpayment to the subcontractor.
AGC of Washington Subcontract Pay-if-Paid Provision
As mentioned above, Washington courts have not yet interpreted pay-if-paid vs. pay-when paid provisions. However, the recent case from Ohio may shed some light on what Washington courts may focus on, if presented the opportunity. The following pay-if-paid provision provided from the AGC of Washington Subcontract would likely be interpreted as a valid pay-if-paid provision based on the Ohio Court of Appeals opinion because it clearly and expressly states that payment to subcontractor is a condition precedent, and that the subcontractor bears the risk of the owner's nonpayment:
Payment Contingent on Owner Payment. It is agreed that as a condition precedent to any payment by Contractor to Subcontractor hereunder the Contractor must first receive payment from the Owner for the Work of Subcontractor for which payment is sought. Subcontractor specifically agrees that it is relying upon the Owner's credit (not the Contractor's) for payment, and Subcontractor specifically accepts the risk of nonpayment by the Owner. At the reasonable request of Subcontractor, Contractor agrees to furnish such information as is reasonably available to Contractor from Owner regarding Owner's financial ability to pay for performance under the Main Contract. The parties agree Contractor does not warrant the accuracy or completeness of information provided by Owner.
Comment: The result in Ohio represents a departure from most jurisdictions' holdings that phrases such as "condition precedent," "if and only if," or "unless and until" constitute valid pay-if-paid provisions. Although Washington courts have not yet tackled this issue, they likely will someday soon and may look to other courts' decisions for guidance. Contractors should examine their subcontracts to make sure the pay-if-paid clauses are sufficiently clear, explicit, and contain the "required" language that the Ohio Court of Appeals indicated in the event that a dispute arises regarding the pay-if-paid provision.
[ii] Id. (citing Kalkreuth Roofing & Sheet Metal, Inc. v. Bogner Constr. Co. (Aug. 27, 1998) 5th Dist. No. 97 CA 59, 1998 WL 666765.
In a landmark case, the Washington Supreme Court re-affirmed the principal that a trustee conducting a non-judicial foreclosure (a foreclosure that is not under the auspices of the Superior Court) owes an duty to both the lender and the borrower and can be liable to the borrower for failure to properly exercise the trustee’s discretion in conducting a sale.[i]
Justice Chambers, writing for the majority, provided: “The power to sell another person’s property, often the family home itself, is a tremendous power to vest in anyone’s hands.” Chambers wrote that the law “requires that trustee to be evenhanded to both sides and to strictly follow the law.” In this case, the Supreme Court ruled that Washington Mutual Bank (“WaMu”), one of the West Coast’s major players in the foreclosure industry, violated the state Consumer Protection Act (“CPA”) by falsely notarizing legal documents and not considering requests to delay the auction of a Whidbey Island home.
In 2008, the nonprofit group Puget Sound Guardians sued WaMu and Quality Loan Service Corporation (“Quality”) for allegedly violating the CPA after the trustee (Quality) sold Dorothy Halstien’s home at a foreclosure auction for a dollar more than the $83,087.67 that the disabled senior owed, stripping Halstien of more than $150,000 in equity. The property’s new owners quickly flipped the home, selling the property for $235,000. Halstien owed WaMu about $75,000 at the time she developed dementia and had a guardian appointed. The cost of her medical care ate up funds to pay the mortgage. She died in late 2008 at 76.
The Court held that Quality falsely notarized the date on the notice of trustee sale and apparently trained its notaries to do this regularly from 2004 to 2007. Had the notice of sale been correctly dated, the foreclosure auction would have been delayed at least a week, the Court said. That was important because there was a pending sale that Halstien’s guardian had secured that may have closed had the trustee agreed to continue the sale at the request of the guardian.
In Washington, trustees have the discretion to postpone foreclosure sales. However, Quality testified that it only would continue a sale if agreed to by the lender. In fact, Quality had a written agreement with WaMu that forbade it from postponing a sale without the bank’s approval.
In the majority opinion, Justice Chambers concluded “that it is an unfair or deceptive act or practice under the CPA for a trustee of a nonjudicial foreclosure to fail to exercise its authority to decide whether to delay a sale.”
On November 5, 2012, voters approved Initiative 502 (I-502) which legalized marijuana use in Washington State. Under I-502, which goes into effect December 6, 2012, adults age 21 and over in Washington State can no longer be arrested under state law for possessing either 1 oz. of useable marijuana, 16 oz. of marijuana-infused product in solid form, or 72 oz. of marijuana-infused product in liquid form. I-502 does not change Washington State employment law, which allows for a drug-free workplace and for employee drug testing. In fact, I-502 does not provide any protection for employees who use marijuana.
Marijuana remains illegal under federal law, and is classified as a Schedule I controlled substance under the Controlled Substances Act (CSA), 21 U.S.C. § 801-971.
In Roe v. Teletech Customer Care Mgmt.,[i] the Washington Supreme Court held that Washington's Medical Use of Marijuana Act (MUMA) did not provide a private cause of action for employees discharged for violating an employer's anti-drug policy, even if the employee lawfully used marijuana pursuant to MUMA. The court reasoned that since marijuana remains illegal under federal law, employers in Washington are not required to permit illegal activity in the workplace.
In an article published on November 17, 2012, the Seattle Times[ii] reported that the City of Seattle informed its employees that the city was maintaining its drug-free workplace policy because it receives federal funding, and federal law still bans marijuana, I-502 notwithstanding. The same logic applies to contractors who perform work on federally funded projects.
Based on the reasoning in Teletech, employers may maintain drug-free workplace policies which prohibit employees from using marijuana, or other illegal substances even if those substances are legal under state law. Most state government employees will still not be permitted to use marijuana regardless of I-502 decriminalizing certain amounts of marijuana usage. Private sector employers should update their drug-free workplace policies to inform their employees that use of any illegal substances under state and federal law is cause for termination I-502 notwithstanding, particularly for projects funded by the federal government.
[i] 171 Wn.2d 736, 257 P.3d 586 (2011).
The Seattle City Council is considering legislation, CB 117583, which could alter the way in which employers in construction (and other industries) are allowed to use criminal background information when making hiring decisions. The legislation seeks to make it an "unfair employment practice within the City for any:"
Employer to engage in the following prohibited employment practices by reason of an applicant's or employee's record of arrests or criminal convictions or pending criminal charges.
- 1. No employer shall discharge, refuse to hire, or carry out a tangible adverse employment action because of
- a) an employee's or applicant's arrest record; or
b) an employee's or applicant's criminal conviction record, unless there is a direct relationship between the conviction record and the employment sought or held; or
c) a pending criminal charge against an applicant or employee, unless there is a direct relationship between the circumstances of the pending criminal charge and the employment sought or held.
2. No employer shall obtain or consider information about an applicant's arrest or criminal conviction record or pending criminal charge, or request a job applicant to supply such information, until after the employer has given the applicant a conditional offer of employment.
The mission of the ordinance is to "increase job assistance through reducing criminal recidivism and enhancing positive reentries to society by prohibiting certain adverse employment actions against individuals who have been arrested, convicted, or charged with a crime." Although the intent of the ordinance is understandably supported by some in the Seattle community and members of the Council, the effects on the construction industry cannot be ignored. Most often, if not always, construction projects have a schedule and set completion date. Thus, the delays associated with (1) being able to conduct a criminal background check until a conditional offer of employment has been made and (2) not being able to discharge or refuse to hire an employee or applicant until a pending criminal charge is adjudicated can cause a tremendous strain on contractors staying on schedule for a bid or job in Seattle. The alternative, of course, would be to take a chance on any liability associated with hiring an individual without the criminal background check.
The proposed legislation is still "in committee" at this time.
Just as two major California cities declared Chapter 9 bankruptcies in consecutive weeks, the Supreme Court of California ruled that charter cities may avail themselves of substantial savings by circumventing California's prevailing wage laws for locally funded projects. In a 5-2 decision, the Supreme Court of California upheld a charter city ordinance prohibiting city contracts from requiring payment of prevailing wage. State Bldg. & Const. Trades Council of Cal., AFL-CIO v. City of Vista, 54 Cal. 4th 547, 279 P.3d 1022 (2012). The decision is a huge win for charter cities, which stand to save millions of dollars in construction-related labor costs. Union contractors are those most negatively affected because prevailing wages are effectively union wages.
The case involved the City of Vista in San Diego County, which amended an ordinance to prohibit city contracts from requiring payment of prevailing wages for all locally funded contracts involving municipal affairs. Shortly thereafter, the City approved contracts to design and build two fire stations without requiring compliance with the state's prevailing wage law. The State Building and Construction Trades Counsel of California, AFL-CIO petitioned San Diego County Superior Court to require the City to comply with California's prevailing wage law. The trial court denied the petition and the Supreme Court of California affirmed, holding that "the construction of a city-operated facility for the benefit of a city's inhabitants is quintessentially a municipal affair". The Court found no convincing basis for the state's interference in what would otherwise be a merely local affair and rejected arguments that labor standards are statewide concerns as too abstract.
The significance of the decision in California cannot be understated. With cities such as Stockton and San Bernardino already filing for bankruptcy, analysts suggest that these are just the tip of the iceberg. It is likely that many other California charter cities facing significant budget shortfalls will follow the City of Vista's lead to cut down costs while continuing to construct and remodel city structures.
What about Washington? How will this decision have an effect on Washington's prevailing wage statue? Do the same arguments apply to the Washington State Constitution?
Although many Washington cities, such as Gold Bar, Normandy Park, and others, are facing serious money woes, it is unlikely that the recent decision by the Supreme Court of California will have any significant effects on Washington's prevailing wage statue. First, California's Constitution is more favorable to city ordinances than Washington's Constitution. Under the California State Constitution, ordinances of charter cities supersede state law with respect to "municipal affairs." Cal. Const. art. XI, § 5. Under the Washington State Constitution, however, a city has the authority to "make and enforce within its limits all such local police, sanitary and other regulations as are not in conflict with general laws." Wash. Const. art. XI, § 11. Second, but related, California courts' test for state preemption is more favorable to city ordinances than Washington courts' test. In California, a city is preempted from enacting ordinances where the subject of the state statute is one of statewide concern and that the statute is reasonably related to its resolution and not unduly broad in its sweep. In Washington, however, a city is preempted from enacting ordinances where the state legislature expressly or implicitly states its intention to preempt the field.
First enacted in 1945, Washington's prevailing wage statute expressly preempts cities from enacting ordinances permitting government contractors to pay less than the prevailing wage. RCW 39.12.042. For Washington, this means that the cost of public-works projects will continue to be driven up by ever increasing prevailing wages. A study by Washington Research Council of Spokane-area construction suggests that allowing non-prevailing wage bids for school construction would save taxpayers approximately 27 percent on labor costs and 12.7 percent on overall project costs. With growing demand by voters and tax-payers to stretch every dollar as far as possible, Washington's prevailing wage law does just the opposite by interfering in labor choice in the marketplace and artificially inflating its own costs.
Stacy Curtin, Three California Cities Bankrupt: 'This Is The Tip of the Iceberg,' Says Fmr. Statesman, Daily Ticker, July 13, 2012, available at http://finance.yahoo.com/blogs/daily-ticker/three-california-cities-bankrupt-tip-iceberg-says-fmr-155121281.html
Washington Research Council, Schools Would Benefit From Repeal of Prevailing Wage, Policy Brief, December 21, 1999, available at http://www.researchcouncil.org/docs/PDF/WRCEducation/SchoolsWouldBenefit.pdf
Recent years have seen a proliferation of lawsuits brought by lawyers who make their money from wage disputes for such things as the employer's failure to provide its employees with breaks. Statutorily, employees are entitled to certain breaks during their work day. The question was whether the state of California (the "nanny" state) may require that employers mandate and ensure that those breaks are taken. That issue came before the California Supreme Court in Brinker Restaurant Corp. v. Superior Court. Workers' attorneys argued that abuses are routine and wide spread when companies aren't required to issue direct orders to take breaks. The case was filed approximately nine years ago against a parent company of Chili's restaurant (Brinker International) and other restaurants, and alleged that the companies had deprived their workers of meal breaks in violation of California labor law. The court unanimously ruled on April 12, 2012, that although employers must free workers of job duties for the required 30-minute meal break, employers are "not obligated to police meal breaks and ensure no work thereafter is performed." A management side employment lawyer termed the decision one that will free employers from the "specter of frivolous lawsuits . . . [the] only clear losers today are the lawyers who make their money off of wage class-action lawsuits."
Rights of Union Benefit Trusts Against General Contractors’ Payment Bonds and Retainage on Washington Public Projects and to Assert Mechanics’ Lien Claims
There continues to be a split between Washington courts and federal courts as to whether Union Benefit Trusts are entitled to claim against a general contractor's payment bond and retainage on a Washington public works project or entitled to file a mechanics' lien on a private project. Union Benefit Trusts provide benefits to union workers. If the Union Benefit Trusts do not receive payment for the benefits of workers on a particular project, the Union Benefit Trusts seek to recover the contribution from nonpaying contractors and subcontractors, including claiming against the general contractor's payment bond or retention on a public project or filing a lien on a private project. The Washington Supreme Court in Brotherhood of Electrical Workers, Local Union No. 46 v. Trigg Electric Construction Co., 142 Wn.2d 431, 13 P.3d 622 (2000), however, held that the Employee Retirement Income Security Act ("ERISA") (federal law) preempted state lien (RCW 60.04) and bond statutes (RCW 39.08), thus, precluding the Union Benefit Trusts from bringing claims against a general contractor's payment bond and retention. The decision was decided narrowly, only 5 to 4, and the Washington Supreme Court has not revisited the issue since it issued this opinion in 2000.
Federal courts, on the other hand, have allowed Union Benefit Trusts to bring such claims against a general contractor's payment bond and retention on a Washington public works project. In Ironworkers District Council of the Pacific Northwest v. Jordan Sollit Corp., 2002 WL 31545972 (W.D. Wash.), the Washington federal district court held that the Union Benefit Trust's bond claim was not pre-empted by ERISA under Federal law, and denied the defendants'motion to dismiss the bond claim, despite the Washington's Supreme Courts' decision in Trigg Electric. The federal district court only had jurisdiction over the state bond claim because of diversity jurisdiction (the plaintiff and defendant resided in different states and the amount in controversy exceeded $75,000). Generally, in a diversity jurisdiction case, the federal court will apply state law yet, the court in Jordan Sollit applied federal law because it stated that the issue was federal preemption, not a state bond claim issue. Similarly, in Cement Masons & Plasterers Health & Welfare Trust v. GBC Northwest LLC, 2007 WL 1306545 (W.D. Wash.), the district court entered an order establishing its jurisdiction over a state lien foreclosure action brought by a Union Benefit Trust. The court held that there was supplemental jurisdiction over such a claim in the ERISA action, because the claim arose "under the exact same set of facts surrounding the employer's failure to make required payments to the Union's Trust actionable under ERISA."
In sum, if the Union Trusts Benefit forecloses its bond or lien action in state court, the action should get dismissed under the Washington Supreme Court's decision in Trigg Electric. But if the Union Trusts Benefit forecloses its claim in federal court under diversity jurisdiction, the federal court will likely not dismiss the action and the Union Benefit Trust can proceed under both ERISA and the state bond or lien statutes. The lesson for general contractors is to monitor their subcontractors, to ensure they are making their required payments to the subcontractor employees' Union Benefit Trusts, to avoid potential liability to the Union Benefit Trusts in either state or federal court.