The Contractor's Compass May 2015 by American Subcontractors Association

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ASA’s

THE OFFICIAL EDUCATIONAL JOURNAL OF THE AMERICAN SUBCONTRACTORS ASSOCIATION

WWW.ASAONLINE.COM

How to Negotiate Retainage

MAY 2015

Eliminating Retainage

The Retainage Conundrum — The Industry Needs a Paradigm Shift Disarming A Dozen Dangerous Subcontract Clauses — Part 3 Protecting Lien Rights on Retainage ASA Attorneys’ Council Examines Terms and Conditions of Textura’s Construction Payment Management System Legally Speaking: Eliminate or Reduce Financial Impact of Retainage

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March 3-5, 2016 Miami, FL • See page 16

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May 2015

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EDITORIAL PURPOSE The Contractor’s Compass is the monthly educational journal of the Foundation of the American Subcontractors Association, Inc. (FASA) and part of FASA’s Contractors’ Knowledge Network. The journal is designed to equip construction subcontractors with the ideas, tools and tactics they need to thrive.

How to Negotiate Retainage............................................................ 6 by Jim Sienicki and Sarah Delaney

The Retainage Conundrum — The Industry Needs a Paradigm Shift.................................................................. 10

The views expressed by contributors to The Contractor’s Compass do not necessarily represent the opinions of FASA or the American Subcontractors Association, Inc. (ASA).

by Adam C. Harrison, Esq.

Disarming a Dozen Dangerous Subcontract Clauses — Part 3................................................. 13

EDITORIAL STAFF Editor-in-Chief, Marc Ramsey MISSION FASA was established in 1987 as a 501(c)(3) taxexempt entity to support research, education and public awareness. Through its Contractors’ Knowledge Network, FASA is committed to forging and exploring the critical issues shaping subcontractors and specialty trade contractors in the construction industry. FASA provides subcontractors and specialty trade contractors with the tools, techniques, practices, attitude and confidence they need to thrive and excel in the construction industry.

by Dan McLennon

Protecting Lien Rights on Retainage....................................... 18 by Scott Wolfe, Jr.

ASA Attorneys’ Council Examines Terms and Conditions of Textura’s Construction Payment Management System..... 21 by Dan McLennon

FASA BOARD OF DIRECTORS Richard Wanner, President Letitia Haley Barker, Secretary-Treasurer Brian Johnson Robert Abney Anne Bigane Wilson, PE, CPC SUBSCRIPTIONS The Contractor’s Compass is a free monthly publication for ASA members and nonmembers. Subscribe online at www.contractorsknowledgedepot.com.

Departments

ADVERTISING Interested in advertising? Contact Tony Kozak at (716) 844-8174 or advertising@asa-hq.com.

CONTRACTOR COMMUNITY............................................................ 4

EDITORIAL SUBMISSIONS Contributing authors are encouraged to submit a brief abstract of their article idea before providing a fulllength feature article. Feature articles should be no longer than 1,500 words and comply with The Associated Press style guidelines. Article submissions become the property of ASA and FASA. The editor reserves the right to edit all accepted editorial submissions for length, style, clarity, spelling and punctuation. Send abstracts and submissions for The Contractor’s Compass to communications@asa-hq.com.

LEGALLY SPEAKING.......................................................................... 24

ABOUT ASA ASA is a nonprofit trade association of union and non-union subcontractors and suppliers. Through a nationwide network of local and state ASA associations, members receive information and education on relevant business issues and work together to protect their rights as an integral part of the construction team. For more information about becoming an ASA member, contact ASA at 1004 Duke St., Alexandria, VA 22314-3588, (703) 684-3450, membership@asa-hq.com, or visit the ASA Web site, www.asaonline.com.

Eliminate or Reduce Financial Impact of Retainage by Lee Brumitt, Esq.

Quick Reference ASA/FASA CALENDAR..................................................................... 26 COMING UP....................................................................................... 26

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Contractor Community ASA Calls for Full Funding of Change Orders on Federal Contracts ASA, joined by eight other construction associations, petitioned the Office of Federal Procurement Policy to modify the Federal Acquisition Regulation to “make explicit” that before ordering a change to a construction contract the contracting officer must assure that funds are available to pay for additional work being ordered. “Our members are facing increasing numbers of instances in which a Contracting Officer will direct a change in the scope of work on a construction project, lacking funds available to pay for the increased costs being imposed upon the contractor,” the associations wrote in a March 18 letter to OFPP Administrator Anne Rung. In testimony delivered in May 2014, the General Accountability Office reported that it had identified 77 instances of violations of the AntiDeficiency Act by the Department of Defense between 2007 and 2013, totaling $1.24 billion. GAO further noted that “[T]he number of violations and dollar amounts reported may not be complete because of weaknesses in DOD’s funds control and monitoring processes that may not have allowed all violations to be identified or reported.” The associations recommended modifications to the FAR, including a new provision under FAR Subpart 36.5 that would require the contracting officer to take actions required by FAR Part 43.105 (Availability of Funds) as well as the requirements of the Anti-Deficiency Act. The group also recommended an amendment to FAR Part 52.243.4 (Changes) that would allow the

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contracting officer to continue to make changes in the work within the general scope of the contract, at any time and without notice to sureties, “but only if funds are available to pay the costs of such changes.” In addition to ASA, signatories to the letter included The American Council of Engineering Companies, the Associated General Contractors of America, the Design-Build Institute of America, the Mechanical Contractors Association of America, the National Association of Surety Bond Producers, the National Electrical Contractors Association, the Sheet Metal and Air Conditioning Contractors’ National Association, and The Surety & Fidelity Association of America.

OSHA Underestimated Construction Cost of Silica Rule by $4.5 Billion According to the Construction Industry Safety Coalition, the Occupational Safety and Health Administration’s proposed silica standards for U.S. construction industry will cost the industry $5 billion per year — roughly $4 .5 billion per year more than OSHA’s estimates. The cost and impact analysis from OSHA reflects a fundamental misunderstanding of the construction industry. The OSHA analysis included major errors and omissions that account for the large discrepancies with the CISC report. The CISC report estimates that about 80 percent of the cost ($3.9 billion/year) would be direct compliance expenditures by the industry such as additional equipment, labor and record-keeping costs. The remaining 20 percent of the cost ($1.05 billion/year) would come in the form of increased prices that the industry would have to pay for construction materials and

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building products such as concrete block, glass, roofing shingles and more. OSHA failed to take into account these additional costs to the construction industry that will result from the proposed standard, which will then be passed down to customers in the form of higher prices. Not only would the proposed rule be more costly than originally estimated, but it would translate into significant job losses for the construction industry and the broader economy. The CISC estimates that the proposed regulation would reduce the number of jobs in the U.S. economy by more than 52,700 annually. That figure includes construction industry jobs, jobs in related industries such as building material suppliers, equipment manufacturers and architects, as well as losses in nonconstruction sectors. ASA has called on OSHA to withdraw its proposed rule as it applies to the construction industry. ASA Chief Advocacy Officer E. Colette Nelson said, “ASA believes that the proposed rule is simply unworkable and its requirements unattainable for most employers in today’s construction environment.” ASA is a member of the Construction Industry Safety Coalition.

EPA Approves New ClimateFriendly Refrigerants The Environmental Protection Agency has increased the options for refrigerants used in various kinds of refrigeration and air conditioning equipment in the United States. This new rule, which took effect on April 10, addresses refrigerants under the Climate Action Plan that calls on EPA’s Significant New Alternatives Policy (SNAP) Program to identify and approve additional climatefriendly chemicals. After receiving

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input from industry, environmental groups, and others, EPA approved additional low-GWP hydrocarbon refrigerants, subject to use conditions, in the following refrigeration and air conditioning applications: • Ethane in very low temperature refrigeration and in nonmechanical heat transfer. • Isobutane in retail food refrigeration (stand-alone commercial refrigerators and freezers) and in vending machines. • Propane in household refrigerators, freezers, or combination refrigerators and freezers, in vending machines, and in room air conditioning units. • The hydrocarbon blend R-441A in retail food refrigeration (standalone commercial refrigerators and freezers), in vending machines and in room air conditioning units. • HFC-32 (difluoromethane) in room air conditioning units. HFC-32 has one-third the GWP of the conventional refrigerants currently being used in room air conditioning units. These refrigerants are already in use in many of these applications in Europe and Asia. In addition to adding these climate-friendly alternatives, EPA is also exempting all of these substances, except HFC-32, from the Clean Air Act venting prohibition, as current evidence suggests that their venting, release, or disposal does not pose a threat to the environment. “[This] rule is an example of how we can turn the challenge of climate change into an opportunity to innovate our way to a better future,” said EPA Administrator Gina McCarthy. “By working together, businesses and EPA are bringing new, climate-friendly refrigerants to market that better protect our health and the environment.”

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Learn more about EPA’s SNAP Program and this rule at http://www. epa.gov/ozone/snap/index.html.

CCO Mobile Crane Operator Written Exams Now Available in Spanish In response to numerous industry requests to serve the growing Spanish-speaking construction labor force, and in light of its 20th anniversary commitment to refine and evolve its safety mission, the National Commission for the Certification of Crane Operators is making its CCO Mobile Crane Operator written certification exams available in Spanish. The Spanish-language CCO exams are direct translations of the Englishlanguage exams, based on identical content outlines and with the same number of questions. First to be made available are the mobile crane operator Core exam along with the Telescopic Boom Crane (Fixed Cab), Telescopic Boom Crane (Swing Cab), and Lattice Boom Crawler Crane Specialty exams. All load charts (Manitex Boom Truck, Grove Rough Terrain, and Manitowoc, respectively) are also provided in Spanish. Publication of the Spanishlanguage CCO exams marks over two years of development work by NCCCO’s Spanish Technical Review Group. This panel of bilingual crane experts assisted in the process of crafting the language to ensure only “operator terminology” was used and was careful to follow international standards on the process of translating certification exams. Consequently, all exams have the same level of difficulty and competencies as their CCO English language counterparts.

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“NCCCO is committed to maintaining the same standard for all its candidates, whether they are English-speaking or Spanishspeaking,” said NCCCO Director of Operations and Program Development Joel Oliva. “We are confident that the new exams provide a level playing field for candidates for whom English is not their first language.” The equivalency of the two sets of exams had been validated by numerous pilot tests over the past two years, Oliva added. The new Spanish-language exams are likely to provide valuable assistance to employers desiring to ensure their Spanish-speaking operators meet the OSHA 1926 CFR Subpart CC requirement. The OSHA crane rule allows for tests to be administered in any language the operator candidate understands, but it requires the certification card indicate the language the test was given in. The employer must also provide the operator with operating manuals written in the language of the certification, and all onsite communication has to be understood by all parties. Spanish-language CCO exams are currently available in a traditional paper-and-pencil format, and work is under way to develop computer-based versions of the tests. CCO Mobile Crane Operator exams have already been translated and administered in Portuguese for the Brazilian market, and Rigger certification in Mandarin has been available for some time. NCCCO is an independent, nonprofit organization established to develop and administer a nationwide program for the certification of crane operators and related personnel. For more information on Spanish-language CCO exams, visit http://nccco.org/ Spanish.

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Feature How to Negotiate Retainage by Jim Sienicki and Sarah Delaney

Construction is one of the few industries that consistently incorporates the concept of “retainage” into its contracts. These provisions, designed to withhold a portion of the contractor’s or subcontractor’s contract price until construction is completed, are often created with two goals in mind. First, many owners trust that retainage encourages the contractors and subcontractors to complete the project. Second, many owners also trust that retainage protects the owner against any liens or default by the contractor or subcontractors which could arise during the project. At its core, retainage is designed to mitigate risk. Given the growing complexity of construction projects, the economic challenges still affecting our industry, and the

IN THIS ARTICLE . . . • Submit bids or negotiate subcontracts with two prices, one with and one without retainage. • Offer other methods of security to ensure performance. • Request aggressive subcontract provisions to require, without limitation, prompt payment.

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traditional inclusion of retainage provisions in construction contracts, these provisions are still routinely used today. But they often mean that contractors and subcontractors are not fully paid for years until the project is “substantially complete.” Additionally, general contractors typically “pass” the owner’s retainage requirements on to their subcontractors. For example, the grading subcontractor who performs its work at the beginning of the project may not receive its retainage until the entire project is “substantially complete” three to five years later. Compounding the problem, sometimes the contractor withholds retainage from its subcontractors at a higher percentage than the owner withholds. This may actually incentivize the general contractor to not promptly request the retainage from the owner. In any event, a subcontractor may have completed all its work in a timely and appropriate manner, but still wait for months, or even years, to ever be paid in full. These problems have encouraged some states to enact legislation regarding retainage provisions in public and private contracts. For example, Delaware has capped the amount of retainage allowed on state work to 5 percent, while New Mexico prohibits retainage on almost all public or private work. The U.S. government also developed provisions regulating retainage more than 30 years ago. In 1983, Federal Acquisition Regulation 32.103 was enacted, which states in part that “retainage should

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not be used as a substitute for good contract management.” 48 F.A.R. 32.103. Owners and contractors are generally only allowed to withhold funds with cause, and any decision to withhold retainage should be based on “the contracting officer’s assessment of any past performance and the likelihood that such performance will continue.” 48 F.A.R. 32.103. By incorporating other methods to avoid risk and to prevent problems, subcontractors can alleviate many of the concerns underlying retainage. They can submit bids or negotiate their subcontracts with two prices, one with and one without retainage, and can stick to their price when the contractor wants to withhold retention and wants to use their “without retainage” price. Contractors and subcontractors can offer other methods of security to ensure performance. If the owner requires performance and payment bonds on the project, contractors and subcontractors can urge the owner that it doesn’t need the “belt and suspenders” approach to also require retainage. If retainage cannot be eliminated, subcontractors can instead request aggressive subcontract provisions to require, without limitation, prompt payment of progress payments throughout the project. Subcontractors can and should apply a variety of tactics to negotiate down retainage — it may be in everyone’s best interests.

Tip #1: Demonstrate Why Retainage Is Not Necessary One of the most powerful ways to negotiate retainage in subcontractor agreements is by showing contractors

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and owners how retainage works against them. Submit multiple bids, showing the realistic increased prices with retainage. Retainage often requires additional upfront use of the subcontractors’ capital or line of credit to ensure the subcontractor has enough funds to operate, since a significant percentage (often greater than the subcontractors’ profit margin in these lean years) is being withheld as retainage. Articulate any positive history of on-time performance and contractor/client feedback to show that your company consistently performs very well, even during market fluctuations, and will do so in this case even if retainage is not withheld. Offer incentives to the contractor or owner if they eliminate or reduce retainage, such as a discount against the released retainage if retainage is reduced and paid at an earlier point in the project, or a reduction in your final bill if payment of retainage is timely made after your subcontractor work has been substantially completed. The subcontractor can also ask that only a small retainage be withheld from the final payment due upon Final Completion of the subcontracted work, as a true “encouragement” for the subcontractor to reach Final Completion of its work, and that these withheld funds be released within 10 days after Final Completion of the subcontractor’s work. Subcontractors should also discuss the industry-wide reasons why retainage should be eliminated. Retainage reduces competition. A 1999 ASA study found that 91 percent of subcontractors are disinclined to bid for projects with retainage provisions. Dennis Bausman, Clemson University and the Foundation of the American Subcontractors Association, “Retainage Practice in the Construction Industry,” (2004). It results in higher bids: 69 percent of respondents to the same study explained that they would lower their bids by about 3 percent if retainage was not withheld. Eliminating or

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reducing retainage also improves the cash flow for small and medium-size companies, which is good for both the subcontractor and the overall project by ensuring the subcontractors have the necessary funds to complete their work. Both contractors and subcontractors have significant financial incentives to avoid retainage, as it essentially requires them to finance the project, and often places the burden on certain companies which can least afford it. By explaining how retainage hurts contractors and owners and by providing incentives to reduce or eliminate retainage, subcontractors have a strong argument for modifying the retainage provisions. These strategies can be particularly useful when employed with the below methods, such as an alternative method for guaranteeing timely performance.

Tip #2: Offer Other Methods of Security Subcontractors can negotiate retainage provisions by offering alternatives to guarantee timely performance that also give the subcontractor more control over the funds. An escrow account can be a great compromise. Any funds withheld by the owner or contractor are placed in an escrow account, earning interest, preventing unwarranted expenditure of the funds, and keeping them away from the owner’s creditors. The subcontractor can also offer a substitute security, such as securities in lieu of retention, or a letter of credit from the subcontractor’s bank in the amount of the normal retainage, to demonstrate that the contractor could re-collect the same amount of funds if the project is not properly or timely completed. Public sector work often requires performance and payment bonds from the contractor, who also often requires performance and/or payment bonds from key subcontractors, providing an alternative source of assurance to the owner and/or

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contractor if work is not properly performed or if subcontractors or suppliers are not timely paid. These bonds are often required by owners and contractors in private sector contracts for the same reasons. An owner would be properly protected by the bonds if the work is not performed as agreed or if subcontractors and suppliers are not timely paid, while the contractor and subcontractor receive full payment (without retainage) each period, resolving all parties’ concerns. Contractors can likewise utilize performance bonds or other insurance products

LEARN HOW TO REDUCE OR ELIMINATE RETAINAGE WITH ASA PODCAST In the podcast “Eliminating or Limiting Retainage,” available from ASA and the Foundation of ASA, construction subcontractors can learn about commonly stated justifications for retainage and their flaws, and how industry model contracts, and federal and state laws, treat retainage. They’ll also get strategies and negotiating tips to better position their companies to avoid having to accept undue or excessive retainage. As a value-added membership benefit, ASA members can download this podcast for free by logging in to the members-only section of the ASA Web site at “LOGIN/ACCESS MEMBER RESOURCES,” and selecting “audio podcasts” under Contractors’ Knowledge Bank. Non-members can access the podcast through ASA’s online store for $65.

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to protect themselves regarding the subcontractor’s performance. The bonding prequalification or insurance products process also help screen out companies who would be unable to effectively perform the project. If the subcontractor offers or is required to provide a performance bond, it should ensure that this bond requirement would not be in addition to any retainage; otherwise, the owner and contractor receive “double protection” while the subcontractor is doubly penalized. Instead, the subcontractors should explain that forgoing retainage in this situation could mean a lower contract price for the owner. If the owner wants a cheaper option and therefore rules out the bond (which generally costs 1 percent to 2 percent of the total bonded amount), the contractor and subcontractors can also explain that eliminating retainage would mean even lower contractor and subcontractor bids or negotiated prices, resulting in additional cost savings to the owner.

Tip #3: Agree to Retainage But Require Lower Percentage, Retainage Cap, and/or Prompter Progress Payments and Interest in Event of Payment Delays A contractor may not be willing to eliminate all retainage from its agreements. Some may believe that retainage gives them better control over the subcontractors’ performance. Others may be required to include retainage under the terms and conditions of the owner’s agreement. Subcontractors should still negotiate, however, even if retainage must remain in the subcontract. It may be possible to reduce the percentage withheld from each payment or cap the total dollar amount of funds withheld. If the contractor will not budge from the amount withheld as retainage, the subcontractor may want to get more aggressive in negotiating its payment terms to ensure that it receives its progress payments in a timely manner. For example, the subcontractor may want to negotiate

prompt payment terms, significant interest provisions, and the right to suspend work if prompt payment is not received. These provisions may be necessary to provide the subcontractor with sufficient funds to complete the project, given the potentially lengthy delay in receiving prompt payment of any retainage. The subcontractor may also want to request the contractor pay interest on all withheld retainage funds, and negotiate this interest rate. As the owner and/or contractor are holding on to a portion of the subcontractor’s rightfully-earned funds, this interest may compensate for the delay in payment. The subcontractors may also want to significantly increase this interest rate in the event the contractor does not timely release the funds to the subcontractor even after payment of retainage was received from the owner. This menu of proposed terms may encourage owners and contractors to pay retainage as quickly as possible or encourage them to reconsider reductions in retainage. You may also

ASA MANUAL HELPS SUBCONTRACTORS NAVIGATE ‘RETAINAGE LAWS IN THE 50 STATES’ An ASA reference manual, Retainage Law in the 50 States, is helping construction subcontractors understand retainage laws where the projects they bid and work on are located. As it applies to subcontractors, retainage is the practice of regularly holding a portion of progress payments that subcontractors earn for performing construction services. “In many states, the withheld funds are to be held in escrow, to be paid back to the contractor or subcontractor with interest,” the guide explains. “Many states also permit contractors and/ or subcontractors to substitute securities in lieu of retainage. The majority of states permit contracting agencies or owners to reduce or even eliminate the rate of retainage once a certain portion of the contract is complete.” Each state entry in the manual reviews critical factors in retainage law for private and public work, including the retainage rate permitted under law, retainage release milestones, and any options to provide alternative securities in lieu of retainage. The manual also contains a chart summarizing the major

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elements of retainage law for each state. Retainage is generally held as an assurance for the timely completion and quality of a contractor’s or subcontractor’s work. It is calculated as a percentage of the total contract price. However, the practice places a severe financial hardship on contractors and subcontractors. When contractors and subcontractors are forced to complete work without full payment, they, in essence, finance the job, making it difficult to timely pay their own creditors. In some cases, contractors and subcontractors are burdened with sizable retainage receivables long after project completion. The ASA-member law firm and ASA general counsel, Kegler, Brown, Hill and Ritter, Columbus, Ohio, prepared the manual, which contains contributions from construction attorneys from across the country. The manual is available for free to ASA members as a downloadable PDF document on the ASA Web site in the “Contracts & Project Management” section under “Advocacy & Contracts.”

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ASA TIP SHEET EXPLAINS HOW TO DEAL WITH TERMS WHERE ‘RETAINAGE FOR SUB IS MORE THAN FOR GC’ While the federal government has adopted policies strongly discouraging the use of retainage on federal projects and on federally funded transportation projects, the practice of retainage remains prevalent in both public and private contracts. Many subcontracting firms are reluctant to get involved in contracts with excessive retainage, because it can tie up their capital and, in some instances, can force them to borrow money to meet expenses. ASA has published a “Subcontractor’s Negotiating Tip Sheet” examining contract terms where “Retainage for Sub Is More Than for GC.” ASA tip sheets are designed to provide the subcontractor with the information it needs to negotiate a particular subcontract clause, including ASA-recommended language, samples of what a subcontractor may see in a client’s proprietary subcontract, an explanation of the impact of poor language on a subcontractor, negotiating tips, and sources for more information. Retainage perpetuates adversarial relationships that marginalize and reduce individual and collective performances on the job. The very premise of retainage is based on lack of trust. Furthermore, the general contractor may have a disincentive to complete the project if it is retaining more from its subcontractors

want to consult with a knowledgeable construction attorney about any Prompt Payment Acts with beneficial provisions that may govern the project, which may provide leverage to you. Subcontractors should learn, and be armed with, information and knowledge about applicable federal, state, and local laws regarding retainage. As discussed above, many states have capped allowable retainage percentages or have other helpful retainage statutes. Subcontractors may want to confirm that any subcontract follows appropriate state law before signing. Subcontractors may also want to consult with a knowledgeable construction attorney regarding the retainage laws in the state where the project is located. For additional information about your state’s statutes or regulations on retainage, you should also review ASA’s available information, articles and Web site.

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than the owner retained from it. Most model construction industry contracts reference retainage, suggesting its pervasiveness in privately-owned construction. ASA recommends that typical retainage language, such as “the General Contractor shall retain ten percent of the amount of each progress payment to the Subcontractor,” should be replaced with: “Customer shall not deduct retainage from Subcontractor’s payments except to the extent of retainage held by project owner on Subcontractor’s work.” If a general contractor argues, “It’s really none of your business how much the owner retains,” the subcontractor could reply, “If the owner felt that we were not entitled to payment, he wouldn’t have released the funds for our work.” If the general contractor says, “Ten percent retainage is standard industry practice,” the subcontractor could respond: “That may have been true a generation ago. But today, industry leaders like ConsensusDocs and even the federal government and many states prohibit GCs from retaining more from their subs than the owner is retaining from the GC.” The ASA tip sheet is available in the members-only section of the ASA Web site.

Conclusion Subcontractors should negotiate retainage whenever possible. These provisions affect the subcontractors, contractors, and the project owners. They often result in raised bid or contract prices, reduce competition, and may have little effect on the completion of work. By using these negotiation tips, subcontractors can communicate the problems with retainage and propose solutions to ease the general contractor’s and owner’s fears while also helping their bottom line. This would also mean more money in subcontractors’ pockets earlier in the project when it could be most helpful in timely completing the project. Jim Sienicki is a partner with Snell & Wilmer L.L.P., Phoenix, Ariz., and Sarah Delaney is an associate with Snell & Wilmer L.L.P., Phoenix, Ariz. Founded in 1938, Snell & Wilmer is a full-service business law firm with more than 400 attorneys practicing in nine locations throughout the western

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United States and in Mexico. The firm represents clients ranging from large, publicly traded corporations to small businesses, individuals and entrepreneurs. Sienicki’s practice involves construction law representation and litigation, procurement law and bid protests, general commercial litigation, creditors’ rights and other litigation, alternative dispute resolution and appellate matters. He was the head of the firm’s construction practice group from 2000-2013. Sienicki can be reached at (602) 382-6351 or jsienicki@swlaw.com. Delaney focuses her practice in commercial litigation. As a third-year law student, she interned at a local county attorney’s office, where under the supervision of a licensed attorney, she handled more than 75 criminal misdemeanor and felony cases and first-chaired two criminal felony trials. She can be reached at (602) 382-6231 or sdelaney@swlaw.com.

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Feature ASA Position: ASA supports the elimination of retainage. If funds are retained: • • • • •

The contractor should not retain more from subcontractors than the owner retains from it. Funds should be placed in an interest-bearing escrow account. Interest should accrue to the party to which the funds are owed. Funds should be released on a line-item basis. Funds should be released promptly through all tiers of construction.

The Retainage Conundrum — The Industry Needs a Paradigm Shift by Adam C. Harrison, Esq. Fairly often when I speak with gatherings of people that include folks unfamiliar with the construction industry, the conversation turns to shop talk and the concept of “retainage.” When the unknowing ask what the term means, my response is always the same: Retainage is the industry-wide practice of snatching 10 percent of the money earned by subcontractors to finance the overall construction project and pay for the owner’s unexpected cost overruns. I always get a few chuckles from those “in the know” along with a few nodding heads from the others with the response “hmmm … I didn’t know that. They can do that?” The next response is always “Yes. Yes they can.” A few minutes on Google yields the origins of the concept. According to Wikipedia, the practice of retainage dates back to the construction of the United Kingdom railway system in the 1840s. The size of the railway project increased demand for contractors, which led to the entrance of new contractors into the labor market. These new contractors were inexperienced, unqualified and

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unable to successfully complete the project. Consequently, the railway companies began to withhold as much as 20 percent of contractors’ payments to ensure performance and offset completion costs should the contractor default. The point was to withhold the contractor’s profit only, not to make the contractor, and its subcontractors, finance the project. Retainage is a big problem in the modern day construction industry. Owners and general contractors, as creatures of habit, insert “copy and paste” retainage provisions that typically require 10 percent retention withholding until final completion of the overall project. When this occurs at the early stage of the contract drafting process, the damage is already done to subcontractors. Prime contractors will thereafter mirror this retainage language in “downstream” subcontracts and, to aggravate the problem, also complement the retainage language with conditional payment terms such as “pay-whenpaid” and “pay-if-paid” clauses that condition payment from the owner to the prime contractor — including retainage — before the subcontractor

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can receive its payment. Take, for example, a large complex commercial project with an asplanned schedule duration of 36 months. The earthwork contractor with a $4 million site package may complete 75 percent of its work within four months after it receives a notice to proceed. Thus, $3 million of progress payments would amount to $300,000 dollars of withheld retainage. In this scenario, the site work contractor will not see this money for three years or longer, regardless of whether there are any deficiencies with its work and long after the work was likely accepted by the owner. This archaic retainage practice causes a multitude of problems for the subcontractor community. For starters, the practice stifles both cash flow and growth potential of subcontractor businesses nationwide. In the above example alone, it does not take a master of business administration degree to understand how the $300,000 can be otherwise allocated (the concept for those of us that majored in economics, such as myself, is known as “opportunity

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cost”). The withheld funds could have been used by the subcontractor to increase its net worth and by extension its available bonding capacity. The subcontractor could then hire additional estimators, project managers and superintendents, bid and acquire more projects, and grow the business to better serve the same prime contractors and owners that insist on withholding the funds. Another problem arises when one considers the reality that mechanic’s lien and bond rights do not last forever. In many states, these rights begin to tick away from the moment the subcontractor last renders labor or material on the project. Delayed retainage payments often lead to the unknowing expiration of payment protections to recover the withheld monies should the funds, for lack of better words, “somehow disappear.” Finally, by establishing blanket retainage rules across the board, the current retainage system fails to account for the possibility that a major construction default by one trade will hold up the aggregate retainage release to all trades, regardless of any particular fault by an innocent subcontractor trade. The process hardly seems fair, and it’s not. This concept is archaic in a world where payment and performance bonds are commonplace as a risk allocation device that guarantees completion and performance of the subcontractor’s obligations by commercial bond sureties. In fact, led in part by the legislative lobbying efforts of ASA, many states now have statutes on the books to limit retainage if payment security mechanisms such as payment and performance bonds are in place. However, lobbying efforts and retainage statutes are not enough. The industry needs to establish a new paradigm and enter the new modern retainage era.

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Like most problems, attacking the issue at its root is the logical starting place. The contract between the owner and prime contractor must be completely rewritten. Rather than the simple and tired “10 percent retainage shall be withheld from the prime contractor until completion of the project” language, a better approach would tie retainage rates and release criteria on a case-by-case basis for both the prime contractor and each trade subcontractor on a schedule of values and performance criteria approach. In other words, first separate retainage into two divisions — one for the prime contractor and its separate obligations, and the other for the obligations of the subcontractor community. Retainage withholding and release rates would be tied to completion and performance criteria on a subcontractor-by-subcontractor basis using a formula that limits the retention value to the actual shifting risk of non-performance using objective criteria. From there, prime contractor — subcontractor contracts would flow down this criteria to subcontractors without alteration. As I see this new retainage model in practice, I envision the objective measurement criteria to include, by means of example, the percentage complete for the particular subcontractor, whether the subcontractor was on schedule, whether the owner has accepted the subcontractor’s work, whether the subcontractor is bonded, whether any defaults exist, whether the subcontractor has demonstrated the financial ability to

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complete its contractual obligations, and most importantly whether the value of the withheld retainage bears a logical nexus to the risk of future non-performance. The system should be implemented in a way where, generally speaking, the subcontractor’s individual retainage pool is built up during the first third of the subcontractor’s schedule of values, levels off during the second third of the subcontractor’s schedule of values, and is gradually paid out during the subcontractor’s final third of its schedule of values. The key to this retainage model is removing the financial road block between the owner and prime contractor. The new retainage model would effectively null the conditional payment language as it would establish a systematic release of retainage throughout the project, starting with the owner, down to the prime contractor, and finally down to the trade subcontractors.

IN THIS ARTICLE . . . • The archaic practice of retainage causes a multitude of problems for subcontractors. • Retainage stifles both cash flow and growth potential. • Mechanic’s lien and bond rights do not last forever.

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There is the ability to build a better mouse trap. Yet, it will likely never happen. Why? There is indeed a simple answer. On May 3, 1965, a “Wizard of Id” strip, by Johnny Hart as the primary writer and Brant Parker as the primary illustrator, presented the satirical golden rule in The Dallas Morning News and other newspapers. In the first panel the diminutive tyrannical King addressed his subjects from the balcony of his castle and emphasized the need for “peace and harmony.” In the second panel the King continued by stating, “We must all live by The Golden Rule.” This caused some confusion in the third panel because his listeners were uncertain about the nature of The Golden Rule. In the fourth panel the troubadour character delivered the explanatory punchline. Whoever has the gold makes the rules. Who has the gold? Banks and, by extension, project owners. Until banks

and project owners realize a need for their own paradigm shift, there will always be a belief that retaining as much money as possible until final project completion serves the best interest of the project. I submit that this is narrow-minded thinking. Releasing the money downstream to the life blood of the construction industry — to the extent it can be done in those cases where there is no increase in risk — strengthens the very industry that actually builds projects and generates returns on investments. A healthier and stronger subcontractor community fosters healthy and increased competition which, in turn, drives down prices and construction costs — which in my paradigm shift is OK because the subcontractor industry would be receiving a corresponding increase in cash flow and financial growth. Greater economists than I can flush out the benefits, but I believe the thinking is sound.

In the meantime, subcontractors must rely on the traditional approach to protect its interests. Lobbying, careful contract revisions, and similar efforts must stay the course. However, the message must be sent loudly up the chain. The industry is short-sighted and needs change. And the voices must come from below. Adam C. Harrison, Esq., is president of Harrison Law Group, a boutique law firm that provides counseling and legal representation to construction industry professionals at all levels of the building process, including owners, architects, engineers, sureties, general contractors, construction managers, subcontractors and material suppliers. For more information, please visit www. harrisonlawgroup.com.

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Feature Disarming a Dozen Dangerous Subcontract Clauses — Part 3 by Dan McLennon This installment is part three of a three-part article discussing how trade contractors may use conditional bids and proposals to set the stage for negotiations and use legal arguments, industry standard the ConsensusDocs and American Institute of Architects model subcontract forms, and fairness arguments to negotiate more favorable terms in subcontracts. Parts 1 and 2 are found in the March and April 2015 issues, respectively, of The Contractor’s Compass. Today’s installment discusses negotiation tips for clauses on Dispute Resolution, Claims, Right to Cure, and Waivers.

Protect Against ‘Rogue Arbitrator’ Justice is not swift in California, with the state’s courts understaffed and clogged. It can take several months to have a simple motion be heard. For this reason and many more, contractors are turning to arbitration instead of the courts as the forum for dispute resolution. Subcontractors need to be aware that, absent protections in the subcontract form, arbitration awards are binding and not appealable, except for egregious abuses. The AAA and other arbitration rules provide no protections against an arbitrator’s failure or refusal to follow the law or contract terms. Most trial lawyers can tell stories of how they won an arbitration they believed they should have lost, and vice versa, due to an arbitrator’s whim. Both the GC and subcontractor benefit if an arbitrator believes he or she will be held accountable and the parties’ contract allows them to hold the arbitrator accountable. California courts have held certain accountability clauses enforceable, and most GCs will accept subcontractor-suggested protections against the possible “rogue” arbitrator, such as: The parties agree to arbitrate any dispute between Contractor and Subcontractor. In the interest of fairness and to ensure that any arbitrator renders an award in accordance with California law, the parties agree that the

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arbitrator shall not have the power (a) to commit errors of (i) law or legal reasoning, (ii) fact, or (iii) mixed questions of law and fact; or (b) to render an award: (i) not based on substantial evidence, (ii) based on evidence not presented at the hearing, or (iii) not in conformity with the substantive and procedural law of the state of California. If the arbitrator exceeds any of the foregoing specific powers, the award may be vacated or corrected by filing a petition pursuant to the Act in the Superior Court in and for the county of __________. In reviewing the award, the Superior Court shall sit as if it were an appellate court, in all respects, including but not limited to the scope of review. The decision of the Superior Court is, itself, subject to review by the California appellate courts. The arbitrator shall hear and determine the matter, and shall execute and acknowledge the award in writing and cause a copy thereof to be delivered to each of the parties. The award shall include factual findings, conclusions of law, and the reasons on which the decision is based. The decision of the arbitrator shall be final, binding, and conclusive, except to the extent the decision may be submitted for judicial review as provided herein. The award of the arbitrator may be confirmed by

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the Superior Court in __________ County, and such Court may vacate, modify, or correct the award in accordance with the prevailing sections of the Act and in accordance with the terms and conditions herein.

Insist on Right to Bring Claims Only the GC is in privity — in a direct contractual relationship — with the owner, and the subcontractor cannot bring a claim in its own name against the owner. Typical claims clauses require a subcontractor to inform the GC of a claim early enough for the GC to bring a timely claim against the owner under the contract documents. The subcontractor must therefore review the contract documents’ claim timing provisions to ensure compliance. Often the subcontract claims provisions require the subcontractor to foot the entire bill for such claims (even though the GC will recover its markup if the subcontractor prevails), yet the GC undertakes no obligation whatsoever, including whether to bring the claim in the first place, using language such as: The Subcontractor shall pay all of the costs of chasing the owner for payment, including the prime contractor’s attorneys’’ fees and the time for the Contractor’s inhouse personnel to work on it. Subcontractor’s sole remedy shall be to receive the amount received

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by the Contractor from the Owner with respect to such claims. Subcontractor may suggest that the ConsensusDocs 750 presents a fairer way to handle subcontractor claims against the owner, where the subcontractor handles the claim in the name of contractor: 5.3.2 CLAIMS RELATING TO OWNER The Subcontractor agrees to initiate all claims for which the Owner is or may be liable in the manner and within the time limits provided in the Subcontract Documents for like claims by the Constructor upon the Owner and in sufficient time for the Constructor to initiate such claims against the Owner in accordance with the Subcontract Documents. At the Subcontractor’s request and expense to the extent agreed upon in writing, the Constructor agrees to permit the Subcontractor to prosecute a claim in the name of the Constructor for the use and benefit of the Subcontractor in the manner provided in the Subcontract Documents for like claims by the Constructor upon the Owner. Be aware, however, that paragraph 5.3.2, above, should be modified to remove the words “to the extent agreed upon in writing”, because this language could be construed as making the paragraph into an unenforceable “agreement to agree”. Unfortunately, the AIA A401 – 2007 version is not helpful on this issue, because it requires the subcontractor to timely submit claim information to the GC, but it is otherwise silent on how the GC is to handle the subcontractor’s claim with the owner.

Ensure Right to Cure Often, subcontract forms permit GCs to terminate the subcontract — after nominal notice and no right to cure — for any default by subcontractor under the subcontract, with “default” being defined to include a laundry list of performance issues and any breach

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of the subcontract, no matter how trivial. Such clauses may well be unenforceable, and GCs should rely on them sparingly, but such clauses should be modified to better reflect the law and allow the subcontractor the right to cure the problem so as to avoid a GC’s mistakenly making matters worse by using a nominal default to get rid of a subcontractor. Additionally, such clauses often allow the GC to take possession of subcontractor’s tools and equipment and materials wherever located, even at the subcontractor’s shop: H. RECOURSE BY CONTRACTOR. In the event that Subcontractor at any time refuses or neglects to supply a sufficient number of properly skilled workmen or a sufficient quantity of materials of proper quality, or in effect be adjudicated a bankrupt, or files an arrangement proceeding or commits any act of insolvency, or makes an assignment, for benefit of creditors, without Contractor’s consent, or fails to make prompt payment to his material-men and laborers, or fails in any respect to properly and diligently prosecute the work covered by this Agreement, or otherwise fails to perform fully any and all of the agreements herein contained, Contractor may, at his option, after giving fortyeight (48) hours written notice to the Subcontractor, provide any such labor and materials as may be necessary and deduct the cost thereof from any money then due or thereafter to become due to the Subcontractor under this Agreement; or Contractor may, at his option, terminate the Subcontractor’s right to proceed with the work and, in that event, Contractor shall have the right to enter upon the premises of the project or Subcontractor’s warehouse and take possession, for the purpose of completing the work included under this Agreement, of all materials, tools, equipment and appliances thereon, and may employ any

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other person or persons to finish the work and provide the materials therefor. [Italics added.] Both the ConsensusDocs 750 and the AIA 401 forms provide fair and reasonable protections for claimed subcontractor defaults, by providing notice and opportunity to cure the alleged default. Subcontractors would be well advised to insist on the opportunity to cure similar to those provided by the ConsensusDocs and AIA forms, and subcontractors should strike language allowing a GC to take over their tools and equipment and thereby deprive the subcontractor the ability to perform replacement work. The AIA 401 provides: § 7.2.1 If the Subcontractor repeatedly fails or neglects to carry out the Work in accordance with the Subcontract Documents or otherwise to perform in accordance with this Subcontract and fails within a ten-day period after receipt of written notice to commence and continue correction of such default or neglect with diligence and promptness, the Contractor may, by written notice to the Subcontractor and without prejudice to any other remedy the Contractor may have, terminate the Subcontract and finish the Subcontractor’s Work by whatever method the Contractor may deem expedient. The ConsensusDocs 750 provides more generous notice and chance to cure: 10.1.1 NOTICE TO CURE A DEFAULT If the Subcontractor persistently fails to supply enough qualified workers, proper materials, or equipment, to maintain the Progress Schedule, or fails to make prompt payment to its workers, subsubcontractors, or suppliers, or disregards Laws or orders of any public authority having jurisdiction, or otherwise is guilty of a material breach of a provision of this Agreement, the Subcontractor shall be deemed in default of this Agreement. If the Subcontractor fails within three

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Image courtesy of franky242 at FreeDigitalPhotos.net

(3) Business Days after written notification to commence and continue satisfactory correction of the default with diligence and promptness, then the Constructor shall give a second notice to the Subcontractor and surety, if any, to correct the default within a two (2) Business Day period. If the Subcontractor fails to promptly commence and continue satisfactory correction of the default following receipt of such second notice, the Constructor without prejudice to any other rights or remedies, shall have the right to any or all of the following remedies: [progressive remedies omitted]. Subcontractors will want to ensure that the subcontracts they enter provide for notice and opportunity to fix problems before the GC is allowed to remove the subcontractor from the job.

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Watch Out for Waivers Often GCs’ subcontract forms contain multiple clauses under which subcontractors waive rights. Some clauses are obvious, and some are less so — for example, searching a document for the word “waive” or the like may not capture all subcontract waiver clauses. Courts do not like to enforce waivers absent prejudice to the GC, so it is better to modify waiver language to avoid a GC’s mistakenly creating an expensive dispute by trying to rely on an unenforceable clause. Because of the various language used, waiver clauses need to be modified case-by-case. Some examples of obvious and less obvious waiver clauses and suggested fixes: Site Conditions Waiver: Prior to commencement of the Subcontractor’s work, Subcontractor shall thoroughly inspect existing structures or substrates which are to

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receive, or be integrated with, Subcontractor’s work. Not later than 48 hours prior to the Subcontractor’s commencement of its work, Subcontractor shall conduct the inspection and provide to Contractor a written report of any conditions that are not in compliance with the Contract Documents or which would delay or render more expensive the Subcontractor’s work. The failure to provide such notice shall constitute a waiver of any right by the Subcontractor for an extension of time or additional compensation resulting from any such noncompliant conditions. [Italics added.] This site conditions waiver clause has many problems. First, subcontractor should not be held to identifying any violations of the Contract Documents. That is GC’s and architect’s job, and subcontractor may not have the expertise to identify violations. Subcontractor should be

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held to report only those reasonably discoverable defects that may impact subcontractor’s work. Additionally, the 48 hours’ notice is unreasonable, for one, because the condition may not even exist 48 hours before subcontractor starts work. Also, the problem may impact only later parts of subcontractor’s work, which could be months after the start of work. Better would be to change the language to require subcontractor to give notice of a problem to GC a reasonable amount of time before commencing work in that area and shifting to subcontractor only the consequences of failing to give such notice. Extra Work Waiver: Subcontractor’s duty to provide “Changed Work Documentation” for work performed during the period covered by the monthly Application for Payment exists whether or not the Changed Work was authorized in writing or verbally, disputed or undisputed, or fixed price or time and materials. The failure to provide Changed Work Documentation during any period covered by a monthly Application for Payment, or within 35 days of performing any changed work whichever is less, results in a waiver of Subcontractor’s right to claim compensation for the changed work and/or extension of time to perform the work. [Italics added.] Generally, except for public works jobs where the change order process is governed by statute, courts will find ways to invalidate such waivers and force GCs to pay subcontractors for work that the GC has requested the subcontractor to perform. This clause might be made enforceable to make the waiver apply only in the event the GC is prejudiced from recovering from owner due to subcontractor’s delay. Subcontractor should argue to change the clause’s last sentence by adding to the end: “but only to

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the extent Contractor’s ability to obtain extra time or compensation from Owner has been prejudiced by Subcontractor’s delay in providing Changed Work Documentation.” Here is an example of a more subtle waiver clause that does not use any form of the word “waive”: 6.1 Subcontractor shall make no changes in the work covered by this Agreement without written direction from the Contractor’s authorized representative. Subcontractor shall not be compensated for any change which is made without such written direction. This clause might be made enforceable by adding “to the extent Contractor is prevented from recovering compensation from Owner” in front of “Subcontractor shall not be compensated”, because it would fairly shift to subcontractor only the prejudice subcontractor caused to GC. Likewise, “no damage for delay” clauses are waiver clauses: Delay Damages Waiver 5.3 In the event Subcontractor’s performance of the Work is delayed for any reason, including acts of Contractor, Owner or any other subcontractor on the project, Subcontractor’s sole and exclusive remedy against Contractor shall be an extension of time equal to the period of delay, provided Subcontractor has given Contractor written notice of the commencement of delay within 48 hours of its occurrence. [Italics added.] This clause would act as a waiver by removing dollar damages recovery and by removing any remedy if 48 hours’ notice is not given. This clause might be improved by changing “48 hours” to “a reasonable time” and adding a new sentence at the end: “Additionally, to the extent delays are caused to Subcontractor’s

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work by acts of Contractor or other subcontractors under Contractor’s control Subcontractor shall be entitled to an equitable adjustment to the Subcontract Time and Subcontract Price.” As the old proverb goes: “Forewarned is forearmed.” Many subcontract forms are onerous and heavily GC-favorable. The hope of this article is to enlighten and empower subcontractors to discern and negotiate to disarm some of the more dangerous subcontract clauses. Dan McLennon, managing partner, McLennon Law Corporation, San Francisco, Calif., has been in private practice since 1986. His legal career has focused on cases litigated in the State and Federal Courts in California, representing defendants and plaintiffs, alike. He has resolved hundreds of cases through mediation, arbitration and trial, and he has been awarded Martindale-Hubbell’s “AV” rating, the highest rating in legal ability and ethics as established by confidential opinions of members of the Bar. McLennon represents public entities, general contractors, subcontractors, suppliers, premises owners, manufacturers, professionals, corporations, and individuals by prosecuting or defending cases in the follow subject areas: insurance subrogation and equitable contribution among carriers; licensure disciplinary proceedings; mechanic’s liens and stop notices; partnership disputes; payment issues under construction contracts, including acceleration and delay claims; bond claims; commercial landlordtenant disputes; construction defect actions; contract disputes; indemnity among contractors; insurance bad faith; unfair business practices, and business torts. He can be reached at (415) 394-6688 or dmclennon@ mclennonlaw.com.

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Feature Protecting Lien Rights on Retainage by Scott Wolfe, Jr.

It appears that the laws on retainage and the laws on mechanic’s lien rights were written in two different universes and two different eras. These laws could barely be more contradictory, and comparing the two policies and statutory frameworks is likely to end in head-scratching. Subcontractors must nevertheless navigate the troubled waters. This article examines the friction between the two issues and discusses what subcontractors must keep in mind while, on the one hand protecting their lien rights, and on the other, making sensible relationship decisions that keep the project moving forward.

The Friction Between Retainage & Lien Rights The friction between retainage requirements and lien rights needs little introduction. Retainage contract provisions and laws empower owners to withhold a certain sum of money — sometimes as much as 10 percent — until the very end of a project. This withheld amount is actually not contractually due until the project ends. Subcontractors, however, typically have only a small window of time to file their mechanic’s lien claim, and this window may expire long before the retainage is actually due. So, can the subcontractor file a lien against the project before the retainage payment is ever due? And if they can, should they?

Part 1: Can the Subcontractor Lien for Retainage Before Retainage Is Actually Due?

IN THIS ARTICLE . . . • Can the subcontractor lien for retainage before retainage is actually due? • Should the subcontractor file a lien for retainage? • Other retainage protections can offer ease of mind.

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In most states, the mechanic’s lien laws require a subcontractor to file a lien claim within a certain period of time from when they finish their work. Accordingly, the lien filing window may expire long before the whole project is completed, and thus the retainage is due. In these situations, what does the lien law say about filing? Surprisingly, very little. There are few exceptions to the legislative silence on this perplexing question. In 2011, the New York legislature amended its lien law to accommodate for the problem, amending

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Lien Law Section 10 to allow liens against retainage to be filed at any time within ninety (90) days after the retainage payment is actually due. (See: Crossing the Bridge When You Get There: Why New York Builders Should No Longer Worry about Losing Retainage Lien Rights; September 2011: http://www.zlien.com/articles/ crossing-the-bridge-when-youget-there-why-new-york-buildersshould-no-longer-worry-about-losingretainage-lien-rights/) In most states, however, subcontractors are left with very little to help with the legal friction. Most states are extremely strict with the timeframe to file a mechanic’s lien, with most lien statutes written like the law in Washington state, which requires a lien to be filed within “ninety days after the person has ceased to furnish labor, professional services, materials, or equipment.” (RCW § 60.04.091). There is little ambiguity in such type of laws. If a lien claim is not filed within the 90 days, it is a forfeited right. Full stop. A few states do introduce a bit more ambiguity. States such as a California, Louisiana, Illinois, Massachusetts, and Utah calculate the lien filing deadline from the completion of the project as a whole instead of an individual subcontractor’s last furnishing date. While this does not address the retainage problem head-on, it does minimize the problem significantly since the completion of the project will also trigger the retainage payment. One legal unknown the subcontractor must struggle with is whether they are even capable of filing a mechanic’s lien claim on retainage before the payment is due.

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In many states, even though the lien claim is due within a strict window of time, the claimant is often restricted to filing a lien for the “amount due” on the project. If the retainage is not yet due, the right to file a lien on it may never exist.

Part 2: Should the Subcontractor File a Lien For Retainage The previous section addressed whether a subcontractor could file a mechanic’s lien for retainage, and the answer is unfortunately unclear. The next question is whether the subcontractor should file a lien for retainage. Answering this question should involve two different thoughts for the subcontractor. First, the subcontractor must decide whether protecting lien rights on the project’s retainage is worth the disruption the lien may cause to their relationship with project participants and to the project itself. Many general contractors, owners, and lenders would consider filing a lien for retainage when the retainage is not technically due pretty adverse. While there is room to debate whether this should be the case, the subcontractor must nevertheless determine if the juice is worth the squeeze. Second, the subcontractor may actually be taking a legal risk by filing a lien claim for retainage. Depending on the state’s specific lien statute, there may or may not be ambiguity about whether such a claim could be filed. If there is ambiguity, the subcontractor is likely in a fine position to assert the claim. If there is no ambiguity, however, the subcontractor could be later held liable for attorney fees, damages and other penalties if the owner, lender, or general contractor proceeds legally to remove the lien. Note, however, as discussed in the next part, most lien statutes enable subcontractors to lien for the value of their work, labor, and materials, and accordingly, retainage

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is a legal fiction that affects the distribution of contract funds only.

Part 3: Caveat — You Can Almost Always Include Retainage Within Your Lien It is worth making one caveat in this discussion. Thus far, the article has addressed the situation of whether a mechanic’s lien can or should be filed on retainage. It is important to distinguish this debate from the question of whether retainage amounts can be included in a mechanic’s lien filing overall. In other words, if situations lead a subcontractor to file a mechanic’s lien, can retainage amounts be included in that lien — even if the retainage is not technically due? The answer to this question, in most cases, is yes. If a mechanic’s lien claim is being filed, most states empower the subcontractor to file the claim for the full amount of their claim against the project. The lien claim, in other words, is equal to the value of the work, labor, and materials that the subcontractor furnished to the job. The component of that amount related to retainage is usually irrelevant to the calculation.

Other Retainage Protections Offers Ease of Mind While the intersection between retainage and lien laws is an absolute mess, subcontractors can find some peace of mind by other protections available to them. Notably, a healthy number of states require retainage proceeds to be placed into escrow accounts, and subject contractors and owners to strict fines in the event of noncompliance. Escrowing requirements are common, but states have a number of other bespoke provisions that protect retainage payments for subcontractors, and in most cases these will prove sufficient to protect the retainage payment. Typically, if these protections are not enough,

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the lien will be timely and warranted because there are other larger problems with the project or project participant.

Conclusion Subcontractors have capital challenges all over a construction project, and one of those capital challenges is floating the retainage payment across multiple jobs until those jobs are completed and the retainage is released. When it comes to capital, protecting the subcontractor’s right to get paid can often boil down to protecting the right to file a lien. In the case of retainage, however, the right to lien is often hazy and always practically challenging. It sometimes seems like retainage laws and mechanic’s lien laws are so different that they must come from two different legal systems. They are contradictory principles, and in tricky situations, they often lead subcontractors or lawyers scratching their heads. When confronted with a retainage mechanic’s lien problem, subcontractors would be best served to analyze their existing situation and the actual language of the state’s lien laws to determine the best course of action. Scott Wolfe is CEO of zlien in New Orleans, La., a platform that reduces credit risk and default receivables for contractors and suppliers by giving them control over mechanic’s lien and bond claim compliance. Wolfe is a licensed attorney in six states with extensive experience in corporate credit management and collections law, including the use of mechanic’s liens, UCC filings and other security instruments to protect and manage receivables. He can be reached at (866) 720-5436, Ext. 700, scott@zlien. com, or @scottwolfejr on Twitter.

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Feature ASA Attorneys’ Council Examines Terms and Conditions of Textura’s Construction Payment Management System by Dan McLennon The American Subcontractors Association’s (“ASA”) Attorneys’ Council was privileged to review the Standard Terms and Conditions (“Contract”) for the Textura Construction Payment Management (“CPM”) System and speak with two Textura executives in connection with the ASA’s annual convention, SUBExcel, held in March in Seattle. This article flags concerns about CPM from a subcontractor’s point of view.

Overview In general terms Textura’s CPM provides a neutral, cloud-based platform for exchange of information among participants in a construction project leading to payment. Textura is clear that CPM does not act as agent for any party, and the platform is flexible to allow the controlling party, typically the general contractor, construction manager, designbuilder or other prime contractor (“GC”), to set parameters on what documentation and modifications to that documentation will and will not be accepted. Subcontractors’ complaints about CPM are not so much levied at Textura, though Textura has its share, as levied against GCs using it. Primarily, subcontractors argue that it is unfair to make them pay for this service. In essence, CPM allows GCs to shift part of their construction management overhead cost to subcontractors by requiring subcontractors to pay for the system GCs use to lighten their burden in checking and verifying payment applications and supporting documentation. To the extent that GCs need to satisfy themselves that the paper they receive from subcontractors meets

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the contract requirements, GCs and not subcontractors should pay that overhead. When asked whether the Textura developers ever considered a model whereby owners or general contractors pay for the CPM service, the Textura executives did not know of any. However, the Denver International Airport is widely publicized (including by Textura (https://www.denvergov. org/Portals/743/documents/TexturaCPM%20FAQs%20pricing.pdf)) to have required GCs to use the CPM service and include the cost of the service as part of their bids. This would seem to be a fairer model than requiring subcontractors to bear this cost. GCs may argue that subcontractors would ultimately not bear this cost, because they can increase their bids to include amounts to cover it. However, in the low-bid world, the reality is that the low-bidding subcontractor will absorb that cost so as not to be underbid, so in reality competition among subcontractors will force subcontractors to eat that cost. The better solution would be to follow the Denver International Airport lead by requiring GCs to include the cost in their bids so that the cost is not forced down to the subcontractors. A complaint levied at Textura that belongs to GCs is the apparent rigidity of the system. CPM may

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appear ridged to subcontractors, but that is due to the rules adopted by GCs in setting up CPM for their projects. For example, a GC may set a parameter in CPM that will not allow subcontractors to modify lien waiver forms, though subcontractors need to modify the forms to preserve claims already presented to the GC. A Textura representative commented that CPM always allows subcontractors to attach additional documentation to any upload, which could include the claim-preserving language, but the lien waiver itself cannot be modified to incorporate this language, so a subcontractor cannot rely on this method to preserve claims. To the frustration of subcontractors, reportedly, the restriction on

IN THIS ARTICLE . . . • Textura’s CPM solution provides a neutral, cloud-based platform for exchange of information. • Subcontractors argue that it is unfair to make them pay for the CPM service. • One complaint levied at Textura that belongs to GCs is the apparent rigidity of the CPM system.

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documents modification and other CPM rules employed by GCs are used to delay payment to subcontractors. CPM does include traps for the unwary subcontractor. Once a subcontractor has uploaded an enforceable lien waiver, it will sit in the system until 72 hours after payment instructions have been transmitted to the GC’s bank. If Textura receives no notice within 60 hours that the payment has not gone through, Textura will release the waiver. If Textura receives the notice of non-payment 61 hours after payment instructions are issued, the lien waiver may already have been transmitted to the GC. In addition, one subcontractor counsel related a case in which, after a GC determined that it would lose a subcontractor’s payment claim, the GC issued payment and obtained the lien waiver, thereby barring the subcontractor’s right to recover attorney fees incurred in prosecuting the claim. A Textura representative noted that a subcontractor owns the materials it uploads until it has been shared, and the subcontractor may withdraw a lien waiver until payment issues. Therefore, subcontractors are forewarned to withdraw lien waiver forms by at least the start of litigation. This will require communication with Textura personnel, because there is no online way to do this yet, although the Textura representatives indicated the firm might consider adding a withdrawal button. Withdrawn forms can later be resubmitted if needed as part of the claim’s resolution. Finally, subcontractors rightfully complain that they are forced to pay for a system that provides them no promises and no protections — although ostensibly promises and protections are found in the Contract — these are illusory because “what the one hand giveth, the other taketh away” in the form of releases, waivrs and limitations of liability. Issues with CPM are explored below.

What Does CPM Cost? The Contract does not specify the actual cost of using CPM, other than to state that the subcontractor

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agrees to three different fees: usage fees, subcontractor deferral fees, and subcontractor service fees by ACH. The fees are nowhere defined in the Contract, but the user is directed to the Textura Web site. However, review of the Web site leads only to the direction to contact Textura sales staff. Absent incorporating a writing by reference, the Contract cannot include statements by sales staff, so the Contract in reality does not state what subcontractors will have to pay for the service. However, while Textura reserves the right to change fees on three months’ notice, for a project already started, Textura agrees that the rates will be locked for the duration of the project.

Are Notices Posted to CPM Effective?

What Does The Subcontractor Get In Return For These Fees?

Only superficially. The terms and conditions promise to use commercially reasonable efforts to protect any information uploaded to the site by subcontractors. However, those promises are backed up by nothing. The Contract contains at least 13 different clauses waiving and releasing any liability by Textura for any breaches by Textura. In at least three different places, Textura waives any warranty whatsoever. Textura’s waivers and releases are as broad as any attorney could imagine.

The subscriber is a limited, nonexclusive, non-transferrable license to use the Textura site and the CPM service. However, the Contract provides no description or guarantee or promise on what these actually do or provide.

Can General Contractors Use CPM to Claw Back Prior Payments? The Contract is not clear whether the general contractor may use the Textura system to claw back prior payments, for example to recover back-charges or damages. Nothing in the Contract suggests that the ACH could be used this way, but nothing in the Contract says that it cannot.

What Is Textura’s Role? Textura goes to great lengths to clarify that it is a neutral third party and is not an agent or employee, joint venturer or partner of any party using the system. In two separate clauses, Textura states that it is not an agent of the subcontractor or the GC. The Textura executive explained that CPM simply provides a platform for exchange of information between the parties.

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The Textura executives confirmed that any notice given by a subcontractor to a GC through the CPM system is ineffective unless and until the GC actually downloads that notice. Uploading a change order request or claim notification to the CPM site in itself is ineffective since Textura is not the GC’s agent. Therefore, any change order or claim documentation must be transmitted by traditional means outside of the CMP platform to guarantee effectiveness.

Does The CPM Protect Subcontractors?

Does Textura Require General Contractors To Protect Subcontractor Information? The Contract does state that a person receiving a subcontractor’s confidential information agrees not to use it for any purpose other than to complete the construction payment management process or for other specified, limited uses, and to take such precautions to protect the confidential information as the receiver would take to protect its own information. However, the GC is not signatory to the Contract and, therefore, is not bound by it. Moreover, when asked if subcontractors may view a GC’s contract with Textura to confirm its confidentiality provisions, the Textura executive stated flatly that Textura

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respects the GC’s confidentiality and Textura does not release those contracts to anyone other than the GC itself. Thus, subcontractors must ensure that their subcontracts with GCs using CPM require the GC to maintain in confidence any information received by the GC from the subcontractor directly or through CPM.

Does Textura Protect a Subcontractor’s Lien Rights? Comfortingly, Textura promises that it may release unconditional lien waivers only after payment has been completed and only if expressly agreed by both the subcontractor and the GC. Textura reserves the right to demand reasonable verification of the existence of such agreement. On the other hand, the devil is in the details. A payment is considered “completed” 72 hours after payment instructions have been transmitted to the GC’s bank unless Textura receives a notice of non-payment within 60 hours after transmission of the payment instructions. Notice of nonpayment requires written notice to Textura either from the subcontractor or the ACH network that the payment has not been received. If timely notice of non-payment is not received, the payment will be deemed completed after 72 hours whether or not payment has actually been received. If the release of the lien waivers goes through without payment being received, that is too bad for the subcontractor, because the subcontractor waives any claim against Textura for such release. Lower tier subcontractors have no protection whatsoever. If a subcontractor uploads a lien waiver for a sub-tier who is not in the CPM system for invoicing and payment, CPM will release that waiver immediately. Textura takes no responsibility for ensuring the sub-tier will be paid.

Does Textura Protect Itself? You bet. In addition to the limitations and disclaimers of warranties and the waivers and releases of liability mentioned above,

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Textura has no fewer than three clauses requiring the subcontractor to indemnify Textura for any damage related to the use of the site or the service. Moreover, Textura reserves the right to have any dispute be decided on its own home turf in Illinois, using local Illinois law. Subcontractors can expect to be hauled into Illinois court for any dispute arising out of or related to the use of the site or the CPM service. Moreover, if a subcontractor were lucky enough to get by all of the disclaimers, waivers, and releases, and liability against Textura were found, Textura’s aggregate liability would be the lesser of any fees paid to Textura in the six months before the claim or $100. Also, Textura creates its own special statute of limitations, requiring that any claim be brought within one year after the claim or cause of action arises, or it is forever barred. In addition, Textura requires users to protect its intellectual property, in about 23 separate paragraphs. It reserves the right to obtain equitable relief, in addition to damages caused by a user’s wrongful conduct. Interestingly, the contract nowhere provides for recovery of attorney fees.

Can The Contract Be Terminated? By its terms, the Textura CPM contract may be terminated at any time by a subcontractor. However, the subcontractor may not have that leeway under its subcontract with the GC. Before terminating, the subcontractor would need to review the subcontract to determine whether it requires use of the CPM system for the duration of the project. On the other hand, Textura may terminate the agreement for any breach of any of the terms and conditions.

Conclusion The Textura CPM product is a tool for transmitting payment applications and supporting information to general contractors in an acceptable form to make it easier for general contractors to approve payment applications and seek payment from the owner.

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However, the system allows general contractors to be unduly rigid in the processing of payments, and user experience is often that the generals blame the system and use it to delay issuing payments, when Textura allows general contractors flexibility in setting the parameters for acceptable payment documentation. When a general contractor blames a system requirement, essentially the general contract is saying “we set up the system that way, and we are not willing to change it.” Subcontractors have no leverage to negotiate the Textura terms and conditions. Because the Textura contract provides no protections for subcontractors, subcontractors must be vigilant and persistent in negotiating with general contractors the terms of use of that system. Dan McLennon, managing partner, McLennon Law Corporation, San Francisco, Calif., has been in private practice since 1986. His legal career has focused on cases litigated in the State and Federal Courts in California, representing defendants and plaintiffs, alike. He has resolved hundreds of cases through mediation, arbitration and trial, and he has been awarded Martindale-Hubbell’s “AV” rating, the highest rating in legal ability and ethics as established by confidential opinions of members of the Bar. McLennon represents public entities, general contractors, subcontractors, suppliers, premises owners, manufacturers, professionals, corporations, and individuals by prosecuting or defending cases in the follow subject areas: insurance subrogation and equitable contribution among carriers; licensure disciplinary proceedings; mechanic’s liens and stop notices; partnership disputes; payment issues under construction contracts, including acceleration and delay claims; bond claims; commercial landlordtenant disputes; construction defect actions; contract disputes; indemnity among contractors; insurance bad faith; unfair business practices, and business torts. He can be reached at (415) 394-6688 or dmclennon@ mclennonlaw.com.

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Legally Speaking Eliminate or Reduce Financial Impact of Retainage by Lee Brumitt, Esq. In the 1840s, the United Kingdom was constructing a massive railway system. The huge work demand brought unqualified and insolvent contractors to the fray. Defective and incomplete work was commonplace. To combat the losses and assure that work was completed, the government withheld 20 percent of the contract amount. Thus, the practice of retainage was born. Critics say its time has come and gone. Advocates of the practice, such as the surety industry, argue that retaining funds offsets the risks of overpayment for quantity or quality of work actually installed, defective work, or insolvency. The practice was considered a sacred cow until the early 1980s when the federal government led what has become a slow erosion of the tradition. In 1983, the federal government proclaimed a new policy providing for the elimination of retainage on all federal construction projects. “Retainage should not be used as a substitute for good contract management, and contracting officers should not withhold funds without cause,” said the Office of Federal Procurement Policy. This “cause” standard was fully implemented in the Federal Acquisition Regulations in 1986 and the Department of Defense, the GSA, and the Department of Transportation all adopted a policy of “zero” retainage. Using federal funds as a carrot, many state departments of transportation now have “zero” retainage policies. As a result of the economic downturn, retainage reform has accelerated over the last decade. The downturn has caused state legislatures to understand more clearly that retainage causes cash

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flow problems, provides gratuitous financing for owners, and allows owners and generals less incentive to properly inspect and manage a project’s progress. Where retainage at 10 percent was the prior norm, a number of states have stripped retainage to 5 percent or less, particularly on public projects. New Mexico banned retainage on most public and private projects in 2007. Some states such as Kansas, Michigan, Nevada, Ohio, Oregon, Tennessee, and Texas require owners to place retained funds in interestbearing accounts. Additionally, states such as Missouri require retainage to be held in trust accounts restricting the owner’s ability to use and consume those funds for other purposes. Many states such as Colorado, North Carolina, Missouri, and Kansas have procedures for the release of retainage to early-completing subs or upon a percentage of completion. Some states also allow a subcontractor to post alternative security such as certificates of deposit, letters of credit, or bonds in lieu of withholding retainage. Most states and contract forms require the prompt payment of retainage to the sub once the owner releases retainage to the general or once a project is “substantially complete.” Despite the current climate, subcontractors still need to take steps to lessen or eliminate the financial impact of retainage or to, at a minimum, insure that contract language complies with applicable laws and regulations. Educate yourself on the retainage regulations governing your work. Many owners, generals, or subs often do not know the current status of retainage statutes or regulations

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governing the work. As a result, contract language frequently defaults to the 10 percent standard and violates other applicable legal standards. Before you enter into any contract, educate yourself on the retainage laws and regulations applicable in the location of the work. They vary significantly from state to state. Subcontractors should never accept retainage terms or practices which are less favorable than the relevant law. It is hardly unusual for the subcontract form provided by the general to contain more onerous retainage terms and conditions than allowed by the jurisdiction governing the project. While the ConsensusDocs standard contract form states that the retainage percentage “shall not exceed statutory requirements,” the AIA standard form does not contain such language. Neither form provides for strict compliance with the retainage rules and regulations where the project is located. If the contract does not comply with the law in every instance, educate the general and make sure the contract you sign is in strict compliance. Subcontractors should never accept retainage terms which are less favorable than the general construction contract. “Flow down” clauses make the general construction contract’s terms and conditions part of the subcontract. A sub should always obtain a copy of the general construction contract and review, among other things, the retainage provisions before signing. A subcontract should never have more onerous retainage provisions than the owner is requiring from the general. For instance, a subcontract should never allow a general to withhold

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more retainage from the sub than the owner is withholding from the general. The standard ConsensusDocs form provides some protection in that it requires any percentage withheld by the general from the sub to be “equal to the amount retained from the Constructor’s payment by the Owner for the Subcontract Work.” Additionally, the ConsensusDocs form requires that “the Subcontractor’s retainage shall also be reduced when the Constructor’s retainage of the Subcontract Work has been so reduced by the Owner.” The AIA standard forms do not contain these basic protections. More favorable contract terms supersede statutory requirements. The terms and conditions of a construction contract relating to retainage can and, depending on the state where the work is located, should be more favorable than the applicable law. Many generals are willing to negotiate retainage terms, especially with a subcontractor that they trust and with whom they have had positive experience. One of the best arguments for reduction or elimination of retainage is that all contract forms allow the owner, design professional, and/or general to withhold funds based for any number of reasons including defective work, insolvency, or evidence that the work will not be completed on time or at all. In other words, owners and generals which manage a project appropriately already have the contractual means to protect themselves from those very things that retainage was meant to address. The following are some of the items that should be the subjects of negotiation: • Reduction or elimination of retainage once a project has reached a certain percentage of completion, such as 50 percent. • Release of a portion of retainage already withheld once the work gets to a certain percentage of completion, such as release of

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half of the retained funds once the project is at 50 percent completion percentage. • Release of retainage upon successful completion of work, including completion of a separately identifiable “line item” on the Schedule of Values. • Deposit of withheld retainage funds in a segregated interestaccruing trust account. • Payment of all interest on retained funds. • Elimination of retainage where the subcontractor is required or willing to purchase performance and payment bonds for the project. Early-completing subcontractors should always request a release of retainage upon completion of work. If you are an early completing trade, always request a release of retainage upon completion of work whether those terms are in your contract or not or whether state law provides for such a remedy. This rule also applies to the subcontractor which has completed a separate line item scope of work on the Schedule of Values even if it has additional line items to complete. Take caution not to waive lien or bond rights. Lien and bond rights can easily be waived through partial or final lien waivers. If waived, the ability to protect and leverage your right to receive retainage may be sacrificed. Subcontractors should exercise extreme caution and never sign contracts containing broad waivers of lien or bond rights, lien waivers which are not conditioned on actual receipt of payment, and lien waivers that expressly waive all liens/bonds as of a specific date. It is recommended that each time a sub signs a lien waiver, the following language should be affixed to the lien waiver above the signature line: This waiver shall apply only to work for which payment has not been received in full; shall not apply to retention; shall not apply

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to unbilled changes, claims which have been asserted in writing or which have not yet become known; and shall be conditional upon receipt of funds. Protect and perfect your lien and/ or bond rights. If your request for release of retainage on completed scopes of work is rejected, you should always protect your lien and/ or bond rights and immediately file a mechanic’s lien or payment bond claim if the time for doing so will or is likely to expire before your retainage is expected to be paid. Early-completing subcontractor are frequently required to wait several months, if not years, before retained funds are to paid. It is not uncommon for retained funds to simply go unpaid or become “unavailable” at the completion of the project because of other problems having nothing to do with the early completing subcontractor’s work such as poor project management, defective work by others, or the insolvency of the owner or general. An ASA study in 2007 cited “slow final payment” as a “very serious concern” and a majority of subcontractors responded that they do not collect 75 percent of the retainage they are owed. Filing a lien or bond claim will not only assure that your claims do not become stale, it may also have the desired effect of compelling the owner, general, or surety to pay retainage in a more timely manner. Lee Brumitt is a director and shareholder with the Kansas City law firm of Dysart Taylor Cotter McMonigle & Montemore, P.C. He has more than 30 years of experience in construction law and litigation. He represents subcontractor trades and specialty contractors on public, commercial and residential projects. He currently serves as the attorney for the ASA-Greater Kansas City chapter. He can be reached at (816) 714-3027 or lbrumitt@dysarttaylor.com

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ASA/FASA Calendar May 2015

March 2016

12 — Webinar: Managing the Life Blood of Contracting - Cash Flow

3-5 — SUBExcel 2016 Miami, Fla.

Coming Up . . . in the June 2015 Issue of ASA’s

June 2015

THE

9 — Webinar: Bidding from the Other Side: How GCs Use GradeBeam to Find Subcontractors

Theme: Contracts

Contact information for all ASA and FASA events/programs: www.asaonline.com education@asa-hq.com

• 10 Killer Contract Clauses Subs Should Watch Out For • ASA Provides Big Protection Tools in Small Packages

New On-Demand Video from FASA

Contractors’ Knowledge Network

When it comes to managing your business, the Foundation of ASA is your partner in education. View and listen to FASA’s on-demand videos at an individual workstation or in a conference room for group training. Your order includes access to the on‑demand video any time, and as many times as you’d like! This is just one of the on-demand videos available through the FASA Contractors’ Knowledge Depot to meet your business management training needs.

“Negotiating Retainage” (Item #8076) Learn effective strategies for convincing general contractors to reduce or eliminate retainage with “Negotiating Retainage” (Item #8076), a video-on-demand available from the Foundation of ASA. Presenter Eric Travers, Kegler, Brown, Hill & Ritter, Columbus, Ohio, explains how subcontractors can broach the topic of reducing or eliminating retainage with their clients and how to negotiate from a position of strength. He also illustrates how subcontractors modify their bids to reduce or wholly eliminate retainage, including discouraging withholding for closeout line items. Price: $65 Members / $95 Nonmembers

• Indemnity Obligations Vs. Obligations to Provide Additional Insured Coverage • Key Elements of an Effective Joint Check Agreement • Change Orders — The Bane of All Subcontractors • California Prompt Payment Statutes (Or Maybe Not) • Legally Speaking: Federal Subcontracting and The False Claims Act

Look for your issue in June. Past Issues: Access online at www.contractors knowledgedepot.com

Order online at www.contractorsknowledgedept.com or call 1-888-374-3133

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To learn more about CNA’s coverages and programs for building contractors, contact your independent agent or visit www.cna.com/construction. The examples provided in this material are for illustrative purposes only and any similarity to actual individuals, entities or places is coincidental. Please remember that only the relevant insurance policy can provide the actual terms, coverages, amounts, conditions and exclusions for an insured. All products and services may not be available in all states and may be subject to change without notice. CNA is a registered trademark of CNA Financial Corporation. Copyright © 2015 CNA. All rights reserved.