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Prompt Payment Law a Boon to General Contractors

Fall 2006Cole Schotz Docket

With much fanfare, Governor Corzine signed a new prompt payment law (the “law”), on September 1, 2006, which applies to all contracts entered into on or after that date.  While hyped as a law intended to benefit the “little guy,” the law mostly benefits general contractors and trade contractors contracting directly with owners, (collectively “prime contractors”).  Subcontractors, subsubcontractors and material suppliers (collectively, “subcontractors”) do not, for the most part, share in the benefits accorded to prime contractors.  The main benefit for subcontractors is that the law may go a long way to reducing unwarranted payment delays by owners, both public (with limited exceptions) and private.  As all contractors know, some of the most serious payment delays have been on public projects.  Getting the cash to the prime contractor should theoretically result in that cash flowing down to subcontractors.  But the law does little to help subcontractors faced with unwarranted payment delays on the part of prime contractors.  The law will cause serious headaches for owners and their construction managers and architects.

The law provides that when a prime contractor has performed work in accordance with its contract with the owner, and billing for the work (including progress payments, final payment, change orders and release of retainage) has been approved and certified by the owner or its agent, the owner must pay the prime contractor the amount due within 30 days after the billing date.  The billing is deemed approved and certified 20 days after the owner receives it unless the owner, before the end of the 20-day period, provides the prime contractor with a written statement of the amount withheld and the reason for withholding payment.  These time periods may be different for certain public contracts.

There has been no material change to existing law for subcontractors, and subcontractors are not entitled to the remedies described above.  Under existing law, a prime contractor is only required to pay a subcontractor within ten days of the prime contractor’s receipt from the owner of payment for the work performed by the subcontractor, and then only if the work has been accepted by the owner or the prime contractor.  Further, in the case of ongoing work by the subcontractor on the same project for which partial payments are made, the prime contractor is only obligated to pay if the subcontractor is performing to the prime contractor’s satisfaction.  Finally, all of these rights of the subcontractor may be contracted away in the subcontract.

If any payment is not made to a prime contractor or subcontractor when due, they are entitled to recover interest from the owner or prime contractor, as applicable, at a rate equal to the prime rate plus 1%.  In many instances this will result in a substantial increase over the much lower judgment interest rate.

If payment is not made when due, a prime contractor or subcontractor may send a seven-day written notice to the owner or prime contractor, as applicable, after which further performance under the contract or subcontract may be suspended until payment is made, without risk of breach of contract.  This notice is only effective if, in addition to payment not being made, the party withholding payment has not provided a written statement of the amount withheld and the reason for the withholding, and the payor is not engaged in a good faith effort to resolve the reason for the withholding.

Press reports that all contracts and subcontracts will now be required to contain binding arbitration clauses are simply inaccurate.  The law does provide that all such contracts must have alternate dispute resolution clauses.  Alternate dispute resolution would include mediation and non-binding arbitration, in addition to binding arbitration. In any civil action to enforce rights under the law, the prevailing party is entitled to recover reasonable costs and attorneys fees.  This would probably not apply to arbitration.

Tips for owners:  Get systems in place and train key personnel, so that you do not miss deadlines for payment and notices.  Be diligent.  If there is a question about the work and reason to withhold payment, make sure you send the notice within the 20-day period.  Put mandatory mediation and binding arbitration clauses in all of your contracts.  After you send the required notice for withholding payment, make a demand for mediation.  This will substantiate your good faith effort to resolve the reason for the withholding, and avoid the contractor’s suspension of performance, at least during the mediation process.  If the dispute is not resolved through negotiation or mediation, send an arbitration demand.  This will likely avoid exposure for attorneys’ fees.

Tips for prime contractors:  If you want to preserve the ability to effectively exercise your remedy to suspend performance, do not agree to a mediation clause in your prime contracts.  Mediation takes time, and during that time the owner will claim he is making a good faith effort to resolve the dispute.  If you are unable to eliminate a mediation clause in a prime contract, consider trying to avoid a binding arbitration clause, so that you will be able to recover your attorneys’ fees if you prevail in a lawsuit against the owner.  In your subcontracts, you would want to include both mediation and binding arbitration clauses, for the reasons set forth above.  Otherwise, understand your rights and be diligent in exercising your considerable remedies. 

Tips for subcontractors:  Your only new remedies under the law are the rights to suspend performance, and possibly, to collect attorneys’ fees.  See “Tips for Prime Contractors,” above, as to mediation and binding arbitration clauses.

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