Construction Contract Tip – How Can Owners Make Sure Subcontractors Are Paid?

By Sam DeBaltzo

In my last post, I discussed ways subcontractors can protect themselves from waiving their right to lien before the owner pays. However, what if an owner pays its general contractor (GC), but the funds never make it to the subcontractors who subsequently lien? The owner can go after the GC for defaulting in its obligations and likely has indemnity rights under its contract, but what if the GC is bankrupt or otherwise unable to perform its indemnity obligations? Unfortunately, this type of situation is not hypothetical, and an owner may have to pay subcontractors the same amount already paid to the GC in order to obtain a lien-free project.

With that in mind, owners often ask what they can do to make sure subcontractors are paid. Once a payment has been made directly to a GC, an owner cannot guarantee the GC fulfills its obligations to subcontractors. However, a prudent owner can take steps to verify payments make it to the subcontractors with (1) smart contract drafting on the front end and (2) vigilance in connection with every progress payment. Bonding is another possibility (previously discussed by my colleague Joseph Voboril).

Smart Drafting – Key Contract Provisions

First, owners should make sure they have key provisions in their contracts with general contractors, including:

  • Lien Waivers with Every Progress Payment. Prior to issuing a progress payment, develop a provision allowing the owner to require (a) unconditional lien waivers from the GC and all subcontractors for work covered by previous progress payments and (b) conditional lien waivers for the work covered by the progress payment requested. This provision does not guarantee that the GC will pass along the current progress payment to the subcontractors, but does allow owners to make sure subcontractors have been paid for all work covered by previous payments. If the GC then defaults, the owner’s exposure to subcontractors is reduced to just one progress payment.
  • Retainage. Create a provision providing for retainage, which in Oregon is limited to 5%. A retainage protects the owner because it further reduces the amount the owner is out of pocket in the event the GC does not pay its subcontractors.
  • Proof of Timely Payment. Include a provision allowing the owner to request at any time evidence from the GC that subcontractors have been paid. The contract can detail the extent of evidence required, such as lien waivers (discussed above) or invoices and receipts showing payment made. The GC should have a reasonable amount of time to provide sufficient proof.
  • Contacting Subcontractors.
  1. Provisions Allowing Owners to Contact Subcontractors. Some GCs will include in their contract a provision prohibiting owners from contacting subcontractors except as expressly permitted in the contract. Owners may want to push back against that provision and instead allow the express right to contact subcontractors directly at any time. By doing so, owners can reach out to subcontractors informally throughout the project to discuss the status of work. In addition to receiving progress updates, owners are much more likely to hear about lack of payment through these discussions.
  2. Provisions Regarding Confirmation of Payment. If the GC will not permit an owner the broad right to contact subcontractors at any time, consider a provision allowing the owner to contact the subcontractors directly to obtain confirmation that they have been paid. Most GCs will allow this provision, so long as the right is triggered only if the GC does not timely provide proof of payment to the owner. In this scenario, the owner is not going over the head of a responsible GC, but can still take independent steps for protection if needed.
  • Issuing Joint Checks. If, through any of the various methods discussed above, the owner finds out subcontractors are not being timely paid, utilize a provision allowing the owner to issue joint checks to the GC and the applicable subcontractors.

Vigilance in Progress Payments

The above drafting tips are helpful in ensuring subcontractors are paid, but they are effectively useless if owners are not vigilant in utilizing their contractual rights in connection with progress payments. Far too many owners fail to follow through in practice. In many cases, this results in owners finding themselves having paid large amounts of money to the GC, only to find their property is burdened with liens by subcontractors that haven’t been paid. Contracts can provide protections to owners – taking advantage of those protections is up to the owners themselves.

Please note, these tips can also be used by a GC with respect to its subcontractors as well. Sam’s practice involves the drafting, review, and negotiation of construction contracts for owners, contractors, and subcontractors alike. Be on the lookout for more posts on tips and tricks.