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JOINT CHECKS – WHERE AND HOW JOINT CHECK ARRANGEMENTS CAN GO AWRY

January 29, 2019 Aaron L. Blankenship, Travelers Bond; Kim Gessner, Moss & Associates; Mary Joanne Dowd, Arent Fox

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“When a subcontractor and his materialman are joint payees, and no agreement exists with the owner or general contractor as to allocation of proceeds, the materialman by endorsing the check will be deemed to have received the

money due him”

Post Brothers Constr. Co. v. Yoder, 20 Cal. 3d 1, 3, 141 Cal. Rptr. 28, 30, 569 P.2d 133, 135 (1977).

The “Joint Check Rule”

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Which states follow the Joint Check Rule? Does the Joint Check Rule extend to Sureties?

The Surety and the “Joint Check Rule”

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SD

NE

CO

NM

AK

HI

KS

MS AL

TN

FL

KY

IL IN

MIMN WI

WV

NJ, DE, DC

NY NH,MA, RI, VT

ME

NC

No Reported Joint Check Rule Cases

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Joint Check Rule Extends to Sureties

WA

OR*

CA

TX*LA

MO

IA PA*

SC

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Unclear/Silent Whether Joint Check RuleExtends to Sureties

UT

AZ OK AR

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Joint Check Rule Does NOT Extend to Surety

MT

OH MDVA

Disclaimer

The views expressed in this presentation are those of the author and do not necessarily reflect the views of The Travelers Companies, Inc. or any of its subsidiaries. This presentation is for general informational purposes only.

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Drafting Joint Check Agreements

Zero Regulation Nationwide

• There are exactly zero laws governing what is allowable in a joint check agreement;

• No standard form exists;

• Each agreement can differ drastically

• Be in control of the form

How are they helpful?

Joint Check Agreements:

• A good tool to facilitate distribution of project funds to the intended recipient;

• Help the project to keep moving; and

• Prevent General Contractor from paying twice.

How are they helpful?

Joint Check Agreements should include:• Identification of all three parties;• Identification of the particular project;• Lien waivers will be issued in exchange for the payment; • No continuing duty; • Maximum amount to be paid• A provision in their subcontracts that gives them the right to issue joint

checks; and• Watch for language which creates an obligation rather than a

discretionary option.• Agreement made as a convenience• Ensure language does not create contractual relationship with lower tier

Provisions that should be kept

Key provisions in Subcontract Agreement:

• A provision in their subcontracts that gives GC the right to issue joint checks

• Watch for language which creates an obligation rather than a discretionary option

• Main concern is to ensure that no contractual relationship can be argued between you, the GC, and the lower tier

Provisions to include in prime & subcontract agreements

Watch out:

• Unliterally issuing joint checks may be a breach of the subcontract;

• Address this issue up front with express language in the subcontract;

• Make clear that the right to issue joint checks does not create a duty; and

• Consider including a form joint check agreement as an exhibit to the subcontract.

Delivery of the Joint Check

• A general contractor should require the debtor to come to the general contractor’s office to endorse the joint check and then the general contractor should deliver that check to the creditor

• Eliminate any risk of forgery

• Ensures that the check is actually delivered

• A trust fund agreement in subcontracts is also an option, discussed in next segment

Treatment of Joint Checks in Bankruptcy

•QUESTION: Can a non-debtor co-payee of a check made jointly payable to it and the debtor cause the check to be turned over to it after a bankruptcy is filed? What are the competing interests?

•ANSWER: It depends on whether the debtor holds “bare legal title only” and “no equitable interest” in the joint check. In other words, does the debtor hold the joint check in an express, constructive, or statutory trust for the co-payee as a matter of state law.

Treatment of Joint Checks in Bankruptcy•Why does this matter to an issuer of a joint check?

• If a joint check is property of the bankruptcy estate, it is administered as an asset of the bankruptcy and is not available to pay the co-payee. It may be subject to a lien, such as an accounts receivable security interest or a federal tax lien, or it may be available to pay all unsecured creditors ratably.

• If a joint check is not property of the bankruptcy estate, the check may be turned over and paid to the co-payee.

Treatment of Joint Checks in Bankruptcy •Bankruptcy courts look to state law to determine whether a joint check is held in trust and, therefore, not property of the estate. (See, e.g., Mid-Atlantic Supply v. Three Rivers Aluminum, 790 F.2d 1121, 4th Cir. 1986).

•Courts have considered:– intent of parties – whether or not there is a three party joint check agreement– reliance of co-payee on issuer’s credit – timing: as part of initial contract or after payment arrears

Joint Check Agreement: Bankruptcy Preference?

•QUESTION: Is a joint check agreement entered into within 90 days of a bankruptcy filing to pay past due debts avoidable as a preferential transfer?

•ANSWER: Yes. If the agreement is made to provide for payment of past due debts, the agreement itself is likely preferential and avoidable. This is because it gives the creditor more than it would otherwise have received.

•Note: the co-payee/creditor may have defenses to the preference.

Joint Check Payment: Bankruptcy Preference?

•QUESTION: Is a payment by joint check within the preference period preferential if made pursuant to a joint check agreement entered into prior to the preference period?

•ANSWER: Law is unsettled.

Joint Check Payment: Bankruptcy Preference?QUESTION: What factors do courts look to in determining whether or not a payment by joint check within the preference period is preferential?

ANSWER: Inquiry is highly fact specific. Factors include:- whether joint check was debtor’s property or was impressed with

express, constructive, or statutory trust - intent of parties - terms of agreement - whether issuer had an independent obligation to pay co-payee- Whether issuer had a right of setoff or recoupment

Alternatives to Joint Checks

QUESTION: Are there options other than joint check arrangements that allow a general contractor to better assure that payments it makes are properly allocated between its subcontractor and lower tiers subs?

ANSWER: Payments made through third-party escrow accounts, approved by the sub and lower tier in accordance with payment requisitions, are likely to be honored and not avoided as preferences in a subcontractor bankruptcy.

States that impose statutory trusts on funds paid to subcontractors for the benefit of lower tiers offer protection in bankruptcy.

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JOINT CHECKS – WHERE AND HOW JOINT CHECK ARRANGEMENTS CAN GO AWRY

January 29, 2019 Aaron L. Blankenship, Travelers Bond; Kim Gessner, Moss & Associates; Mary Joanne Dowd, Arent Fox