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WHAT DO YOU DO IF A SUBCONTRACTOR’S SUPPLIER MAKES A CLAIM

TO YOU FOR PAYMENT As with many things in construction, the devil is in the details and missteps can prove costly. The

first step when handling a claim from a subcontractor’s supplier is to gather as many facts about the

claim as possible. To obtain this “free discovery,” ask the supplier the following:

Does it have a contract or purchase order with the subcontractor? If yes, try to obtain a copy of it.

Has it received any objections, rejections or complaints, such as quality, timeliness, improper quantity, etc., about the material?

Has it sought payment from the subcontractor? If so, what was the response from the subcontractor?

Is the claim for final payment? Does the supplier have more materials to supply the project?

When were materials furnished to the project? You should obtain the most recent delivery date.

When did payment become due?

Gathering this information and presenting it to your attorney in an organized fashion is an

excellent way to lower your legal expenses.

TERMS OF CONTRACT WITH SUBCONTRACTOR

Letter of default

The second step when handling the claim is to read your contract. This cannot be emphasized

enough. If well-drafted, your subcontract should provide you with remedies for your subcontractor

failing to pay its suppliers. This would be a good time to consult with your attorney. During the

early stages of the process, you may be able to receive guidance from your attorney without having

to pay him or her to take the lead on handling the matter, saving you legal expenses.

What will your attorney do with the information you supplied? As any good attorney will

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tell you, it depends on what your fact-finding efforts yielded. Your attorney will review your

agreement with the subcontractor to see if the subcontractor has an obligation to make timely

payments to its subcontractors or suppliers. If so, a letter from you (to save costs) or your attorney

(for extra emphasis) declaring a default of the subcontract and demanding a prompt cure from the

subcontractor may be an efficient and effective resolution method. Your subcontractor may have the

obligation to obtain written authorization before engaging this lower-tier claimant, which, if

disregarded, could provide for another basis for default of the subcontract.

Joint check agreement

Your subcontract also may provide you with the right to issue joint checks or direct payments to

lower-tier subcontractors and suppliers. If this is not the case, you may want to discuss with your

attorney and subcontractor the option of entering into a joint checking agreement wherein the

subcontractor agrees you have the right, but not the obligation, to issue joint checks to the

subcontractor and its supplier, deducting any amount owed to the subcontractor. This can be a short-

term agreement that provides a low-cost way to de-escalate a lower-tier claim situation.

Substantial compliance with subcontract—voluntary payment doctrine

In addition to lien and bond claims discussed in the next section, the voluntary payment doctrine is

another way contractors subject themselves to paying twice for the same materials. The voluntary

payment doctrine states if a payment is made when no payment is required (because of ignorance of

the law and material facts), then that payment may not be recoverable. If a contractor was aware of

defects or deficiencies with the materials or if the subcontractor claimed defects or deficiencies that

proved true and the contractor makes a payment to the supplier, the contractor may be deemed, in

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some states, to have made a voluntary payment that cannot be recovered. And the contractor still

may be liable to pay its subcontractor for the materials under the subcontract.

CLAIMANT’S STATUS ON PROJECT—LIEN AND BOND RIGHTS The third and final step when developing a strategy to address a supplier’s claim is to assess the

claimant’s status on the project. Your approach may change depending on whether the supplier still

is supplying the project. This is particularly true if the general contractor has special access to

required materials, such as an exclusive dealer arrangement. Likewise, general contractors may

have business reasons for adapting their approaches if, for example, they need to work with the

supplier on other projects. For these reasons, the general contractor may want to ensure the supplier

gets paid regardless of its exposure to the claim. These considerations should be discussed when

developing your response strategy.

Whether the claimant has lien rights also may affect how you handle a lower-tier claimant.

A lien claim is another way you may end up paying twice for the same materials. Lien law is

fraught with potential pitfalls and varies greatly from state to state—consulting with your attorney is

highly recommended. In some states, lower-tier suppliers may have preliminary notice obligations

to maintain their lien rights. For example, if a Notice of Commencement is properly filed in Georgia

or Florida, a lower-tier claimant must serve a Notice to Contractor or Notice to Owner, respectively.

In addition, in most states there are strict time limits a lien claim may be asserted. Whether the

supplier provided the proper notices and is within the time frame for filing a lien are points that

must be analyzed when developing a response strategy.

Although the supplier may be governed by different statutory regimes, a similar analysis

should be conducted to determine whether the supplier has payment bond rights if you or the

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general contractor procured payment bonds on the project. A payment bond claim can be an

additional method for the supplier to force a contractor to pay twice for materials despite not having

a contract with the contractor. If the supplier failed to maintain its lien and bond rights, you may

wish to take a hardline approach when responding to the claim. However, if the supplier maintained

its lien or bond rights, you may be inclined to ensure the supplier’s payment through a joint check.

DEVELOP THE RIGHT RESPONSE FOR YOU

Whether it’s a letter of default to your subcontractor or a joint check agreement with your

subcontractor and its supplier, or some other strategy, what is right for you depends on the facts and

circumstance of the claim. However, identifying the facts and discussing them with your attorney

will inevitably assist you when developing the right response strategy for you.

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