Following the Money

By: Rick Reed

Effective September 1, 2007, the enforcement of contingent payment clauses in certain construction contracts will now be governed by statute. Such clauses are often found in agreements between general contractors and subcontractors, and make payment to the subcontractor “contingent” on the general contractor’s receipt of payment by the owner. Such clauses essentially pass credit risk to the subcontractor. The new statute was codified at §35.521 of the Texas Business & Commerce Code with the passage of S. B. 324, a copy of which is attached to this paper as Appendix 1. It is only about eight pages long, and to try to explain its complexities in three times as many pages is a real challenge.

Contingent payment clauses have been the focus of legislative attention in Texas for years, and they are very controversial. Many in the construction industry have been surprised and troubled by the new Texas statute. Some question why it was needed at all, or denounce it as an improper legislative intrusion on the right of parties to enter into contract. Others assert that contingent payment clauses should be void as a matter of public policy, as they are in some other jurisdictions. Some have expressed skepticism that the new statute only ensures a lot of lawyers will charge a lot of legal fees to explain, negotiate, and litigate over the meaning and effect of the statute.

But, for all its criticism, the new statute does seem to establish some ground rules that, if followed, may help mitigate the risk of owner non-payment, preserve the general contractor’s ability to ask subcontractors to share in the risk of an owner’s financial failure, and protect subcontractors against unscrupulous enforcement of a contingent payment clause if the owner’s non-payment is the general contractor’s fault. Additionally, the statute mitigates the general contractor’s risk that a contingent payment clause might be deemed unconscionable as a matter of law, if the general contractor and the owner, for the subcontractors benefit, provide information about the owner’s ability to fund a project. Most importantly, subcontractors now have a statutorily protected right to block the general contractor’s enforcement of a contingent payment clause in a circumstance where its enforcement would be improper under the statute and both contractors and subcontractors can stop work if they do not receive the evidence of funding information to which they are entitled.

Despite their controversial nature, there hasn’t been a lot of case law in Texas over the enforceability of contingent payment clauses in construction contracts. Yet, the risk of an owner’s financial failure or default is a very real and significant risk.

Many general contractors try to pass on to their subcontractors the risk of owner non-payment by requiring subcontractors to agree they will be paid when (or not until) the owner pays the general contractor. A so-called “pay-when-paid” clause merely leaves the time of payment uncertain. Eventually, the fact of an owner’s non-payment becomes irrelevant, and the contractor must still pay the subcontractor. These clauses only permit the general contractor to require the subcontractor to wait for a reasonable time to allow the contractor to try to collect payment from the owner. Some general contractors go further, and shift to the subcontractor the risk that payment may never come — through a so-called “pay-if-paid” clause that makes the subcontractor’s payment absolutely conditional upon the owner’s payment. Such a “pay-if-paid” clause is considered a contingent payment clause under the new Texas statute.

Most would agree it would be unfair to enforce a contingent payment clause to deny payment to a subcontractor if the owner’s refusal to pay was caused by the contractor’s own breach of the contract with the owner. Conversely, if a subcontractor’s default causes the owner not to pay, most would agree the contractor should have every right to enforce its contingent payment clause against the defaulting subcontractor. But, what if the owner’s non-payment is not due to a breach by either the contractor or the subcontractor? What if the owner’s non-payment is due to the owner’s breach, either because the owner has become insolvent, or has simply refused without justification to pay for the work? What if the owner’s nonpayment is due to a different subcontractor’s default? When does the law allow a contractor to enforce a contingent payment clause against a subcontractor? This paper will attempt to address these questions.

I. The Law of Contingent Payment Clauses Pre-2007

As discussed infra, not all construction contracts are subject to the new Texas statute. Therefore, it is important to remember that the common law may still be important in evaluating the enforceability of a contingent payment clause in some situations.

Texas courts have construed contingent payment clauses to either (i) make the owner’s payment a condition precedent to the subcontractor’s right to receive payment (“pay if paid”), or (ii) defer the subcontractor’s right to payment for a reasonable time to allow the general contractor to collect payment from the owner before allowing the subcontractor to enforce the general contractor’s payment obligation (“pay-when-paid”).

In Wisznia v. Wilcox an architect hired a structural engineer for a project. The contract stated: “The engineer should be paid in the same proportionate manner as the architect being paid by the [owner].” The architect claimed it was entitled to pay its sub-consultant only to the same extent that the owner paid the architect. The court held that “whether the parties . . . intended to make the payment of money conditional must be gathered from the four corners of the instrument and the language used therein, the situations of the parties, the subject matter and the purpose to be accomplished.” In dicta, the court stated that solvency of the owner was a credit risk of the general contractor that should be contractually transferred only upon evidence of “an express condition clearly showing that to be the intention of the parties.”

In Gulf Construction Company, Inc. v. Shaw Plumbing, the Corpus Christi Court of Appeals followed its earlier decision in Wisznia: “. . . [I]n order to transfer . . . normal credit risk incurred by general contractor from the general contractor to the subcontractor, the contract between the general contractor and the subcontractor should contain an express condition clearly showing that to be the intention of the parties.” The contingent payment clause before the Court stated:

“Under no circumstances shall the general contractor be obligated to advance or make payments to the sub-contractor until the funds have been advanced or paid by the owner or his representative to the general contractor.”

The court held the contractor’s obligation to pay the subcontractor under this clause remained absolute and only the timing of payment was affected because it did not “expressly and unequivocally” transfer the credit risk to the subcontractor. Thus, it appears that Texas law could be leaning toward the same strict drafting requirements applied to the enforcement of broad form indemnity clauses.

In Sheldon L. Pollack Corp. v. Falcon Industries Inc. , the Corpus Christi Court of Appeals again declined to enforce a contingent payment clause that read:

“Contractor will pay subcontractor . . . for work incorporated or materials suitably stored as acceptable to owner and contractor for which payment has been made by owner or lender to contractor.”

The Court compared this clause to the one in Gulf and decided it only affected the timing of payment, not the liability of the general contractor to pay the subcontractor for money owed under the contract.

Thus, Wisznia, Gulf Construction, and Pollack all declined to enforce a conditional payment clause in favor of a contractor who sought to shift to a subcontractor the risk of owner non-payment. However, in North Harris County Junior College Dist. v. Fleetwood Construction Co. , the Houston Court of Appeals found the following clause to be enforceable as a contingent payment clause:

“. . . contractor may, at its option on each payment retain the percentage specified in the Contract Document, of each estimate until final payment (which final payment shall be made after completion of the work covered by this contract…and full payment therefore by owner.”

The court held this provision, in the context of the document as a whole, showed the parties intended that payment of the retainage was contingent upon the owner’s payment.

More recently, in 2005, the Amarillo Court of Appeals released a memorandum opinion in Pyramid Constructors, L.L. P. v. Sunbelt Controls Inc., holding that a contractor could not rely on a contingent payment clause to avoid its obligation to pay its subcontractors if the owner’s non-payment resulted from the general contractor’s default. This has been referred to in other jurisdictions as the prevention doctrine, and it has essentially been codified into the new Texas statute, as discussed infra.

Before enactment of §35.521 of the Texas Business & Commerce Code, the courts in Texas were generally thought to be willing to enforce a contingent payment clause as long as it clearly stated the parties’ intention that the subcontractor would bear the risk of the owner’s failure to pay the contractor. As seen from the brief summary of some of the Texas cases above, however, it has been doubtful whether a contractor could, at common law, confidently rely upon a contingent payment clause to always shift the risk of owner non-payment. Clearly, Texas courts would not allow a contractor to forever avoid payment to a subcontractor if the contingent pay clause was at all unclear on or failed to expressly state the parties’ intent. As will be seen, however, the new Texas statute provides guidance to a contractor and subcontractor that may take some of this uncertainty away.

II. Enforcement of Contingent Payment Clauses under
§35.521 of the Texas Business & Commerce Code

Certain Types of Construction Contracts Excluded from the Statute

The statutory restrictions on contingent payment clauses do not apply to all construction contracts. Construction management contracts and construction contracts to improve real property executed on or after September 1, 2007, are covered. Instead of using traditional party designations of owner-contractor-subcontractor, the statute adopts the corresponding terminology of “primary obligor,” “obligor,” “contingent payor,” and “contingent payee,” to apply the new rules governing contingent payment clauses uniformly to the parties at all levels, including lower tier subcontracts and supply contracts.

The statute excludes the following categories of construction contracts from its application :

– Contracts solely for design services;

– Contracts for the construction or maintenance of a road, highway, street, bridge, utility, water supply project, water plant, wastewater plant, water and wastewater distribution or conveyance facility, wharf, dock, airport runway or taxiway, drainage project, or related type of project associated with civil engineering construction; or

– Contracts for construction or improvement of quadruplex or smaller residential construction projects.

Therefore, the enforceability of contingent payment clauses in these types of contracts will remain subject to Texas common law.

Contracts Subject to Sovereign Immunity The statute also expressly provides that a contingent payment clause can be enforced if non-payment is due to the primary obligor’s “successful” assertion of the defense of sovereign immunity. The primary obligor who can assert such a defense is, of course, the State of Texas and, to a lesser extent, its primary government units. However, the contingent payor must exhaust all remedies available to it to collect payment under the Texas Government Code. A contractor’s efforts to exhaust its remedies for non-payment through the State Office of Administrative Hearings (SOAH) process can be a costly and uncertain endeavor.

Enforceability of Contingent Payment Clauses

A “contingent payment clause” is defined as follows:

“‘Contingent payment clause’ means a provision in a contract for construction management, or for the construction of improvements to real property or the furnishing of materials for the construction, that provides that the contingent payor’s receipt of payment from another is a condition precedent to the obligation of the contingent payor to make payment to the contingent payee for work performed or materials furnished.”

By definition, a “pay-when-paid” clause, which does not make receipt of owner payment a condition precedent to payment to a contingent payee, is not subject to the statute. Thus, a contractor may provide in its subcontract that if a contingent payment clause is subject to valid objection under the statute, the parties will convert to a pay-when-paid clause. There is a sample contingent payment clause to this effect for the contractor in Appendix 2, obligating the subcontractor to cooperate and assist in the collection of the funds due for the subcontractor’s work, and also obligating the subcontractor to accept a pass-through claim in satisfaction of the contractor’s payment obligations under the subcontract.

The statute also does not preclude a subcontractor from refusing to accept a contractor’s contingent payment clause. This is still a matter left to negotiation between the parties. Subcontractors who refuse to bargain on a contingent payment clause may try to compromise by agreeing to a pay-when-paid clause that preserves their right to ultimately collect payment from the contractor if payment cannot be collected from the owner. This may be palatable to a contractor if the subcontractor is willing to give up its right to payment if it fails to preserve its mechanics’ lien and/or bond claim rights. There is a sample contingent payment clause to this effect for the subcontractor in Appendix 2.

The law does not prohibit the use of, but restricts the enforceability of contingent payment clauses. The statute declares when a contingent payment clause will and will not be enforced :

“A contingent payor (or its surety) may not enforce a contingent payment clause to the extent that the obligor’s nonpayment to the contingent payor is the result of the contractual obligations of the contingent payor not being met, unless the nonpayment is the result of the contingent payee’s failure to meet the contingent payee’s contractual requirements.” (Emphasis added.)

The underlined phrases make it clear that a contingent payment clause may still be enforced if the reason for owner non-payment is unrelated to the contractor’s failure to meet its obligations to the owner. If owner non-payment for the work of both Subcontractor A and Subcontractor B is due to the default of Subcontractor A (which will also necessitate re-performance of the work of Subcontractor B), the owner’s non-payment is due to the “obligations of the contractor not being met” – albeit the obligations that Subcontractor A assumed, but did not perform, under its subcontract to the contractor. Thus, a defaulting subcontractor may render the contractor unable to enforce its contingent payment clause against other non-defaulting subcontractors. This makes the careful selection of capable subcontractors all the more critical.

If owner non-payment is due to the owner’s insolvency or default, a contingent clause should still be enforceable if it is well drafted, as long as the contractor is prepared to take appropriate countermeasures (discussed below) upon receipt of a subcontractor’s valid objection to its enforcement.

Contingent payment clauses are unenforceable under the following four (4) situations:

(1) Owner non-payment is caused by the contractor’s failure to meet its obligations to the owner (unless such failure is due to the failure of the subcontractor against whom the contractor enforces the contingent payment clause);

(2) The subcontractor gives the contractor a timely and effective notice objecting to the enforcement of the clause, and the contractor fails to timely advise the subcontractor in writing that its notice of objection is ineffective due to the subcontractor’s default;

(3) The contingent payment clause is contained in a sham contract, as defined in §53.026 of the Texas Property Code (i.e. a situation where the general contractor is controlled by the owner, or the general contractor and owner had no good faith intention that the contractor would perform the prime contract); or

(4) Enforcement of the contingent payment clause would be “unconscionable.”

Note that the statute does not distinguish between a progress pay application and a final pay application for release of final retainage. Thus, a subcontractor’s objection to a contingent payment clause can force the contractor to pay the objecting subcontractor its final retainage before collecting the final retainage from the owner, unless the contractor can countermand the subcontractor’s objection on the grounds that the owner is in default for withholding of final retainage, or that there is a good faith (or bona fide) dispute with the subcontractor that justifies withholding under the applicable prompt payment statute.

Mechanics Lien Rights Protected

A contingent payment clause cannot be used to invalidate the enforcement or perfection of a mechanic’s lien for labor performed or materials furnished. The Statute does not expressly state that a contingent payment clause is “unenforceable” as a defense to a mechanic’s lien, but that probably is the case with respect to an owner’s contention that the contingent payment clause should defeat a subcontractor’s mechanic’s lien (particularly if the subcontractor has properly objected to the contingent payment clause in accordance with the statute, by the time of the foreclosure proceeding on a perfected lien, ). Conversely, a contractor who effectively countermands a defaulting subcontractor’s improper objection to a contingent payment clause will presumably be in a better position to defend the owner against the defaulting subcontractor’s lien claim.

Waivers Expressly Prohibited

A party cannot be forced to waive its rights under the statute to object to the enforcement of a contingent payment clause or to obtain certain information relating to the owner’s ability to pay for the project. Similarly, an obligor or primary obligor cannot prohibit a contractor from using a contingent payment clause to allocate the risk of owner non-payment in a construction contract.

III. Notice requirements

Subcontractors’ (or other Contingent Payees’) Notice Requirements

To effectively object to the enforcement of a contingent payment clause and protect its right to receive payment on its pay application, a subcontractor (or other contingent payee) must meet several requirements set out in §35.521(c) of the statute:

1. Written Objections; 45-Day Waiting Period

The subcontractor may send a written notice objecting to enforcement of a contingent payment clause after forty-five (45) days has passed from the submission of the subcontractor’s pay request. As noted in Subparagraph (3), below, the objection must be specific to the subcontractor’s request for payment. Thus, a subcontractor’s notice of objection may be deemed ineffective if it is sent before the 45-day waiting period has run.

Obviously, a pay application cannot be considered submitted until it is received. So, the objecting subcontractor must be able to show when the general contractor actually received its pay application in order to know when the forty-five (45) day waiting period has passed. The subcontractor can either establish the time of receipt by obtaining a signed receipt or other written acknowledgment from the contractor showing the date when the subcontractor’s pay application was received, or send its pay application by certified mail, return receipt requested.

2. Pay Applications Must be Complete

The Subcontractor’s submission of the pay application must have been made substantially in accordance with the subcontract. Subcontracts often require a subcontractor to submit considerable back-up documentation with each pay request, including partial releases of liens, indemnities, receipts, certifications, etc. Thus, the subcontractor needs to be able to prove that, on the date of submission, its payment request properly reflected the amount due under the express terms of the subcontract, allowed all appropriate credits, and included all the necessary supporting documentation required by the subcontract. Otherwise, the contractor will be able to maintain that the subcontractor’s notice of objection is ineffective.

3. Written Objections Required for Each Pay Application

A subcontractor’s notice of objection, once effective (as discussed further below), precludes the contractor’s enforcement of a contingent payment clause for all purposes until the subcontractor gets the payment of the debt giving rise to its effective written notice of objection. The statute therefore requires the subcontractor to send separate notices objecting to enforcement of a contingent payment clause for each pay application on which payment has not been received. While an effective notice blocks enforcement of the contingent payment clause as to materials and labor furnished thereafter, the contingent payment clause is “reinstated” as to any later payment applications once the owner or contractor has paid the subcontractor’s payment application that was the subject of the notice of objection. Thus, the subcontractor who has objected to one late pay application should continue to issue objection notices as to additional pay application that goes unpaid for more than the 45 day waiting period.

4. Effectiveness of Subcontractor’s Written Objection

Assuming the subcontractor’s pay request was properly submitted and the 45 day waiting period has run with respect to the subcontractor’s notice of objection, §35.521(c) states that the subcontractor’s right to prevent enforcement of the clause depends on when the subcontractor’s written objection becomes effective. §35.521(c) also states a contingent payment clause will not be enforceable once the subcontractor’s notice of objection has become effective. If the contractor never receives a written notice of objection from the subcontractor, or if the notice is ineffective, the contractor will be able to enforce a contingent payment clause to avoid payment to the subcontractor. When the subcontractor’s notice of objection becomes effective is found in §35.521(d). This is where it gets very complicated for both the contractor and the subcontractor.

Assuming the contractor cannot or does not countermand it, the statute provides that a subcontractor’s notice of objection to the enforceability of a contingent payment clause will become legally “effective” on the later of:

– the 10th day after the Contractor receives it, or

– the 8th day or the 11th day following the date when interest begins to accrue on the payment due the Subcontractor, depending on whether the project is a private job governed by the Prompt Pay Act , or a public job or a federally financed public job subject to the Texas Government Code or the U. S. Administrative Code.

In Appendix 3 is a sample form that a subcontractor may use to object to the enforcement of a contingent payment clause.

The Contractor’s (or Continent Payor’s) Notice Requirements

The contractor’s notice requirements to countermand a subcontractor’s objection to a contingent payment clause are found in §35.521(e). If owner non-payment is due to the owner’s financial failure or other default, §35.521(b) would make these requirements inapplicable; however, the contractor would be wise to countermand a subcontractor’s notice of objection to avoid any doubt over its right to enforce the contingent payment clause as the result of an owner default. To the extent owner non-payment is due to the subcontractor’s failure to meet its contractual obligations, however, there are two (2) major requirements:

1. Contractor must contend Owner’s Non-payment is Due to the Subcontractor’s Failure

The contractor must be able to show that the “obligor” (the owner) is withholding payment because the objecting subcontractor failed to meet its obligations under its subcontract. There are no time limits on how soon the contractor must be able to show that the owner’s non-payment is due to a dispute over the subcontractor’s default. A contractor may want to seek the owner’s agreement to cooperate in identifying the particular subcontractor whose default is the reason for non-payment, as well as an express agreement to release payment for any subcontractor’s work that is not in dispute.

Note that the statute does not require the owner to confirm that its non-payment is due to a particular subcontractor’s default, although this would be helpful for the contractor to know in order to countermand the subcontractor’s notice of objection. An owner should be willing to agree in a prime contract that it will, to the extent reasonably possible, advise the contractor upon request whether payment is withheld due to an objecting subcontractor’s nonperformance, since the prompt payment statutes requires an owner to specifically state the reasons why payment has been withheld in order to provide the contractor reasonable opportunity to resolve the problem.

2. Contractor Must Timely Counter the Subcontractor’s Written Objection.

The contractor must be able to show that it timely advised the subcontractor in writing that the subcontractor’s notice of objection “does not prevent enforcement of the contingent payment clause.” This means the contractor must be able to establish that the owner’s non-payment (i) is not due to the contractor’s failure to meet its own obligations, and (ii) is due to the objecting subcontractor’s failure to meet its obligations. Assuming the contractor can show these facts, the contractor must advise the subcontractor in writing of this within a very short time. The subcontractor must receive the contractor’s countermanding written notice that the contingent payment clause is enforceable before the later of the:

(a) 5th day before the day the subcontractor’s notice of objection becomes legally effective (discussed above), or

(b) 5th day after the day the Contractor actually receives the objecting subcontractor’s notice objecting to enforcement of the contingent payment clause.

The contractor’s safest course is to assume that a subcontractor’s notice of objection will become effective upon the expiration of 10 days after receiving it, and to be prepared to countermand within 5 days after receiving it. Note that the statute does not establish any deadline for a subcontractor to object to the enforcement of a contingent payment clause. Thus, if a subcontractor waits to give notice of its objection until (or within 5 days of) the time that interest begins to accrue under the applicable prompt payment statute, the contractor would be faced with only a 5-day window within which to timely object. Therefore, a contractor would be well-advised to tell a subcontractor as soon as possible that it is countermanding the subcontractor’s objection. If a contractor informs a defaulting subcontractor that its default will result in non-payment or withholding of payment even before the subcontractor issues a notice of objection, such notice may avert the subcontractor’s issuance of an improper notice of objection.

Putting it All Together

The above requirements for giving and countermanding objections to contingent payment clauses are complex, and advising a client requires careful consideration of the statute. The following diagram shows all the key notice requirements in one diagram.

Enforcement of a Contingent Payment Clause Cannot Be “Unconscionable”

Assuming the contractor countermands a subcontractor’s notice of objection to a contingent payment clause as discussed above, the contractor may still not be able to enforce a properly drafted contingent payment clause if its enforcement would be “unconscionable.” The statute does not say when a clause might be found to be unconscionable; however, it sets forth certain steps, discussed below, which a contractor can take both before and after entering into a binding subcontract to protect against a subcontractor’s claim that the contingent payment clause is “unconscionable.”

Unconscionability, generally With respect to consumers, the term “unconscionable” is defined in the Texas Business & Commerce Code under the Deceptive Trade Practices Act as follows:

“”Unconscionable action or course of action” means an act or practice which, to a consumer’s detriment, takes advantage of the lack of knowledge, ability, experience, or capacity of the consumer to a grossly unfair degree.”
In determining whether a contract is unconscionable, a court will examine: (1) the “entire atmosphere” in which the agreement was made; (2) the alternatives, if any, available to the parties at the time the contract was made; (3) the “non-bargaining ability” of one party; (4) whether the contract was illegal or against public policy; and (5) whether the contract is oppressive or unreasonable, but “the fact that a bargain is a hard one does not entitle a party to be relieved therefrom if he assumed it fairly and voluntarily.” The totality of the circumstances relating to a claim of unconscionability must be assessed as of the time the contract was formed. A jury may determine facts relevant to a determination of whether an agreement is unconscionable, but the ultimate determination of unconscionability is one of law for the court to decide.

For an in-depth discussion of the unconscionability of a contractual provision, consider the recent North Carolina Supreme Court case of Tillman v. Commercial Credit Loans, Inc., et. al. , in which the court stated:
“A court will find a contract to be unconscionable only when the inequality of the bargain is so manifest as to shock the judgment of a person of common sense, and where the terms are so oppressive that no reasonable person would make them on the one hand, and no honest and fair person would accept them on the other.”

Most legal scholars would agree that, of all clauses found in contracts, an arbitration clause would seem to be the most invulnerable to a claim of unconscionability. However, over the dissent of two judges, and the Federal Arbitration Act notwithstanding, the North Carolina Supreme Court in Tillman refused to enforce an arbitration clause in a consumer lending agreement on grounds of unconscionability. Two consumers sought to join in a class action to recover premiums paid to CitiFinancial Services for credit life insurance that they claimed was never discussed and that they did not need. The court found the arbitration clause to suffer from both “substantive unconscionability” (the contractual provision gave the defendant lender strong, one-sided advantage over the consumer) and “procedural unconscionability” (described as “bargaining naughtiness” in the form of unfair surprise, lack of meaningful choice, and an inequality of bargaining power). Key among the findings of fact in the Tillman decision:

– The offending arbitration clause was drafted by the defendant lender.

– The plaintiffs were relatively unsophisticated in contracting with corporate defendants.

– In closing the loans, consumers were rushed through negotiations and the defendant lender made no mention of the arbitration clause, which it considered non-negotiable. (The lenders’ general counsel testified, “We do not make loans without an arbitration provision.”)

– Substantively, the arbitration clause gave the defendant a decidedly one-sided advantage by allowing the defendant the advantages of arbitration while at the same time deterring the plaintiffs’ use of arbitration through a clause that prohibited joinder of multiple consumer claims in a class action, and by imposing a “loser-pay-all-costs” provision if arbitration exceeded 8 hours (in connection with which the court took a dim view of the financial disadvantage to the consumers, given their inability to afford lawyers).

Applying the logic of Tillman, it would seem, then, that a subcontractor could attack a contingent payment clause as unconscionable by arguing that it was drafted by the contractor; that the subcontractor was relatively unsophisticated compared to the contractor; that the clause was non-negotiable; and that, as a substantive matter, it gave the contractor, as contingent payor, a strong advantage over the subcontractor as contingent payee, in a manner that is grossly unfair.

In a dispute over the unconscionability of a contingent payment clause, it would be relevant whether the contractor refused to do business with any other subcontractor who would not accept the clause, whether the contingent payment clause was discussed by and negotiated between the parties, and whether the negotiations involved legal counsel for both parties. Thus, a subcontractor who does not negotiate or involve counsel in negotiation over a contingent payment clause may be able to assert the clause is unconscionable. While unconscionability is still an extremely tough burden for a subcontractor to meet, it is not insurmountable. Therefore, a contractor would be wise to document that a contingent payment clause was the subject of serious negotiation, in addition to following the statute’s safe harbor provisions discussed below.

Statutory Safe Harbor Provisions for Avoiding Unconscionability

Under the statute, the unconscionability of a contingent payment clause will turn on whether the contractor has taken certain steps to provide the subcontractor with meaningful information about an owner’s ability to pay, and to purse the collection of funds due the subcontractor if the owner fails or refuses to pay for the subcontractor’s work.

Before entering into a binding subcontract, the contractor must exercise diligence to investigate the owner’s ability to pay. After subcontracting, and in the event of owner non-payment, the contractor must either make reasonable effort to collect from the owner or enable the subcontractor to do so directly. When taken, these steps establish so-called “safe harbors” for the contractor to successfully defend against a claim that a contingent payment clause is unconscionable. However, a contractor who fails to undertake these steps remains vulnerable to a claim that the clause is unconscionable.

To defend against a claim of unconscionability, a contractor must be able to prove it “exercised diligence in ascertaining and communicating” to the subcontractor the “financial viability of the primary obligor and the existence of adequate financial arrangements to pay for the improvements.” Again, this must be done before the subcontract becomes effective. The extent of information about an owner’s financial arrangements to pay will vary depending on whether the project is public or private.

Owner’s Duty to Provide Evidence of Financial Viability and the Risk of a Work Stoppage.

Owners are required to provide the contractor certain information specified in the statute to demonstrate due diligence within thirty (30) days after it has been requested, and if the owner refuses to do so, the contractor and any subcontractor or supplier and any surety are relieved of any obligation to perform. If an owner refuses to provide the required information, and the contractor continues to perform despite such refusal, an owner might take the position that the contractor’s continued performance waived any right to stop performance. However, a person will not be held to have waived a right under the statute contract or other means. Therefore, it appears that the contractor or any subcontractor who continues performance for an uncooperative owner in this situation could later choose to stop performance at any time during the project. Also, the subcontractor’s right to stop work under the statute is independent of and in addition to its right to stop work under the prompt pay statutes for the owner’s failure to pay undisputed funds within the prescribed time limits after receiving the requisite written notice to owner and its lender.

A contractor who entered into a prime contract before the statute went into effect on September 1, 2007, and has yet to enter into a related subcontract after the statute’s effective date, should still be concerned that the subcontractor may object to the enforcement of a contingent payment clause and/or that it has the right to stop work even though the owner, at the time the prime contract was executed, was under no statutory duty to provide the information related to its ability to pay for the project. The statute is unclear on whether it applies in this situation. Section 2 of S. B. 324 states:

“Section 35.521, Business & Commerce Code, as added by this Act, applies only to a contingent payment clause under which payment is contingent on the receipt of payment under a contract or other agreement entered into on or after September 1, 2007.” (Emphasis added.)

This provision is susceptible of two interpretations. One interpretation is that the statute only applies where the receipt of payment is under a prime contract that is entered into on or after September 1, 2007. Under this interpretation, the date of the subcontract is irrelevant, and the subcontractor has no statutory right to object to the enforcement of the contingent payment clause in a post-September 1, 2007 subcontract. The other interpretation is that the statute applies to any subcontract entered into on or after September 1, 2007, even if the prime contract was executed before September 1, 2007. Under this interpretation, a subcontract entered into after September 1, 2007 could be governed by the statute even though the prime contract was entered into before September 1, 2007, and the owner could be vulnerable to a work cessation.

However, the statute also states:

“The enforcement of a contingent payment clause is not unconscionable if the contingent payor (the contractor) : . . . proves that [it] has exercised diligence in ascertaining and communicating in writing to the contingent payee (the subcontractor), before the contract in which the contingent payment clause has been asserted becomes enforceable against the contingent payee (the subcontractor), the financial viability of the primary obligor (the Owner) and the existence of adequate financial arrangements to pay for the improvements; . . . . ”

Therefore, a contractor who wants to take advantage of the safe harbor provisions to avoid a claim of unconscionability should assume that the statute still applies even though the prime contract predated September 1, and ask the owner to provide information on its ability to pay for the project. If the contractor can show that it diligently sought the information from the owner before the effective date of the subcontract containing the contingent payment clause, the contractor should not be precluded from relying on the statute’s safe harbor protection against a claim of unconscionability.

Evidence of Owner’s Financial Arrangements for Private Projects

To demonstrate diligence on a private project, the contractor must have obtained and furnished to the subcontractor prior to execution of the subcontract the owner’s and any surety’s identity and contact information, a legal description of the property to be improved, and information about any financing for the project. For an owner who may have borrowed funds to pay for the improvements, the owner must provide a statement supported by “reasonable credible evidence” from the lender of the amount borrowed. The contractor must also provide the subcontractor with the following information:

o a summary of the terms of the loan ,

o a statement of whether there is foreseeable default of the primary obligor , and

o the identity of all lenders and all borrowers.

Finally, the owner/primary obligor must provide the contractor a statement (for the subcontractors) that is “supported by reasonable and credible evidence from all applicable banks or other depository institutions, of the amount, source, and location of funds available to pay the balance of the contract amount if there is no loan or the loan is not sufficient to pay for all of the construction of the improvements.” Therefore, it appears that the owner (primary obligor) is only required to furnish the two statements described above (one being the statement of the lender as to the amount borrowed, and the other being the statement of the banking institution as to the availability of funds to pay outside any loan), leaving the contractor to obtain all other information required to be provided to the subcontractors.

The following is an example of a modification to §2.2.1 of the 1997 AIA A-201 General Condition referencing the statute’s requirement for providing reasonable evidence of financial arrangements:

“The Owner shall, at the written request of the Contractor, prior to commencement of the Work and thereafter, furnish to the Contractor reasonable evidence that financial arrangements have been made to fulfill the Owner’s obligations under the Contract including the information described in Texas Business and Commerce Code §35.521(m). Furnishing of such evidence shall be a condition precedent to commencement or continuation of the Work. Contractor shall be entitled to furnish this information to its lower-tier subcontractors and suppliers if they have first signed and delivered to Contractor a written agreement of confidentiality from its subcontractors and suppliers in form approved by Owner (such approval not to be unreasonably withheld). After such evidence has been furnished, the Owner shall not materially vary such financial arrangements without prior notice to the Contractor.”

The contractor is not required by the statute to have the owner swear to the accuracy of its financial information, but the contractor could be exposed to liability if it knows or should know that the information furnished is false or inaccurate. A contractor should consider obtaining the subcontractor’s agreement that it accepts the information without recourse to the contractor if it turns out to be incorrect or misrepresented by the owner. A provision to this effect is included in the sample contractor’s contingent payment clauses in Appendix 2.

A contractor is not limited by the statute in its request, or how many times it may request, information concerning an evidence of an owner’s ability to pay for the Work. However, the statute only requires the owner (primary obligor) to furnish the items enumerated above “as applicable” in order to avoid the risk of a work stoppage by the contractor (contingent payor), its subcontractors (the contingent payees), which would also relieve a surety of its obligations.

The new AIA 2007 A-201 General Conditions encourages contractors to request “reasonable evidence that the Owner has made financial arrangements to fulfill Owner’s obligations under the contract” and requires owners to provide this as “a condition precedent to commencement or continuation of the Work.” However, unlike the 1997 version of the AIA 201, it is now critical for the contractor to request such evidence prior to any commencement of work on the project, because the contractor’s right to request it thereafter is more limited. The AIA documents do not provide input on what type of evidence is considered “reasonable.”

The 2007 ConsensusDocs provide more detailed guidance on what a contractor could seek as “reasonable evidence” of an Owner’s ability to pay for the Work, including a form of questionnaire to obtain such things as:

o Owner identity;

o Owner’s financial statement;

o Dunn & Bradstreet report;

o Credit report;

o Owner’s loan documents;

o Lender’s “set-aside” letter reserving sufficient construction loan proceeds to exclusively pay for the Work;

o Owner’s prior payment history;

o Owner’s agreement with design professionals (which may be relevant if loan proceeds will be used to pay for their services);

o Owner’s property insurance policies;

o Extent to which financing is governmental backed; and

o Requests for information from others concerning Owner’s past payment history.

A sample form is provided in Appendix 4 that may be adapted to request information from the owner for a private project. It calls for the establishment of a construction escrow account to hold funds for payment on the project. This would require a corresponding escrow agreement. A contractor considering an especially high risk project involving an owner who has no proven track record and who is entirely dependent on the project as collateral for financing to pay for the project, may want to insist that the owner furnish some or all of the information. The ConsensusDocs Questionnaire is available at www.consensusdocs.org.

Whatever the level of financial information a contractor decides to seek from an owner for a private project about its ability to pay, an owner will want, and the contractor should expect the owner to require, absolute confidentiality on the part of the contractor and each subcontractor, as a condition of being qualified to be considered for the project. A commitment of confidentiality in the nature of an inducement is stated in the funding confirmation form in Appendix 4, but most owners will want to require a much more strict confidentiality agreement from the contractor and all subcontractors.

Evidence of Financial Arrangements for Public Projects

For a public project, the due diligence requirements are far easier for the contractor to meet. The contractor is only required to obtain the identity and contact information of the government owner, the surety on the payment bond, and the owner’s statement that “funds are available and have been authorized for the full contract amount.” It should be noted that the general contractor cannot be faulted if the provided information shows a substantial credit risk. The general contractor must simply provide such information as it has been provided by the owner.

For public projects, the sample form provided in Appendix 5 may be used to request sufficient information from the owner that is sufficient to fulfill the requirement for diligence on a public project.

Steps Required in Event of Owner Non-Payment

In the event of owner non-payment, the contractor’s enforcement of a contingent payment clause will not be unconscionable if the contractor does either of the following: (i) make reasonable effort to collect for the subcontractor’s work, or (ii) assign, or offer to assign, to the subcontractor a pass-through claim against the owner.

There are constraints on a contractor’s right to assign a pass-through claim. The contractor must assign it to the subcontractor within a reasonable time, i.e. sufficient to allow the subcontractor to pursue the claim against the owner directly. The pass-though claim cannot be barred by the contractor’s failure to preserve it. The statute does not appear to put the contractor to an election between attempting to collect or assigning a pass-through claim. The contractor should, therefore, be able to attempt to collect, and then decide later to assign (or offer to assign) to the subcontractor a pass-through claim to continue to pursue collection from the owner, as long as the contractor has not prejudiced the validity of the pass-through claim.

It may be possible to have a subcontractor agree to accept a pass-through claim in full satisfaction of the contractor’s payment obligation under a pay-when-paid clause (as distinguished from a contingent payment clause). The contractor’s sample contingent payment clause in Appendix 2 includes a provision to this effect. This may be a viable approach to managing the risk of owner non-payment if the subcontractor is careful to preserve its lien or bond claim rights. However, the parties to the subcontract will need to agree whether the pass-through claim rights will be effective from the date of the subcontract, or only upon the contractor’s election to assign the pass-through claim, as discussed above. In either case, a subcontractor’s (or other contingent payee’s) right to enforce a pass-through claim against an obligor is expressly recognized under the statute. Since the statute prohibits contractual waivers, an owner cannot contractually restrict or preclude a contractor from giving pass-through claims to a subcontractor, which were generally permissible under Texas law before the statute was adopted.

Failure by the contractor to fulfill all aspects of the above requirements may preclude the general contractor’s from statutory protection against a claim of unconscionability. However, such a failure does not automatically render enforcement of the contingent payment clause unconscionable.

Conclusion

While the new Texas statute restricting contingent payment clauses is complex, and may need further adjustments, it is undoubtedly a unique legislative approach that encourages all parties on a construction project to work cooperatively. The statute obligates a contractor to pay a subcontractor who properly performs on the project if the contractor is to blame for the owner’s non-payment, yet it preserves the contractor’s right to seek and enforce an agreement with its subcontractors to share in the risk of an owner’s financial failure or default. The statute requires owners to furnish and share evidence of financial ability to pay for the work, so that all parties involved in the project may undertake their work with reasonable confidence that they will be paid if they perform. If an owner is unable provide sufficient financial assurances to the contractors to get them to agree to start a project, the risk of financial loss for everyone involved is mitigated. Above all, the statute does not allow a contingent payment clause to preclude any party from being held accountable if it fails to perform its obligations.

APPENDIX 1 – Copy of S. B. 324

S. B. No. 324

AN ACT
relating to contingent payment clauses in certain construction contracts.
BE IT ENACTED BY THE LEGISLATURE OF THE STATE OF TEXAS:
SECTION 1. Subchapter D, Chapter 35, Business & Commerce Code, is amended by adding Section 35.521 to read as follows:
Sec. 35.521. AGREEMENT FOR PAYMENT OF CONSTRUCTION SUBCONTRACTOR. (a) In this section:
(1) “Contingent payee” means a party to a contract with a contingent payment clause, other than an architect or engineer, whose receipt of payment is conditioned on the contingent payor’s receipt of payment from another person.
(2) “Contingent payment clause” means a provision in a contract for construction management, or for the construction of improvements to real property or the furnishing of materials for the construction, that provides that the contingent payor’s receipt of payment from another is a condition precedent to the obligation of the contingent payor to make payment to the contingent payee for work performed or materials furnished.
(3) “Contingent payor” means a party to a contract with a contingent payment clause that conditions payment by the party on the receipt of payment from another person.
(4) “Improvement” includes new construction, remodeling, or repair.
(5) “Obligor” means the person obligated to make payment to the contingent payor for an improvement.
(6) “Primary obligor” means the owner of the real property to be improved or repaired under the contract, or the contracting authority if the contract is for a public project. A primary obligor may be an obligor.
(b) A contingent payor or its surety may not enforce a contingent payment clause to the extent that the obligor’s nonpayment to the contingent payor is the result of the contractual obligations of the contingent payor not being met, unless the nonpayment is the result of the contingent payee’s failure to meet the contingent payee’s contractual requirements.
(c) Except as provided by Subsection (f), a contingent payor or its surety may not enforce a contingent payment clause as to work performed or materials delivered after the contingent payor receives written notice from the contingent payee objecting to the further enforceability of the contingent payment clause as provided by this section and the notice becomes effective as provided by Subsection (d). The contingent payee may send written notice only after the 45th day after the date the contingent payee submits a written request for payment to the contingent payor that is in a form substantially in accordance with the contingent payee’s contract requirements for the contents of a regular progress payment request or an invoice.
(d) For purposes of Subsection (c), the written notice becomes effective on the latest of:
(1) the 10th day after the date the contingent payor receives the notice;
(2) the eighth day after the date interest begins to accrue against the obligor under:
(A) Section 28.004, Property Code, under a contract for a private project governed by Chapter 28, Property Code; or
(B) 31 U.S.C. Section 3903(a)(6), under a contract for a public project governed by 40 U.S.C. Section 3131; or
(3) the 11th day after the date interest begins to accrue against the obligor under Section 2251.025, Government Code, under a contract for a public project governed by Chapter 2251, Government Code.
(e) A notice given by a contingent payee under Subsection (c) does not prevent enforcement of a contingent payment clause if:
(1) the obligor has a dispute under Chapter 28, Property Code, Chapter 2251, Government Code, or 31 U.S.C. Chapter 39 as a result of the contingent payee’s failure to meet the contingent payee’s contractual requirements; and
(2) the contingent payor gives notice in writing to the contingent payee that the written notice given under Subsection (c) does not prevent enforcement of the contingent payment clause under this subsection and the contingent payee receives the notice under this subdivision not later than the later of:
(A) the fifth day before the date the written notice from the contingent payee under Subsection (c) becomes effective under Subsection (d); or
(B) the fifth day after the date the contingent payor receives the written notice from the contingent payee under Subsection (c).
(f) A written notice given by a contingent payee under Subsection (c) does not prevent the enforcement of a contingent payment clause to the extent that the funds are not collectible as a result of a primary obligor’s successful assertion of a defense of sovereign immunity, if the contingent payor has exhausted all of its rights and remedies under its contract with the primary obligor and under Chapter 2251, Government Code. This subsection does not:
(1) create or validate a defense of sovereign immunity; or
(2) extend to a primary obligor a defense or right that did not exist before the effective date of this section.
(g) On receipt of payment by the contingent payee of the unpaid indebtedness giving rise to the written notice provided by the contingent payee under Subsection (c), the contingent payment clause is reinstated as to work performed or materials furnished after the receipt of the payment, subject to the provisions of this section.
(h) A contingent payor or its surety may not enforce a contingent payment clause if the contingent payor is in a sham relationship with the obligor, as described by the sham relationships in Section 53.026, Property Code.
(i) A contingent payment clause may not be used as a basis for invalidation of the enforceability or perfection of a mechanic’s lien under Chapter 53, Property Code.
(j) A contingent payor or its surety may not enforce a contingent payment clause if the enforcement would be unconscionable. The party asserting that a contingent payment clause is unconscionable has the burden of proving that the clause is unconscionable.
(k) The enforcement of a contingent payment clause is not unconscionable if the contingent payor:
(1) proves that the contingent payor has exercised diligence in ascertaining and communicating in writing to the contingent payee, before the contract in which the contingent payment clause has been asserted becomes enforceable against the contingent payee, the financial viability of the primary obligor and the existence of adequate financial arrangements to pay for the improvements; and
(2) has done the following:
(A) made reasonable efforts to collect the amount owed to the contingent payor; or
(B) made or offered to make, at a reasonable time, an assignment by the contingent payor to the contingent payee of a cause of action against the obligor for the amounts owed to the contingent payee by the contingent payor and offered reasonable cooperation to the contingent payee’s collection efforts, if the assigned cause of action is not subject to defenses caused by the contingent payor’s action or failure to act.
(l) A cause of action brought on an assignment made under Subsection (k)(2)(B) is enforceable by a contingent payee against an obligor or a primary obligor.
(m) A contingent payor is considered to have exercised diligence for purposes of Subsection (k)(1) under a contract for a private project governed by Chapter 53, Property Code, if the contingent payee receives in writing from the contingent payor:
(1) the name, address, and business telephone number of the primary obligor;
(2) a description, legally sufficient for identification, of the property on which the improvements are being constructed;
(3) the name and address of the surety on any payment bond provided under Subchapter I, Chapter 53, Property Code, to which any notice of claim should be sent;
(4) if a loan has been obtained for the construction of improvements:
(A) a statement, furnished by the primary obligor and supported by reasonable and credible evidence from all applicable lenders, of the amount of the loan;
(B) a summary of the terms of the loan;
(C) a statement of whether there is foreseeable default of the primary obligor; and
(D) the name, address, and business telephone number of the borrowers and lenders; and
(5) a statement, furnished by the primary obligor and supported by reasonable and credible evidence from all applicable banks or other depository institutions, of the amount, source, and location of funds available to pay the balance of the contract amount if there is no loan or the loan is not sufficient to pay for all of the construction of the improvements.
(n) A contingent payor is considered to have exercised diligence for purposes of Subsection (k)(1) under a contract for a public project governed by Chapter 2253, Government Code, if the contingent payee receives in writing from the contingent payor:
(1) the name, address, and primary business telephone number of the primary obligor;
(2) the name and address of the surety on the payment bond provided to the primary obligor to which any notice of claim should be sent; and
(3) a statement from the primary obligor that funds are available and have been authorized for the full contract amount for the construction of the improvements.
(o) A contingent payor is considered to have exercised diligence for purposes of Subsection (k)(1) under a contract for a public project governed by 40 U.S.C. Section 3131 if the contingent payee receives in writing from the contingent payor:
(1) the name, address, and primary business telephone number of the primary obligor;
(2) the name and address of the surety on the payment bond provided to the primary obligor; and
(3) the name of the contracting officer, if known at the time of the execution of the contract.
(p) A primary obligor shall furnish the information described by Subsection (m) or (n), as applicable, to the contingent payor not later than the 30th day after the date the primary obligor receives a written request for the information. If the primary obligor fails to provide the information under the written request, the contingent payor, the contingent payee, and their sureties are relieved of the obligation to initiate or continue performance of the construction contracts of the contingent payor and contingent payee.
(q) The assertion of a contingent payment clause is an affirmative defense to a civil action for payment under a contract.
(r) This section does not affect a provision that affects the timing of a payment in a contract for construction management or for the construction of improvements to real property if the payment is to be made within a reasonable period.
(s) A person may not waive this section by contract or other means. A purported waiver of this section is void.
(t) An obligor or a primary obligor may not prohibit a contingent payor from allocating risk by means of a contingent payment clause.
(u) This section does not apply to a contract that is solely for:
(1) design services;
(2) the construction or maintenance of a road, highway, street, bridge, utility, water supply project, water plant, wastewater plant, water and wastewater distribution or conveyance facility, wharf, dock, airport runway or taxiway, drainage project, or related type of project associated with civil engineering construction; or
(3) improvements to or the construction of a structure that is a:
(A) detached single-family residence;
(B) duplex;
(C) triplex; or
(D) quadruplex.
SECTION 2. Section 35.521, Business & Commerce Code, as added by this Act, applies only to a contingent payment clause under which payment is contingent on the receipt of payment under a contract or other agreement entered into on or after September 1, 2007.
SECTION 3. This Act takes effect September 1, 2007.

______________________________ ______________________________
President of the Senate Speaker of the House
I hereby certify that S.B. No. 324 passed the Senate on March 14, 2007, by the following vote: Yeas 30, Nays 0; and that the Senate concurred in House amendment on May 21, 2007, by the following vote: Yeas 30, Nays 0.
______________________________

Secretary of the Senate
I hereby certify that S.B. No. 324 passed the House, with amendment, on May 17, 2007, by the following vote: Yeas 140, Nays 0, two present not voting.
______________________________
Chief Clerk of the House

Approved:

______________________________
Date

______________________________
Governor

APPENDIX 2
SAMPLE CONTINGENT PAYMENT CLAUSES FAVORABLE TO CONTRACTOR
(CONVERTIBLE TO A PAY-WHEN-PAID CLAUSE)

Payment Contingent On Receipt of Owner’s Payment. As a pre-condition to Contractor’s obligation to make payment to Subcontractor under this Subcontract, Contractor must have first received payment from Owner of sums invoiced to Owner for Subcontract Work. Contractor’s receipt of payment from Owner shall be an absolute condition precedent to Contractor’s obligation to pay Subcontractor and Subcontractor’s right to receive such payment. Subcontractor hereby assumes the risk of Owner’s failure or refusal to pay Contractor for the Subcontract Work. Notwithstanding any other provision of this Subcontract, payment to Subcontractor for the Subcontractor’s work hereunder shall be due and owing only to the extent that (i) Subcontractor has submitted its pay request therefor strictly in accordance with the requirements of this Subcontract, and (ii) Owner has paid Contractor therefor. Contractor is not obligated to pay any retainage to Subcontractor until Owner has paid Contractor all of Contractor’s retainage in full. If Owner fails to pay amounts invoiced by Contractor for Subcontract Work under this Subcontract, then Contractor will use reasonable commercial efforts to collect such payments from Owner. Contractor will inform Subcontractor of Contractor’s collection efforts. Notwithstanding the foregoing, if Owner’s failure to pay amounts invoiced by Contractor for Subcontract Work under this Subcontract is due to Contractor’s default in the performance of its obligations to the Owner, and such default is in no way attributable to Subcontractor, then Contractor agrees that Subcontractor may object in writing in to Contractor’s enforcement of this clause against Subcontractor, pursuant to applicable law. This provision controls over all other provisions of this Subcontract that may vary from or be in conflict with it. Any other provision of this Subcontract that conflicts with this provision shall be strictly interpreted or reformed to be consistent herewith.

Parties’ Rights if Contingent Payment Provision is Unenforceable. If, at any time, the provision designating Owner’s payment as a condition precedent to payment hereunder becomes, or Contractor believes that such provision may be deemed, unenforceable for any reason as to all or any portion of any sums due Subcontractor hereunder, then Contractor shall have the right, by giving written notice to the Subcontractor at any time, that Contractor has, for purposes of such sums only, elected to treat such provision as one which merely governs the time for payment of such sums, in which case payment shall not become due and payable until after the expiration of a reasonable period of time for the Contractor to collect such sums from the Owner. In the event of such election, Contractor shall be entitled to delay payment to the Subcontractor for such period of time as is reasonably necessary to exhaust all legal remedies available to Contractor to collect such sums from Owner. Subcontractor shall fully cooperate with Contractor in exhausting such legal remedies. Subcontractor shall reimburse Contractor a portion of Contractor’s reasonable costs, including legal fees, to do so. Subcontractor’s portion of such costs shall be at least be in the same proportion that the total of Subcontractor’s claims bear to the total of all claims of both Subcontractor and Contractor. Contractor may, at any time after making such written election, further elect to assign and transfer to Subcontractor in writing all rights that Contractor has to collect any such sums due it Subcontractor from the Owner, in which case Subcontractor shall independently pursue in the Subcontractor’s name recovery of such sums directly from the Owner. Subcontractor agrees to accept Contractor’s assignment of its claims against Owner for such sums as full and final satisfaction of Contractor’s obligation to pay such sums to Subcontractor.
APPENDIX 2 (Continued)

SAMPLE CONTINGENT PAYMENT CLAUSES FAVORABLE TO CONTRACTOR

Use of Information Obtained from Owner Concerning Project Funding (for Private Projects). Subcontractor acknowledges that, prior to execution hereof, it has received from Contractor certain information relating to the Owner’s financial ability to pay and/or secure payment for the work to be performed on the Project. Subcontractor warrants and represents that it has furnished, or shall furnish, such information to any of its lower tier Subcontractors and suppliers prior to execution of any contract with them for the performance of any portion of the Subcontractor’s Work that contains a contingent payment provision, and Subcontractor shall indemnify Contractor against any loss or damage incurred as a result of Subcontractor’s failure to do so. SUBCONTRACTOR WARRANTS AND REPRESENTS THAT IT HAS MAINTAINED, AND SHALL CONTINUE TO MAINTAIN, THE CONFIDENTIALITY OF SUCH INFORMATION, RELEASES THE CONTRACTOR FROM ALL LIABILITY ARISING OUT OF ANY OMISSION, INACCURACY OR MISSTATEMENT BY OTHERS WHO FURNISHED SUCH INFORMATION, HAS FULLY CONSIDERED SUCH INFORMATION, HAS CONDUCTED SUCH INDEPENDENT INVESTIGATION AS IT DEEMS REASONABLY NECESSARY TO CONFIRM OR VERIFY THE SAME, HAS CONSULTED ITS OWN PROFESSIONAL ADVISORS CONCERNING THE SAME, AND HAS READ, UNDERSTANDS AND ACCEPTS THE FULL IMPORT AND MEANING OF THE PRECEDING PROVISION DESIGNATING OWNER’S PAYMENT AS A CONDITION PRECEDENT TO PAYMENT HEREUNDER, WITH FULL AWARENESS THAT SUCH PROVISION COULD RESULT IN SUBCONTRACTOR NOT RECEIVING PAYMENT FOR ITS WORK THROUGH NO FAULT OF THE SUBCONTRACTOR. Subcontractor expressly agrees that Contractor’s reliance upon and enforcement of such condition precedent shall be reasonable and shall not be unconscionable. Without waiving any statutory right that Subcontractor may have to object to Contractor’s enforcement of such condition precedent if Contractor independently causes the Owner to withhold payment for reasons not due to the fault of the Subcontractor, Subcontractor agrees to furnish any such objection to the Contractor’s representative specifically designated in the notice provision of this Subcontract, failing in which Subcontractor agrees that any statutory deadline for Contractor to respond to such notice shall be extended to run from the time that Subcontractor delivers an effective notice to such representative. If Subcontractor’s notice of objection to Contractor’s enforcement of such condition precedent is determined to be ineffective under applicable law, Subcontractor shall promptly reimburse Contractor all of its costs and expenses to countermand such objection or otherwise enforce the condition precedent, including Contractor’s reasonable attorney fees.

APPENDIX 2 (Continued)
SAMPLE CONTINGENT PAYMENT CLAUSE FAVORABLE TO SUBCONTRACTOR
(PAY-WHEN-PAID CLAUSE)

Parties’ Rights if Owner Withholds Payment. If Owner, for any reason unrelated to the Subcontractor’s failure to perform hereunder, withholds payment from Contractor for the Subcontractor’s Work performed in accordance with this Subcontract, Contractor shall have the right, to defer payment to the Subcontractor for such Work until Contractor is able to collect such sums from the Owner. This provision shall be deemed to merely govern the time for payment of such sums, in which case payment shall not become due and payable until after the expiration of a reasonable period of time for the Contractor to collect such sums from the Owner. Contractor shall be entitled to delay payment to the Subcontractor only for such period of time as is reasonably necessary to exhaust all legal remedies available to Contractor to collect such sums from Owner. Subcontractor shall fully cooperate with Contractor in exhausting such legal remedies. Notwithstanding the foregoing, if Contractor has been unable to collect the sums due to Subcontractor hereunder within ___ days from the date when such sums are due, then Contractor shall, at the request of Subcontractor, assign and transfer to Subcontractor in writing all rights that Contractor has to collect any such sums due Subcontractor from the Owner, in which case Subcontractor shall be permitted to independently pursue in the Subcontractor’s name recovery of such sums directly from the Owner. Subcontractor’s acceptance of such assignment shall not waive Subcontractor’s right to recover from Contractor any sums due hereunder that Subcontractor is unable to recover from Owner, except that Subcontractor shall be deemed to waive its right to recover to the extent that the failure of recovery is due to the Subcontractor’s failure to preserve its right to assert a mechanics’ lien or bond claim therefor.

APPENDIX 3
SAMPLE LETTER FOR SUBCONTRACTOR TO OBJECT
TO ENFORCEMENT OF A CONTINGENT PAYMENT CLAUSE

DATE: __________, 20__

TO: _____________________________ (Contractor)

FROM: _______________________ (Subcontractor)

PROJECT: ____________________________________

RE: OUTSTANDING PAY APPLICATION(S) AND INVOICES

As of _______, 20__, more than 45 days has expired since our pay application(s) and invoice(s) for the month(s) of _______________ were delivered to you for your review, approval and payment. Additional copies of these pay application(s) and invoice(s) are attached. We have not received payment for our billed work, nor have we received any explanation as to why payment is being withheld. If you are withholding payment of this pay application on the basis of a contingent payment (or “pay-if-paid”) clause in our subcontract because the owner has withheld payment from you for our work, this letter is our formal notice that we object to the enforcement of that clause in accordance with §35.521(c) of the Texas Business & Commerce Code. If you contend that our pay application(s) fail(s) in any respect to comply with the requirements of our subcontract, or that you are entitled to withhold payment because of a deficiency in our work, we request that you immediately and specifically advise us of any such failure or deficiency. This request is made pursuant to our statutory right to require prompt payment of amounts due us under the subcontract.

If you contend that you received this notice less than 45 days after the date you received the above referenced pay application(s), we request that you confirm in writing the actual date that you contend you received our pay application(s). If you do not provide us with this information within five (5) days of your receipt of this notice, you will be presumed to have agreed that you have been in possession of our pay application(s) in proper form for at least 45 days prior to your receipt of this notice. Unless and until you demonstrate otherwise, we will consider this notice effective with respect to the aforementioned pay application(s).

Please also consider this letter our request that you provide us with all type of information you are required to provide to us under and in accordance with the provisions of §53.159 of the Texas Property Code or §2253.024 of the Texas Government Code, as applicable, including the name and last known address of the person to whom you furnished labor or materials for the construction project; and whether you have furnished or have been furnished a payment bond or performance bond for any of the work on the project and if so, the name, last known address and toll free telephone number of the surety and a copy of the bond(s). Our request that you furnish this information to us shall not be considered a waiver of our right to assert that the enforcement of any contingent payment clause in our subcontract would be unconscionable, nor shall this notice waive our right under §35.521(p) of the Texas Business & Commerce Code to stop our work at any time we may deem it necessary to do so to protect our interests.

Sincerely,

APPENDIX 4
CONFIRMATION OF FUNDING TO PAY FOR WORK ON A PRIVATE PROJECT

Pursuant to Texas Business & Commerce Code, §35.521, the undersigned Owner provides the following information to ______________ (“Contractor”), for it and its subcontractors, as evidence of Owner’s financial arrangements and availability of funding to pay for the _________________________(“Project”):

1. Owner’s full legal name, physical and mailing address, and business telephone number:
______________________________
______________________________
______________________________
______________________________
(___) ___ – _____________

2. Please state below or attach the legal description of the real property on which the improvements are to be constructed, together with the volume and page number of the county real property records where Owner’s title is recorded. ___ Check here if you prefer to attach a copy of owner’s recorded title to the real property, containing its property legal description.

3. If Owner plans to fund payment for the Project out of Owner’s current funds through a Construction Escrow Account, please attach written confirmation from Owner’s banking institution of the availability of sufficient funds to establish a Construction Escrow Account in the amount of $______________________________________.

4. If one or more loans have been arranged to fund the Project, please state the following for each such loan. For any loans that have not been arranged but are anticipated to fund the Project, please provide the following information as currently known or anticipated for each such loan.

A. Name, address and business B. Name, address and business
telephone number of the lender: telephone number of the borrower:
______________________________ ______________________________
______________________________ ______________________________
______________________________ ______________________________
______________________________ ______________________________
(___) ___ – ________ (___) ___ – ________

(For each partnership or limited liability company involved in a borrower’s organization, please provide contact information for each member or general partner, as applicable.)

C. Amount of such loan which will be available to pay for the construction of the improvements.

$______________________________________

OR

___ See attached true and correct copy of loan agreement furnished in lieu of summary.

D. Summary of loan terms, e.g. repayment terms, equity funding requirements, financial covenants or conditions which may give rise to default, and other terms relevant to availability of funding.
___________________________________________________________________________
___________________________________________________________________________
___________________________________________________________________________
__________________________________________________________________________.

– OR –

___ See attached true and correct copy of loan agreement furnished in lieu of summary.

E. Is the loan in default or are you aware of any circumstances indicating a default under the loan agreement is foreseeable? ___ Yes ___ No

If yes, please explain: _________________________________________________________
___________________________________________________________________________
__________________________________________________________________________.

(Attach additional pages or repeat for each such loan as necessary.)

5. Please attach a copy of each lender’s loan commitment letter or other written statement confirming the existence and amount of each loan disclosed above.

– OR –

___ See attached true and correct copy of loan agreement furnished in lieu of summary.

6. To the extent that the Owner will not finance the entire contract amount from the loan(s) described above, please attach a statement of the (a) amount, (b) source, and (c) location of all other funds available to pay for the Project.

7. Please attach written confirmation from each bank or other depository institution of all other funds available for construction.

NOTE: OWNER HEREBY CONFIRMS THE ABOVE INFORMATION IS TRUE AND CORRECT, THAT OWNER HAS ESTABLISHED (OR SHALL ESTABLISH WITHIN ___ DAYS AFTER EXECUTION OF THE CONSTRUCTION CONTRACT), A CONSTRUCTION ESCROW ACCOUNT TO HOLD AND PROCESS PAYMENTS OF FUNDS DUE UNDER THE CONTRACT, AND THAT, FOR AND IN CONSIDERATION OF THIS CERTIFICATION, CONTRACTOR AGREES TO MAINTAIN, AND SHALL REQUIRE ALL SUBCONTRACTORS TO MAINTAIN, THE CONFIDENTIALITY OF THE INFORMATION PROVIDED BY OWNER AND OWNER’S LENDER IN CONNECTION HEREWITH.

OWNER: _________________________Date: ______

By: __________________________________________

Name: ________________________

Title: _________________________

(To be completed by Contractor, if applicable.) The name and address of Contractor’s Payment Bond Surety to whom a claim may be sent:
______________________________
______________________________
______________________________

APPENDIX 5
CONFIRMATION OF FUNDING TO PAY FOR WORK ON A PUBLIC PROJECT

TO: _______________________________________ (Owner)

FROM: _______________________________________ (Contractor)

PROJECT: _______________________________________ (Project)

Date of Contractor’s Request: ___________, ____

Pursuant to the requirements of Texas Business & Commerce Code, §35.521, please provide to us, within thirty (30) days from the date you have received this request the following information to be furnished to Contractor’s subcontractors to demonstrate the financial viability of the Public Owner as the Primary Obligor, and the availability of funding and the existence of adequate financial arrangements to pay for improvements for the Project:

1. Your full legal name, physical and mailing address, and business telephone number:
______________________________
______________________________
______________________________
______________________________
(___) ___ – _____________

For Federal construction only, name of Contracting Officer: ____________________________

2. Are funds are available and has funding been authorized for the full contract amount for the construction of the improvements? ___ Yes ___ No

If no, please explain: _____________________________________________________________
_______________________________________________________________________________
_______________________________________________________________________________
______________________________________________________________________________.

Date of Public Owner’s Response: _____________

PUBLIC OWNER

By: __________________________________________

Name: ________________________

Title: _________________________

(To be completed by Contractor only.) The name and address of Contractor’s Payment Bond Surety to whom a claim may be sent:
______________________________
______________________________
______________________________
______________________________

Posted in Publications and Alerts
Locations

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