An electrical contractor, let’s call him Sparky Inc., was running into financial difficulty. My client, call him Cathode Inc., entered into negotiations to buy Sparky and, in the meantime, agreed to finish one of Sparky’s jobs on a university building as an electrical subcontractor.
Cathode began to submit monthly billings under his own name, even though Sparky was staffing the work along with him. When the job ended, the general contractor (GC) refused to pay Cathode’s final invoice and would not even consider Cathode’s requests for change orders.
This circumstance created confusion as to who had a contract with whom and who was entitled to payment from whom. Legally, was Cathode a sub-subcontractor to Sparky? Was Cathode entitled to unsigned change orders previously submitted by Sparky? Was the GC correct in saying that its only contract was with Sparky? Does anyone really want to leave these issues for a court to sort out?
The legal framework of the problem
Once you sign a contract, you are obligated to perform. But to what extent do you have to perform? Certainly, you are expected to purchase supplies and buy or rent equipment to fulfill your obligations. Subbing out part of your work to a systems contractor and contracting with a company to supply manpower are typical and permissible, and you remain liable for all of the work. However, your subcontract may have a “nonassignment” clause. What does that mean?
Assignment is a legal transfer of rights and/or obligations. The term is not applicable to your supply agreements or to your sub-subcontracts because you are not transferring your rights and obligations under your contract with the general to these other companies.
For a true assignment, the GC wants to know what company it is dealing with and will require that, before any assignment of your subcontract is made, it be notified and consented. Without consent, the assignment is invalid as between the GC and original subcontractor.
An attempted assignment can occur, as with Sparky and Cathode, by having a second subcontractor, Cathode, essentially step into the shoes of the first sub. It can also occur if the second subcontractor has bought out the first and, by doing so, changes the ownership, and possibly the name, of the first subcontractor.
When the GC has not agreed to this “substitution” or “assignment,” legal confusion abounds. Such a case arose recently in Louisiana. In that lawsuit, C&J bought out Tri-Native and took over completion of all of Tri-Native’s contracts. When a GC on one of the jobs refused to pay C&J at project completion, the question became who had the right to sue for that payment. Was it Tri-Native or C&J?
There was proof that the GC knew C&J had taken over Tri-Native and had raised no objection. There was also proof that the GC had sent letters jointly to C&J and Tri-Native concerning contract matters. Under these facts, the court held that C&J may have had an oral agreement of assignment with the GC, at least for the work C&J performed. The court decided that this issue would have to be determined at a trial.
In the case of Sparky and Cathode, the GC had actually issued monthly payments to Cathode. My argument was that, even with a contract prohibiting assignment except by written agreement, the GC had waived the requirement for written agreement in the nonassignment clause by paying Cathode.
What is a novation?
Although there is some overlap between an assignment and a novation, the concept of novation entails the creation of a new contract. For Sparky and Cathode, Sparky probably remained liable to the GC for the work he did plus the work Cathode did despite Sparky’s attempted assignment to Cathode.
Had there been a true novation rather than an assignment, a new agreement would have been signed between Cathode and the GC, and Sparky would have been released from its contract with the general.
If you intend to take over another’s performance and want to have a new agreement with the GC to confirm the new arrangement (a novation), you must exercise care in drafting the transfer documents. The following are some of the considerations that should be addressed:
• Entitlement to past due amounts
• Transfer of right to retention
• Entitlement to outstanding requests for extras
• Preservation of claims
• Confirmation of any verbal agreements between the general and the sub you are replacing
• Confirmation of the existing schedule for completion
• Resolution of any back charges
• Status of lien rights/bond rights
• Status of insurance coverages
If any of these issues are not clarified at the time of the new contract (the novation), the lack of clarity may cause disputes later.
The same considerations apply if you, as an electrical subcontractor, are confronted with a proposed substitution by one of your own subs or suppliers.
Taking over from a terminated contractor
A previous article discussed the problems confronting a completing contractor (See “A Bumpy Road Ahead: Replacement Contractors Face Additional Obstacles,” Electrical Contractor, July 2004, ECmag.com). The article’s points remain valid.
Whether there is a friendly takeover, as when you have purchased a company while it is performing jobs, or the takeover is the result of a default by a prior subcontractor, as when you are asked to complete a project because the prior contractor was terminated, you need to be certain about the parameters of your new starting point.
When there is a new owner or general contractor
I have represented electrical contractors where the owner takes over after its construction manager or GC has been let go. Your subcontract may have a clause “assigning” your subcontract to the owner in this situation. Whether such an assignment clause exists, it is worthwhile to treat this kind of transfer of rights and obligations to the owner as a novation.
The situation is more complex when a new owner steps in, for example, when a bank forecloses or a new entity buys out the owner. The new owner may not want to accept the obligations of the prior owner and may offer you a new contract with different terms and conditions. Be careful, and consult with knowledgeable legal counsel to protect yourself for the entire job and to make sure your lien and bond rights are not diminished.