The following scenario is true, and my rendition of it comes from a recent case. First, the electrical contractor said to the owner: “Is there any problem with your financing for my job?”
The owner said, “Come with me to my bank; you can ask my banker directly.”
The EC asked the banker, “Does it look like there will be enough money for my job?”
The banker’s reply: “Should be no problem.”
The GC was building a small commercial structure for the owner. Many extras were outstanding, and pay was slow. The contractor worried the owner might not have enough money to finish the job.
When the owner defaulted and disappeared, the contractor sued the bank. The court summarily dismissed the case. The judge ruled the questions the EC asked the banker were broad, the banker’s statements were general, and the bank had not made a reliable, specific promise.
You may have encountered owners or GCs running out of money, and you might not know how to act. You might not want to do more work until you know the money is there.
Construction projects are rumor mills. You might hear the GC lost a lot of money on another job or the owner might be affected by a real estate market downturn. You may have wanted financial assurances but did not know if you had a right to ask.
There is some law on your side.
Courts have been asked whether a contracting party had to wait for the other side to actually breach the contract, even though the writing was on the wall. If you know or you can see the indications that the other party will not perform its contractual obligations, the courts have decided you have a right to an intermediate step. This right has been made into a broad rule. In terms of a subcontractor and a GC, the rule would read as follows: “Where reasonable grounds arise to believe that the general contractor will commit a breach, the subcontractor may demand adequate assurance of performance and may, if reasonable, suspend any of its performance until he receives such assurance.”
Limiting this rule to financial concerns, it means, if you have good reason to believe the GC will not be able to pay you, you can ask for confirmation that it has sufficient funds. If you do not get an adequate response, you can suspend your work.
This concept is well-established in the law. Variations of this rule appear in court decisions and in the Uniform Commercial Code, which applies to the sale of goods. Court decisions emphasize that the subcontractor’s concerns must have a reasonable foundation—something more than rumor or innuendo—and that the request for assurances be in writing.
When faced with such a request, the GC would be well-advised to respond quickly. And, according to the rule, the response needs to be adequate. In everyday language, these legal concepts of reasonable and adequate mean that there were facts that would satisfy a person generally, not just address the personal feelings of the worried subcontractor. The term of art here is “objective facts.”
Because of the potential for harm to the project by a suspension of work, the wording for the request and for the response needs to be carefully considered. You should consult with your attorney before you proceed.
Other avenues for assurances
For reference, check out a booklet produced by the Associated General Contractors of America (AGC) called “Guidelines for Obtaining Owner Financial Information,” and in “Guidelines for a Successful Construction Project,” which was adopted by the AGC. Commentary by the American Institute of Architects to its A-201 Form contains similar suggestions. These guidelines recommend research into the owner’s finances. But these efforts are all precontract.
What do you do once the job is underway? Many subcontractors have inserted a clause into their agreements with the GC that gives the sub permission to inquire of the owner or architect directly as to the status of outstanding pay requests. Without such a clause, a sub may not be permitted to make such direct contacts with the owner.
Aside from the obvious benefit of allowing a subcontractor to gain up-to-date information on project payments, such a clause is also helpful in determining rights under relevant prompt pay acts and trust fund statutes. Note that, in federal and many state government contracts, a sub can get payment and other financial information from the owner through a Freedom of Information Act request.
A sub needs to be cautious in making an adequate assurance request and in researching the financial status of the GC. For example, in one case, a subcontractor added other demands to its request for assurances. The sub demanded that all change orders had to be finalized within 10 days and there would be no back charges, otherwise it would suspend its work. A court held that these additional demands were outside the sub’s rights and were themselves a breach of contract.
In another case, the sub’s telephone calls and letters to third parties asking what they knew about the GC’s poor financial position gave rise to a suit by the general for claims that the inquiries hurt its business.
A more general application
The rule written about here applies to any performance by another contracting party, not just to payments. For example, the rule can be used, if justified, to request assurances from a supplier of timely delivery or from your own subs that they have sufficient staffing.
When one party has obligations to another, and there are reasonable grounds for believing that this performance is in jeopardy, the rule is available.