Monday, March 23, 2015

Join Divisions 1, 10, and 12 for cocktails at the Annual Meeting

Please remember to register for the 2015 Annual Meeting of the ABA Forum on Construction Law from April 16-18 in Boca Raton, Florida.

If you're planning to attend, Divisions 1, 10, and 12 are having cocktails on Thursday night at The Blue at the Boca Raton Resort. 

Please contact Emily Anderson to RSVP for this event. Space is limited. If you'd like to make reservations for a sit-down meal, you can do so online here.

Thursday, March 12, 2015

Misuse of Construction Trust Funds May Prevent a Contractor From Discharging Its Liability in Bankruptcy

In a recent bankruptcy case in Texas, the court rejected a contractor’s attempt to discharge its liability for violation of a construction trust-fund statute. Tag Invs., Ltd. v. Monaco (In re Monaco), 514 B.R. 477, 2014 Bankr. LEXIS 3276 (Bankr. W.D. Tex. 2014). The trust-fund violation established that the contractor had breached its fiduciary duties to the trust beneficiaries with either actual knowledge of wrongdoing or reckless disregard to the risk that the conduct would violate the contractor’s duties. This was sufficient to reject a discharge under § 523(a)(4) of the Bankruptcy Code.

In many states, funds paid by an owner to a contractor to pay for subcontractors’ work are considered statutory “trust funds.” See, e.g., Tex. Prop. Code §§ 162.001, et seq. The contractor is deemed to be a “trustee” with certain fiduciary duties to the “beneficiaries” of the trust funds, including the subcontractors. Violation of the statute occurs when the contractor intentionally or knowingly does not apply the funds in the manner required under the statute. This can lead to civil liability and, depending on the statute, potential criminal prosecution. Such liability applies not only to the contractor, but to any officers, directors, or agents who control or direct the trust funds.

If such violations occur, the contractor may attempt to discharge its liability to the owner for the misapplied payments through bankruptcy proceedings. If the subcontractors have perfected liens against the owner’s property, the owner faces the risk of paying twice for the subcontractors’ work without any possibility of collecting reimbursement from the contractor.  

To reduce this risk, the owner has the option to challenge the discharge of the debtor’s liability. Section 523 of the Bankruptcy Code prohibits discharge of a debt “for fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny.” 11 U.S.C. 523(a)(4). If successful, the owner may then seek to recover the misapplied funds from the debtor (which could be the contractor, its officers, its directors, and/or its agents).

In the Monaco case, a contractor and several individual officers sought to discharge debts in bankruptcy that included claims asserted by an owner based on the debtors’ misapplication of trust funds. The contractor failed to pay several subcontractors despite receiving the funds to do so from the owner. The bankruptcy court found that the debts were not dischargeable, as the owner had shown that the debtors misapplied funds with sufficient knowledge to meet the requirements of § 523(a)(4) of the Bankruptcy Code. In particular, this finding was based on evidence that one of the officers submitted written certifications that all subcontractors and suppliers had been paid, when he knew they had not. These false certifications were intended to obtain payment from the owner and conceal the misapplication of the trust funds. Thus, the discharge was denied as to the officer who had signed the certifications. Another officer evidently was permitted a discharge because, though she likely knew the subcontractors had not been paid, she did not sign false certifications or engage in other conduct suggesting intentional violation of the trust-fund statute.

Bankruptcy proceedings can impose significant obstacles to the successful pursuit of claims against the debtors. Statutory fiduciary duties can serve as an important tool to owners seeking to overcome these obstacles.

Tuesday, March 3, 2015

New Retainage Law Takes Effect in Massachusetts

The Commonwealth of Massachusetts has a new retainage law applicable to most private construction projects, which took effect on November 6, 2014.  The Retainage Law limits the ability of owners and contractors to negotiate retainage, punchlist, and substantial-completion provisions of certain private construction contracts.  It applies to any construction contract with an original contract price of not less than $3,000,000, and to which the Massachusetts mechanic’s lien law, M.G.L. Ch. 254, §§ 2 and 4, applies (i.e., contracts with prime contractors, all first- and second-tier subcontractors, and all first- and second-tier suppliers). Residential construction projects consisting of four or fewer units are exempt regardless of the contract value.  All construction contracts executed after the effective date are subject to the new law.
The Retainage Law limits the amount of retainage withheld from each progress payment to no more than five percent (5%) of the payment.  The law also specifically defines “substantial completion” as the stage of the project (or phase thereof, if applicable) at which work “is sufficiently complete . . . so that the project owner may occupy or utilize the work for its intended use.”  Any contract terms which conflict with this new statutory definition are void and unenforceable. 

The Retainage Law also prescribes a timeline and procedure for the release of retainage.  In general, retainage cannot be withheld for more than 90 days after substantial completion and seven additional days for each contract tier below the prime contractor.  The Retainage Law imposes a new statutory form of notice of substantial completion, which the prime contractor must submit to the owner within 14 days after achieving “substantial completion.”  The owner must accept or reject the substantial completion notice within 14 days of receipt and must send the general contractor a punchlist of deficient or incomplete items within 14 days after the owner’s acceptance. 

An owner may continue to withhold retainage, in limited amounts specified by the Retainage Law, for incomplete or incorrect work or deliverables and for certain outstanding claims.  In such event, the owner must, before the date payment is due, provide the party seeking payment with written notice describing the deficient or missing work items and deliverables, the basis of the outstanding claims, and the value attributable to each. 

The PowerPoint presentation in the link below provides more detail on the timeline and process for releasing retainage and on other aspects of the Retainage Law.  

The text of the New Retainage Law can be found here