On default, the legal contract terms that seemed to be academic now dictate whether or not you get your money. However, contract terms will not prevent all problems or make sure that you are held harmless. This is an unrealistic job description for any attorney or risk manager. If you do business with the wrong people, you will have problems. If you supply the wrong project, you will have problems. In most cases, business people put their contract documents in the file and never look at them again. If there are no problems, there is no need. If there are minor problems, business people usually discuss and resolve these issues in order to preserve relationships and keep moving forward. Contract terms usually do not matter. Does this mean contract terms are unimportant?

Contract terms are about leverage, cost and risk. If you end up in an unavoidable and irresolvable problem, your leverage, cost and risk determine whether you have profit or loss. In times of insolvency, mechanic’s lien or other security rights may be the only avenue to collect. You must be sure contract terms do not waive those rights. You also want to make sure that your debtor is amply motivated to resolve the problem. Raise the priority of your debt and encourage a quicker resolution. Contract terms can hold down your costs in resolving the dispute, while making sure your debtor faces a cost penalty for avoiding resolution. You want to avoid risk and limit problems where possible. Contract terms will not avoid all problems for you, but you can lower the risk of a complete loss and lower the costs of problems. It is all about leverage, cost and risk.

This chapter will discuss:

Supplier Credit Applications and Quotes
Contractor Proposals and Contracts
Guarantees and Joint Check Agreements
Reviewing and Revising Contracts Received
Contract Administration
Lien and Bond Claim Waivers

You also should review Chapter 3 (Uniform Commercial Code Sale of Goods) if your transaction involves buying or selling materials. The UCC adds many terms to an agreement to buy or sell materials. The chapter on Changes, Delays and Other Claims will discuss contract terms, contract administration and other legal issues peculiar to change orders, scheduling, delays and other claims.

Some of the following discussion applies only to suppliers; some applies only to subcontractors, while other parts are applicable to all contractors. In any event, all suppliers and contractors have something to learn in a discussion of construction contracting. We do not intend to be taking “one side or the other.” The terms “seller” and “customer” or “buyer” are sometimes used instead of “general contractor,” “subcontractor” or “supplier” to help avoid confusion or offense.

YOUR CONTRACT FORMS

Contract terms are a credit management issue upon default. They will determine whether or not you collect all of your money. That is why powerful customers are so insistent on using their forms. Some customers very consciously set up a network of contract terms and corporate protection that allow them to unabashedly refuse payment if they get in trouble. With a marginal customer or project you want to be just as insistent on using your form or on modifying the customer’s form to add important protection.

There are going to be a certain number of jobs in which you will have an opportunity to supply the contract, waiver, change order or other form. Surprisingly, many contractors and suppliers do not have their own forms for this purpose. When you have the opportunity to supply the form for a transaction, use a custom form that protects your interest.

These forms can be produced at a low cost and can return your investment many times over. It will only hurt for a little while. You must only spend a few hours and a few hundred dollars with a good lawyer to review your current forms and develop better forms for your use. Once you have gone through this process and make the right forms available to your staff, they will not take any longer to use than your current forms. This is working smarter, not working harder. Examples of such forms are included in the Appendices.

Supplier Credit Applications and Quotes

The Credit Application form attached at Appendix 1 can be used to qualify customers. Some customers will complete this application as would a borrower from a bank. Even if a customer will not complete this form, it will remind you about the various pieces of information that you should collect. Fill the form out as you gather information from various sources.

The Credit Application contains information that will be very important in the event of a default. If you know where a customer works or banks, for example, you may be able to file garnishments after obtaining a judgment. It is much easier to get this type of information from your customer while you are still friends.

The form attached at Appendix 1 also includes important legal terms in the “Terms and Conditions” section, some of which are discussed below.

Service Charges and Attorney’s Fees

Most credit managers already know about attorney’s fee provisions. This may be the most important contract term in the event of default, however, and is an excellent example of the concept of leverage. Legal costs are one of the reasons you try to avoid and settle disputes. If the dispute will cost you more in legal fees than your debtor, you have bad leverage. The buyer is already holding your money for the materials. The dispute is more of a problem for you than it is for your debtor. You must reverse that leverage and make sure the debtor will pay a penalty for the dispute and, therefore, is motivated to resolve the dispute.

If an attorney is necessary to collect your account, this will eat up all of your profit. You want a check to get this profit back. The usual rule in the U.S. is that no attorney’s fees can be recovered unless the defendant has agreed in writing to pay attorney’s fees.

A high service charge such as 1% or 2% per month is a way to partially collect your own high internal administrative cost for dealing with default. Your credit manager and sales staff will lose time and money dealing with default. Service charges will help recoup these administrative costs. This also is an important penalty to a debtor for making you wait. You may rarely actually charge or collect service charges, but it helps move the debtor along and get your payments in. In some states, it is important to say that this higher rate will apply both “before and after judgment.” Otherwise some states will apply a lower “judgment rate of interest” after judgment.

Many frustrated sellers have waited a year for payment, gone through frustrating litigation, heard the court rule that the seller “wins” and collected $10,000, only to be handed a legal bill for $12,000. If your contract does not have a provision for attorney’s fees, there is no way that the legal process can make you whole. You will always be faced with a partial payout. Many “smart” customers in default will propose a settlement for less than you are owed. They will tell you how you will have to sue, then wait many months and pay attorney’s fees. If you have service charge and attorney’s fee clauses, you can tell the customer how they will pay more by employing this tactic.

You have to make sure that the customer pays a penalty for making you wait a long time for payment. If you have no attorney’s fee or service charge clauses, the most the debtor will ever have to pay is principal (and perhaps legal interest). The debtor has less incentive to pay you sooner and is more likely to make you wait, make you act as the debtor’s bank and make you incur legal fees. If the debtor will pay a penalty comprising your legal fees on top of his legal fees, the debtor is more likely to decide that paying you sooner is the best business decision. This “leverage” helps get you resolutions of disputes on accounts. An attorney’s fee clause, in other words, makes it less likely your attorney will have a job.

We also recommend identifying a specific percentage for attorney’s fees, rather than stating that the debtor will pay “reasonable” attorney’s fees. The word “reasonable” can lead to arguments about what is reasonable. In some states, the creditor must actually bring in an expert witness to help the court determine what is “reasonable.”1 This means the creditor must hire a second lawyer to be a witness on the attorney fee issue. This adds considerably to the cost of collection. If the debtor has agreed to pay 33% of the debt as attorney’s fees, it is more likely the court will award this amount without the need for an expert witness and even if actual attorney’s fees were lower. The following clause accomplishes all of these objectives:

Customer agrees that any amount not paid within 30 days of invoice date will carry interest at the rate of 1 1/2% per month, both before and after judgment, and further agrees to pay all costs incurred in collection, including attorney’s fees in the amount of 1/3 of the total bale due if this account is placed with an attorney for collection, whether suit is filed or not.

Trust Fund Agreement

Trust Fund Statutes and Trust Fund Agreements are discussed in detail in another chapter of this book.2 However, they are an important and underutilized opportunity for credit agreements and other contracts.

Suppose a bankrupt debtor is the trustee on his niece’s college tuition trust fund. The bankruptcy debtor’s creditors cannot attach this college trust fund, because it is not the bankruptcy debtor’s money. The money belongs to the niece. The trustee has only “legal” title. The niece is the “beneficiary” of the trust and has “equitable” title to the money.

Some states have trust fund “statutes” or laws to protect subcontractors and suppliers in the construction industry, including Maryland, New York and New Jersey. When a general contractor receives payment from the construction project owner, the general contractor holds funds in trust for the benefit of the subcontractors and suppliers. Subcontractors then hold funds in trust for their suppliers and sub-subcontractors.

Even in states without trust fund laws, it is possible to create a trust fund relationship by agreement. This works just like a bank trust fund (or the college tuition trust fund for the niece) and would apply in any non-construction industry. It is possible to add clear trust language to a joint check agreement, credit agreement, proposal, quote or to any contract with just a few sentences.

Customer agrees that all funds owed to Customer from anyone or received by Customer, to the extent those funds result from the labor or materials supplied by Seller, shall be held in trust for the benefit of Seller (“Trust Funds”). Customer may commingle Trust Funds, but agrees it has no interest in Trust Funds held by anyone and to promptly account for and pay to Seller all Trust Funds.

We believe that this language creates a trust fund relationship that should work just like the trust fund laws. Your debtor agrees that all funds received are held in trust, to the extent funds result from your labor or materials. If your debtor files bankruptcy, these funds will not be property of the bankrupt estate. You will not need to share with the general unsecured creditors and should be able to keep these funds as the trust beneficiary.

This language also should be relatively easy to “sell” to a customer on a credit agreement or quote. The customer certainly intends to pay you promptly on receipt of funds. That is all this language says. It does not create any additional burden or cost on the customer. The issue is whether you would have to “share” this receivable with your customer’s other creditors in the unlikely event of insolvency. This language allows you to identify your customer’s receivable as produced or created by the labor and materials you supplied and claim ownership of that receivable.

Since your debtor is never the owner of trust funds, it also is impossible for the debtor to grant a security interest in trust funds. The trustee could not give away or sell trust property, since a trustee does not have title. The beneficiary of the trust could claim ownership of the trust property, even in the hands of third parties. By the same token, a trustee cannot grant an effective security interest in trust property. The trustee has no good title to sell, give away or grant a security interest in trust property.

Accordingly, trust fund laws or agreements are one way that a vendor can gain priority over a customer’s bank that has a blanket security interest on receivables. This also makes sense. You are essentially saying to a customer that you will not give them the value of your labor and materials, if some other lender will have priority over the receivable that is generated by the value you provide. You can refuse to supply labor or materials unless you will have absolute first priority to the value you provided. This absolute first priority is a trust fund agreement.

In the event of bankruptcy, the trust funds held for the benefit of subcontractors and suppliers do not become a part of the bankruptcy estate. While the creditor may need to get appropriate bankruptcy orders, the creditor may be entitled to payment directly from an owner or general contractor. A trust fund claimant may even be able to obtain payment from the bankruptcy estate, by bankruptcy court order, since trust funds are not property of the bankruptcy estate and always belong to the beneficiary.

Trust fund laws or agreements also can be very helpful in “preference” litigation.3 If a creditor received payments less than 90 days before a bankruptcy, the creditor may have to give the money back as a “preference.” If a trust fund law or agreement applied, however, the payment cannot be a preference. The debtor was giving you your own money. It was never the debtor’s property and was not a payment from the debtor.

Trust fund agreements may be more effective in contracts, proposals, quotes, joint check agreements or other agreements created for a particular project for a particular owner. There is no downside, however, to putting a blanket trust agreement in your credit agreement to cover all sales to this customer.

Limitation of Liability

A buyer can agree that remedies will be limited for any breach of contract by a seller. One example would be an exclusion of express or implied warranties, discussed below.

Where sophisticated business professionals enter into an arms-length transaction, a court will enforce the terms of the agreement between them, unless it is unreasonable or unjust.4 When an agreement is plain and unambiguous in its terms, it has full effect.5 Construction industry buyers and sellers are sophisticated business people. If they waive warranties or limit liability in contract documents, they will be held to those terms. These terms could even be inserted during the “Battle of the Forms” in a response or confirmation without the actual knowledge of the buyer.6

A buyer can be bound to limits of liability and exclusions of warranties in a credit agreement for any sales of goods after the credit agreement is signed. A buyer also can be bound to these same limits of liability and exclusions of warranty if they are stated in each proposal or quote for each individual sale of goods.7

The sample Credit Application as Appendix 1 and the Supplier Quote at Appendix 6 state:

Seller agrees to replace or, at Seller’s option, repair any defective goods within a reasonable time. Buyer’s remedies for any delay or any defect in the materials are subject to and limited by any limitations contained in the manufacturer’s terms and conditions to Seller. Further, Buyer’s sole and exclusive remedy and Seller’s limit of liability for any and all loss or damage resulting from defective goods shall be for the purchase price of the particular delivery and materials with respect to which loss or damage is claimed, plus any transportation charges actually paid by the Buyer. In no event shall Seller be liable for any damage due to delay of any type, nor consequential, special or punitive damages. THE FOREGOING WARRANTY IS EXCLUSIVE AND IS IN LIEU OF ALL OTHER WARRANTIES, WHETHER WRITTEN, ORAL, EXPRESS OR IMPLIED, INCLUDING THE WARRANTY OF TITLE, AGAINST LIENS, INFRINGEEMENT, THE WARRANTY OF MERCHANTABILITY AND THE WARRANTY OF FITNESS FOR A PARTICULAR PURPOSE.

Buyer shall make a careful inspection at the time of delivery. Buyer’s failure to give written notice specifying any claim within ten (10) days of delivery shall constitute an unqualified acceptance of the labor and material delivered and a waiver of all claims. Seller will not be liable for any damage, warranty or remedy and back charges will not be accepted without prior notification, an opportunity to view and repair, replace or otherwise cure, and approval by Seller. No returned product will be accepted without prior approval. A restocking charge of 25% will apply on products approved for refund.

These provisions evidence a clear intent to create a comprehensive set of remedies. First, the limitations in any manufacturer’s warranty are passed on to a buyer. This creates a “conduit relationship” for a distributor that did not manufacturer the goods. The eventual buyer and end user is limited to the manufacturer’s warranties and remedies. The “middleman” distributor cannot be responsible for more that the manufacturer.

These provisions also limit a buyer’s remedies to return of the goods and repayment of the price or to repair and replacement of non-conforming goods.8 This could eliminate the potential for any claim or counterclaim against a seller for allegedly defective material, if the buyer has not paid the purchase price. A buyer would have at most a defense to a seller’s claim for the unpaid purchase price. If the seller repairs or replaces any defective goods within a reasonable time, the buyer would owe the full purchase price.9

It is probably important to be clear in a contract that these remedies are “sole and exclusive.” Remedies for breach of contract or breach of warranty are generally cumulative. Saying a buyer has one remedy does not necessarily mean that all other remedies are excluded.10

A buyer also can waive incidental, consequential, special, punitive or delay damages. Consequential damages are discussed in greater detail in another chapter of this book.11 However, it is possible to waive the right to consequential damages in a contract, just as it is possible to waive other remedies. It also is possible to waive damages for delay in a “no damage for delay” clause. This is discussed in greater detail in the other chapter of this book.12 In short, however, suppliers do want the above Limitation of Liability provision in their credit applications and quotes.

Exclusion of Warranties

Express and implied warranties under the Uniform Commercial Code are discussed in detail in another chapter of this book.13 Express and implied warranties are cumulative. In other words, a buyer would have the choice of suing under an express written warranty or an implied warranty or both. Even if an express warranty is offered, the seller must carefully exclude any implied warranty.

The UCC permits disclaimers of express warranty.14 If a seller has excluded all express warranties, it does not matter what any salespeople may have said in any meetings. The buyer has agreed in advance not to rely on any oral statement.15

An exclusion of warranty should be “conspicuous.” This is why you often see such language in large print, all caps, in a contract or written warranty. This would make the exclusions conspicuous as a matter of law.16

Seller agrees to replace or, at Seller’s option, repair any defective goods within a reasonable time. Buyer’s remedies for any delay or any defect in the materials are subject to and limited by any limitations contained in the manufacturer’s terms and conditions to Seller. Further, Buyer’s sole and exclusive remedy and Seller’s limit of liability for any and all loss or damage resulting from defective goods shall be for the purchase price of the particular delivery and materials with respect to which loss or damage is claimed, plus any transportation charges actually paid by the Buyer. In no event shall Seller be liable for any damage due to delay of any type, nor consequential, special or punitive damages. THE FOREGOING WARRANTY IS EXCLUSIVE AND IS IN LIEU OF ALL OTHER WARRANTIES, WHETHER WRITTEN, ORAL, EXPRESS OR IMPLIED, INCLUDING THE WARRANTY OF TITLE, AGAINST LIENS, INFRINGEEMENT, THE WARRANTY OF MERCHANTABILITY AND THE WARRANTY OF FITNESS FOR A PARTICULAR PURPOSE.

The smaller wording at the beginning of this paragraph describes the limited warranty provided. The “conspicuous” language in large print, all caps, waives express and implied warranties.

In a construction context, a materials supplier will normally supply goods to a subcontractor, who then supplies the goods to a general contractor, who then supplies the goods to a real estate owner. The general contractor and owner are “third parties” to the supply contract between the supplier and subcontractor. The general contractor and owner do not have “priority of contract” with the supplier.

Third parties, with no privacy of contract, cannot normally make a claim for breach of contract. The third party owner or general contractor has no contract with the supplier. The Uniform Commercial Code has an exception to the normal privacy of contract rule stating that “[l]ack of privacy . . . . shall be no defense in any action brought against the . . . seller of goods to recover damages from breach of warranty . . .”17 If you buy a malfunctioning dishwasher from a department store, you can sue the manufacturer under the UCC, even though you have no privacy of contract with the manufacturer.

However, recovery for breach of warranty for a third party not in privacy is limited to the warranty that exists between the contracting parties.18 If the original contract of sale excluded or modified warranties or remedies for breach, such provisions are equally operative against beneficiaries of warranties under this section.19 In other words, if a material supplier had excluded express and implied warranties in its contract with the subcontractor, these warranties also are excluded to the general contractor or owner. The end user of a product can enjoy no more contractual rights than are enjoyed by the original purchaser.”20

Material sellers should consider adding language to their credit agreements and quotes that exclude warranties and limit the buyer’s remedies and the seller’s liability for damages.

Notice of Breach to Seller

The Uniform Commercial Code Section 2-607(3) states that when a buyer has accepted goods, the buyer must notify the seller within a reasonable time after the buyer discovers or should have discovered any breach—or be barred from any remedy.21 This generally means that a buyer has to notify a seller fairly promptly after delivery if there are any defects in the material. Otherwise, the buyer will lose the right to claim breach of contract or breach of warranty.22

This code section is helpful to a seller, especially where a buyer waits to complain of problems until after the seller files suit to collect the purchase price. However, the UCC probably does not require written notice or a complete statement of defect23 and a buyer may claim that notice of defects was given verbally to employees of the seller. It also is not clear how long a buyer can wait to complain.24

These uncertainties can be eliminated in a contract term requiring written notice and an opportunity for the seller to cure within a defined period of time.

Buyer shall make a careful inspection at the time of delivery. Buyer’s failure to give written notice specifying any claim within ten (10) days of delivery shall constitute an unqualified acceptance of the labor and material delivered and a waiver of all claims. Seller will not be liable for any damage, warranty or remedy and back charges will not be accepted without prior notification, an opportunity to view and repair, replace or otherwise cure, and approval by Seller. No returned product will be accepted without prior approval. A restocking charge of 25% will apply on products approved for refund.

The Right to Stop Work

Monitoring marginal projects is very important. If a problem is developing, you want to stop sending money out the door at the earliest possible stage. A seller must be concerned, however, with being declared in default for refusing to supply materials. Open account suppliers who have not agreed to supply any particular quantity of materials can generally stop shipment at any time. This is explained in greater detail in the Uniform Commercial Code chapter.25

If you have a contract with a defined scope of work or material quantities, however, you have an obligation to supply that scope of work in the scheduled time. Even if a customer is late in paying you, you may need to continue to send money out the door. It is very difficult to tell when a customer has breached the contract so completely that you have no further obligation.26 The customer may be in breach for paying you late, but you may also be in breach for failing to supply in a timely manner.27

Even suppliers with a defined scope of material quantities in a contract may be able to demand an “adequate assure of due performance” from a buyer when the material supplier has reasonable grounds for “insecurity.”28 If a seller, for example, has reasonable grounds to believe that the buyer will be unable to make payment, that seller could demand an assure that the buyer is capable of paying, before goods are delivered. The right to demand an “adequate assure of due performance” comes from the Uniform Commercial Code.29

Suppliers prefer an express contract term allowing the supplier to stop supplying materials until disputes are resolved if a payment is not received for any reason. It is important that this situation also result in a time extension on the contract.

The contract term on the Credit Application at Appendix 1 and Supplier Quote at Appendix 6, states:

Seller shall have no obligation to begin or continue performance until adequate credit and funding information is provided, at any time on request of Seller. Seller may stop the manufacture or supply of any labor or materials when it, in its sole discretion, determines that Buyer is in breach of this Agreement or any other contract with Seller, or Seller has insecurity with respect to funding or creditworthiness, until payment is made and any dispute or insecurity has been resolved.

In no event shall Seller be liable for any damage due to delay of any type, nor consequential, special or punitive damages.

This allows the seller to stop deliveries when it, in its sole discretion, determines that the customer’s creditworthiness or funding is in question or that the customer is in breach. This term also states “seller shall not be responsible for damages due to delay of any type.” This is known as a “no damage for delay” clause and is generally enforceable.30 This clause, coupled with the right to stop work for non-payment, should protect sellers who desire to stop performance because of payment problems. This puts the pressure on the customer to resolve disputes with you and make payment.

Authorization to Run Credit Checks and Verify Funding

For small, closely held companies, it is always the best practice to obtain authorization to run both corporate and individual credit checks and to contact various references, including lenders.

I/We authorize Seller from time to time to obtain Business and Consumer Credit Reports on Customer or any principals listed above or to obtain credit and funding information from any other persons or entities.

The Supplier Quote includes an authorization to run credit reports on all of the individual officers, shareholders or partners listed in the application. Under the Federal Fair Credit Reporting Act, it is still questionable whether the one officer signing the application can give you permission to run credit checks on the other non-signing officers.31 Separate signatures are still preferable for this reason.

You have independent business reasons to ask each individual officer or partner to sign the Credit Application. If one officer signs a credit agreement and later leaves the business, the remaining partners may claim that the original signer was not authorized. If you are shipping materials on a long-term basis to a company, it is important to make sure that all partners, officers or owners are aware of the terms of credit. Therefore, your company asks that all officers sign the credit agreement. This ensures that you will be able to enforce your credit terms. It also means you have the right to run a personal credit report on all owners of the company that have signed the Credit Application, allowing you to accurately evaluate and predict the future credit relationship with the company.

The Personal Guaranty form at Appendix 8 also contains an authorization to run personal credit reports. With this guaranty form, you have the right to run a personal credit report anytime you are getting a personal guarantee.

A construction seller should strive for a contract term allowing it to monitor the health of the project and adequate funding as often as necessary. It also is helpful to have the right to consult the architect, lender and any other persons who may have knowledge concerning the health of the project, funding, scheduling, expected changes and other matters. The terms above accomplish these objectives, including the right to verify adequate funds to complete the project before the project begins and at various later stages of the project. This is especially important when large change orders are requested or when it is apparent that the project schedule will be much longer than planned. At a minimum, the seller should be allowed to verify funding for change orders in excess of a certain dollar amount. The seller should have the contractual right to refuse to perform any further work if adequate funds cannot be established. A similar term actually appears in the standard AIA Document A201-1997 (General Conditions of the Contract for Construction).32

Forum Selection Clause

Your customer can agree to allow you to sue the customer in the court (forum) near your office. The customer can even agree to file suit on your home turf, even if the customer initiates the litigation. This holds down your costs of litigation and increases the debtor’s cost. This “leverage” helps the seller get a quicker resolution of accounts.

If you do not have this “Forum Selection” agreement, you will need to travel to the customer’s home to litigate. The collection process will be more convenient for your customer, its lawyers and witnesses, while your litigation costs increase. You want a forum selection clause to help ensure that you will litigate any dispute on your home turf, hold down your costs and increase your customer’s cost of litigation.

Similarly, you want the debtor to agree to submit the “jurisdiction” in your forum state. This is a similar concept, but means that the debtor will not argue that your home court lacks jurisdiction or that constitutional due process prohibits your court from hearing the case.

Remember that it is different to say, “This agreement will be decided under the laws of Virginia.” This is a “choice of law” provision. It does mean that the court must interpret your contract under Virginia law, but it does not guarantee that it will be a Virginia court making the decision. In other words, you may end up with a case in New York, where the New York court is required to figure out Virginia law to decide the case.

You want to make sure your credit agreements and other contracts state that the forum for litigation is your home county and state; that the debtor agrees to submit to jurisdiction there; and that the court will decide the case under the law of your home state. The following provision in the appendices accomplish all of this:

Customer expressly agrees to submit to personal jurisdiction in Virginia and agrees that the forum for any litigation pursuant to this Agreement or any other contract between Seller and Customer, whether Seller or Customer brings suit, shall be the County of Fairfax, Virginia. This Agreement shall be governed by and construed in accordance with the laws of Virginia.

Preservation of Security Rights

The following language concerning waivers should help avoid an accidental waiver of lien or bond rights:

All mechanic’s lien, payment bond or similar waivers or restrictive endorsements on checks shall be effective only to the total dollar amount of payments actually received without any bankruptcy filing for ninety days thereafter. Customer agrees that Seller retains its mechanic’s lien, payment bond or other legal rights for unpaid deliveries, regardless of what other waiver documents may imply otherwise.

Otherwise, some later contracts and progress payment waivers will waive all lien or bond rights, even for future deliveries or even though the seller has not been paid in full. This provision may not be enforceable against any owner or bank that is not a party to the credit agreement or contract. There is more information on this problem in the section below titled Waiver Forms.33

The following sentence allows the seller to decide how to apply payments received:

Customer further agrees that Seller has the right to determine, in its sole discretion, how to apply payments, and which invoices to pay with all payments received on this account, despite any advice to the contrary.

This also may help preserve mechanic’s lien and bond rights if a debtor wants to argue that payments sent were intended for a job on which you are claiming mechanic’s lien or bond rights. However, if you have reason to know for which project or invoices the payment was intended, you may be bound to apply the payment to those invoices. This provision also may not be enforceable against any owner or bank that is not a party to the contract.

Continuing Agreement

The third paragraph of “Terms and Conditions” of the Credit Application states that this credit agreement remains in force until the debtor has sent you “written notice closing this account mailed U.S. Mail Certified Return Receipt Requested.” This makes it harder for a debtor to claim an old credit agreement is no longer in force or that it was applicable for only one project. For the same reason, it is better not to include “job information” on the credit agreement. Instead, use the separate “Project Information Sheet” at Appendix 4. It is, of course, still a good practice to update all of your credit agreements on a periodic basis to get up-to-date information about the customer, its officers and stockholders.

It also is important to have any credit agreement state that you can “raise credit limits or change other terms at any time.” On the one hand, this makes it clear that you have not promised to lend money. You can stop lending at any time. On the other hand, this also keeps a debtor (and especially a guarantor) from saying that the agreement is not enforceable because you lent more money than the stated credit limit.

Changes in Borrower Entity

You may have a long-term open account relationship with a small, closely held corporation. This small corporation may have signed your standard credit application many years ago. Ten years later, you sue on your credit agreement, only to find out that the “customer” on the credit application closed its business years ago. You are now dealing with the same people on the telephone everyday, but do not know you are dealing with a different corporation. Your “new customer” may claim that your credit agreement is not applicable to this new corporation and that you are not entitled to 2% service charges, attorney’s fees or other credit agreement terms.

You are even more likely to have this problem with personal guarantees. The guarantor may claim that their guarantee applied only to sales for the earlier corporation. You may even find out that the person who gave you a guarantee is no longer involved in the corporation. You want to put the responsibility on the corporation or guarantors to inform you of such changes.

This is accomplished in the Credit Application and Personal Guaranty forms with the following:

Customer further agrees to pay all amounts due under this Agreement until Seller has received written notice closing this account, mailed U.S. Mail Certified Return Receipt Requested. In the event other entities or individuals order or use the labor or materials pursuant to this Agreement, it is agreed that both the Customer and such other legal entities or individuals shall be obligated for all amounts due under this Agreement.

In Appendices 1 and 8, the Credit Application states that it remains in effect no matter what changes occur in the corporate entity, unless and until you receive notice in writing closing the account. Likewise, the Personal Guaranty states that it remains in effect until the guarantor provides you written notice.

Internal Office Approval and Changes in Terms

The Internal Office Approval Form, shown at Appendix 3, can be used to record the procedure used to collect information and approve the account. There should be a clear record in the file that all references and other information have been confirmed. This form should not be sent to your customer but can be attached to the Credit Application once the applicant has signed it.

A specific credit limit should be established and an automatic internal system should be in place to alert the credit department when the debtor is approaching this credit limit. It is better not to have the limit appear on the credit agreement signed by the debtor. Debtors and guarantors sometimes argue that their liability should be limited to the credit limit established in the agreement. This limit should remain an internal number that can be later modified internally. Credit Agreements should state that credit limits and other terms can be changed by the creditor at any time, without notice.

In the case of individual debtors or guarantors, internal credit department records should show that the financial assets of an individual (all assets titled in the individual’s name alone) have been evaluated and found to be insufficient before a spousal signature is required.34

This is not an agreement by Seller to lend money; it is an agreement by Customer for the benefit of Seller if Seller determines to extend credit. Seller may change credit limits or other credit terms at any time, in its sole discretion. No modifications may be made otherwise to this Agreement, except in a writing signed by Seller.

Project Information Sheet

It is probably better not to have project information on the Credit Agreement. Otherwise, a debtor or guarantor may later argue that the agreement was applicable only to that project. In addition, it is the best practice to have a new project information sheet for every project to which you will supply substantial labor and materials. Each project should be analyzed before you expend large sums of money for labor and materials, to determine whether you will be a secured creditor or an unsecured creditor. It also is very important to have information on the project in the event of a default, to speed up collection and lower your costs.35

A Project Information Sheet is attached at Appendix 4. The identity of the project, the owner and general contractor should be collected and recorded at the start of any major project to which you will supply labor and materials. The other project information is needed at the first sign of trouble. All of this information and the documents described should be sent to your attorney in order to enforce your collection rights.

Supplier Quote

The Supplier Quote at Appendix 6 contains many of the same provisions described in the Credit Application at Appendix 1. Any supplier should refer to that section when reviewing their Supplier Quote to add provisions for Service Charges and Attorney’s Fees, Trust Fund Agreement, Limitation of Liability, Exclusion of Warranties, Notice of Breach to Seller, the Right to Stop Work, Authorization to Run Credit Checks and Verify Funding, Forum Selection Clause and Preservation of Security Rights In addition material supplier quotes have the following special considerations.

Battle of the Forms

Let’s think about the way modern commerce works. Material suppliers mail or fax quotes. Contractors send back purchase orders. Both quotes and purchase orders often have detailed “fine print.” The fine print terms on the quote often conflict with the fine print terms on the purchase order. What provisions are in the final contract? This “Battle of the Forms” will determine the contract terms between a buyer and seller of construction materials, discussed in another chapter of this book.36

It is important to join the “battle of the forms” within the meaning of the UCC. The best advice is to expressly limit acceptance of all proposals, quotes, purchase orders or confirmations you send out. Quotes sent out by material suppliers should state that “any acceptance of this quote is limited to the terms of this quote.” This would make it difficult for the return “acceptance” to change the terms of the agreement.37 The sample Supplier Quote at 37 The sample Supplier Quote at Appendix 6 states:

Acceptance is limited to terms of this Quote. Seller objects to any different or additional terms contained in any purchase order, offer or confirmation sent or to be sent by Buyer, which are expressly rejected.

Deadline for Acceptance

Any supplier should have a deadline for acceptance, since costs can increase, availability can decrease and schedules can be filled. Any proposal or quote will be “open” for acceptance for a reasonable period of time. You do not want to get into arguments later about your right to change prices or scheduling. Make sure all proposals or quotes have a specific deadline for acceptance, especially those with special pricing.

The deadline paragraph included in the sample Supplier Quote at Appendix 6 also requires the customer to send a signed copy of the proposal to your office for acceptance This helps assure you will receive an enforceable contract and prevents buyers from “riding both sides of the fence.” Customers will sometimes hold proposals, claim you are bound if your proposal becomes favorable, but also claim you never had a deal if they find a better price. You can prevent this by combining a deadline on acceptance with a required manner of acceptance

You also should remember to withdraw proposals or quotes that contain special pricing or scheduling, if they have not already expired. You may send out special low-priced proposals because your orders are low and have excess output. If you start to become busy, however, you must remember to go back and “withdraw” proposals that are no longer favorable to you. Any offer that you make can normally be withdrawn at any time before the customer accepts it. For information about the sale of goods under the Uniform Commercial Code, you should refer to that chapter below.38

Delivery Schedule

In a sale of goods covered by the UCC, all goods must be delivered in a single lot (group) unless otherwise agreed.39 If a supplier needs more time to make deliveries, the supplier must say so in the contract. If the goods are shipped in multiple lots, a material supplier is entitled to payment on each delivery.40 On the other hand, the contract could say that no payment is due until all deliveries are complete.

Storage

Suppliers will want an agreement calling for a reasonable storage fee if the customer does not promptly call for delivery. The payment terms in the sample Supplier Quote also state that the full price is due when the seller is ready for delivery of the described materials. This is especially important for specially manufactured materials. Otherwise, there is no cost to a customer who orders materials but never requests delivery.

Limitations of Liability and Exclusion of Warranties

Material sellers should add language both to their credit agreements and quotes that exclude warranties and limit the buyer’s remedies and the seller’s liability for damages. A buyer also can waive incidental, consequential, special, punitive or delay damages. These provisions are discussed in greater detail in the section above on Credit Applications and in another chapter of this book41; they should be included on each quote as well.

Order Acknowledgment

Many material suppliers will receive orders from buyers by telephone or mail. Suppliers should verify these orders with some type of written order acknowledgment. The seller wants to be certain that the correct materials are manufactured or shipped. Telephone orders leave room for later arguments on specifications.

Material suppliers also should take every opportunity to get agreement on their protective terms and conditions. Remember, you must have a signature from the purchaser to make most terms or conditions effective. You also may need to countermand some of the terms in a buyer’s written order. This is the “battle of the forms,” discussed above. In a sale of goods covered by the UCC, the last writing sent between a buyer and seller may control some terms and conditions.42

Delivery Ticket

Signed delivery tickets are important to serve as evidence that materials were in fact delivered and received in the correct quantities. They can evidence proper allocation for mechanic’s lien or bond claim purposes. Delivery tickets also should include an acknowledgment that the buyer has made a careful inspection of the goods and that they are acceptable.

Delivery tickets also are one last opportunity to get a signature on some of the other terms and conditions, including service charges, attorney’s fees, limitation of liability and exclusion of warranties. Depending on who signed the delivery ticket, however, there may be arguments about whether the signature was authorized and whether the terms and conditions are enforceable.

It is preferable to get agreement on terms and conditions in a credit agreement or quote before shipment. This will make it clearer that these terms and conditions were a part of the agreement for this shipment. A delivery ticket is signed after shipment. The supplier has already fully performed the agreement. A court may conclude that there must have been some prior agreement, which did not include these terms and conditions. Otherwise, the supplier would not have shipped.

Rental Ticket for Equipment

Equipment lessors have many of the same concerns as labor and material suppliers. They just rent their equipment for short periods of time rather than selling them permanently. The Rental Ticket at Appendix 7 can be used to make an order and later to acknowledge receipt of that order, fulfilling the same roles as the Proposal or Quote and the delivery ticket.

The Rental Ticket includes a confirmation of the type of equipment supplied, the length of time it was used, moving charges and the total amount due. Rental Tickets also are a last opportunity to reach agreement on important terms and conditions. The second page of the Rental Ticket at Appendix 7 contains many of the terms discussed in the Credit Application and Supplier Quote sections discussed above.

Contractor Proposals and Contracts

A sample Proposal for Labor and Materials can be found at Appendix 5. A proposal or contract form, however, also should contain other clauses. If the customer signs your proposal and sends it back, this will be your entire contract for the project. There are going to be a certain number of jobs in which you will have an opportunity to supply the contract form. Contractors should have their own forms for this purpose. When you have the opportunity to supply the form for a transaction, use a custom form that protects your interest.

Contractor proposals and contracts should contain many of the important terms discussed above regarding Credit Applications and Supplier Quotes. Any contractor should refer to those sections when reviewing their Proposals to add provisions for Service Charges and Attorney’s Fees, Trust Fund Agreement, Limitation of Liability, Exclusion of Warranties, Notice of Breach to Seller, the Right to Stop Work, Authorization to Run Credit Checks and Verify Funding, Forum Selection Clause and Preservation of Security Rights. In addition contractor proposals have the following special considerations.

Governmental Requirements

Many states, counties and cities have regulatory or licensing requirements for the contracts used by construction contractors, including Virginia,44 You must make sure that the forms you use will comply with the requirements of all states, counties, cities and towns in which you are supplying labor and materials. Contractors doing residential and home improvement work often have special requirements, in addition to the requirements for all contractors. Those regulatory requirements are beyond the scope of this outline. Residential contractors should contact state and county agencies, this law firm or another lawyer to make sure their contract forms comply with the regulations in their state.

Draw Schedule

The general rule is that payment is due for labor and materials supplied upon completion of work. This may work fine for smaller projects that can be finished in a day or two. If you will need progress payments to fine a job, however, you must specify them in your contract. Otherwise, no progress payments are assumed.

This may be the most important provision in a proposal or contract. If the customer signs your proposal and sends it back, this will be your entire contract for the project. You want to make sure that your proposal has all the contract terms you need. You do not want to end up fining a project for months because you forgot a draw schedule. It is enough to say that you will “be paid at the end of each month for all work in place.”

Often a customer intends that you will eventually sign the customer’s long contract form. Often however, the subcontract is never sent or never signed. A seller is usually satisfied with this result, as long as the proposal has a few basic terms, especially a draw schedule.

Deadline for Acceptance

Any seller of labor or materials should have a deadline for acceptance, since costs can increase, availability can decrease and schedules can be filled. Any proposal or quote will be “open” for acceptance for a reasonable period of time. You do not want to get into arguments later about your right to change prices or scheduling. Make sure all proposals or quotes have a specific deadline for acceptance, especially those with special pricing.

The deadline paragraph included in the sample forms provided also requires the customer to send a signed copy of the proposal to your office for acceptance This helps assure you will receive an enforceable contract and prevents buyers from “riding both sides of the fence.” Customers will sometimes hold proposals, claim you are bound if your proposal becomes favorable, but also claim you never had a deal if they find a better price. You can prevent this by combining a deadline on acceptance with a required manner of acceptance

Bid packages on particular projects can require that bids be left open for a prescribed period of time. You may be bound to keep these bids open when you submit a proposal.

Incorporation of Proposal

The first paragraph of the Proposal Form states that “This proposal shall be incorporated into and shall become a part of any further or additional agreement made for the job described.” If the customer signs your proposal form, this may help you enforce some of your own contract provisions, even if your customer eventually requires you to sign their contract form.

Suppliers and contractors often submit quotes but later receive a detailed contract form from the customer. Consider adding wording in that contract form that the supplier or contractor’s “proposal is incorporated herein by reference.” Then the customer will have its detailed contract clauses for protection, but you will at least have a few protective clauses from your proposal form.

Service Charges and Attorney’s Fees

Contractors have the same concerns with service charge and attorney’s fee provisions as material suppliers and should review that discussion above.45 Your buyer has leverage on you from holding your purchase price for your labor and material. You must reverse that leverage and make sure the debtor will pay a penalty for holding your money and, therefore, is motivated to resolve the dispute.

The usual rule in the U.S. is that no attorney’s fees can be recovered unless the defendant has agreed in writing to pay attorney’s fees. Contractors would normally want a unilateral attorney’s fees clause if possible:

Customer agrees that any amount not paid within 30 days of invoice date will carry interest at the rate of 1 1/2% per month, both before and after judgment, and further agrees to pay all costs incurred in collection, including attorney’s fees in the amount of 1/3 of the total bale due if this account is placed with an attorney for collection, whether suit is filed or not.

Contractors want an attorney’s fee provision, since they are the most likely to be a plaintiff in litigation. If a seller breaches its contract, the customer can usually withhold money. They can make themselves whole without resorting to litigation. If a customer breaches, however, the seller must litigate to change the “status quo.” The seller cannot make itself whole without recovering the cost of litigation. Contractors also should readily agree to add a bilateral provision (goes both ways) anywhere in the contract:

In any action or proceeding involving a dispute arising out of this agreement, the prevailing party shall be entitled to receive from the other party reasonable attorney’s fees to be determined by a court or arbitrator.

Trust Fund Agreement

Trust fund statutes and trust fund agreements are discussed in detail in another chapter of this book.46 Subcontractors have the same concerns with trust fund statutes and trust fund agreements as material suppliers and also should review that discussion above.47 Trust fund agreements are an important and underutilized opportunity for subcontractors.

Even in states without trust fund laws, it is possible to create a trust fund relationship by agreement. It is possible to add clear trust language to a joint check agreement, proposal, quote or to any contract with just a few sentences.

Customer agrees that all funds owed to Customer from anyone or received by Customer, to the extent those funds result from the labor or materials supplied by Seller, shall be held in trust for the benefit of Seller (“Trust Funds”). Customer may commingle Trust Funds, but agrees it has no interest in Trust Funds held by anyone and to promptly account for and pay to Seller all Trust Funds.

We believe that this language creates a trust fund relationship that should work just like the trust fund laws. This language also should be relatively easy to “sell” to a customer in a contract. The customer certainly intends to pay you promptly on receipt of funds. That is all this language says. It does not create any additional burden or cost on the customer. This language allows you to identify your customer’s receivable as produced or created by the labor and materials you supplied and claim ownership of that receivable.

Limitation of Liability

A buyer can agree that remedies will be limited for any breach of contract by a contractor. Contractors should consider adding language to their agreements that limit the buyer’s remedies and the seller’s liability for damages.

Where sophisticated business professionals enter into an arms-length transaction, a court will enforce the terms of the agreement between, unless it would be unreasonable or unjust.48 When an agreement is plain and unambiguous in its terms, it has full effect.49 Construction industry buyers and sellers are sophisticated business people. If they waive warranties or limit liability in contract documents, they will be held to those terms.

A buyer can be bound to limits of liability and exclusions of warranties in a proposal or contract.50

Seller agrees to replace or, at Seller’s option, repair any defective labor or material within a reasonable time as Buyer’s sole and exclusive remedy and Seller’s limit of liability for any and all loss or damage resulting from defective labor or material. Buyer’s remedies for any delay or any defect in any materials are subject to and limited by any limitations contained in the manufacturer’s terms and conditions to Seller. In no event shall Seller be liable for any damage due to delay of any type, nor consequential, special or punitive damages. THE FOREGOING WARRANTY IS EXCLUSIVE AND IS IN LIEU OF ALL OTHER WARRANTIES, WHETHER WRITTEN, ORAL, EXPRESS OR IMPLIED, INCLUDING THE WARRANTY OF TITLE, AGAINST LIENS, INFRINGEEMENT, THE WARRANTY OF MERCHANTABILITY AND THE WARRANTY OF FITNESS FOR A PARTICULAR PURPOSE.

Buyer shall make a careful inspection of all labor and material at the time of delivery. Buyer’s failure to give written notice specifying any claim within ten (10) days of delivery shall constitute an unqualified acceptance of the labor and material delivered and a waiver of all claims. Seller will not be liable for any damage, warranty or remedy and back charges will not be accepted without prior notification, an opportunity to view and repair, replace or otherwise cure, and approval by Seller.

These provisions evidence a clear intent to create a comprehensive set of remedies. First, the Limitations in any manufacturer’s warranty are passed on to a buyer. This creates a “conduit relationship” for a contractor that did not manufacture materials. The eventual buyer and end user is limited to the manufacturer’s warranties and remedies.

These provisions also limit the buyer’s remedies to repair and replacement of non-conforming work. This could eliminate the potential for any claim or counterclaim against a seller for allegedly defective work, if the buyer has not paid the purchase price. A buyer would have at most a defense to a seller’s claim for the unpaid purchase price. If the seller repairs or replaces any defective work within a reasonable time, the buyer would owe the full purchase price.51 It is probably important to be clear in a contract that these remedies are “sole and exclusive.”

A buyer also can waive incidental, consequential, special, punitive or delay damages. Consequential damages are discussed in greater detail in another chapter of this book.52 However, it is possible to waive the right to consequential damages in a contract, just as it is possible to waive other remedies. It also is possible to waive damages for delay in a “no damage for delay” clause. This is discussed in greater detail in another chapter of this book.53 In short, however, contractors do want the above Limitation of Liability provision in their proposals and contracts.

Exclusion of Warranties

Express and implied warranties under the Uniform Commercial Code are discussed in detail in another chapter of this book.54 Subcontractors have the same concerns with express and implied warranties as material suppliers and also should review that discussion above.55 Express and implied warranties are cumulative. In other words, a buyer would have the choice of suing under an express written warranty or an implied warranty or both. Even if an express warranty is offered, the seller must carefully exclude any implied warranty.

It is possible to disclaim any express warranty.56 If a seller has excluded all express warranties, it does not matter what any salespeople may have said in any meetings. The buyer has agreed in advance not to rely on any oral statement.57

Seller agrees to replace or, at Seller’s option, repair any defective labor or material within a reasonable time as Buyer’s sole and exclusive remedy and Seller’s limit of liability for any and all loss or damage resulting from defective labor or material. Buyer’s remedies for any delay or any defect in any materials are subject to and limited by any limitations contained in the manufacturer’s terms and conditions to Seller. In no event shall Seller be liable for any damage due to delay of any type, nor consequential, special or punitive damages. THE FOREGOING WARRANTY IS EXCLUSIVE AND IS IN LIEU OF ALL OTHER WARRANTIES, WHETHER WRITTEN, ORAL, EXPRESS OR IMPLIED, INCLUDING THE WARRANTY OF TITLE, AGAINST LIENS, INFRINGEEMENT, THE WARRANTY OF MERCHANTABILITY AND THE WARRANTY OF FITNESS FOR A PARTICULAR PURPOSE.

The smaller wording at the beginning of this paragraph describes the limited warranty discussed above. The “conspicuous” language in large print, all caps, excludes express and implied warranties.

Notice of Breach to Seller

Any contractor wants “notice and an opportunity to cure” any problems in its work. This generally means that a buyer has to notify a seller fairly promptly if there are any defects, allow the seller to see the problem and have an opportunity to repair. Otherwise, the buyer will lose the right to claim breach of contract or breach of warranty. This is accomplished as follows:

Buyer shall make a careful inspection of all labor and material at the time of delivery. Buyer’s failure to give written notice specifying any claim within ten (10) days of delivery shall constitute an unqualified acceptance of the labor and material delivered and a waiver of all claims. Seller will not be liable for any damage, warranty or remedy and back charges will not be accepted without prior notification, an opportunity to view and repair, replace or otherwise cure, and approval by Seller.

The Right to Stop Work

Monitoring marginal projects is very important. If a problem is developing, you must turn off the money spigot at the earliest possible stage. If you have a contract with a defined scope of work, however, you have an obligation to supply that scope of work in the scheduled time. Even if a customer is late in paying you, you may need to continue to send money out the door. It is very difficult to tell when a customer has breached the contract so completely that you have no further obligation.59 The customer may be in breach for paying you late, but you may also be in breach for failing to supply in a timely manner. 60

This problem can be largely avoided with a contract term allowing you to stop supplying labor and materials until disputes are resolved if a payment is not received for any reason. It is important that this situation also result in a time extension on the contract. Your contract also can contain a provision that “seller will not, in any event, be responsible for any damage due to delay.” This puts the pressure on the customer to resolve disputes with you and make payment.

The contract term similar in the Proposal in the Appendices states:

Seller shall have no obligation to begin or continue performance until adequate credit and funding information is provided, at any time on request of Seller. Seller may stop the manufacture or supply of any labor or materials when it, in its sole discretion, determines that Buyer is in breach of this Agreement or any other contract with Seller, or Seller has insecurity with respect to funding or creditworthiness, until payment is made and any dispute or insecurity has been resolved.

This allows the seller to stop work when, in its sole discretion, it determines that the customer’s creditworthiness or funding are in question or that the customer is in breach.

The Proposal also states, “In no event shall Seller be liable for any damage due to delay of any type, nor consequential, special or punitive damages.” This includes what is known as a “no damage for delay” clause and is generally enforceable.61 This clause, coupled with the right to stop work, should protect sellers who desire to stop performance because of payment or funding problems.

Authorization to Run Credit Checks and Verify Funding

For small, closely held companies, it is always the best practice to obtain authorization to run both corporate and individual credit checks and to contact various references, including lenders. The Proposal includes an authorization to run credit reports on all of the individual officers, shareholders or partners that sign the Proposal.

I/We authorize Seller from time to time to obtain Business and Consumer Credit Reports on Buyer or any principals of Buyer or to obtain credit and funding information from any other source. Seller shall have no obligation to begin or continue performance until adequate credit and funding information is provided, at any time on request of Seller. Seller may stop the manufacture or supply of any labor or materials when it, in its sole discretion, determines that Buyer is in breach of this Agreement or any other contract with Seller, or Seller has insecurity with respect to funding or creditworthiness, until payment is made and any dispute or insecurity has been resolved.

Under the Federal Fair Credit Reporting Act, it is still questionable whether the one officer signing the contract can give you permission to run credit checks on the other non-signing officers.62 Separate signatures are still preferable for this reason, if possible.

A contractor should strive for a contract term allowing it to monitor the health of the project and adequate funding as often as necessary. It also is helpful to have the right to consult the architect, lender and any other persons who may have knowledge concerning the health of the project, funding, scheduling, expected changes and other matters. The term above accomplishes these objectives, including the right to verify adequate funds to complete the project before the project begins and at various later stages of the project. This is especially important when you have a cost plus time and materials contract, when large change orders are requested or when it is apparent that the project schedule will be much longer than planned. At a minimum, the seller should be allowed to verify funding for change orders in excess of a certain dollar amount. In the case of a cost plus time and materials contract, the seller should be able to verify funding once the original budget has been surpassed.

The seller should have the contractual right to refuse to perform any further work if adequate funds cannot be established. A similar term actually appears in AIA Document A201-1997 (General Conditions of the Contract for Construction), which reads:

2.2.1 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. Furnishing of such evidence shall be a condition precedent to commencement or continuation of the Work. After such evidence has been furnished, the Owner shall not materially vary such financial arrangements without prior notice to the Contractor.

Forum Selection Clause

You want to make sure your contracts state that the forum for litigation is your home county and state; that the debtor agrees to submit to jurisdiction there; and that the court will decide the case under the law of your home state. The following provision in the Proposal accomplishes all of this:

Customer expressly agrees to submit to personal jurisdiction in Virginia and agrees that the forum for any litigation pursuant to this Agreement or any other contract between Seller and Customer, whether Seller or Customer brings suit, shall be the County of Fairfax, Virginia. This Agreement shall be governed by and construed in accordance with the laws of Virginia.

Preservation of Security Rights

The following language concerning waivers should help avoid an accidental waiver of lien or bond rights:

All mechanic’s lien, payment bond or similar waivers or restrictive endorsements on checks shall be effective only to the total dollar amount of payments actually received without any bankruptcy filing for ninety days thereafter. Customer agrees that Seller retains its mechanic’s lien, payment bond or other legal rights for unpaid deliveries, regardless of what other waiver documents may imply otherwise.

Otherwise, some later contracts and progress payment waivers will waive all lien or bond rights, even for labor and material supplied later or even though the seller has not been paid in full. This provision may not be enforceable against any owner or bank that is not a party to the contract. There is more information on this problem in the section below titled “Waiver Forms.”63

Substitution of Materials

The Proposal and Quote forms provided allow the seller to substitute materials or terminate the contract if specified materials are unavailable.

Indemnity Clause

This clause primarily concerns personal injury or damage to property from accidents on projects to which a seller is supplying labor and materials. The buyer agrees to “indemnify and hold harmless the seller” in the event someone is injured on the job site, even if the injury is partially caused by the seller. Please note, however, that some state codes do limit the enforceability of this type of indemnity clause.

Personal Guarantee

The bottom of the Proposal and Quote provide a place for the buyer to personally guarantee performance Some buyers will not be willing to do this, and sellers may not be in a position to require it. It can be helpful, however, to have this possibility readily available on your form.

Signatures and Facsimiles

Needless to say, you must have a signature on an agreement to make it effective and enforceable. If your staff does not make sure that credit agreements and contracts have been signed and received back, you probably do not have any of the protections discussed above. Adding “Terms and Conditions” on invoices does not normally make them enforceable.

It is always best to get signed originals. If an original is unavailable for some legitimate reason, however, a copy is usually equally enforceable. For the same reasons, a facsimile will probably be as enforceable as originals or a good copy. With copies and facsimiles, however, make sure it is clear that the customer has agreed to all terms and conditions. Debtors will often copy or telecopy only the signature page of a contract or credit agreement. This can raise questions later about an attorney’s fee clause or forum selection clause that is on a different page. Make sure that the signature page states that the customer “agrees to all terms and conditions on the reverse side of this contract.” It is even better to have a signature on the “Terms and Conditions” page. The best way to avoid an argument, of course, is to eventually get the original back.

It is not necessary to have any contract, agreement or guaranty notarized in order to make it enforceable against the party that signed it. It is possible, however, that a debtor will claim that he or she never signed the document and that any signature is a forgery. A notary will help defeat this argument. Notarized signatures also may be necessary in order to have documents recorded in the land records or court clerk’s office.

If your contract is with an individual, you do not need a personal guarantee to sue them personally. If your customer is married, however, your ability to collect under the contract is severely impaired if you do not get the spouse to sign.

If you are building a house on property owned by a husband and wife and only the husband has signed the contract, then you may not be able to file a mechanic’s lien on the project. If you sell goods to the husband, you end up suing him for your money and get a judgment against him, this judgment will not be enforceable against any property owned by the couple together as tenants by the entirety.64 The personal residence is the major asset of most people. Mr. and Mrs. Customer usually own it as tenants by the entirety. Bank accounts and other assets can also be owned as tenants by the entirety. You cannot touch any of these assets if you only have a judgment against Mr. Customer.

If you contract with a corporation and you get a personal guarantee signature, the same problem exists. The husband may be the only officer and only stockholder in the corporation and may not think that his wife should sign for a company matter. If you sue on the personal guarantee, however, you will end up with a judgment only against the husband. You will not be able to touch any assets he jointly owns together with his wife as tenants by the entirety.

You should be aware that federal Equal Credit Opportunity Act will not allow you to automatically require a spouse’s signature on credit agreements and personal guarantees. Creditors should always qualify an individual debtor or guarantor on their own independent assets. Spousal signatures should be required only after determining that the individual spouse has insufficient assets to qualify for the debt.65

Guarantees

A great deal of business is conducted by “shell” corporations. The “ABC” corporation named in your contract may look substantial, but careful analysis will reveal that it has no assets. It may be important to look carefully at this situation. A construction or development corporation may have no asset other than the property being developed. This property is mortgaged in excess of value once the construction process begins. You can be sure that the construction lender has protected itself by requiring guarantees. You may need to do the same, especially if your mechanic’s lien would have low priority.66

If the owner is a shell corporation and the contract waives mechanic’s lien rights, then the owner can close the corporation and walk away from the project at the first sign of trouble. There will be absolutely nothing you can do to collect. The bank that loaned the owner $10,000 to buy a truck made the borrower sign personally; why shouldn’t a contractor that is lending $40,000 worth of labor and materials also require a personal signature? You are a lender too.

With many small corporations you can and should require personal guarantees from the principals involved. If a small business person has a corporation with no real assets and refuses to personally sign a contract, perhaps you should just plain refuse to supply. This customer is asking you to go into your pocket for materials and payroll for several months but is not willing to take any risk in order to make sure you get paid. You may be able to tell this customer that you believe in him/her personally and that you are entering into the transaction based on personal trust. You are only asking this customer to put in writing what you have been told over and over again: that he/she will make sure that you are paid. Remember that you may need to obtain the signature of spouses in order to make the guaranty enforceable against all of the guarantor’s assets.67

A guaranty from another corporation also may be sufficient. There are often a number of related corporations operating together. The corporation with the money may not be the corporation with which you have your contract.

A Guaranty form appears at Appendix 8. This form contains many of the terms and conditions contained in the Credit Application, discussed above, including provisions for attorney’s fees, a forum selection clause, changes in borrower entity, and preservation of security rights. The importance of all of these terms is discussed above. This Guaranty form also contains explicit permission for the lender to run credit reports on the guarantors in order to ensure compliance with the federal Fair Credit Reporting Act and a waiver of rights under the Equal Credit Opportunity Act.68

Joint Check Agreements

A common credit management devise is the joint check agreement. This requires the consent not only of your customer but also your customer’s buyer (normally the general contractor).

The most important thing to remember with a standard joint check agreement is that IT ONLY HELPS YOU IF A CHECK IS EVER WRITTEN. For example, you may supply materials to a construction subcontractor who has a joint check agreement with the general contractor. However, the general contractor may later assert back charges against the sub or claim that the subcontractor never completed its contract. If the general contractor is not obligated to pay the sub, the general contractor also is not obligated to write a check and the joint check agreement will do no good.

The next important thing to understand about joint check agreement is that they vary tremendously in how they are worded. There is no such thing as a “standard” joint check agreement. You do not know what rights it gives you until you see it. Some joint check agreements actually remove more rights than they give, by including a waiver of mechanic’s lien and bond rights.

The most commonly used joint check agreements are not actually “security,” and this difference also can be very important in the event of bankruptcy. For this reason, it may be worthwhile to reword joint check agreements, as shown in the form at Appendix 9.

Suppliers would certainly prefer a guarantee from the general contractor. Here, the general contractor guarantees that the supplier will be paid no matter what problems he has with the subcontractor. This option should be remembered, although the word “guarantee” usually sends shivers up and down spines.

Another option is to request that materials be sold on the owner’s or general contractor’s account. This avoids the risk of liens or bond claims on this project, and the general contractor may avoid a mark-up on the materials.

If these options are rejected, a joint check agreement is a terrific opportunity to establish the trust fund provision discussed above. Remember that the trust fund provision does not place any additional burden or risk on the general contractor or the customer. It just puts the supplier in a better position vis-à-visa the other creditors of the customer, including the customer’s secured lender. Both the supplier and the general contractor would be in a much stronger position, especially if the subcontractor files bankruptcy. General contractors on bonded projects do not want the risk of liability to a supplier on a payment bond, when the general has already paid the subcontractor in full. This is discussed in greater detail in the chapter below on Trust Fund Agreements.69

Suppliers also may succeed in slightly rewording the standard joint check agreement to include an outright assignment of or a security interest in the accounts receivable to be due to your buyer. This is security, which would make you a secured creditor in the event of bankruptcy. Without this security, your buyer’s accounts receivable goes into the general bankruptcy fund to pay all general unsecured creditors. With the security interest, you may have first claim to this one fund.70 With the assignment, you are already the owner of the fund, not your customer. These mechanisms are not in the joint check agreement at Appendix 9, although an Assignment is shown at Appendix 14. It is probably better for you to use the assignment, the security interest or the trust fund provision, but not more than one of these mechanisms in one document. The trust fund agreement is probably preferable.

The form at Appendix 9 includes a guaranty of the account and a trust fund provision. If someone objects to one of these provisions, it can be stricken out of the form and you will still have some of the important protections included in the form.

A creditor also wants a joint check agreement that requires checks be sent directly to the supplier and provides a power of attorney to endorse checks on behalf of the customer. This solves the problem of the debtor that disappears, refuses to endorse a joint check or refuses to give it to the creditor. The debtor also can agree that the owner or general contractor can rely on the creditor’s statements of the total current indebtedness to the creditor. In other words, the debtor may tell the owner or general contractor to issue a check in a lower amount or instruct the owner of general contractor not to issue any check, especially if there is a dispute with the supplier. This provision essentially lets the money flow now and makes the debtor take up any dispute with the supplier later.

REVIEWING AND REVISING CONTRACTS RECEIVED

The guidepost in determining the legal responsibilities is the contract itself. The contract constitutes the law that governs the parties’ relationship.71 Where sophisticated businessmen enter into an arms-length transaction, a court will enforce the terms of the agreement, unless it would be unreasonable or unjust.72 When an agreement is plain and unambiguous in its terms, it has full effect.73

Legal clients often want to tell their lawyer a story and then ask, “What is the answer?” The “answer” usually is that “We need to read your contract to know.” Construction industry buyers and sellers are sophisticated business professionals. They will be held to the terms in their contract documents. The construction industry generally works with sophisticated and detailed contract form documents that determine the result of most events on a construction project. Construction industry buyers and sellers essentially decide for themselves what “the law” will be for their transaction through these contract documents.

When customers do insist on using their own contract form, you or someone in your risk management or credit management department must be able to read them and negotiate modifications that will limit your exposure and add important protections. This can often be a daunting task, but it can directly impact your costs and easily make the difference in collecting your accounts. There are a limited number of provisions that will truly impact your cost and risk, which are very repetitive and easy to find in contract forms. You may be more willing to accept the form of an established customer with whom you have a track record. If your risk analysis has left you nervous because the customer is new or undercapitalized, you must take the time to make sure you have preserved a few important legal rights.

If an owner or general contractor has given you a contract form to sign, you may not be in a position to demand substantial changes. It is often not worthwhile to review, discuss or attempt to negotiate a contract agreement in great detail. First, owners or general contractors are not normally willing to change many terms. Second, there are many terms that are unlikely to ever cause a practical problem. Third, it can be very expensive in terms of legal fees and good will. Accordingly, in making proposed revisions you are looking for items that are likely to cause you practical problems, with a potential for large cost to you, and which an owner or general contractor is more likely to agree to modify. You are looking for the “greatest hits.”

Some of the following discussion only applies to subcontractors, while some is applicable to all contractors. The terms “seller” and “customer” or “buyer” are sometimes used instead of “general contractor” or “subcontractor” to avoid offense or confusion. In revising contracts, general contractors and subcontractors will want to add many of the same provisions described in the Credit Application at Appendix 1, the Proposal for Labor and Materials at Appendix 5 and the Supplier Quote at Appendix 6. Any contractor should refer to these above sections when reviewing contracts received from other parties.

Incorporating Proposal or Quote

When a customer insists on using its own long form, many contractors can still succeed in attaching their proposal or quote as an exhibit to the contract. It is logical to attach your proposal to describe your bid, to describe the specifications of the work and to quietly include a few critical contract terms. Add one sentence in the contract form stating that the quote is “incorporated herein by reference and made a part of this contract.”

This can be done with the Proposal for Labor and Materials at Appendix 5 and the Supplier Quote at Appendix 6. You also can do this with a quote drafted on a computer. Some of the contract terms on your proposal will now conflict with the terms in your customer’s contract. In the event of problems, you would much rather have terms in conflict, with some of the terms for your benefit, rather than having all the terms favor the customer.

Waiver of Lien or Bond Rights

Lien and bond waivers are discussed in detail in the section below titled Waiver Forms.74

In connection with contract review, however, it is important to know that many construction contracts state that the seller may not lien the project. This means what it says in most states. If you sign a contract with a waiver, the courts may strike your lien. If the customer is insolvent, this probably means you just worked for nothing.

Some states have created special laws making some waivers in contracts “void as a matter of public policy.” Lien rights cannot be contractually waived in Maryland, for example, unless the waiver is a separate document signed after the contract. Waivers also are limited in Pennsylvania. If you are not in a state with special legislation, however, the general rule will apply that any legal right can be waived in a contract as long as it is a clear waiver.

The importance of lien rights depends on the financial strength of your customer. If the customer is never going to run out of money, your lien rights do not matter. If your customer is a small, closely held corporation or an individual, your lien rights are absolutely critical.

Lien rights are normally considered “hallowed ground” in the construction industry. Owners and general contractors will normally agree to modify or delete lien waivers in a contract. General contractors do not have lien rights unless the owner owes them money. In other words, it is a part of any lien proceeding for a general contractor to prove that they are owed money and that the owner breached the contract. The lien only provides security for that money if the owner is insolvent. The owner has nothing to worry about as long as it is not in breach of contract.

In a “defense of payment” mechanic’s lien state, a subcontractor cannot enforce a lien unless the owner owes the general contractor money.75 In other words, an owner and the property are only liable to pay a subcontractor what is owed to the general contractor anyway. Owners are in a radically different position in a state with no defense of payment, however.76

Complete waivers of lien rights are sometimes included in progress payment waivers, even for work supplied in the future. Progress payment waivers are discussed in more detail later in this chapter.77 However, it is important to notice whether a progress waiver form is attached to the contract as an exhibit and you are agreeing to sign this waiver form in exchange for each progress payment. You may be agreeing in advance to permanently waive lien rights in exchange for your first progress payment. If a progress waiver form is attached to the contract as an exhibit, you must review and modify that waiver now as a part of your contract review.

Contractors can consider adding the following language concerning waivers to help avoid an accidental waiver of lien or bond rights:

All mechanic’s lien, payment bond or similar waivers or restrictive endorsements on checks shall be effective only to the total dollar amount of payments actually received without any bankruptcy filing for ninety days thereafter. Customer agrees that Seller retains its mechanic’s lien, payment bond or other legal rights for unpaid deliveries, regardless of what other documents may imply otherwise.

Otherwise, some later contracts and progress payment waivers will waive all lien or bond rights, even though the seller has not been paid in full. This provision may not be enforceable against any owner or bank that is not a party to the contract. There is more information on this problem in the section below titled Waiver Forms.

Subordination of Mechanic’s Lien Rights

Subordination of mechanic’s lien rights to the rights of the construction lender can be as deadly as a complete waiver in states such as Virginia with a high mechanic’s lien priority. This subordination gambit may include assures that you are not waiving your rights at all but “merely” subordinating them. While this statement is technically true, from a practical point of view you might as well not have lien rights at all. If a project goes belly up, it is normally over-encumbered by the construction loan. Upon foreclosure, the lender will receive less than what it is owed. In this case, all subordinate or “junior” liens are wiped out forever. If the project does not go belly up, you are probably not going to need your lien rights anyway. Subordination of mechanic’s lien rights is not as big an issue in states, such as Maryland and Pennsylvania, where your mechanic’s lien is already inferior to the construction lender.

Notice and an Opportunity to Cure

This may be the single most important clause in the contract for a contractor or supplier.78 Watch out for clauses that state simply:

If seller breaches any provision of this contract, then buyer may declare this contract in default and terminate this contract on written notice to seller.

Under this clause, the contractor can wake up one morning, without any notice, and discover that its contract has been terminated. It is very important to modify this term so that the seller is not in “default” until the seller has received notice of the breach and has failed to correct the breach within a reasonable period of time. The previous clause should be changed to read:

If seller breaches any provision of this contract and seller does not begin to diligently cure such default, within 10 days after receiving written notice specifying the default, then buyer may declare this contract in default and terminate this contract on written notice to seller.

This clause is the most advantageous to a contractor. Note that the contractor does not have to completely cure the default within 10 days, only diligently begin to cure. Some defaults cannot be cured in 10 days. Also note that the contractor must actually receive notice of the breach. There is often a question whether or when notice was actually received. It also is important that the clause requires the notice to be written and to specify the breach. Verbal notice of breach should not be effective to terminate the contract. Owners or general contractors will sometimes send vague written notices declaring a contractor to “be in breach.” A contractor cannot effectively cure a breach, however, if they do not know the specific complaint.

Contracts sometimes have one provision discussing the owner or general contractor’s right to terminate the contract on default and other provisions allowing supplementation of the contractor’s forces or allowing a cure of the breach and a back charge of the costs. Make sure each of these provisions contains the same requirement for notice and an opportunity to cure before you are liable for costs.

A contractor can consider adding a requirement that the buyer has to provide notice fairly promptly if there are any defects, to allow the seller to see the problem and to have an opportunity to repair. Otherwise, the buyer will lose the right to claim breach of contract or breach of warranty. This is accomplished as follows:

Buyer shall make a careful inspection of all labor and material at the time of delivery. Buyer’s failure to give written notice specifying any claim within ten (10) days of delivery shall constitute an unqualified acceptance of the labor and material delivered and a waiver of all claims. Seller will not be liable for any damage, warranty or remedy and back charges will not be accepted without prior notification, an opportunity to view and repair, replace or otherwise cure, and approval by Seller.

Attorney’s Fees and Interest

Most customer contract forms do not allow the seller to recover attorney’s fees. Even worse, attorney’s fees are often recoverable by the customer but not the seller (unilateral provision). This is a difficult situation for the customer to justify. What is good for the goose is good for the gander. If a customer must have an attorney’s fee provision to protect itself from the horrible things a seller can do, then a seller also needs an attorney’s fee provision to protect itself.

Contractors should review the discussion above regarding attorney’s fees provisions in their own contract forms.79 The usual rule in the U.S. is that no attorney’s fees can be recovered unless the defendant has agreed in writing to pay attorney’s fees.

Contractors want an attorney’s fee provision, since they are the most likely to be a plaintiff in litiga. If a seller breaches its contract, the customer can usually withhold money. They can make themselves whole without resorting to litigation. If a customer breaches, however, the seller must litigate to change the “status quo.” The seller cannot make itself whole without recovering the cost of litigation. Your buyer has leverage on you from holding your purchase price for your labor and material. You must make sure the debtor will pay a penalty for holding your money and, therefore, is motivated to resolve the dispute.

Attorney’s fees provisions should always be “bilateral.” Either both parties get them or neither gets them. Sellers will usually prefer to have an attorney’s fee provision, since they are the most likely to be a plaintiff in litiga. It is normally best to change a few words in the contract to make a unilateral attorney’s fees clause bilateral (going both ways). Where the contract says

if (sub)contractor breaches this contract, then it will be liable for attorney’s fees

change this to say:

if either party breaches this contract, then it will be liable for attorney’s fees.

You also could add a bilateral provision anywhere in the contract:

In any action or proceeding involving a dispute arising out of this agreement, the prevailing party shall be entitled to receive from the other party reasonable attorney’s fees to be determined by a court or arbitrator.

You may even want to add your own unilateral provision:

In the event that General Contractor (or owner) breaches this contract or in the event arbitration, litigation or other dispute resolution is instituted by either party, then (Sub)Contractor shall be entitled to recover its costs and attorney’s fees.

Unilateral attorney’s fees provisions are often in the Indemnity Provisions in the subcontract. These indemnities are primarily for insure or personal injury purposes, but sometimes add unilateral liability for attorney’s fees for contractual disputes.

Indemnity Provisions

Contracts normally state something to the effect that:

(Sub)Contractor agrees to defend, indemnify and hold harmless General Contractor (or Owner) and their agents and employees, from any against any claim, cost, expense or liability (including attorney’s fees) attributable to bodily injury, sickness, disease or death, or damage, loss or destruction of property caused by, arising out of, resulting from or occurring in connection with the performance of the Work by (Sub)Contractor or their agents or employees, whether or not caused in part by the active or passive negligence or other fault of a party indemnified hereunder

This is an ind