Pay-When-Paid Clause in Subcontract Not Condition Precedent to Sub’s Right to Payment – IL Court

Pay-if-paid and pay-when-paid clauses permeate large construction projects

In theory, the clauses protect a contractor from downstream liability where its upstream or hiring party (usually the owner) fails to pay.

Beal Bank Nevada v. Northshore Center THC, LLC, 2016 IL App (1st) 151697 examines the fine-line distinction between PIP and PWP contract terms. a lender sued to foreclose

The plaintiff lender sued to foreclose commercial property and named the general contractor (GC) and subcontractor (Sub) as defendants.  The Sub countersued to foreclose its nearly $800K lien and added a breach of contract claims against the GC.

In its affirmative defense to the Sub’s claim, the GC argued that payment from the owner to the GC was a condition precedent to the GC’s obligation to pay the Sub.  The trial court agreed with the GC and entered summary judgment for the GC.  The Sub appealed.

Result: Reversed.

Reasons:

The Subcontract provided the GC would pay the Sub upon certain events and arguably (it wasn’t clear) required the owner’s payment to the GC as a precondition to the GC paying the Sub.  The GC seized on this owner-to-GC payment language as grist for its condition precedent argument: that if the owner didn’t pay the GC, it (the GC) didn’t have to pay the Sub.

Under the law, a condition precedent is an event that must occur or an act that must be performed by one party to an existing contract before the other party is obligated to perform.  Where a  condition precedent is not satisfied, the parties’ contractual obligations cease.

But conditions precedent are not favored.  Courts will not construe contract language that’s arguably a condition precedent where to do so would result in a forfeiture (a complete denial of compensation to the performing party). (¶ 23)

The appeals court rejected the GC’s condition precedent argument and found the Subcontract had a PWP provision.  For support, the court looked to the contractual text and noted it attached two separate payment obligations to the GC – one was to pay the Sub upon “full, faithful and complete performance,”; the other, to make payment in accordance with Article 5 of the Subcontract which gave the GC a specific amount of time to pay the Sub after the GC received payment from the owner.

The Court reconciled these sections as addressing the amounts and timing of the GC’s payments; not whether the GC had to pay the Sub in the first place. (¶¶ 19-20)

Further support for the Court’s holding that there was no condition precedent to the GC’s obligation to pay the Sub lay in another Subcontract section that spoke to “amounts and times of payments.”  The presence of this language signaled that it wasn’t a question of if the GC had to pay the Sub but, instead, when it paid.

In the end, the Court applied the policy against declaring forfeitures: “[w]ithout clear language indicating the parties’ intent that the Subcontractor would assume the risk of non-payment by the owner, we will not construe the challenged language…..as a condition precedent.” (¶ 23)

Since the Subcontract was devoid of “plain and unambiguous” language sufficient to overcome the presumption against a wholesale denial of compensation, the Court found that the Subcontract contained pay-when-paid language and that there was no condition precedent to the Sub’s entitlement to payment from the GC.

Take-aways

Beal Bank provides a solid synopsis of pay-if-paid and pay-when-paid clauses.  PIPs address whether a general contractor has to pay a subcontractor at all while PWPs speak to the timing of a general’s payment to a sub.

The case also re-emphasizes that Section 21(e) of the Illinois Mechanics Lien Act provides that the presence of a PIP or PWP contract term is no defense to a mechanics lien claim (as opposed to garden-variety breach of contract claim).

Tacking Unsigned Change Orders On To Contractors’ Lien Not Enough For Constructive Fraud – IL Court

Constructive mechanics lien fraud and slander of title are two central topics the appeals court grapples with in Roy Zenere Trucking & Excavating, Inc. v. Build Tech, Inc., 2016 IL App (3d) 140946.  There, a commercial properly developer appealed bench trial judgments for two subcontractor plaintiffs – a paving contractor and an excavating firm – on the basis that the plaintiffs’ mechanics liens were inflated and fraudulent.

The developer argued that since the subcontractors tried to augment the lien by adding unsigned change order work to it – and the contracts required all change orders to be in writing – this equaled that voided the liens.  The trial court disagreed and entered judgment for the plaintiff subcontractors.

Affirming the trial court’s judgment, the appeals court provides a useful summary of the type of proof needed to sustain constructive fraud and slander of title claims in the construction lien setting and when attorneys’ fees can be awarded to prevailing parties under Illinois’ mechanics lien statute, 770 ILCS 60/1 (the Act).

Section 7(a) of the Act provides that no lien shall be defeated to the proper amount due to an error of overcharging unless it is shown that the error or overcharge was made with an “intent to defraud.”  Constructive fraud (i.e., fraud that can’t be proven to be purposeful) can also invalidate a lien but there must be more than a simple overcharge in the lien claim.  The overage must be coupled with other evidence of fraud.

Slander of title applies where (1) a defendant makes a false and malicious publication, (2) the publication disparages the plaintiff’s title to property, and (3) damages.  “Malicious” in the slander of title context means knowingly false or that statements were made with a reckless disregard of their truth or falsity.  If a party has reasonable grounds to believe it has a legal or equitable claim to property, even if it’s later proven to be false, this won’t amount to a slander of title.

Here, the appeals court agreed with the trial court that there was no evidence to support a constructive fraud or slander of title claim.  The defendant property owner admitted that the subcontractor plaintiffs performed the contract as well as the extra change order work.

While the Court excluded the unsigned change order work from the lien amount, there was still insufficient constructive fraud or slander of title evidence to sustain the owner’s counterclaims.  Though unsuccessful in adding the change orders to the lien, the Court found the plaintiffs had a reasonable basis to recover the extra work in their lien foreclosure actions based on the parties’ contracting conduct where the owner routinely paid extras without signed change orders.

The Court then examined whether the subcontractors could add their attorneys’ fees to the judgment.  Section 17(b) of the Act allows a court to assess attorneys’ fees against a property owner who fails to pay “without just cause or right.”  This equates to an owner raising a defense not “well grounded in fact and warranted by existing law or a good faith argument for the extension, modification, or reversal of existing law.”  770 ILCS 60/17(b), (d).

The evidence at trial that the subcontractors substantially performed the paving and excavation work cut in favor of awarding fees to the plaintiffs.  There was no evidence to support the owner defendant’s failure to pay the subcontract amounts.  The Court held that this lack of a colorable basis not to pay the subcontractors was “without just cause or right” under the Act.

Afterwords:

1/ Constructive fraud requires more than a computational error in the lien amount.  There must be other “plus-factor” evidence that combines with the overcharge;

2/ Where a contractor has reasonable basis for lien claim, it will be impossible for plaintiff to meet the malicious publication requirement of a slander of title claim;

3/ This case is pro-contractor as it gives teeth to the Mechanics’ Lien Statute’s fee-shifting section.

 

 

Lien Inflation and “Plus Factors” – Constructive Fraud in Illinois Mechanics Lien Litigation

The contractor plaintiff in Father & Sons Home Improvement II, Inc. v. Stuart, 2016 IL App (1st) 143666 was caught in several lies in the process of recording and trying to foreclose its mechanics lien.  The misstatements resulted in the nullification of its lien and the plaintiff being on the hook for over $40K in opponent attorneys’ fees.

The plaintiff was hired to construct a deck, garage and basement on the defendant owner’s residence.  Inexplicably, the plaintiff recorded its mechanics lien 8 months before it finished its work. This was a problem because the lien contained the sworn testimony of plaintiff’s principal (via affidavit) that stated a completion date that was several months off.

Plaintiff then sued to foreclose the lien; again stating an inaccurate completion date in the complaint.  The owner and mortgage lender defendants filed separate summary judgment motions on the basis that the plaintiff committed constructive fraud by (1) falsely stating the lien completion date and (2) inflating the dollar value of its work in sworn documents (the affidavit and verified complaint).

Affirming summary judgment and separate fee awards for the defendants, the Court distilled the following mechanics lien constructive fraud principles:

  • The purpose of the mechanics lien act (Lien Act) is to require someone with an interest in real property to pay for property improvements or benefits he encouraged by his conduct.  Section 7 of the Lien Act provides that no lien will be defeated because of an error or if it states an inflated amount unless it is shown that the erroneous lien amount was made with “intent to defraud.”  770 ILCS 60/7;
  • The intent to defraud requirement aims to protect the honest lien claimant who simply makes a mistake in computing his lien amount.  But where there is evidence a lien claimant knowingly filed a false lien (either in completion date or amount), the lien claim will be defeated.  (¶¶ 30-31);
  • Where there is no direct proof of a contractor’s intent to defraud, “constructive fraud” can negate a lien where there is an overstated lien amount or false completion date combined with additional evidence;
  • The additional evidence or “plus factor” can come in the form of a false affidavit signed by the lien claimant that falsely states the underlying completion date or the amount of the improvements furnished to the property.  (¶ 35).

Based on the plaintiff’s multiple false statements – namely, a fabricated completion date and a grossly exaggerated lien amount based on the amount of work done – both in its mechanics lien and in its pleadings, the court found that at the very least, the plaintiff committed constructive fraud and invalidated the lien.

Attorneys’ Fees and Rule 137 Sanctions

The court also taxed the property owners’ attorneys’ fees to the losing contractor.  Section 17 of the Lien Act provides that an owner can recover its attorneys’ fees where a contractor files a lien action “without just cause or right.”  The Lien Act also specifies that only the owner – not any other party involved in the chain of contracts or other lienholders – can recover its attorneys’ fees.  A lien claim giving rise to a fee award is one that is “not well grounded in fact and warranted by existing law or a good faith argument for the extension, modification or reversal of existing law.”  770 ILCS 60/17(d).

Based on the contractor’s clear case of constructive fraud in filing a lien with a false completion date and in a grossly excessive sum, the court ordered the contractor to pay the owner defendants’ attorneys’ fees.

The lender – who is not the property owner – wasn’t entitled to fees under Section 17 of the Lien Act.  Enter Rule 137 sanctions.  In Illinois, Rule 137 sanctions are awarded to prevent abuse of the judicial process by penalizing those who file vexatious and harassing lawsuit based on unsupported statements of fact or law.  Before assessing sanctions, a court does not engage in hindsight but instead looks at what was objectively reasonable at the time an attorney signed a document or filed a motion.

Because the plaintiff contractor repeatedly submitted false documents in the course of the litigation, the court awarded the mortgage lender its attorneys’ fees incurred in defending the lien suit and in successfully moving for summary judgment.  All told,  the Court sanctioned the contractor to the tune of over $26,000; awarding this sum to the lender defendant.

Afterwords:

This case serves as an obvious cautionary tale for mechanics lien plaintiffs.  Plainly, a lien claimant must state an accurate completion date and properly state the monetary value of improvements.  If the claimant realizes it has made a mistake, it should amend the lien.  And even though an amended lien usually won’t bind third parties (e.g. lenders, other lienholders, etc.), it’s better to correct known lien errors than to risk a hefty fee award at case’s end.