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).

No-Reliance Clauses and Fraud Pleading Requirements – IL Fed Court Weighs In

The Case: Walls v. VreChicago Eleven, LLC, 2016 WL 5477554 (N.D.Ill. 2016)

Issues:  1/ Viability of ‘no-reliance’ clauses and as-is clauses in commercial real estate contracts; and 2/ Fraud pleading requirements under Federal Rules of Civil Procedure

Facts: Property purchaser plaintiffs claimed they were fraudulently induced to buy property by defendants who falsely claim the property was garnering annual rentals of $171K and the lease guarantor was a multi-million dollar business.

A few months after the purchase, the tenant (a KFC restaurant) fell behind in rent and informed plaintiff it could only pay $70K in annual rent.   Plaintiff evicted the KFC operator and re-leased it to a substitute tenant who paid less than the former (evicted) tenant.

Plaintiff sued the seller and its broker for fraud in the inducement and negligent misrepresentation. The defendants moved to dismiss.

Result: Motions to dismiss denied.

Reasons:

A standard no reliance provision is a type of contractual exculpatory clauses and provides that a purchaser is not relying on any representations of the seller that are not specifically spelled out in the purchase contract.

The purpose of a no reliance clause is to preemptively head off a fraud action by eliminating the reliance element that is a required component of a fraud claim.

No reliance clauses serve useful purpose as they insure that the transaction and any litigation stemming from it is based on the parties’ writings rather than unreliable memories and not subject to the risk of fabrication.

At the same time, exculpatory clauses are not favored under Illinois law and must be clear, explicit and unequivocal to be enforced.

Here, the court found the no reliance clause ambiguous.  First, the clause only spoke to representations or warranties of the seller; it said nothing about seller’s silence or omissions.  At least one Illinois court has held that a non-reliance clause only applies to affirmative fraud (e.g. representations, assertions of fact) and not to fraudulent concealment – defined as silence in the face of a duty to speak.  See, e.g. Benson v. Stafford, 941 N.E.2d 386, 410 (2010).

A second reason the court declined to dismiss the suit at the pleadings stage was because the no-reliance’s clause’s scope was unclear.  It found plausible plaintiff’s position that its claims that defendant misrepresented annual rent projections and the guarantor’s financial health exceeded the reach of the no-reliance clause.

A final reason the Court found the no-reliance clause ambiguous was because it was couched in the contract’s As-Is paragraph.  Because of this, it was reasonable  to conclude for the sake of argument that the no-reliance language only governed the condition of the property – not the tenant’s expected rents or the guarantor’s financial condition.

Textual ambiguity aside, the court turned to whether the no reliance clause was enforceable.  To determine the clause might be enforceable, the court considered (1) the clause’s ambiguity, (2) plaintiff allegations of seller’s misstatements contained in written offering and sales brochure documents (instead of in the purchase contract), (3) plaintiff’s claims that defendants impeded plaintiff’s pre-sale due diligence efforts, and (4) the assertion that defendants orchestrated a plan to deceive the plaintiffs and induce them to buy the property.

According to the court, there were too many disputed fact issues to decide that the no reliance clause was enforceable.  As a result, it was premature to dismiss plaintiff’s claims without the benefit of discovery.

Pleading Standards for Fraud – Rule 9(b)

The court also addressed the pleading standards for fraud in Federal court.

Rule 9(b) provides that a fraud plaintiff allege with particularity the circumstances that constitute fraud.  Specifically, the plaintiff must plead the who, what, where, when and how of the fraud.  The reason for elevated pleading rules for fraud is because of a fraud claim’s potential for severe harm to a business’s reputation.  The law requires a more thorough pre-complaint investigation than other causes of action so that fraud claims are factually supported and not extortionate or defamatory.

But when the details of a fraud are within the exclusive possession of a defendant, the fraud pleading rules are relaxed.  In such a case, the plaintiff must still allege the grounds for his/her suspicions of fraud.

Here, the plaintiff’s fraud allegations were premised on statements contained in the sales contract, the offering circular and sales brochure.  In addition, the plaintiff provided detailed facts supporting its claims that the defendants misled plaintiffs concerning the tenant, the annual rent and the guarantor’s fiscal status.  The Court found the plaintiff’s complaint adequately stated a fraud claim sufficient to survive a motion to dismiss.

Afterwords:

No reliance clauses are enforceable but they must be ambiguous and clearly encompass the subject matter of a lawsuit;

Fraud requires heightened pleading but when the critical fraud facts are solely in the defendant’s domain, the plaintiff is held to less pleading particularity.

 

General Contractor Insolvency, Not Owner Recourse, is Key Implied Warranty of Habitability Test – IL First Dist.

In Sienna Court Condominium Association v. Champion Aluminum Corporation, 2017 IL App (1st) 143364, the First District addressed two important issues of common law and statutory corporate law.  It first considered when a property owner could sue the subcontractor of a defunct general contractor where there was no contractual relationship between the owner and subcontractor and then examined when a defunct limited liability company (LLC) could file a lawsuit in the LLC’s name.

The plaintiff condo association sued the developer, general contractor (“GC”) and subcontractors for various building defects.  The subcontractors moved to dismiss the association’s claims on the ground that they couldn’t be liable for breaching the implied warranty of habitability if the plaintiff has possible recourse from the defunct GC’s insurer.

The trial court denied the subcontractors’ motion and they appealed.

Affirming denial of the subcontractors’ motions, the First District considered whether a homeowner’s implied warranty claim could proceed against the subcontractors of an insolvent GC where (1) the plaintiff had a potential source of recovery from the GC’s insurer or (2) the plaintiff had already recovered monies from a warranty fund specifically earmarked for warranty claims.

The court answered “yes” (plaintiff’s suit can go forward against the subs) on both counts. It held that when deciding whether a plaintiff can sue a subcontractor for breach of implied warranty of habitability, the focus is whether or not the GC is insolvent; not whether plaintiff can possibly recover (or even has recovered) from an alternate source (like a dissolved GC’s insurer).

For precedential support, the Court looked to 1324 W. Pratt Condominium Ass’n v. Platt Construction Group,   2013 IL App (1st) 130744 where the First District allowed a property buyer’s warranty claims versus a subcontractor where the general contractor was in good corporate standing and had some assets.  The court held that an innocent purchaser can sue a sub where the builder-seller is insolvent.

In the implied warranty of habitability context, insolvency means a party’s liabilities exceed its assets and the party has stopped paying debts in the ordinary course of its business. (¶¶ 89-90).  And under Pratt’s “emphatic language,” the relevant inquiry is GC’s insolvency, not plaintiff’s “recourse”.¶ 94

Sienna Court noted that assessing the viability of an owner’s implied warranty claim against a subcontractor under the “recourse” standard is difficult since there are conceivably numerous factual settings and arguments that could suggest plaintiff has “recourse.”  The court found the insolvency test more workable and more easily applied then the amorphous recourse standard. (¶ 96).

Next, the Court considered the chronological outer limit for a dissolved LLC to file a civil lawsuit.  The GC dissolved in 2010 and filed counterclaims in 2014.  The trial court ruled that the 2014 counterclaims were too late and time-barred them.

The appeals court affirmed.  It noted that Section 35-1 of the Illinois LLC Act (805 ILCS 180/1-1 et seq.) provides that an LLC which “is dissolved, and, unless continued pursuant to subsection (b) of Section 35-3, its business must be wound up,” upon the occurrence of certain events, including “Administrative dissolution under Section 35-25.” 805 ILCS 180/35-1

While Illinois’ Business Corporation Act of 1993 specifies that a dissolved corporation may pursue civil remedies only up to five years after the date of dissolution (805 ILCS 5/12.80 (West 2014)), the LLC Act is silent on when a dissolved LLC’s right to sue expires.  Section 35-4(c) only says “a person winding up a limited liability company’s business may preserve the company’s business or property as a going concern for a reasonable time”

The Court opted for a cramped reading of Section 35-4’s reasonable time language.  In viewing the LLC Act holistically, the Court found that the legislature contemplated LLC’s having a finite period of time to wind up its affairs including bringing any lawsuits.  Based on its restrictive interpretation of Section 35-4, the Court held the almost four-year gap between the GC’s dissolution (2010) and counterclaim filing (2014) did not constitute a reasonable time.

Afterwords:

Sienna Court emphasizes that a general contractor’s insolvency – not potential recourse – is the dominant inquiry in considering a property owner’s implied warranty of habitability claim against a subcontractor where the general contractor is out of business and there is no privity of contract between the owner and subcontractor.

The case also gives some definition to Section 35-4 of the LLC Act’s “reasonable time” standard for a dissolved LLC to sue on pre-dissolution claims.  In this case, the Court found that waiting four years after dissolution to file counterclaims was too long.