New York’s Public Policy On Construction Dispute Venue Trumps Illinois Forum-Selection Clause – IL 2d Dist.

Dancor Construction, Inc. v. FXR Construction, Inc., 2016 IL App (1st) 150839 offers a nuanced discussion of forum selection clauses and choice-of-law principles against the backdrop of a multi-jurisdictional construction dispute.

The plaintiff general contractor (GC) sued a subcontractor (Sub) in Illinois state court for breach of a construction contract involving New York (NY) real estate.  The contract had a forum selection clause that pegged Kane County Illinois (IL) as the forum for any litigation involving the project.  

The trial court agreed with the Sub’s argument that the forum-selection clause violated NY public policy (that NY construction litigation should be decided only in NY) and dismissed the GC’s suit.  Affirming, the Second District discusses the key enforceability factors for forum-selection clauses when two or more jurisdictions are arguably the proper venue for a lawsuit.

Public Policy – A Statutory Source

The Court first observed that IL’s and NY’s legislatures both addressed the proper forum for construction-related lawsuits.  Section 10 of Illinois’ Building and Construction Contract Act, 815 ILCS 665/10, voids any term of an IL construction contract that subjects the contract to the laws of another state or that requires any litigation concerning the contract to be filed in another state.

NY’s statute parallels that of Illinois.  NY Gen. Bus. Law Section 757(1) nullifies construction contract terms that provide for litigation in a non-New York forum or that applies (non-) NY law.

Since a state’s public policy is found in its published statute (among other places), NY clearly expressed its public policy on the location for construction litigation.

Forum Selection and Choice-of-Law Provisions

An IL court can void a forum-selection clause where it violates a fundamental IL policy.  A forum-selection clause is prima facie valid unless the opposing side shows that enforcement of the clause would be unreasonable.

A forum-selection clause reached by parties who stand at arms’ length should be honored unless there is a compelling and countervailing reason not to enforce it. (¶ 75)

A choice-of-law issue arises where there is an actual conflict between two states’ laws on a given issue and it isn’t clear which state’s law governs.  Here, IL and NY were the two states with ostensible interests in the lawsuit.  There was also a plain conflict between the states’ laws: the subject forum-selection clause was prima facie valid in IL while it plainly violated NY law.

Which Law Applies – NY or IL?

Illinois follows Section 187 of the Restatement (Second) of Conflicts of Laws (1971) which provides that the laws of a state chosen by contracting parties will apply unless (1) the chosen state has no substantial relationship to the parties or the transaction and there is no other reasonable basis for the parties’ choice, or (2) application of the law of the chosen state would violate a fundamental policy of a state that has a materially greater interest than the chosen state on a given issue.

The Court found the second exception satisfied and applied NY law.  

Section 757 of NY’s business statute clearly outlaws forum-selection clauses that provide for the litigation of NY construction disputes in foreign states.  As a result, the contract’s forum clause clearly violates NY’s public policy of having NY construction disputes decided in NY.

The question then became which state, NY or IL, had the greater interest in the forum-selection clause’s enforcement?  Since NY was the state where the subcontractor resided, where the building (and contract’s finished product) was erected and the contract ultimately performed, the Court viewed NY as having a stronger connection.  Since allowing the case to proceed in IL clearly violated NY’s public policy, the Court affirmed dismissal of the GC’s lawsuit.

Afterwords:

Forum selection clauses are prima facie valid but not inviolable.  Where a chosen forum conflicts with a public policy of another state, there is a conflict of laws problem.  

The Court will then analyze which state has a more compelling connection to the case.  Where the state with both a clear public policy on the issue also has a clearer nexus to the subject matter of the lawsuit, the Court will apply that state’s (the one with the public policy and closer connection) law on forum-selection clauses.

 

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).

‘Expensive, Yes’; Impossible, No’ – Massive Wind Turbine Tower A Trade Fixture, Not Lienable – IL Second Dist.

Q: Does a multi-story wind turbine tower that can only be removed by detonating several bombs at a cost of over half a million dollars qualify as a lienable property improvement?

A: Not if it’s a “trade fixture” that remains the personal property of its manufacturer.

Source: AUI Construction Group, LLC v. Vaessen, 2016 IL App (2d) 160009, a recent Second District case that examines, among other things, the property improvement vs. trade fixture dichotomy and just how impractical structure removal must be to fall outside mechanics lien protection.

Facts: The property owner and turbine seller signed an easement agreement for the seller to install a turbine on defendant’s land for an annual fee.  The easement specifically provided the turbine would remain the seller’s property and required the seller to remove the structure on 90 days’ notice.  The easement also obligated the seller to remove the structure from the defendant’s property upon termination of the easement.

The turbine seller then contracted with a general contractor to install the turbine who, in turn, subcontracted out various aspects of the installation.

The contract between the owner and general contractor and the various downstream subcontracts all referenced the easement and made clear that the property owner was not the turbine system’s owner.

When the plaintiff sub-subcontractor didn’t get paid, he sued its subcontractor, ultimately getting an arbitration award of over $3M.  When that proved uncollectable after the subcontractor’s bankruptcy, the plaintiff sued the property owner to foreclose a mechanics lien based on the amount of its judgment against the bankrupt contractor.

Trial Court Result: The trial court dismissed the suit on the basis that the turbine was a removable trade fixture that was non-lienable as a matter of law.

Appellate Result: Affirmed

Reasons: The Court first noted that the purpose of the Mechanics Lien Act (770 ILCS 60/0.01 et seq.) is to protect those who, in good faith, furnish material or labor for the improvement of real property.  The Act allows a lien where a benefit has been received by the owner and where the property’s value has increased or improved by the furnishing of labor or materials.  In Illinois, real estate improvements are lienable; trade fixtures are not.

The factors considered in determining whether equipment is lienable includes (1) the nature of attachment to the realty, (2) the equipment’s adaptation to and necessity for the purpose to which the premises are devoted, and (3) whether it was intended that the item in question should be considered part of the realty.  Crane Erectors & Riggers, Inc. v. LaSalle National Bank, 125 Ill.App.3d 658 (1984).

Intent (factor (3)) is paramount.  Even where an item can be removed from land without injuring it, it will not categorically destroy lienability.  As long as the parties manifest an intent to improve the realty, a removable item can still be lienable.

Parties are also free to contract that title to equipment furnished to property does not pass to the land owner until fully paid for.  Such an agreement will be enforceable so long as no rights of third parties are unfairly affected.

Applying the three-factored fixture test, the court found that the first two factors – nature of attachment, and necessity of the item or production of wind energy on the defendant’s property – weighed in favor of finding that the turbine system was lienable.   However, the all-important intent factor suggested the opposite.

The easement agreement made it clear that the turbine seller retained its ownership interest in the turbine and could (and had to) remove it at the easement’s end.  The court wrote: “the easement agreement establishes that the tower was a trade fixture.”  (¶ 20)

The Court also found that plaintiff’s “third party” rights were not impacted since plaintiff’s contract with the subcontractor referred to both the easement and the general contract and each document established that the property owner did not own the turbine. (¶ 23)

The Court then dove deeper and examined some additional factors as part of its improvement-versus-fixture calculus.  From a patchwork of Illinois cases through the decades, the Court looked at (1) whether the turbine provided a benefit or enhancement to the property, (2) whether the turbine was removable without material damage to the property, (3) whether it was impractical to remove the item, (4) whether the item (turbine) was used to convert the premises from one use to another, and (5) the agreement and relationship between the parties.

According to the Court, the lone factor tilting in favor of lienability was the fourth factor – that the turbine was instrumental in converting the defendant’s land from farmland to harnessing wind energy.  All other factors pointed to the turbine being a nonlienable trade fixture.

The Court first found that the property owner didn’t derive a benefit from the turbine other than an annual rent payment.  Rent is generally not regarded as a lienable benefit under the law.  The Court next noted that the tower could be removed even though doing so was an expensive and cumbersome exercise.  Lastly, and most importantly, the parties’ intent was that the turbine was to remain seller’s personal property and for it not to be a permanent property improvement. (¶¶ 38-39)

The Court then rejected the subcontractor’s remaining arguments that the Illinois Property Tax Code evinced a legislative intent to view wind turbines as lienable improvements and that it’s unfair to disallow the plaintiff’s lien claim since it could not have a security interest in the turbine under Article 9 of the Uniform Commercial Code (UCC).

On the tax issue, the Court held that Illinois taxes turbines to ensure that wind turbines do not escape taxation.  It is purely a revenue generating device.  The mere fact that the State assesses taxes against turbines is not tantamount to a legislative intent that turbines are permanent property improvements. (¶¶ 43-44)

The Court then agreed with plaintiff that under UCC Section 9-334, security interests do not attach to “ordinary building materials incorporated into an improvement on land.”  Since the turbine was replete with building materials (e.g. concrete, rebar, electrical conduit), the UCC didn’t give the plaintiff a remedy.  But even though the UCC prevented plaintiff’s security interest, this didn’t mean that plaintiff should be given mechanics lien rights instead.  Again, the key inquiry was the parties’ clear intent that the turbine remain the seller’s personal property.

This case strikes a blow to contractors who play a role in installing behemoth-size equipment on real property.  Even something as massive as a turbine system, which one would think has a “death grip”- level attachment to land, can be nonlienable as long as there is clear intent that it remain personal property and removable by the system owner.

Another case lesson is for contractors to be extra diligent and insist on copies of all agreements referenced in their contracts to ensure their rights are protected from ancillary agreements to which they’re not privy.

The case also portrays some creative lawyering.  The court’s discussion of the taxability of wind turbines, UCC Article 9 and the difference between a lease (which can be lienable) and an easement (which cannot) and how it impacts the lienability question makes for interesting (if not mostly academic) reading.