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).

Secretary of State’s LLC File Detail Report Is Public Record – IL Court (A Deep Cut)

R&J Construction v. Javaras, 2011 WL 10069461, an unpublished and dated opinion, still holds practical value for its discussion of the judicial notice rule, breach of contract pleading requirements and a limited liability company member’s insulation from liability for corporate debts.

The plaintiff sold about $70K worth of construction materials to a concrete company associated with the individual defendant.  The concrete company’s legal name was WS Concrete, LLC, an Illinois limited liability company doing business under the assumed name, West Suburban Concrete.  Defendant was a member of the LLC and point-person who ordered supplies from the plaintiff.

The plaintiff sued the individual and did not name the LLC as a party defendant.

The trial court dismissed the complaint because the plaintiff failed to attach the written contract and there was no evidence the defendant assumed personal responsibility for the contract obligations.  The plaintiff appealed.

Result: Affirmed.

Reasons:

The Court first found the trial court correctly dismissed plaintiff’s suit for failure to attach the operative contract.

Code Section 2-606 requires a plaintiff to attach a written instrument (like a contract) to its pleading where the pleading is based on that instrument.  The exception is where the pleader can’t locate the instrument in which case it must file an affidavit stating the instrument is inaccessible.

Here, the plaintiff alleged a written contract but only attached a summary of various purchase orders and invoices to the complaint.  Since it failed to attach the contract, the appeals court found the complaint deficient and falling short of Section 2-606’s attached-instrument requirement.

The court next addressed whether the LLC File Detail Report (see above image), culled from the Illinois Secretary of State “cyberdrive” site was admissible on Defendant’s motion to dismiss.  In ruling the Report was admissible, the Court cited to case precedent finding that Secretary of State records are public records subject to judicial notice.  (Judicial notice applies to facts that are readily verifiable and not subject to reasonable dispute.)

Since the LLC Report plainly demonstrated the proper defendant was the LLC (as opposed to its member), and there was no evidence the individual defendant took on personal liability for plaintiff’s invoices, the trial court correctly dismissed the defendant.

Added support for the defendant’s dismissal came via the Illinois Limited Liability Company Act, 805 ILCS 180/1 et seq.  Section 10-10 of the LLC Act provides that an LLC’s contractual obligations belong solely to the LLC and that a member cannot be personally responsible for LLC contracts unless (1) the articles of organization provide for personal liability and (2) the member consents in writing.

The Court next addressed plaintiff’s agent of a disclosed principal argument.  The plaintiff asserted that since the individual defendant is the person who ordered plaintiff’s construction materials and it was unclear who the defendant represented, the defendant was responsible for plaintiff’s unpaid invoices.

The court rejected this argument.  It noted that under Illinois law, where an agent signs a contract by signing his own name and providing his own personal contact information (address, phone number, SS #, etc.) and fails to note his corporate affiliation, he (the agent) can be personally liable on a contract.  In this case, however, there was no documentation showing defendant ordering supplies in his own name.  All invoices attached to the plaintiff’s response brief (to the motion to dismiss) reflected the LLC’s assumed name – “West Suburban Concrete” – as the purchasing entity.

Afterwords:

(1) the case provides a useful analysis of common evidentiary issues that crop up in commercial litigation where a corporate agent enters into an agreement and the corporation is later dissolved;

(2) Both the LLC Act and agency law can insulate an individual LLC member from personal liability for corporate debts;

(3) Secretary of State corporate filings are public records subject to judicial notice.  This is good news for trial practitioners since it alleviates the logistical headache of having a Secretary of State agent give live or affidavit testimony on corporate records at trial.

 

 

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.