A joint check is simply a check issued by one party, the payor, and made payable to two parties as co-payees. The use of joint check agreements and the issuance of joint checks are practices well established by custom in the construction industry and are typically used to get downstream subcontractors and suppliers paid as soon as the upstream subcontractors are paid. Typically, a joint check arrangement involves an agreement between the prime contractor and its first tier subcontractor whereby the two parties agree that the prime contractor will issue all or part of a progress payment as a joint check, or as a series of individual joint checks, payable to the subcontractor and one of the subcontractor’s material suppliers or lower-tier subcontractors as co-payees. Joint check arrangements are also sometimes made by using a three-party agreement where one of the first-tier subcontractor’s material suppliers or lower-tier subcontractors is also a party to the formal joint check agreement.
There are many reasons why a joint check agreement may be desired. The prime contractor may seek a joint check agreement if the contractor fears that the subcontractor will pocket a progress payment while leaving the subcontractor’s suppliers and lower-tier subcontractors unpaid, thus provoking the suppliers or lower-tier subcontractors to file materialman’s and mechanic’s liens or to make claims against the prime contractor’s payment bond. A joint check agreement helps the prime contractor insure that the subcontractor properly disburses the subcontract funds to the subcontractor’s material suppliers and lower-tier subcontractors. Similarly, a subcontractor’s supplier or lower-tier subcontractor may seek a joint check arrangement to insure that the subcontractor won’t run off with the progress payments and leave the supplier or lower-tier subcontractor out in the cold. The supplier or lower-tier subcontractor may desire a joint check arrangement because the subcontractor is in financial trouble, the subcontractor is undercapitalized, the subcontractor has bad credit, the subcontractor’s previous business dealings with the supplier or lower-tier subcontractor have been unfavorable, or they simply mistrust the subcontractor.
While seemingly simple in concept, joint check agreements and the issuance of joint checks raise several important issues which, if not properly addressed, could defeat the purpose of using joint checks in the first place. Accordingly, whether you are the anticipated payor or co-payee, you should consider the following points and discuss these points with your construction attorney well in advance of establishing a joint check arrangement.
Be aware of the Joint Check Rule. What if the supplier or lower-tier subcontractor endorses the joint check but does not receive all of the check’s proceeds? A co-payee who endorses a joint check may be deemed paid even if it does not receive all of the proceeds. Many states have adopted the Joint Check Rule, which provides that when the payor (usually an owner or general contractor) makes a subcontractor and supplier or lower-tier subcontractor co-payees on a check that includes payment for labor and materials furnished, and no other agreement exists between the supplier or lower-tier subcontractor and the payor as to the allocation of the proceeds, then the supplier or lower-tier subcontractor, by endorsing the check, will be deemed to have been paid the money due him or her, up to the amount of the joint check. The co-payee has the opportunity to protect itself by refusing to endorse the check. The supplier or lower-tier subcontractor, for example, could demand full payment from the subcontractor in return for endorsing the joint payee check.
The prime contractor should take steps to avoid independent liability to pay the subcontractor’s suppliers or lower-tier subcontractors. If the payment arrangement involves a three-party agreement, the prime contractor should make clear that the payment arrangement is being made merely as an accommodation to the subcontractor’s supplier or lower-tier subcontractor and should not be relied upon to establish any contractual obligations flowing from the prime contractor to the supplier or lower-tier subcontractor. Suppliers and lower-tier subcontractors should be aware that endorsing a joint check may constitute a release of the prime contractor’s surety and a waiver of materialman’s and mechanic’s lien rights.
The prime contractor should make sure that its subcontracts authorize the use of joint checks. What happens if a prime contractor does not enter into a formal joint check agreement with its subcontractor but nonetheless issues joint checks made payable to the subcontractor’s supplier? Unilaterally issuing joint checks may be a breach of the subcontract. The prime contractor must obtain the consent of its subcontractor before making joint payments. The best practice is to address this issue up front with express language in the subcontract giving the prime contractor the right, but not the obligation, to issue joint checks if necessary. Make clear that the right to issue joint checks does not create a duty to issue joint checks. Absent express authorization in the subcontract to issue joint checks, the prime contractor cannot relieve itself of its payment obligations to the subcontractor by unilaterally issuing joint checks and will still be responsible for ensuring that its subcontractor is paid in full regardless of whether the supplier is paid. That said, a general contractor does not need the supplier’s or lower-tier subcontractor’s consent to enter into a joint check agreement with the subcontractor. Consider including a form joint check agreement as an exhibit to the subcontract and making the subcontractor’s failure to execute the joint check agreement as to any supplier or lower-tier subcontractor a basis for withholding progress payments to the subcontractor.
Negotiating a joint check without the proper endorsements may have serious consequences. What happens if the subcontractor successfully deposits the check without the co-payee’s endorsement? In this situation, the bank paying on a joint check with only one signature may be liable for conversion to the co-payee supplier or lower-tier subcontractor who did not endorse the joint check. The supplier or lower-tier subcontractor will also have a claim against the subcontractor if the subcontractor did not pay the supplier or lower-tier subcontractor after receiving the proceeds from the joint check. What happens if the subcontractor forges the co-payee’s endorsement before cashing the check? In this situation, the bank can be liable for making payment over a forged endorsement. Banks, however, are often times able to limit their liability by demonstrating that they acted in good faith and that it was commercially reasonable for the bank to have cashed the check. The subcontractor who forged the supplier’s signature will still be liable to the supplier even though the bank may be off the hook. Be aware that in either of these situations the prime contractor and its surety may remain liable to the non-signing co-payee and thus may be required to pay twice.
The process of establishing formal joint check agreements, issuing joint checks, and negotiating joint checks carries with it important rights and obligations that may vary based on the contractual agreements involved, the relationships among the various parties, representations made to the co-payees, and applicable law. Accordingly, whether you are the anticipated payor or co-payee, you should not hesitate to seek the advice of your construction attorney when considering establishing or carrying out a joint payment arrangement.