Since contractors work in order to be paid, it is vital to make sure the funds are actually available.  A recent Ohio appellate case, ably reviewed by Bonnie Wolf (Wolf Article), demonstrates the danger.  Advantage Renovations, Inc. v. Maui Sands Resort, Co. LLC (Erie Co. 2012), 2012 -Ohio- 1866.  As Ms. Wolf noted, a contractor on a $17.4 million contract became concerned about cost overruns on the project and inquired of the bank providing the financing about the availability of funds to pay that contractor.  In the space of three conversations, a bank officer arguably represented to the contractor that funds were available and that it would be paid.  The contractor relied on the bank officer’s statements, completed its work and, unfortunately, was left with an unpaid balance of $1.63 million.  The bank is now being sued for an oral guaranty and negligent misrepresentation, among other things.  Although it is good for the contractor that it has this claim against the bank, it is not good that it finds itself in this position that it must now engage in contentious and expensive litigation, while not being paid, in the hope of recovering part of its loss.

What should the prudent contractor do to avoid getting into this kind of mess?  There’s no magic bullet.  But here are a few suggestions:

  1. The contractor can look for credit support like a parent company guaranty, letter of credit, or advance payments from the owner as work proceeds when it is a low-credit entity.
  2. The contractor should be alert for signs of trouble.  An owner rarely goes along like everything is fine and suddenly crashes and burns.  There are usually indications that the owner is getting into financial trouble before it hits the wall.  The contractor should contact the lender if in doubt, like the contractor in the case above did.
  3. The contractor should insist on standard AIA or other proper “stop work” rights in its contract to protect it in the event that, during the project, the owner stops paying.  The contractor should resist owner terms that say the contractor has to keep working regardless of any “dispute,” i.e., regardless of not being paid because of an alleged “dispute.”
  4. A general contractor can consider putting a “pay if paid” clause in its contracts with subcontractors, thereby transferring the risk of non-payment from the owner to them.  Of course, the subcontractors will undoubtedly have an equally strong interest in resisting such clauses.