ConstructionRisk Report (May 2023)

Inside this Issue

• A1 - Engineer Satisfied State Licensing Requirement by Using Licensed Independent Contractor as its Licensed Full-Time Registered Professional Engineer Manager
• A2 - Pay-If-Paid Clause Enforced in New Jersey

Article 1

Engineer Satisfied State Licensing Requirement by Using Licensed Independent Contractor as its Licensed Full-Time Registered Professional Engineer Manager

See similar articles: Independent Contractor | professional license

Where a state law requires engineers to designate a full-time person or “manager” as being in “responsible charge” of engineering activities, the state agency responsible for administering the statute found an engineer in violation because it used a used an independent contractor instead of an employee to perform that role.  This was reversed by the court which held that an “independent contractor” can be the “manager” of the employee’s personnel.  “In today’s world, it is not at all uncommon for a manager to be an independent contractor rather than a W-2 employee.”  TWISM Enterprises, LLC v. State Board of Registration for Professional Engineers and Surveyors, 2022 WL 17981, (Ohio Supreme Ct., 2022).

TWISM, a small start-up firm, applied to the Board for a certificate of authorization. TWISM's application designated James Cooper as its manager. Cooper attested that he is a full-time engineer “in responsible charge for and in charge of the professional engineering * * * activities and decisions of the firm.” Cooper represented that he provides engineering services to TWISM on a per-project basis and that he provides all of TWISM's engineering services. TWISM's operating agreement lists Cooper as a “manager” “vested with the management” authority “to oversee the day to day operations of the engineering department.” For tax purposes, the firm reports his income to the IRS as an independent contractor on a form 1099, rather than withholding and reporting his income as an employee under a W-2 tax form.

In denying TWISM’s application, the Board stated that the firm “failed to designate one or more full-time partners, managers, members, officers, or directors as being responsible for and in charge of professional engineering activities and decisions for the firm.” In the Board's view, a manager had to be a “W-2” employee rather than a “form-1099” independent contractor.

Two problems with the application were identified by the Board. First, Cooper did not work “full time” for TWISM.  It pointed to Ohio Adm. Code 4733-39-02(B)’s definition of “full-time,” which requires more than 30 hours of work weekly or “working substantially all the engineering or surveying hours for” the firm. According to the court, “The Board … never explained why Cooper, who indisputably performed “all the engineering hours” of TWISM, failed to meet this definition.”

Second, the Board found that TWISM did not satisfy the requirement that it have a full time “manager.” The Board said that it was necessary that the holder of the certificate of authorization have control over the professional engineer's activity and “[t]hat control is ensured by an employer/employee relationship.” Thus, the Board adopted a hardline rule that R.C. 4733.16(D) requires formal W-2 employment; and a business may not designate an independent contractor as professional engineer.

The court stated:

“In the administrative proceedings and lower courts, the Board maintained that Cooper cannot work “full-time” as an independent contractor—only an employee can satisfy R.C. 4733.16(D)’s full-time requirement. Now, the Board argues that Cooper, in his independent-contractor capacity, cannot possibly be “responsible for and in responsible charge of” TWISM's engineering services. Both arguments rely on the legal status of an independent contractor.

The Board's own regulations define “full time” as including someone who works all the engineering hours of the firm, and there is no dispute that Cooper meets this requirement. And there is nothing in the term “manager” that requires someone to be a W-2 employee instead of an independent contractor. In common parlance, a manager is simply “one that manages” or “a person that conducts, directs, or supervises something.” Webster's Third New International Dictionary 1372 (2002) … In today's world, it is not at all uncommon for a manager to be an independent contractor rather than a W-2 employee.

In the court proceedings the Board argued that “independent contractors may be managers, but they cannot be managers who are in responsible charge of and responsible for the hiring entity's work.” TWISM's operating agreement provides that Cooper, as manager, is “responsible for and in responsible charge of the professional engineering activities and decisions for TWISM Enterprise, LLC.”

The Board contends that it is legally impossible for Cooper to satisfy those conditions. “Responsible for” and “in responsible charge of,” the Board says, are terms of art with distinct, technical meanings in the engineering profession. Their specialized meanings, adds the Board, involve a degree of “liability,” “supervision[,] and control” that only an employee, never an independent contractor, could possess.”

As further explained by the court:

The Board contends that Cooper cannot be in responsible charge as an independent contractor because TWISM lacks the ability to control the mode and manner of his work. But that misses the point. The applicable language in R.C. 4733.16(D) requires the registered engineer to be in responsible charge of the engineering activities of the firm; it says nothing about the firm's control over the manager. Quite simply, the Board's concern for TWISM's control over Cooper is unconnected to the text of R.C. 4733.16(D).

The Court found that the Board was presenting policy arguments that it tried to dress up as statutory ones. The critical point, found the court was that “these are arguments why an independent contractor should not be allowed to be a firm's manager, not arguments about whether R.C. 4733.16(D) allows a firm to hire an independent contractor as manager. They are arguments about what the Board would like the statute to say, not about what it does say. And for this reason, they are best addressed to the General Assembly.

In conclusion the court stated, “If the General Assembly meant to require an employment relationship, it easily could have done so.”  It held that the firm satisfied the legal requirements and is therefore entitled to a certificate of authorization to provide professional engineering services.

 

About the author: Article written by J. Kent Holland, Jr., a construction lawyer located in Tysons Corner, Virginia, with a national practice (formerly with Wickwire Gavin, P.C. and now with ConstructionRisk Counsel, PLLC) representing design professionals, contractors and project owners.  He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects.  He is publisher of ConstructionRisk Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932.  This article is published in ConstructionRisk Report, Vol. 25, No. 4 (May 2023).

Copyright 2023, ConstructionRisk, LLC

Article 2

Pay-If-Paid Clause Enforced in New Jersey

See similar articles: knock-out rule | Pay-If-Paid | unilateral contract modification

Where subcontractor executed a contract containing a pay-if-paid provision, the contractor subsequently used that clause as a basis to refuse paying for work performed by that sub because the project owner refused to pay the Prime for that same work.  In New Jersey no statute or caselaw prohibits pay-if-paid clauses.  The appellate court held that because there were disputed facts concerning whether Prime contractor conduct caused the Owner to not pay for the services, the trial court should not have dismissed the subcontractor’s complaint for payment. JPC Merger Sub, LLC v. Tricon Enterprises, Inc., 286 A.3d 1186, 474 N.J. Super. 145 (2022).

In this case the Sub entered into a purchase order with the defendant prime contractor.  The Sub made unilateral changes to the text of the purchase order despite the printed wording stating that no changes would be accepted.  New Jersey applies the “knock-out” rule where there are conflicting terms in a contract like this one and that means the subcontract would be interpreted under the Uniform Commercial Code wording instead.  The trial judge found a “conflict” in what was added by the Sub to the purchase order.   In contrast, the appellate court held the knock-out rule was not applicable to the pay-if-paid clause because there were no “conflicting terms” in what the subcontractor added to the purchase order and the original text with regard to payment because one clause established a payment schedule while the other created an absolute precondition to payment.  This meant the pay-if-paid clause would be enforceable and the suit properly dismissed on summary judgment unless other factors came into play.

The facts giving rise to this complaint involve the purchase order for production of steel beams by the subcontractor.  The Sub received from the Prime a two-sided pre-typed PO for materials needed for the project. In the PO, the Prime offered to buy from plaintiff thirty-eight fabricated prestressed box beams for $12,000 each, totaling a fixed sum of $456,000. Although the front of the PO stated it was “[n]ot [v]alid [u]ntil [s]igned and [r]eturned in its [e]ntirety [w]ithout [m]odification,” the Sub’s president crossed out sections and made a number of changes. In the section concerning pay-if-paid, the Sub made changes shown in underlining the text quoted below.

PAYMENT. Tricon shall pay Vendor for the [w]ork furnished within fourteen (14) days after Tricon's receipt of payment from the Owner for such [w]ork, less retainage (if any) in the corresponding amount withheld from Tricon. Vendor understands and agrees that Tricon's obligation to make any payment to Vendor is subject to, and shall not exist unless and until, Tricon's receipt of payment on account of Vendor's [w]ork from the Owner the occurrence and satisfaction of which shall be a condition precedent to Tricon's duty to remit payment. Payment by Tricon shall not constitute acceptance of any [w]ork or [g]oods, nor shall tender of payment be a condition to Vendor's duty to furnish the [w]ork required hereunder.

The Prime paid the sub for the first two invoices but after the Sub completed production of the balance of the beams, the Prime refused to accept delivery of the beams or pay the remaining invoices plus the cost of storage for the beams.  This was because the Prime stated it could not use the beams because the County “failed to obtain the approval of Jersey Central Power & Light (‘JCP&L’) to move high voltage power lines that r[a]n precariously close to the [p]roject.” The Prime “anticipated using a crane to both remove the old bridge structure and install the [b]eams for the new bridge [p]roject.” However, “when JCP&L refused to move the power lines, the construction of the [p]roject became an impossibility” and the beams “remain[ed] unused.” Maqsood certified that “although Tricon ... invoiced [the County] for the cost of the [b]eams,” the County “failed and refused to make payment for the [b]eams” and “refused to accept delivery of the [b]eams.”  Because the Owner didn’t pay the Prime, the Prime didn't pay the Sub.

New Jersey Law concerning Pay-if-Paid. 

In New Jersey, there is no statute or published caselaw in New Jersey governing the enforceability of a pay-if-paid contract provision. Courts generally, however, require clear and unambiguous language before enforcing a pay-if-paid clause to block payment to a subcontractor. The court decision quoted decisions from courts in other states that explained: “[t]o create a pay-if-paid clause in a construction contract, the relevant contract terms must unequivocally state that the subcontractor will be paid only if the general contractor is first paid by the owner and set forth the fact that the subcontractor bears the risk of the owner's nonpayment.”

Another case quoted by this court stated: “Accordingly, in order to transfer this normal credit risk incurred by the general contractor from the general contractor to the subcontractor, the contract between the general contractor and subcontractor should contain an express condition clearly showing that to be the intention of the parties.”

Like other states, in New Jersey, freedom of contract “is a factor of importance.”  It is a “settled principle that parties bargaining at arm's-length may generally contract as they wish.” To that end, “parties may make contractual liability dependent upon the performance of a condition precedent.”

The court here stated:

“We believe that a prohibition against the use of pay-if-paid provisions as conditions precedent in construction contracts should come from the legislature rather than the courts. Thus, we hold that as long as the contract specifies a clear and unambiguous intent and agreement by the parties to shift the risk of nonpayment, a pay-if-paid provision is enforceable subject to the parties' implied duty to not frustrate conditions precedent to their performance.”

“A bedrock principle of contract law is that absent fraud, duress, mutual mistake or unconscionability — none of which are alleged here — a signed contract will bind both parties.”

Applying the Law to the Facts in this Case

Specifically addressing the applicability and enforceability of the pay-if-paid provision, the judge stated the provision:

“operates as an absolute condition precedent to Tricon's obligation to pay [plaintiff],” which is “only triggered once payment to Tricon is made.” The judge explained that “[c]ourts will ordinarily enforce contracts as written,” and found the pay-if-paid provision to be “clear and unambiguous on its face, ... shift[ing] the risk of loss resulting from nonpayment by ... the County ... from Tricon to [p]laintiff.” The judge concluded that “because the absolute condition precedent of Tricon's receipt of payment for the beams from the County was no[t] satisfied,” the pay-if-paid provision, “which was agreed to by all parties notwithstanding any proposed modifications,” was “triggered and Tricon [was] contractually excused from [remitting] payment to [p]laintiff.”

Having concluded that it was satisfied that the pay-if paid provision was clear and unambiguous, the court went on to state that “Ordinarily, we are content to let experienced commercial parties fend for themselves.”

Question of Fact Prevent Court from Granting Summary Judgment to Enforce the Pay-if-Paid Clause – Jury must decide

The Sub here argued that the even if the pay-if-paid clause might be generally enforceable in New Jersey, it should not be applied in the instance where the Prime’s conduct is what caused the Owner to not make payment. It argued  that a pay-if-paid provision can be enforced only when the project owner's nonpayment to the general contractor was the result of default or insolvency and not when nonpayment is due to the fault of the general contractor.

The court found that although the judge correctly found that the pay-if-paid provision was silent on the allocation of fault, there is a factual dispute as to whether the County's nonpayment was precipitated by the Prime’s “inadvertent actions, deliberate conduct, or poor project management.” Where a promisor “prevents or hinders” fulfillment of a condition which otherwise would have been fulfilled, “performance of the condition is excused” and the promisor's liability is “fixed” regardless of the condition's non-fulfillment. According to the Sub, the Prime mismanaged the project, failed to coordinate with utility companies, failed to conduct its own due diligence, and directed plaintiff to fabricate the beams before considering power lines and other obstructions.

In contrast, the Prime and its surety claim that the County's nonpayment to the Prime was not the inadvertent or deliberate fault of Prime and that the Prime did not act in bad faith.

These counter arguments demonstrate a genuine issue of material fact regarding the County's dispute with the Prime that resulting in nonpayment.  This will need to be resolved by trial instead of by summary judgment.

Contract Review Comment

What can a subcontractor do to protect itself when the contract contains a pay-if-paid clause?   We try to at a minimum add language stating that in the event of non-payment the subcontractor is entitled to cease performance.  We also try to add language stating that the subcontractor will be paid within a reasonable time even if the Prime has not been paid.  Here are a couple examples:   

1. 1. At the end of the payment clause add the following: “If any undisputed payment due under this Agreement is not received within sixty (60) days from the date of an invoice, Subcontractor may elect to suspend Services under this Agreement without penalty.” 
   2. Instead of just stating that the Sub can stop performance of work if it is not paid, we try to add the following: “Notwithstanding the foregoing, in no event shall Subcontractor be paid the uncontested amount of any invoice later than 90 days from submittal, and provided further that if payment is not made within 60 days of submittal, Designer, shall without further notice be entitled to suspend its services until payment is made.”

 NOTE: That in some states, even when a pay-if-paid clause is inserted in a contract, the courts hold that payment still must be made within some reasonable amount of time. But courts in other states may hold that the pay-if-paid clause absolutely bars the subcontractor from recovering payment if the Prime has not been paid by its client.  By negotiating some period of time to be paid in the event of non-payment by the client to the Prime, this may shift the risk more appropriately to the Prime.

 

About the author: Article written by J. Kent Holland, Jr., a construction lawyer located in Tysons Corner, Virginia, with a national practice (formerly with Wickwire Gavin, P.C. and now with ConstructionRisk Counsel, PLLC) representing design professionals, contractors and project owners.  He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects.  He is publisher of ConstructionRisk Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932.  This article is published in ConstructionRisk Report, Vol. 25, No. 4 (May 2023).

Copyright 2023, ConstructionRisk, LLC