August 12, 2010

Massachusetts Adopts Landmark Subcontractor Payment Legislation

Holland & Knight Alert
Deborah S. Griffin

On August 10, 2010, Massachusetts Governor Deval Patrick signed new legislation recently passed by the Massachusetts legislature that will have a dramatic impact upon the Massachusetts construction industry. With this new law Massachusetts joins the majority of states restricting the enforceability of conditional payment contract clauses, also known as so-called “pay-if-paid” and “pay-when-paid” clauses, which are very common in private construction contracts. Massachusetts has also broken new ground by regulating change order processing and payment on private construction projects. The new law becomes effective November 8, 2010, and under its terms project owners, contractors and subcontractors of any tier who fail to act timely on a pay application or a request for extra compensation will be deemed to have automatically approved the request unless they affirmatively reject it within applicable time limits. For this reason, among others, it is essential that owners and contractors understand the new law and manage its effects proactively.

Contracts Affected

The new law will apply to all projects with prime contracts of $3 million or more that are signed on or after the effective date of the statute, November 8, 2010, and to all subcontracts of any tier under those prime contracts. Any contract eligible for rights under the Massachusetts lien law, Chapter 254, except on residential projects of one to four units, is covered. Because the law applies to prime contracts – not just to subcontracts – owners as well as contractors and subcontractors are affected.

New Contract Clauses Are Required

Each affected contract or subcontract now must specify:

  • billing intervals of no more than 30 days, except that the initial billing period may be up to 14 days longer
  • a deadline of no more than 15 days by which the owner must either approve or reject the pay application, in whole or in part; the deadline for each tier below the owner is seven days longer than for the tier above it
  • a deadline for payment no more than 45 days after approval of a pay application
  • a deadline of no more than 30 days for an owner to approve or reject a written request for additional compensation due to a change; the deadline for each tier below the owner is seven days longer than for the tier above it

Payment Processing

The 30-day limit on billing intervals means that progress payments tied only to actual progress milestones will not be permitted if they result in more than 30 days between billings. This provision applies to periodic progress payments but does not refer to final payment or bonuses.

A pay application that is neither approved nor rejected by the deadline is deemed automatically approved. Approval starts the next time interval – for payment – but can be reversed by actual rejection any time up to the payment deadline. A “deemed” approval remains in effect if not reversed before the payment deadline. As a result, the payment deadline must be carefully tracked and heeded so that the opportunity to reject is not lost by inattention. Any rejection must be made in writing and must include an explanation of the “factual and contractual basis for the rejection and must be certified as made in good faith.” There is no limitation on the grounds for rejection, so long as there is a good faith basis for it.

The time for payment of an approved pay application starts running upon either actual, express approval or deemed approval resulting from inaction within 15 days of submission of the pay application. Since payment becomes due a certain number of days after approval, provisions that express the due date on receipt of payment from a higher tier – pay-when-paid clauses – are likely ineffective. The statute is quite clear that pay-if-paid clauses that condition the obligation to pay on receipt of payment from a higher tier now are enforceable in only two exceptional circumstances, and then only if the exceptions are stated explicitly in the contract.

The first exception applies where the upper tier payment was withheld because of non-performance or substandard performance of the person seeking payment. In order to enforce a conditional payment provision in this situation, the person seeking payment must have been given notice and opportunity to cure in accordance with contractual cure provisions, or, if the contract does not have a cure period, within 14 days.

The second exception applies where the upper tier payment was due from a party that has become insolvent, or becomes insolvent within 90 days, and the party seeking to enforce the conditional payment provision fully exercised its lien rights on the project at the start of its on-site performance and has not dissolved its lien. This means that a party that wants to be in a position to enforce a conditional payment provision downstream in the event of owner (or other upstream) insolvency must file a notice of contract (or, in the case of lower tier subcontractors, a notice of identification) before submitting the first pay application for on-site work. Among other factors, parties will now have to balance the risk of such a filing disrupting a good relationship with an owner against the risk of the owner becoming insolvent during the project.

In addition to prompt and continuous enforcement of lien rights, one seeking to enforce a conditional payment provision in the event of owner or other upstream insolvency must diligently pursue all other reasonable collection rights and remedies unless they are not likely to be fruitful. The statute contains notice and expedited dispute resolution provisions to avoid guesswork as to what remedies must be pursued. Significantly, even in the limited situations where a conditional payment clause can be enforced, the person seeking payment cannot be not precluded from enforcing their lien rights under Chapter 254, and the person whose property is subject to the lien cannot defend by arguing that payment is not yet due because of a conditional payment clause.

Change Order Processing

The right to extra compensation for changes can now arise before completion of a formal change order. A time period for approval or rejection starts to run when a written request for increased compensation is submitted or performance of the extra work starts, whichever is later. As with pay applications, inaction by the deadline means the request is deemed automatically approved, subject to reversal by actual rejection by the time payment of the extra compensation is due. Once the request is approved, either expressly or by inaction, the additional compensation can be included in the next regular pay application even if normal change order paperwork is incomplete. As with pay applications, a rejection of a request for additional compensation can be based on any valid reason and must be certified as made in good faith.

Right to Seek Dispute Resolution

Contract provisions requiring that all disputes be held until the end of a project before dispute resolution procedures can be invoked cannot be fully enforced with respect to disputes over rejection of pay applications and requests for additional compensation. At most, such provisions can require the one whose request for payment or a price increase is rejected to wait 60 days before beginning dispute resolution procedures.

Right to Suspend Work for Overdue Payment

The new law also weakens contract provisions requiring contractors to continue their performance in the face of nonpayment. Contractors now have the right to suspend work if a payment becomes more than 30 days past due unless non-payment is due to a dispute regarding the quality or quantity of the construction furnished by the person seeking to suspend work or a default by that person after approval of the overdue payment and prior notice has been given of the dispute or default.

This new statute will undoubtedly prompt significant changes in both construction industry business practices and contract terms at all levels. This alert only paraphrases and summarizes the new statute, however, and the actual statutory language should be reviewed carefully in developing new practices and contract language. The new law is Chapter 293 of the Acts of 2010, and is codified at Massachusetts General Laws chapter 149 § 29E. We recommend that all industry firms conduct a thorough review of both standard and custom contract terms in order to identify potential revisions needed to comply with and mitigate the effects of the new statute.

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