Subcontractors Gain More Power Under New AIA Forms

This is the third in a series of articles discussing the 1997 editions of AIA documents issued for publication in October, 1997

The new AIA 401-1997, Standard Form of Agreement Between Contractor and Subcontractor, carries the endorsement of the American Subcontractors Association (ASA) and the Associated Specialty Contractors, Inc. (ASC). Representatives of these two national subcontractor organizations were also involved in the A201-1997 drafting negotiations. The presence of the ASA and ASC viewpoint is dramatically evident in the new documents.

Subcontractor payment is now expressly part of the A201-1997 payment process. In addition, A401-1997 incorporates A201-1997 by reference affording subcontractors protections from that document as well.

The prime contractor is now required to furnish information to enable the subcontractor to be able to file and enforce construction liens. Furthermore, if the prime contractor makes or defends a claim against the owner that relates to the subcontractor's work, the prime contractor must make the information relating to that claim available to the subcontractor.

There are termination for convenience clauses. If the owner terminates the prime contractor's contract for convenience, the subcontractor is entitled to payment for the work it has completed, plus costs associated with the termination, and "reasonable overhead and profit on the Work not executed." The prime contractor may also suspend the subcontractor's work for convenience, which entitles the subcontractor to an equitable adjustment including time and money.

Design delegation (or incidental design, as it is called by the AIA) often involves subcontractors, especially those who perform such operations as installation of curtain walls, or vendor-designed HVAC or sprinkler systems. This controversial issue will be discussed in more detail in a later column.

As in the 1976 and 1987 A401 subcontracts, the subcontractor may contact the architect directly to inquire about certain payment issues, including the percentage of work completed or applied for by the prime contractor. However, it is the payment issues beyond this right of inquiry that set the new AIA subcontract apart from most standard or model forms in the industry.

The payment process begins with the subcontractor's application for payment, which is passed through the prime contractor to the architect for processing. Once the architect issues a certificate of payment, the owner makes payment within the time set forth in the contract. Once the owner pays the prime contractor, it must pay the subcontractor "promptly". In both the 1987 and 1997 forms of subcontract, the prime contractor is precluded from requesting payment for work performed by the subcontractor if the prime contractor does not intend to pay the subcontractor for that work.

Subcontractor groups have consistently lobbied for direct pay by the owner. As a fall back, they have tried for trust fund or fiduciary status for payments by the owner to the prime contractor for subcontractor work. The AIA has continued to resist these entreaties, although A401-1997 goes further than past subcontract forms in assuring subcontractors of payment. For example, there is no conditional payment language in A401-1997. There is no "pay when paid" or "pay if paid" clause; there is simply a "pay" requirement.

The most complex and unfathomable aspect of the new AIA subcontract is contained in Article 9.6.7. In many states courts have imposed a fiduciary duty on prime contractor's with respect to money paid by the owner for work performed by subcontractors. These cases often arise in the context of an insolvent or bankrupt prime contractor who received the money, and before it could be passed on was subjected to claims by lenders, sureties, bankruptcy trustees, or the like. In some states statutes have been enacted to establish the prime contractor as "trustee" for these funds to assure the subcontractor that it will be paid for its work. If the prime contractor is a "trustee", or fiduciary of another sort, the prime contractor may be subject to tort liability, personal liability of corporate officers or directors, and even criminal penalties if the monies received for subcontractor work are diverted. In order to strike a middle ground between these extremes and an unfettered right by the contractor to do as it wishes with subcontractor money, the AIA has attempted to increase subcontractor rights to progress payments without increasing prime contractor duties or obligations.

In addition to the prime contractor's preclusion from requesting payment from the owner for amounts it does not intend to pay to the subcontractor in the ordinary course Article 9.7.6 of A201-1997 provides

Unless the Contractor provides the Owner with a payment bond in the full penal sum of the Contract Sum, payments received by the Contractor for Work properly performed by Subcontractors and suppliers shall be held by the Contractor for those Subcontractors or suppliers who performed work . . . for which payment was made by the Owner. Nothing contained herein shall require money to be placed in a separate account and not commingled with money of the Contractor, shall create any fiduciary liability or tort liability on the part of the Contractor for breach of trust, or entitle any person or entity to an award of punitive damages against the Contractor for breach of the requirements of this provision.

On its face, this clause requires the prime contractor to "hold" the money for the subcontractor, and therefore a court may find that the prime contractor does not receive legal title to the funds. However, the prime contractor is not precluded from commingling these funds with its own. This is an obvious attempt to give subcontractors an argument that such payments do not become part of the prime contractor's estate in Bankruptcy or subject to secured interests of the prime contractor's lenders or surety. Leading cases support this interpretation, although the right to commingle will cloud the issue and provide ample fodder for litigation. The question of when is a trust fund not a trust fund will loom large in the next recession.

Therefore, the new A401-1997 subcontract reflects the increasing power of national subcontractor groups in the drafting of standard documents, gives subcontractors some new and expanded powers, while attempting to balance the prime contractor's insistence that it deal with the contractual aspects of its relationship with its subcontractors without interference from the owner. The use of the "pay" clause, when combined with publication of the controversial new joint AGC/ASA/ASC subcontract form, indicates a definite shift away from conditional payment. If prime contractors want to utilize conditional payment language of the "pay when paid" or "pay if paid" variety they will have to modify this form, while subcontractors negotiating this issue now have a further arrow in their quiver to argue that conditional payment is no longer the standard in the industry.

This article is intended to inform the reader of general legal principles applicable to the subject area. It is not intended to provide legal advice regarding specific problems or circumstances. Readers should consult with competent counsel with regard to specific situations.

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