A CONTRACTOR’S RIGHT TO SET-OFF AMOUNTS FROM A SUBCONTRACTOR

UnknownOftentimes, subcontractors perform trade work for the same contractor on multiple projects.  Because of this, it is practical for contractors to include in the subcontract a provision that authorizes them to set-off the subcontract amount due to any defects, breaches, etc. by the subcontractor that occur on another project.  On the other hand, subcontractors that understand the ramifications of this provision, want to delete this provision from any subcontract in order to keep their receivables from one project completely separate from another project.

 

In Carolina Consulting Corp. d/b/a Barrier Wall of South Florida v. Ajax Paving Industries, Inc. of Florida, 2012 WL 163927 (2nd DCA 2012), a roadway contractor subcontracted the paving work on two separate projects (in two different counties).

 

After the subcontractor completed its work for the first project (“Project One”), a payment dispute arose whereby the subcontractor asserted it was owed more money than it was paid.  At this time, the second project (“Project Two”) had not begun and was severely delayed.

 

When Project Two was ready to commence, the paving subcontractor advised the contractor that it would not perform until it was paid in full for Project One and was issued a change order for the increase in material price due to the severe delay to the start date.  The subcontractor later stated that it would not perform until it received adequate assurances from the contractor of the contractor’s ability and willingness to pay for Project Two.  The contractor then terminated the subcontractor and hired another subcontractor to perform the paving work for Project Two at an increased rate and lawsuits between the contractor and paving subcontractor were initiated.

 

The trial court held the subcontractor was entitled to suspend its performance on Project Two until it received adequate assurance that it would be paid for the work.  The trial court further found that the subcontractor should be awarded approximately $119,000 for unpaid work for Project One and approximately $105,000 for the contractor wrongfully terminating the subcontractor on Project Two.

 

The contractor appealed to the Second District Court of Appeal maintaining that the subcontractor breached the subcontract for Project Two when it decided to condition its performance on the receipt of adequate assurances of the contractor’s ability to pay.  The Second District agreed and reversed the trial court.

 

In examining this issue, the Second District looked at Florida’s Uniform Commercial Code, particularly Florida Statute s. 672.609(1), dealing with the sale of goods.  This statute, in short, provides that “a merchant has the right to demand adequate assurance of performance ‘[w]hen reasonable grounds for insecurity arise with respect to the performance of’ the other party.”  Carolina Consulting, 2012 WL at *2.

 

The Second District, however, noted that it previously declined to address whether this right under the Uniform Commercial Code applies in the context of construction contracts. The Court further declined to address this issue in this case.  Rather, it stated that under the facts of the case, the subcontractor did NOT have a reasonable basis to demand adequate assurances from the contractor because the contractor had a payment bond (which is designed to guarantee payment to subcontractors and suppliers, etc.)For this reason, the Court maintained that the subcontractor breached the subcontract for Project Two and the contractor had the right to set-off amounts for the breach for Project Two for any amounts the contractor may have owed the subcontractor for Project One.

 

On this point, the Second District stated:

 

Under the terms of both subcontracts, upon Ajax’s [subcontractor] breach of subcontract, the contractor had the right to hire another subcontractor to perform the work and then deduct the cost from any amount owed to Ajax in connection with the Pasco County subcontract [Project One].

 

This bolded language seems to suggest that the contractor’s subcontract included a provision that allowed it to deduct or set-off amounts owed on one project due to defects or breaches on another project.  However, even without this contractual language, it would seem that any amounts owed to the subcontractor for Project One would be offset by any amounts owed to the contractor for Project Two (due to the subcontractor’s breach of that subcontract).  In this scenario, the outcome could be the same irrespective of the contractual language.  Although, without the contractual set-off language, and assuming the contracts permitted prevailing party attorneys’ fees, it would seem that the subcontractor would be entitled to its fees for the contractor’s breach of the subcontract for Project One and the contractor would likewise be entitled to its fees for the subcontractor breaching the subcontract for Project Two.  With the contractual set-off language, it is highly possible that the subcontractor would not be entitled to recover its fees for the contractor’s breach of the subcontract for Project One because the contractor had the contractual right to set-off such amounts due to any breaches associated with Project Two.  This is a confusing but important distinction.

 

As it relates to the subcontractor demanding adequate assurances, this case is important because it illustrates that if the contractor has a payment bond, it will be very difficult for a subcontractor to ever condition its performance on demanding adequate assurance of the contractor’s ability to pay (i.e., its creditworthiness).  While, irrespective of the payment bond, such an argument seems extremely challenging if made under the Uniform Commercial Code–many times contracts (particularly prime contracts) will include language that allows a contractor to demand adequate assurance of the paying party’s creditworthiness.  Even with this contractual language, it will still be a difficult argument to make if there is a payment bond in place.  Also, expanding this rationale, because of lien rights, a court may find that because a contractor/subcontractor has the right to lien the project (a subcontractor can lien the project if there is not a payment bond), it is really never in the situation to reasonably condition its performance on adequate assurances because it could preserve or try to collateralize its payment claim by recording a lien on real property as well as pursue a breach of contract claim against the nonpaying party.

 

Please contact David Adelstein at dadelstein@gmail.com or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.

Spread the love
Posted in Contract Drafting, payment bond, set-off and tagged , , , .