To update our previous post, Colorado Senate Bill 12-181 regarding construction contracts failed today in the Senate Business, Labor and Technology Committee by a vote of 6-1.
A last minute bill has been introduced in the Colorado Senate. Colorado Senate Bill 12-181, introduced last week by State Senator Lois Tochtrop, proposes new requirements related to construction projects in Colorado. These proposed changes are not favorable to property owners in Colorado and will limit the ability of property owners to negotiate business terms in their construction contracts. SB 12-181 is set for a hearing before the Senate Business, Labor and Technology Committee on Wednesday, May 2, 2012.
SB 12-181 applies to “Building and Construction Contracts” which is defined as any contract subject to Title 38, Article 22 of the Colorado Revised Statutes, Colorado’s mechanics’ lien law. SB 12-181 contains the following points:
- Colorado Law Must Apply. Any provision in a Building or Construction Contract for work to be performed in Colorado that makes the contract subject to the laws of another state or contains a dispute resolution provision governed by the laws of another state, is void and unenforceable.
- Parties Cannot Contract Around Colorado Mechanics’ Lien Law. Any provision in a Building and Construction Contract that requires a contractor or subcontractor to waive its right to file a mechanics’ lien or claim against a payment bond prior to being paid is void and unenforceable.
- Payment to Subcontractors and Suppliers Required Within 7 Days. All principals, general contractors and subcontractors must pay their subcontractors and material suppliers within seven days of receipt of services.
- Mandatory Interest Penalty; Costs and Attorney Fees Award. A 1.5% monthly interest penalty applies to all unpaid amounts, and subcontractors and suppliers who successfully sue to collect this interest penalty will also be entitled to collect their costs of suit, including attorney fees.
- Monthly Progress Payments Required; Retainage Amounts Capped. Property owners or parties responsible for payment must make monthly progress payments to the general contractor unless the Building and Construction Contract specifies otherwise, and owners or payment parties may only reserve as retainage a maximum of 5% of each payment.
- Change Orders. General contractors must submit the costs of any change orders to owners for payment within 30 days of the change order. Owners or payment parties will be required to pay at least 50% of any disputed change order amounts.
A few months ago, I wrote about a recent Colorado Court of Appeals decision that gave a broad interpretation to the Colorado Trust Fund Statute. That decision highlighted the importance of maintaining strict accounting practices and segregating funds for each separate construction project. As a follow up to that post, I would like to highlight a particular accounting practice that has the potential to create liability under the Trust Fund Statue while also invalidating mechanics’ liens filed by subcontractors.
General contractors often use the same supplier or subcontractor on multiple projects. Sometimes a newer project will pay out much quicker than an older project, whether because of construction issues that need to be resolved or delays in payment from the property owner. In these situations some contractors decide to enter into arrangements with their subcontractors whereby invoices get paid based on aging rather than on a project by project basis. This might be because neither the contractors nor the subs like to show past due accounts payable/receivable on their financial statements, or maybe the subcontracts provide for steep interest payments on past due invoices.
Whatever the motivation, the contractor and the sub often view this practice as harmless. However, upon closer scrutiny, these types of arrangements can become disastrous for both contractors and subcontractors. For example, if an older project never pays out as expected and the contractor is left with a shortage of funds, then that contractor will likely face liability under the Trust Fund Statute (to a property owner and/or other subcontractors) for diverting funds from one project to pay for the expenses of another.
Meanwhile, the subcontractor whose invoices were paid based on aging, rather than on a project by project basis, is likely to have some unpaid invoices. In such a case a subcontractor would usually protect itself by filing a mechanics’ lien against the property for which it did work and did not get paid. However, this subcontractor will have a difficult time enforcing a mechanics’ lien for the newer “unpaid” invoices because it in fact already got paid with funds from that very project – those funds were simply misapplied to an older invoice for a different project.
While it can be tempting to maintain informal accounting practices with long standing and trusted subcontractors or suppliers, both sides need to ensure that they properly account for all funds so as not to run afoul of the Colorado Trust Fund and Mechanics’ Lien statutes.
Photo by laffy4k (Flickr)
As Jamie C. Belgum reported in the Colorado Bar Association’s Business Law Newsletter, the Colorado Court of Appeals recently decided a case that gives broad interpretation to the Colorado Trust Fund Statute, C.R.S. § 38-22-127.
The Trust Fund Statute requires contractors to hold funds they receive for a project in trust for the payment of subcontractors. That means if a contractor receives a disbursement from a construction loan or a payment from a home purchaser, the contractor has to use that money to pay subcontractors before paying any general business expenses.
The question presented in AC Excavating, Inc. v. Yale is whether the Trust Fund Statute reaches a manager’s voluntary monetary contribution to his own construction company. Mr. Yale loaned $157,500.00 to his construction company, Antelope Development, LLC, whose sole project was the construction of a retention pond for a golf course community. Yale directed Antelope’s use of the funds to pay general business expenses, including interest on municipal bonds that secured Yale’s loan. AC Excavating, a subcontractor, sued Yale under the Trust Fund Statute for misapplying the funds he himself contributed.
The Court took a broad reading of the statute saying that it reached all funds disbursed irrespective of the intent of the disburser. The Court further held that since Antelope had only one bank account and one project it was clear that the funds were “for the construction project” for which AC Excavating did work. Putting aside the question of whether the Court accurately interpreted the statutory language, there is still some hope for owners/managers seeking to recapitalize their construction company without subjecting themselves to trust fund liability:
- Contractors should set up separate banking accounts for each project into which they can deposit disbursements made specifically for that project. A subcontractor should only be paid from the account for the project for which that subcontractor did work.
- A separate account should also be maintained for general business expenses (i.e., office materials, equipment leases, rent, pay-roll, and marketing). Owners should deposit infusions of capital into the general business account when they plan on using such capital to pay general business expenses.
- Any money left over in a project account after all subs have been paid can then be transferred to the general business account to pay general expenses and profits.
With cash flow tight it is easy to rationalize moving money around to help a struggling project, but to avoid liability under the Trust Fund Statute (which is often non-dischargeable in bankruptcy) contractors must maintain strict accounting practices. Still, with ever broader interpretations of the Trust Fund Statute contractors can never be entirely safe from liability.
Photo from The Library of Congress (Flickr)
Whether caused by the failure to follow precise escrow instructions or inattention to detail by one or more of the parties to a closing or payoff, the indebtedness secured by a lien on real property is often satisfied, but such lien is not released of record. Title companies conducting closings often close on a payoff letter from the holder of the debt, without having obtained a lien release on the date of closing. Many times, such lien release is not subsequently obtained and recorded, leaving the property owner with a cloud on its title. Fortunately, Colorado law offers some guidance and leverage for those who find themselves in that situation.
C.R.S. 38-35-124 requires that the creditor or holder of an indebtedness secured by a lien on real property release that lien of record with ninety days following the satisfaction of such indebtedness and receipt of reasonable costs to release the lien unless: (i) the debtor requests that the lien not be released, or (ii) the person satisfying the indebtedness requests in writing that the holder of the debt deliver to him or her the cancelled instrument of indebtedness (e.g. the promissory note) at the time of satisfaction, in which case the creditor is relieved of any further obligation or liability under C.R.S. 38-35-124 after such delivery has been completed. Any creditor or holder of the indebtedness who fails to comply with Section 38-35-124 is liable to the owner of the real property encumbered by such indebtedness and to any other person liable on such indebtedness for all actual economic loss incurred enforcing the rights provided under Section 38-35-124, including reasonable attorney fees and costs.
If nothing else, “reminding” a creditor that fails to release its lien of the foregoing statutory requirements will likely persuade an otherwise unmotivated (former) creditor to aid in clearing title to your property.