Risk Management Articles
Doing Business In Other States
By Susan L. McGreevy & Paul Odum
It is easier than ever to expand a business. Technology has made it easier to run jobs from locations far from the construction site. There are, however, significant risks associated with leaving the markets which you are familiar with to do business in other states. The legal landscape concerning construction issues may be far different across the state line. In fact, it is likely that an identical contract put into effect in two different states will lead to different results in a variety of potential disputes.
The risks associated with doing business in states you are not familiar with are manageable. First, you need to know the potential trouble areas. These hotspots are the focus of this outline. Second, you need a plan to deal with these potential problems. Often times, the issue can be as simple as making certain that your companies' registration and licenses are current in the states you are doing business. Other issues may be more complicated and require some advice from an attorney to change contract language to make sure your contracts mean what they say. In all cases, knowing the risks is the key. Cautious in going into new markets.
The purpose of this discussion is not to explain to you the laws of other states. You will need the advice of attorneys licensed in each state. The purpose of this discussion is to point out a few of the areas where we see contractors and designers get "bitten" most frequently - to make sure your antennae are up and that you protect yourselves.
- Contractors' Licensure
- Licensure Requirement. Many states require some form of licensure of general contractors and/or subcontractors. Also, there are many cities which require licensure and payment of fees.
- Unenforceability of Unlicensed Contract. Several states, including Michigan, California, Arizona, Arkansas, Utah, Washington and New York, have refused to permit unlicensed contractors to enforce their contracts.
Example: Subcontractor in Arkansas could not recover its contract balance from a general contractor for the work it had performed where an Arkansas statute prohibited subcontractors from entering into subcontracts in excess of $20,000 without being licensed by the state. Williams v. Joyner Cranford Burke Const. Co., 685 S.W.2d 503 (Ark. App. 1985).
No Quantum Meruit/Unjust Enrichment. In some states, even if a contract isn't enforceable for some technical reason, courts will sympathize with the plight of a contractor who did work to improve someone else's property and wasn't paid for it. Those courts can make an award in "quasi-contract" based on a legal theory that the owner would be unjustly enriched if he wasn't required to pay the contractor, and the measure used to arrive at the amount to be paid is "quantum meruit" - or the value of the improvement. Even among the courts that will normally allow such a recover, however, most will still refuse to enforce a contract if the contractor lacked the proper license. See Hester Diamond, Inc. v. Teplitz, 554 N.Y.S. 2d 200 (N.Y. App. 1990). The courts seem to feel that the contractor's failure to obtain a license is so serious that it bars the contractor from any recovery for its work.
Design Professionals' Licensure
- Licensure Requirement. All states regulate the practice of architecture and engineering and require the licensure of individuals practicing those professions. Some are much more rigorous about permitting reciprocity than others
- Unenforceability of Unlicensed Contract. Again, several states, including Missouri, have enacted statutes which provide that contracts for the provision of architectural or engineering services by an unlicensed person are void.
- The Design-Build Dilemma. The statutes described above often create problems with contractors leading design-build teams. When a contractor enters into a design-build contract, it is agreeing to provide architectural and engineering services to the owner. In states like Missouri, such a contract is arguably unenforceable because of the licensure statute which states:
every contract for architectural or engineering . . . services entered into by any person who is not a registered . . . architect or . . . professional engineer . . . shall be unenforceable . . .
R.S.Mo. § 327.461. If the contractor leading the design-build team is not a licensed architect or engineer, the design-build contract with the owner may be unenforceable. Haith & Co., Inc. v. Ellers, Oakley, Chester & Rike, Inc., 778 S.W.2d 417 (Mo. App. 1989). This means that the owner need not pay the design/builder for any services - including all the construction - if the contract also included design. The owner can even sue to get back money already paid, and end up with a complete project for free.
Other Licensure Concerns
Some states have licensure requirements for environmental remediation firms which perform soil remediation or hazardous materials abatement (e.g., asbestos, lead based paint, etc.) The same concerns discussed above apply. Knowing and understanding the licensure requirements and making certain that all entities on a given project are appropriately licensed is a key to avoiding problems when doing business in any state.
Registration/Authorization to do Business
All states have laws which require foreign corporations (defined as any corporation not organized under the laws of that state) to register to do business in that state before "doing business" there. The laws ensure that corporations pay their taxes, designate registered agents in the state, and take the other steps to comply with the state's corporation laws. What constitutes "doing business" can vary from state to state, so it is imperative that you check this out before entering contracts, placing purchase orders - even our old friend the "letter of intent."
Problems arise when companies fail to register to do business or do not keep up with their annual filings. The biggest problem is that a corporation cannot maintain a lawsuit in a state in which it is not authorized to do business.
- In most cases, the problem is easily fixed - proper registration is retroactive. It may require you to pay accumulated fees or franchise taxes however.
- Mechanic's lien foreclosure deadlines can cause serious problems, however, where the authorization to do business problem cannot be fixed before a statute of limitations runs.
- Worst case scenario - companies can lose their right to go to court to collect.
Another problem that can arise from not being registered is that someone could file a lawsuit against you and get a "default" judgment without your knowledge, so that the first time you learn of it is when your bank account has been garnished. This can happen because you did not appoint a registered agent for the purpose of receiving such official notices.
Becoming registered and obtaining a registered agent are usually not difficult to do, and in most cases don't take much time or money. This does vary greatly from state to state, and it is important to find out what the process is before starting work. Remember that fees and taxes may be applicable, and registration makes you easier for the state to locate, too!
Mechanic's Lien Rights
The mechanic's lien and public works bond laws of each of the states are so different that it is hard to even give a general perspective on the differences. The following is a list of certain areas of lien and bond laws which vary widely from state to state:
- Notice requirements - Some states, such as Texas, have preliminary notice requirements during construction. Other states, such as Missouri, have notice requirements prior to filing a lien. Still other states, such as Kansas, have no notice requirements. And states such as California give potential claimants greater rights if they go through the notice steps before delivering goods of performing work.
- What is lienable? In some states, the entire property can be sold, and in others only the "improvements." In some states, contracts with lessees or tenants cannot give rise to lien rights (or what it takes to create a right against the owner of the property may be difficult to prove). In some states "services" (such as design services) are lienable only if the design is used for an improvement (such as Kansas), while in others the designer can file a lien whether the improvement was made or not (such as Missouri).
- Time to file lien - This can be as short at 30 days or as long as the statute of limitations. Some states have no "claim" procedure at all. You merely file suit. It can be different if your contract is with the owner or another contractor (shorter time to file for lower tier subs in Kansas and Texas. The time is the same for all in Missouri.)
- Time to file suit to foreclose on lien - normally is the same for all claimants, but can vary from state to state. It can be triggered by a public filing of the owner indicating that the project is complete.
- When time starts to run - Is it from when your work is completed or when the entire project is completed? Will punchlist work qualify?
- Rights of architects, engineers, and environmental professionals. The laws vary tremendously from state to state. For example, an engineer may be able to file a lien but another professional cannot. NOTE: We have prepared a 50-state survey of lien rights of design professionals. Please let us know if you would like a copy.
- Defenses to liens - Will the owner be able to defend the lien action on grounds that it already paid its contract price? In some states, the owner is expected to protect itself by securing lien waivers from all subs and suppliers before paying the contractor, and if it fails to do this, will be exposed to paying twice to unpaid subs and suppliers. In other states, the burden is on the subcontractor to protect itself. Many states have intricate monthly, ongoing notice requirements which require massive amounts of paperwork (such as Texas' McGregor Act), which seek to "balance" the burden between the owner and the subcontractor.
- Lien priority. Will a mechanic's lien come ahead of a mortgage on the property, or behind it, or equal with it? The law varies.
- Waiver of lien rights in advance - Some states, such as Pennsylvania and Tennessee, permit such a waiver. In others, like Missouri and California, an advance waiver of lien rights is void as against public policy.
- Mechanic's lien waiver forms - In states like California, there are special partial and final lien waiver forms which are required by statute. Many other states require forms which must be executed at various time during construction to preserve lien and bond claim rights.
- "Bonding off" mechanic's liens - Although most states allow owners or contractors to remove the "cloud on title" by posting a bond, and transferring the claim from a lien claim to a bond claim, not all states allow this (Missouri does not). Among the others that do permit transfer bonds, in some states (such as Kansas) the party opposing the lien has to give up its "technical" defenses (such as the lien having the wrong property description, or improper service of the lien) if it wants to replace the lien with a bond. The amount of the bond that has to be filed could be the value of the lien, 125% or 150% or 200% of the value of the lien, or the value of the original contract.
- Public works bond rights - Nearly, but not all, states require bonds to be posted for public work. However, what constitutes "public" work will differ from place to place. Some states don't dictate the form of the bond, while in other states the form of the bond is set out in the statutes.
An identical contract or subcontract put into play in two different states may have huge differences in its effect. The courts in the different states have reached opposite results when interpreting certain contract provisions. Further, state legislatures have stepped in and made contract clauses which are readily enforced in some states, unenforceable in others. The following are a few contract clauses which differ in their effect from state to state.
Pay When Paid/Pay If Paid Clause
- What do these phrases mean?
- If the clause is just talking about the sequence of payment ("after we get our check, we'll give you yours") it is considered "pay when paid."
- If the clause is instead shifting the risk of non-payment ("if the customer doesn't pay me, you won't get paid at all") it is considered "pay if paid."
- Courts and legislatures don't like pay-if-paid, and do whatever they can to prevent enforcement and, in effect, turn it into a pay-when-paid clause - their theory: the sub has no way to gauge finances of the owner, and can't protect itself since the general contractor has all the contact with the owner.
- In some states, including Illinois, Maryland, North Carolina and Wisconsin, statutes have been passed to make pay-if-paid clauses unenforceable.
- In other states (New York and California), courts have said that pay-if-paid clauses violate public policy and are unenforceable.
- In still other states, courts have stated that they will enforce pay-if-paid clauses if the clause is clearly written - including both Missouri and Kansas. This usually requires explicit language such as "condition precedent" or "assumes risk of non-payment by the owner" - Louisiana, Michigan, and Georgia.
Venue/Forum Selection Clauses
- What are these clauses?
- Attempts to choose or limit, in advance, the location of any eventual lawsuit.
- In some states, all forum selection clauses are unenforceable. Arkansas, Florida, Illinois and Texas are examples of states where the courts have held that forum selection clauses violate public policy.
- Other states apply a "reasonableness" test such that forum selection clauses will be enforced in limited circumstances. California, Iowa, Kentucky, and Minnesota are examples of states which have adopted this view.
- Statutes may preclude the enforceability of "reasonable" forum selection clauses. The Miller Act, which confers jurisdiction on the federal district court where the project is located, is an example. Also, state mechanic's lien laws often contain venue provisions which will trump a reasonable forum selection clause if lien rights are at issue.
- What are these clauses?
- Indemnification is a promise by Entity A (Indemnitor) to pay Entity B (Indemnitee) back if Entity B has to pay for a problem created by Entity A.
- Different kinds of indemnity
- Some indemnification clauses obligate the Indemnitor to only pay the Indemnitee to the extent that the Indemnitor caused the problem. These clauses are universally enforced by the courts in every state.
Example: Indemnitor subcontractor and Indemnitee general contractor are each 50% responsible for property damage which occurred on the job site. Owner sues for the full amount of damage, wins and collects 100% from the general contractor. Indemnitor subcontractor will have to pay back the Indemnitee general contractor 50% of the loss.
- Other indemnification clauses go further and obligate the Indemnitor to pay the Indemnitee for the full amount of the loss if the Indemnitor was at all at fault.
Example: Indemnitor subcontractor and Indemnitee general contractor are each 50% responsible for property damage which occurred on the job site. Owner sues for the full amount of damage, wins and collects 100% from the general contractor. Indemnitor subcontractor will have to pay back the Indemnitee general contractor the full 100% of the loss even though the sub only caused 50% of the loss.
- Some courts have refused to enforce this second type of indemnification clause - Texas.
- Some state legislatures have enacted statutes making these clauses invalid or limiting the circumstances in which they may apply (e.g., only where the loss is insured and the indemnitor has recovered the cost of the insurance in its contract - Missouri, California, Illinois, Minnesota.
- Other courts have seen no problem in enforcing these agreements.
No Damage for Delay Clauses
- What are these clauses?
- Contract clauses which purport to limit or eliminate one party's responsibility to pay another party damages arising out of delays which occur during construction, regardless of whose fault the delays are.
- Frequently, they will say that the contractor can get an extension of time, but no money.
- In some jurisdictions, these clauses aren't enforceable in any contracts - Washington state, Ohio.
- In other jurisdictions, no damage for delay clauses aren't enforceable in public contracts - California, Colorado, North Carolina, Arizona, Virginia, Missouri.
- In other states, no damage for delay clauses are enforced as written.
- In still other states (including Kansas, New York and Virginia), the clauses are enforced, but there are numerous exceptions to that enforceability. The exceptions include:
- Active interference by the party disclaiming responsibility for delays. Peter Kiewit & Sons' Co. v. Iowa S. Utils. Co., 355 F.Supp. 376 (S.D. Iowa 1973).
- Circumstances where the delay was not contemplated by the parties. Gemma Construction Company v. City of New York, 668 N.Y.S.2d 195 (1998).
- Circumstances where the party disclaiming responsibility for the delays acts in bad faith. Lane Construction Corp. et al. v. Brown & Root, Inc. 29 F.Supp.2d 707 (E.D. Va. 1998).
Disclaimer of Responsibility for Differing Site Conditions
- What are these clauses?
- When pricing a job, contractors often rely on a soils report provided by the owner. The contract, however, may contain a disclaimer stating that the information on subsurface conditions is not to be relied on by the contractor and/or is not part of the contract.
- Problems arise when subsurface conditions differ from the soils report and additional costs are incurred.
- In some states, courts have refused to enforce disclaimers stating that soils reports or boring logs cannot be relied on - Ohio, Michigan, New York, Iowa.
- In other states, courts have enforced such disclaimers, holding the parties to the express terms of their bargain - Virginia, Kansas, Alabama, Georgia, South Dakota.
- As with all of the examples discussed in these materials, what the contract says may be completely different from what the contract means.
Limitations on Retainage
Some states (particularly for public work) limit the amount of retainage which an owner can keep on a contractor, or which a contractor can keep on a subcontractor. The penalty for withholding funds without just cause (Prompt Pay Statutes) can be very steep.
Other Contract Clauses
- Attorney's Fees Shifting Provisions. In some states, parties are free to agree on any type of attorney's fees shifting clauses. In other states, the courts will not enforce all agreements. For example, in Missouri, the courts will only enforce an agreement to pay attorney's fees to the extent that a party is a prevailing party. In California, a one-sided attorney's fees clause will be interpreted by the court to work in both directions.
- Arbitration Clauses. The Federal Arbitration Act compels that courts enforce arbitration clauses in all contracts which "concern" interstate commerce. Since almost all contracts "concern" interstate commerce, there is usually no doubt that all arbitration clauses will be enforceable. However, in those construction contracts which do not concern interstate commerce (where all entities working on the job are from the same state, for instance), some strange rules may apply in different states. Until relatively recent legislative action, Oklahoma courts would not enforce arbitration clauses on grounds that such clauses violated the state constitution. In Missouri, unless a statutory notice appears on the signature page of a contract, an arbitration clause in the agreement will not be enforced. In Missouri, even an AIA or AGC form contract may not be sufficient to put an enforceable arbitration clause into place.