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Legal - Beware factors and assignment of pay application proceeds

image Ben Wheatley, Shareholder Munsch Hardt Kopf & Harr, P.C. Austin, TX

AUSTIN - As the construction market in Texas continues its explosive activity, more and more new contractors or subcontractors are entering the arena. Many of these new businesses are inadequately capitalized and may need to resort to assignment of receivables in order to cover their cash flow needs, month to month. An example is as follows:




    A contractor enters into a prime agreement with an owner that requires the contractor to make all proper payments to its subcontractor via a third party system like Textura.  That contractor has included a provision in its subcontracts that specifically prohibits the assignment of subcontract proceeds to a third party.  Despite this restriction, one day a contractor receives written notice from a Factor notifying it that subcontract proceeds have been assigned, and that rather than pay the subcontractor via the third party system, all future subcontract proceed payments need to be made directly to the Factor.  The notice asks the contractor to sign an acknowledgment that it will pay the Factor going forward, and may well ask the contractor to sign something warranting that there are no contract claims or defenses that will prevent full payment.

    My first and most important advice to a contractor in this situation is to not sign anything or pay anything until you have discussed the issue with your lawyer, or you may well be at risk for paying the same subcontractor pay application twice.  This is because the law that governs these transactions in Texas, Article 9 of the Uniform Commercial Code (“UCC”), is strongly tilted  in favor of the Factor, and may well result in restrictive subcontract clauses like an anti-assignment provision being rendered null and void.  At the same time, the UCC may protect a contractor from being in breach of its agreement with an owner, if after a careful analysis a contractor pays the Factor directly, thereby circumventing that contractor’s contractual obligation to make payments directly to the subcontractor via the Textura or other third party payment tools.
    The second piece of advice is for the contractor to contact the Factor and request, pursuant to the UCC, all relevant documents regarding the assignment of proceeds, including all documents relating to the agreement between the Factor and the subcontractor, and a copy of any UCC filing that the Factor has made with the county clerk where the project is located in relation to the assignment of the receivables.  The Factor is obligated by the statute to provide you with these documents and they should be carefully reviewed before any document is signed or payments made. 
    There are numerous reasons for such a review including verifying what assignments were actually in place as of the date of the notice sent by the Factor to a contractor, to allow a contractor to safely determine what proceeds, if any, should go to the Factor, and what proceeds, if any, should be paid to a subcontractor.  In addition, lien rights are possibly implicated, and therefore it is important to understand what lien rights a subcontractor might retain, if any, and what lien rights if any belong to the Factor.  
    All of the analysis referenced above is necessary in order for a contractor to fully understand its rights, obligations and defenses in the event a subcontractor assigns proceeds to a Factor.  The third piece of advice for the contractor is to immediately notify the Owner of these issues to set the stage for a collaborative and deliberate process that a contractor can successfully navigate.
    In summary, through education and training, a contractor should be able to put in procedural office safeguards that mitigate the risk of a contractor being legally liable to make double payments.

Ben Wheatley is a Shareholder in the Austin office of Munsch Hardt. He has more than 25 years of experience litigating complex construction matters, negotiating and drafting construction and design contracts and master service agreements, serving as in-house counsel for an international design firm, and working on issues concerning the practice of architecture, engineering, and project construction.

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