| 'Conditional'
and 'Unconditional' Payment Releases
By
John S. Mrowiec
It is customary in construction to employ
"waivers" or "releases" during payment.
The titles
and contents of such documents vary. They contain terms like "final,"
"to date," "to the amount of," "unconditional,"
"conditional," "waive," "release," "all claims,"
or "right to lien."
Sometimes the title of the document says
"to date," but the internal language says "final." If the
different terms used and contradictions within individual documents themselves
were not tricky enough, determining whether the document is effective under various
circumstances can be complex.
A recent court decision addressed a thorny
dispute regarding two different releases, each "to date," in the context
of payments to a supplier owed on multiple projects, ISSC, Inc. v. Baugh Skanska,
Inc., 2005 U.S. App. LEXIS 28629 (9th Cir. Dec. 23, 2005). The result was the
prime contractor effectively "paid twice," once to a subcontractor and
after losing the appeal on the subcontractor's supplier's bond claim.
A Federal Case Baugh Skanska Inc. was the prime contractor
on a federal project, the Whole Barracks Renewal Project, Fort Lewis, Wash. The
prime contractor posted a Miller Act payment bond.
Nordahl Metalfab was
the subcontractor responsible for fabricating and "assembling" structural
steel.
ISSC Inc. supplied structural steel to the subcontractor in a long-standing
relationship under which the supplier supplied on many of the subcontractor's
projects. The supply commenced before November 2002 and continued through January
2003.
The supplier supplied steel valued to $641,525 through January 2003.
Supplier had delivered $268,242 worth through November 2002.
ISSC signed
two releases as part of the payment process on the project. One release, signed
Jan. 27, 2003, was "unconditional" and "waived Miller Act rights"
for all steel delivered "up to Nov. 30, 2002." It referenced an amount
to be paid of $268,242.
The other release, signed a few days earlier, was
for "steel delivered through Dec. 21, 2002" "conditional on payment
of $198,443 on the above referenced job."
The prime contractor paid
the subcontractor at least $641,525. The subcontractor apparently paid that amount
to the supplier. Because the supplier applied the payments to debts on various
projects, the supplier nevertheless contended it was still owed more than $373,283
of the $641,525 on the project.
The supplier made a claim and filed suit
under the Miller Act against the prime contractor and the prime contractor's cosureties.
The prime contractor and cosureties defended on the ground that the two releases
barred the supplier's Miller Act claim.
The supplier conceded that the
supplier could not make a Miller Act claim for the first $268,242 for which it
had signed the "unconditional" release for steel supplied through Nov.
30, 2002. The supplier wanted a Miller Act recovery only for the $373,283 balance
of steel delivered after Nov. 30, 2002.
In the trial court, the prime contractor
and the cosureties contended all amounts paid by the subcontractor to the supplier
that were traceable to prime contractor's $641,525 in payment to subcontractor
must be used to reduce subcontractor's indebtedness to supplier for the project.
The trial court disagreed: Under the facts, the supplier need not have applied
all payments to this project.
The trial court held, however, that the second,
"conditional" $198,443 release was fully enforceable, even though supplier
had not applied the payment to this project debt.
The result was that,
at trial, the supplier received a judgment for only $174,840. Dissatisfied, all
parties appealed.
On the application argument, the appellate court agreed
with the supplier and the trial court. The general rule is that a debtor has the
right to direct application of its payment to a creditor, ISSC, Inc., 2005 U.S.
App. LEXIS 28629, *3 citing American Casualty Co. of Reading v. Idaho National
Bank, 328 F.2d 138, 144 (9th Cir. 1964).
The original debtor, the prime
contractor, did not direct how subcontractor should direct supplier to apply payments.
It was undisputed that, the second debtor, the subcontractor, for years had directed
the supplier to credit each payment first to the oldest outstanding invoice(s)
regardless of project.
One exception to the general rule of application
is that a supplier sometimes must apply a payment to a particular project. If
the supplier knows or has reason to know that the source is a bonded project,
the payment must be applied to that project debt.
Burden of Proof Not Met The contractor and the cosureties
failed to meet their burden of proof to fit that exception. The prime contractor
and cosurety did not prove that the supplier knew or had reason to know the funds
received from the subcontractor came solely from the prime contractor.
After
all, the subcontractor-supplier multi-project payment application method was longstanding.
The subcontractor did not tell the supplier the source of funds or that the supplier
should apply the payments to the obligations for the project.
Moreover,
all the projects to which the supplier applied the payments also were bonded.
Therefore, the supplier was not required to reapply payments to reduce its bond
claim. (The appellate court noted in passing that, even though the supplier was
not pursuing Miller Act rights for the first $268,242, the first release was not
a release of supplier's contract rights against the subcontractor, but only of
lien and payment bond rights.)
The appellate court also agreed with the
supplier and, this time, disagreed with the trial court, on the effect of the
"conditional" release for steel delivered through Dec. 31, 2002. The
second release form differed from the "through November" form. The "through
December" form specifically said that it was "conditional" on payment
of $198,443.15 "on the above referenced job."
Even though supplier
received more than $198,443.15 from the subcontractor, the supplier applied the
payments under the usual oldest invoice method. Under the application discussion
above, only amounts payable for the project under the usual subcontractor-supplier
application of payments qualified toward satisfying the condition. Because the
supplier did not apply as much as $198,443.15 to this project, the trial court
was wrong to strike the entire $198,443.15 from the amount recoverable under the
bond to the extent the funds were received "on the above referenced job."
The
Ninth Circuit Appeals Court designated the ISSC, Inc. decision as "unpublished."
Therefore, its impact in other courts is limited.
Nevertheless,
the principles discussed are instructive. To avoid the problem, the prime contractor
could have directed the subcontractor to direct the supplier's application of
the payments solely to debts on this project. Perhaps, collecting the supplier's
affidavit listing the particular amount as part of the entire debt ultimately
due from the subcontractor on the project would have been sufficient evidence
for the prime contractor to have proved the exception for the supplier's knowledge
of the source of subcontractor's payment.
Sometimes the title of the
document says "to date," but the internal language says "final."
The
contractor and the cosureties failed to meet their burden of proof to fit that
exception.
John
S. Mrowiec is a partner with Chicago-based Conway & Mrowiec, a construction
and public contracts law and litigation practice. He may be reached at (312) 658-1100.
For information, go to the firm's Web site at www.cmcontractors.com.
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