Babcock Scott Babcock Newsletter
January, 2009

Hard Hat Case Note

Paid-If-Paid Clauses Are Likely Unenforceable in Nevada. Utah Remains an Open Issue State.

In its recent opinion in Lehrer McGovern Bovis, Inc. v. Bullock Insulation, Inc., 124 Nev. Adv. Op. 92 (Nev. 2008), the Nevada Supreme Court held that paid-if-paid clauses entered into before N.R.S. §§ 624.624 and 624.626 were amended in 2001 are unenforceable due to public policy concerns.

The Utah Legislature has acknowledged the existence of contingent payment clauses, but has prohibited their enforcement as a defense to an otherwise valid mechanic's line claim. See UCA 13-8-4(3)(a). However, the law does not address contract, bond or equitable claims.

In the Nevada case of Lehrer McGovern Bovis, Inc. the court goes on to say that paid-if-paid clauses enacted after the statutory amendments are enforceable in limited circumstances as laid out in those sections. Bullock Insulation, Inc., 124 Nev. Adv. Op. 92, n.50. But, practically speaking, those sections fail to enforce paid-if-paid clauses.

Section 624.624 provides that higher-tiered contractors must pay their subcontractors within certain enumerated time frames. Moreover, it does not limit a higher-tiered contractor's obligation to pay its subcontractors to situations where the higher-tiered contractor has been paid. It only allows a higher-tiered contractor to withhold payment under certain enumerated exceptions (retention of no more that 10%, a subcontractor's incomplete or defective work, garnishment orders, etc.), none of which is the enforcement of a paid-if-paid clause. N.R.S. § 624.624.

Thus, the existence of a paid-if-paid clause has no bearing on the application of section 624.624. It simply states that absent certain exceptions, higher-tiered contractors are to always pay their subcontractors. Thus, it is unlikely that a paid-if-paid clause could trump this statutorily-imposed obligation. As such, section 624.624 fails to enforce paid-if-paid clauses.

In section 624.626, the Nevada Legislature expressly disregarded the validity of paid-if-paid clauses. It provides that if a higher-tiered contractor fails to pay its subcontractors within 45 days after the 25^th day of the month in which a subcontractor seeks payment, a subcontractor can stop work until payment is received, regardless of whether the parties' agreement contains a paid-if-paid or paid-when-paid clause. N.R.S. § 624.626. Under such terms, a contractor's attempt to withhold payment based

on a paid-if-paid clause would be futile, as its subcontractors would be entitled to stop work regardless.

It is worth noting that neither section 624.624 nor 624.628 expressly state that paid-if-paid clauses are void or unenforceable. The overall effect of their coverage, however, seemingly invalidates paid-if-paid clauses. Thus, paid-if-paid clauses are likely unenforceable in Nevada.

Whether the Utah courts will uphold the enforcement of the paid if paid clause outside the area of mechanic's lien claims remains an open question.

Scott DeGraffenried is an attorney at the law firm of Babcock Scott & Babcock, P.C., in Salt Lake City, Utah and concentrates his practice in the area of construction law. He can be reached by email at scott@babcockscott.com or by phone at (801) 531-7000.

-------------------------------------------------------------------------------------

An increasing global demand for both structural steel and steel scrap has triggered significant domestic increases in the producer price of structural steel during the first half of 2008. As of June 2008, the mill price for wide-flange structural steel has increased 28% to just over $1000 per ton. Other structural materials such as HSS and plate have experienced increases into the $1100 to $1200 per ton range. While there are many reasons for the volatility in steel pricing, this article looks at the difficulties involved and proposes a way, through advance planning, to avoid a catastrophe when the cost of steel turns out to be much more than initially bid.

Oftentimes companies do not appreciate the risks involved with fixed-price contracts until it's too late. In light of recent and dramatic increases in steel prices, when a contract is freely bargained for, it may be a good idea for steel contractors to consider a price escalation clause to protect against the volatility in the market. Fixed-price contracts can be financially dangerous when unexpected increases in steel change the assumptions on which the contract price is based. If the cost of steel increases, the cost to perform the contract will obviously increase. If this happens, when does a price change require a contract adjustment? If it is a fixed-price contract, that increased cost will be borne by the party promising to supply the steel. Very little can be done after the fact to undo a fixed-price contract. Courts will not rewrite contracts that were freely entered into by informed parties. Once a fixed-price contract is entered into, there is almost nothing that can be done to obtain relief from price escalations unless the costs increase is astronomically large.

Contracts in most states are ordinarily rescinded where there is original invalidity, fraud, failure of consideration or a material breach. Other basic grounds for contract rescission which may seem to offer potential relief in the context of steel price escalation include mistake of fact, impossibility, impracticability, frustration of purpose, and force majeure. These grounds are common in nature in that they rely upon the existence of circumstances that render performance difficult or burdensome. While every case must be assessed after careful consideration of all its facts, the facts will not typically justify rescission in the face of escalated steel prices.

Impossibility would likely fail to result in rescission, because steel does exist and the work is capable of being performed. Impracticability offers no greater prospects, because courts are reluctant to apply this doctrine, and when it is applied in the context of price escalation, it is usually done so where the contract is one for supply of goods, as opposed to performance of a service such as construction. Frustration of the purpose is unlikely to succeed in rendering a contract rescinded because the "frustrated event" must be the "purpose" of the contract - not a material element of the purpose, such as steel. Finally, force majeure would not likely result in the rescission of a contract because it is not a ground typically utilized by courts to protect contractors from the risks of contracting.

Ultimately, the approach which offers the best protection to a steel contractor is to be proactive with regard to future contracts by including a price escalation clause. This will protect the steel contractor from steel price increases by shifting the risk to the purchaser. Negotiation of a price escalation clause into your contract, however, is not always possible when the contract is won or lost with a public bid, as such bids require the bidder to be responsive to the bid solicitation, which basically makes it a take-it-or-leave-it contract. Price escalation clauses may also be precluded when a strong corporate buyer yields excessive pressure on a weaker supplier to enter into a fixed-price contract. In situations where a fixed-priced contract is unavoidable, the only courses of action are to add a contingency to the bid or sale price, save for a rainy day, and/or just plain hope for the best.

Because of the volatility in the market, steel contractors may not be able to give fixed quotes to contractors or owners. To account for the actual costs of steel, a price escalation clause such as the one shown below may be considered:

The Subcontract Price is based on the current prices and surcharges for the steel types and shapes necessary for the Project as posted and made publicly available by [MILL] on [DATE]. Notwithstanding anything herein to the contrary, any increases in the price of the steel ordered by the Subcontractor for the Project, or any additional surcharges imposed on the steel ordered by the Subcontractor of the Project, after [DATE], shall result in a corresponding dollar-for-dollar increase in the Subcontract Price.

In this example, the steel contractor is not absorbing the rise in the price of steel and is protected fully. Depending on the need and relationship with your owner or general contractor, variations of this clause can be executed which would allow the steel contractor to possibly absorb an agreed upon portion of the rise in the price of steel up to certain percentage.

While this is a turbulent time and this can be a difficult issue to navigate, it is worthwhile for steel contractors to be proactive and take steps to protect their future contracts. It may be that money spent on an experienced construction attorney in drafting a proper price escalation clause is small compared the potential financial disaster that could take place without this contractual protection.

Parties to fixed-priced contracts must be aware of the risks with such contracts. Where a contractor is free to bargain over the terms of its contract, price escalation clauses should be considered to reduce the risk from volatile markets for steel and other construction materials. Those already locked into a fixed-price contract need to realize that, unfortunately, courts do no usually offer relief. Understanding and implementing some of the precautions discussed in this article can help ensure a favorable outcome to the overall construction process. Through careful communication and attention to detail, your construction projects can be rewarding and productive instead of catastrophic.

Cody W. Wilson is an attorney at the law firm of Babcock Scott & Babcock, P.C., in Salt Lake City, Utah and concentrates his practice in the area of construction law. He can be reached by email at cody@babcockscott.com or by phone at (801) 531-7000.

------------------------------------------------------------------------

News of the Firm

• All Seven lawyers from the law firm of Babcock Scott & Babcock were chosen by their peers to be named to Utah Business magazine's 2009 Utah Legal Elite for the area of Construction Law. Robert F. Babcock, Kent B. Scott, Brian J. Babcock and Jason H. Robinson, shareholders of the firm, were named along with associates Justin E. Scott, Cody W. Wilson and Adam T. Mow. No other firm had more than one of their members receive this honor in the area of Construction Law. Legal Elite and SuperLawyer honorees are selected by their peers in a statewide balloting process. The 6^th Annual Utah Business Legal Elite in a special section of Utah Business in its January, 2009 issue.
  
• Scott DeGraffenried, licensed to practice law in Arizona, has recently joined the firm and will take the Utah Bar Exam in February, 2009.
  
• Kent B. Scott has been named as Chair of the Utah Supreme Court Model Jury Instructions Committee on Construction Contracts. The Committee plans to submit the first ever set of jury instructions dealing with construction law to the Utah Supreme Court Reviewing Committee this month. This project has particular national significance since the Committee has been asked to write the instruction in "plain language" form which will be more user friendly for both judges and juries dealing with construction law.
  
• Brian J. Babcock has been named as a member of the Utah Supreme Court Model Jury Instructions Committee in the area of Liability for Design Professionals.