Leverage is typically a critical element in any construction dispute, and parties should strategically use all available tools at their disposal to enhance their position when conflicts arise. Ohio’s Prompt Payment Act (the “Act”), Ohio Revised Code § 4113.61, represents one such tool. The Act expands the remedies available to subcontractors and material suppliers for non-payment under certain circumstances, subject, however, to important defenses. When properly asserted, the Act is designed to create a strong incentive for general contractors and other upper tier parties to make timely payments due to all lower tier subcontractors, laborers and suppliers. Given the potential ramifications, it is very important for all parties involved in a payment dispute to understand the scope, benefits and risks associated with claims under the Act.
As with any tool, the Act’s effectiveness, and by extension its usefulness as leverage, is diminished when not used in an appropriate manner. In practice, many subcontractors and material suppliers do not fully understand or strategically employ the Act. Even when recognized as a remedy, the Act is often asserted without any meaningful consideration of its intended scope, application and/or potential defenses. From the general contractor’s perspective, the risk associated with an alleged violation of the Act may not be given its necessary weight based on an overbroad interpretation of available defenses and/or limitations contained in the Act.
Under the Act, the contractor (general or prime contractor) must pay its subcontractors and material suppliers within 10 days of receipt of payment from the owner if the party seeking payment submitted its pay request in time to be included in the contractor’s request for payment. Such payment obligations extend to subcontractors and material suppliers in dealing with their lower-tier relationships, and in a similar manner to all lower-tier relationships further down the line. Laborers also fall within the scope of the Act.
If payment is not received by the lower tier entity within 10 days, then the claimant (lower tier entity) is entitled to 18% interest beginning on the 11th day unless the upper tier party has a valid defense. If payment is still not received after 30 days, then the claimant may also be entitled to attorney fees incurred in any suit initiated to collect the amount due. While the statute clearly states that attorney fees shall be awarded to the prevailing party when a claimant brings an action to recover under the Act, it further states that attorney fees may not be awarded if the court determines such an award would be inequitable.
The Act does not apply to residential properties, and there are restrictions that apply to material suppliers. Further, the Act does not invalidate retainage provisions and only extends to lower tier invoice amounts that were paid by the owner. Accordingly, where the owner withholds money due to issues with the claimant’s work, or for any other reason, no relief can be obtained through the Act.
Of particular importance is the Act’s provision allowing an upper tier party to “withhold amounts that may be necessary to resolve disputed liens or claims involving the work or labor performed or material furnished by the subcontractor or material supplier.” It is this limitation that creates confusion with respect to the effective and strategic assertion of a violation under the Act and/or in defending against an alleged violation.
Regardless of the specific context of a dispute, it is crucial to understand the meaning of “disputed liens and claims” for the purposes of the Act. Often, the upper tier contractor will broadly interpret this language to mean that any issues with the subcontractor or material supplier will provide a complete defense against any asserted violation of the Act. Accordingly, if a subcontractor files a lien, makes a claim for additional scope items or delay damages, or refuses to sign off on a deductive change order, the upper tier contractor may assume that it has no exposure under the Act. Moreover, given the belief that there is no exposure, the upper tier contractor may refuse to make any further payments until the subcontractor capitulates, regardless of the amount in controversy or the receipt of payment from the owner.
Contrary to the above view, the Ohio Supreme Court has held that the meaning of “disputed liens or claims” is subject to definitive limitations. In the case of Masiongale Electrical-Mechanical, Inc. v. Construction One, Inc., 102 Ohio St. 3d 1 (2004), a subcontractor disputed a reduction in its contract amount imposed by the contractor and, in violation of its subcontract, filed a lien against the property and then filed an action contrary to an enforceable forum selection clause. The trial court, appellate court, and Ohio Supreme Court all found that the subcontractor’s breaches of the lien-waiver and forum selection clauses in the subcontract did not create “disputed liens or claims involving the work or labor performed or material furnished by the subcontractor.” Id. at 1. The facts and specific findings in this case are instructive.
In the underlying case, the contractor unilaterally reduced the subcontractor’s contract price from $36,124.00 to $29,103.00, purportedly due to untimely and improper performance by the subcontractor, and the subcontractor filed a lien and lawsuit in pursuit of payment of its original contract amount. The contractor counterclaimed, asserting that the subcontractor had breached the subcontract by failing to timely and adequately perform the work and by violating the lien-waiver and forum selection clauses. The trial court determined that the subcontractor was only subject to total back charges of $774.95, and further determined that the contractor violated the Act by improperly withholding $29,103.00, the amount the contractor had acknowledged was owed. Accordingly, the subcontractor was additionally awarded interest and attorney fees pursuant to the Act.
On appeal, the contractor argued that it was entitled to withhold amounts for anticipated bond premiums (to release the lien) and litigation costs to resolve the improperly filed lien and lawsuit. In rejecting this argument, the appellate court held that “only direct, tangible amounts relating to disputes involving alleged faulty labor, work or materials are retainable by the contractor” under the Act. Id. at 2. Thereafter, the Supreme Court conclusively determined that the alleged breaches and anticipated costs did not create “disputed liens or claims involving the work or labor performed or material furnished by the subcontractor,” within the meaning of the Act. Id. at 4. According to the Supreme Court, although the alleged breaches concerned disputes arising out of the construction contract, the lien-waiver and forum-selection provisions at issue were procedural in nature as opposed to involving substantive aspects of performing the work or labor under the contract. Id.
In considering the Masiongale decision and subsequent authority, two crucial points should be recognized by parties asserting and defending against claimed violations of the Act:
- First, the Act’s reference to “disputed liens and claims” does not provide the upper tier contractor carte blanche to withhold payment for any possible dispute arising under the contract documents.
- Second, even where the upper tier contractor has a good faith belief that monies should be withheld to address problems with work, labor or materials on a project, the contractor should avoid overreach by withholding monies in excess of identified offsets or the anticipated damages at issue.
Accordingly, from the perspective of a lower tier subcontractor, a focused, strategic approach to claims under the Act should be employed. First, to enhance its position and narrow the issues, it should limit any asserted violation to the failure to receive requested payment for amounts known or suspected to have been received by the upper tier party from a prior payment application. Second, if the upper tier contractor provides notice that it is refusing to make any further payment until resolution of a specific issue with an identified cost, or that is subject to an objective determination, the lower tier subcontractor should immediately respond that the upper tier contractor is obligated to immediately release payment of all undisputed amounts or it will be in violation of the Act. By appropriately limiting the scope of its claim for payment, the lower tier subcontractor will enhance its prospects of being determined to be the prevailing party if the dispute escalates.
From the upper tier contractor’s perspective, the inverse is true. To limit exposure, it should avoid liquidating damages to the extent current and/or future costs cannot be reasonably ascertained, and any disputes should be characterized as arising directly from the work, labor and materials provided for the project. In addition, it should not withhold net, undisputed payments to unfairly leverage its position and thereby force a lower tier subcontractor or material supplier into submission. A sophisticated opponent will recognize such overreach and use it to enhance its prospects for an award of attorney fees.
In summary, contractors, subcontractors and material suppliers should be aware of the appropriate uses and significant risks of claims arising from the Act and employ a strategic approach when confronted with apparent violations.