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Construction Law: Potential Complications with Joint Check Arrangements

Joint check agreements can be an effective way to ensure that payment makes its way downstream to a subcontractor or supplier, particularly when there is a distressed contractor or subcontractor on a project. Owners and upper-tier contractors and subcontractors weary of lower-tier subcontractors and suppliers filing mechanic’s liens (where rights exist) may elect to make payment by way of a joint check. Similarly, a lower-tier subcontractor or supplier may demand a joint check from the party he contracted with and one tier higher, especially if payment bond and mechanic’s lien protections are not available. Joint check agreements have also been used to ensure that fringe benefit payments to a bona fide benefit plan and other prevailing wage and union obligations are paid. Payment security remains essential as contractors of all sizes and in all trades continue to struggle with delayed accounts receivable, increasing labor and material costs, and therefore, cash flow problems.

Consent of the mid-tier party to enter into a joint check agreement and timely endorsements on those checks is usually the biggest challenge in using such a tri-partite arrangement. Payors may also sometimes apply setoffs and back charges to jointly paid funds, even if unrelated to the beneficiary’s supply of labor or materials. However, unrelated fourth parties may also raise objections to the direct funneling of payment downstream. If the mid-tier contractor or subcontractor has collateralized its accounts receivable as security for a loan or line of credit, the secured creditor may assert a claim or priority in the payments made by joint checks. Depending on the language of the joint check agreement, it could be seen by a court as a security interest, an assignment of right to receive payment, a trust, or even a new contract.

One bankruptcy court has found that a joint check beneficiary had priority in funds over a secured creditor. It pointed specifically to the general contractor’s contractual and legal obligations to guarantee and ensure payment to all subcontractors and suppliers as the purpose for the joint check agreement. If the secured creditor were permitted to intercept the funds, the general contractor might be subject to double liability in satisfying bond or lien claims after already paying for the labor and/or materials. While this case and the court’s explanation provided an excellent outcome for the general contractor and supplier involved, different contractual language and different courts may yield different results. The nuances of construction contracting are often inadequately understood and considered by the courts and secured lenders when faced with competing claims.

Maryland presents an additional layer of protection for lower-tier subcontractors and suppliers in the Construction Trust Fund Statute, which can impose personal liability on principals who divert funds they have received for labor and materials provided by others and fail to pay them. The interplay between a joint check agreement, trust obligations, and fourth party claims will vary with the facts and contractual language of each case. Each party to a joint check agreement should thoroughly consider how the arrangement will affect its rights and obligations as to the contract as well as to unrelated parties who may assert claims to the same funds. While often a good idea, a joint check agreement may not be a final solution.

 

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