Many general contractors manage the risk of a subcontractor’s financial instability by issuing joint checks to the subcontractor and its suppliers on a project. These arrangements are usually governed by a separate agreement that sets forth the roles and rights of the parties, and limits the general contractor’s liability to sub-subcontractors and suppliers with whom the general contractor does not have a contract. A recent decision by the Virginia Supreme Court now calls into question this common practice. As a result, contractors need to review and modify their joint check agreements and procedures regarding communications with lower tier entities to limit the risk of effectively paying twice.
In the case of James G. Davis Construction Corp. v. FTJ, Inc., 2020 Va. LEXIS 42 (Va., May 14, 2020), Davis was a general contractor for a condominium project and subcontracted the drywall work to H&2 Drywall Contractors. H&2 purchased its drywall materials from FTJ, Inc. and entered into a joint check agreement with H&2 and Davis that contained terms similar to many joint check agreements that contractors use, including:
- That any checks for materials would be made payable jointly to H&2 and FTJ;
- That Davis will only make payments to the extent Davis actually owes money to H&2 on the project;
- That the sole purpose of the agreement was to assist H&2 in making payment to FTJ; and
- That nothing in the agreement creates any contractual relationship or equitable obligation between FTJ and Davis.
Predictably, H&2 ran into financial difficulties and was unable to complete its work on the project. Davis informed FTJ to stop shipping materials and then terminated H&2. Davis advised FTJ that its past due invoices were being processed, but Davis later refused to pay FTJ once Davis determined it had incurred costs beyond the remaining subcontract value to complete H&2’s scope of work. Davis relied on the language in its joint check agreement that it was not liable to FTJ because it did not owe H&2 anything further on the project.
The Virginia Supreme Court affirmed the trial court’s determination that Davis was liable to FTJ not by contract, but by the equitable theory of unjust enrichment. Even though the costs of completing the subcontract work exceeded its value, the court found that Davis had not paid for all of the drywall and was unjustly enriched by using it for the project. Prior to this case, courts in Virginia were not receptive to such claims and generally, the only relief available was through the express agreement between the parties (breach of contract), or enforcement of a validly filed mechanic’s lien or payment bond claim. This upsets the common assumption that a party is only liable for economic loss to those with whom it contracts.
Contractors commonly seek continued performance from suppliers when a subcontractor faces trouble to keep a project on track. This has now become a more complicated and risky process. Contractors should consult with a Vandeventer Black attorney now to revisit the terms of any joint check agreements and alter their processes for dealing with vendors with whom they do not have a contract.
If you have questions about this article or need assistance with reviewing your contracts and subcontracts, please contact Jim or one of the other attorneys at the Construction and Government Contracts Practice Group.