(Part two of a two-part article series)
This article is a continuation of Monday’s article, and we will be discussing in detail the new payment terms for all construction contracts in Virginia.
ARE “PAY-WHEN-PAID” CLAUSES A THING OF THE PAST IN VIRGINIA? KINDA, SORTA, MAYBE.
Starting January 1, 2023, all construction contracts in Virginia will be subject to payment terms limiting the right of a party to only pay a lower-tier subcontractor upon receipt of payment from the owner or higher-tier contractor. Along with changes to the Virginia Prompt Payment Act, §2.2-4354 discussed in the first article, new changes to Virginia’s “wage theft” statute, Va. Code §11-4.6, specify new payment requirements to lower-tier subcontractors for all projects, public or private in Virginia.
A. New Payment Obligation for Owners
For the first time by statute, Virginia now requires that the owner pay the general contractor “within 60 days of the receipt of an invoice following satisfactory completion of the portion of the work for which the general contractor has invoiced.” Satisfactory completion is not defined, and most contracts expressly provide that a progress payment is not acceptance of the work, as approval and acceptance usually occurs at final completion. If the owner is going to withhold payment, it must do so in writing and with reasonable specificity of the reasons for nonpayment. This does not affect the right to withhold retainage on a project until final completion. Importantly, this 60-day payment requirement does not apply to public bodies as they are excluded from the definition of “owner.”
The owner’s failure to make timely payment now exposes it to liability for interest payments under the Prompt Payment Act at 1% per month unless otherwise stated in the contract. A smart owner will now include a nominal interest rate in its contracts to blunt any impact arising from this new requirement.
B. Prompt Pay on all Construction Projects? Kind of.
The new payment provisions of Va. Code §11-4.6 then focuses on payment requirements between contractors and subcontractors. The statute expressly excludes persons solely furnishing materials, so material suppliers are unlikely to take advantage of its new payment terms. Any contract between a higher-tier and lower-tier contractor is now deemed to include a provision that the higher-tier contractor is liable to the lower-tier contractor “for satisfactory performance of the subcontractor’s duties under the contract” and must make payment within the earlier of:
(i) 60 days of the satisfactory completion of the portion of the work for which the subcontractor has invoices, or
(ii) Seven days after receipt of the amounts paid by the owner or higher-tiered contractors for work performed by a subcontractor “pursuant to the terms of the contract.”
A contractor is not liable for amounts “reducible pursuant to a breach of contract by the subcontractor.” Like the Prompt Payment Act, the contractor withholding payment must notify the subcontractor, in writing, with the reason for nonpayment, specifically identifying the contractual noncompliance, the dollar amount being withheld, and the lower-tier subcontractor responsible for the contractual noncompliance. This last phrase gives general contractors a difficult task of determining how a subcontractor sub-subcontracted different portions of its work so it can assign responsibility to the right sub-subcontractors.
Because this statute applies to all contractors and subcontractors, even if a public body does not make payment to a general contractor within 60 days, the general contractor is still obligated to pay its subcontractor within that time. If an owner waits a full 60 days to make payment to the general contractor, the general contractor will have to pay its subcontractors before that same 60-day period elapses. Even more confusing, the subcontractor’s invoice may be dated prior to date of the general contractor’s invoice to the owner so that the general contractor must now monitor multiple 60-day clocks with the owner and each of its subcontractors. This promises to be a logistical headache for even the most sophisticated of general contractors. General contractors will now likely engage in a lengthy process to evaluate and approve every aspect of a subcontractor’s invoice, down to the date, often rejecting the invoice and frustrating subcontractors.
Again, the failure to make timely payment results in the Prompt Payment Interest provision of 1% per month, unless the contract states otherwise. Expect contracts to make clear that “satisfactory completion” of subcontract work is something to be determined by the owner and that invoices are not proper or approved until the owner provides its consent. Contractors now have a strong incentive to include a nominal interest provision for late payments to avoid the 12% statutory rate resulting from any violation of this new prompt payment requirement.
C. No Pay-When-Paid in Virginia? Sort of.
The statute also attempts to eliminate pay-when-paid provisions in Virginia, with a curious caveat:
Payment by the party contracting with the contractor shall not be a condition precedent to payment to any lower-tier subcontractor, regardless of that contractor receiving payment for amounts owed to that contractor, unless the party contracting with the contractor is insolvent or a debtor in bankruptcy as defined in §50-73.79.
This means that every general contractor and subcontractor must be prepared to finance the entire scope of work subcontracted to lower-tier contractors. General contractors will need to demand proof of financial assurance of owners, negotiating strict terms of payment before proceeding with work, since payment seemingly is due 60 days after properly invoiced. Yet, the statute then provides an exception to this payment obligation if the owner or general contractor (“party contracting with the contractor”) is insolvent or filed for Chapter 11 bankruptcy protection. So, if the contractor or owner is insolvent, there is no obligation to pay subcontractors for work performed and properly invoiced. Contractors will now modify their subcontracts to make clear that “pay-if-paid” liability still resides with the subcontractor. The statute does not define insolvency and only references corporate liquidation bankruptcy proceeding, not personal bankruptcies or reorganizations, leaving confusion over when these exceptions apply. Also, it is not clear whether there is liability if the contractor makes a “good faith” determination of insolvency, but it is later determined that the owner was not insolvent.
Contractors of all tiers now appear to be responsible for “slow-pay” situations, but rarely “no-pay” projects where financing disappears, and owners or contractors become “insolvent.” They may be able to limit their exposure to this new liability by carefully drafting payment and interest terms, paying strict attention to when work may be invoiced. While 60-day payment terms may be an improvement for contractors, many will still want to include quicker payment requirements in their individual contracts.
The new payment laws create unnecessary confusion in construction contracts. Owners and contractors are now statutorily required to make payment within 60-days of “satisfactory completion” of work subject to an invoice, regardless of payment from the owner or higher-tier contractor. While this obligation does not apply when an owner is “insolvent,” the statute provides little guidance on how a contractor is to make that determination. However, owners and contractors can blunt the impact of this statute with insertion of a nominal interest fee. The Department of General Services is tasked with reviewing payment conditions on public projects by the end of 2022, but contractors should not expect that review to resolve all the confusion caused by this statute.
Ignoring this new law will only cause more headaches later. Contractors, at all levels, need to review their contracts now and proactively craft language to meet project needs for this changing construction landscape in Virginia.