Silence may be Golden

At the end of my last post, I mentioned that an owner should be careful about what s/he says to the subcontractor who is not being paid by the general contractor. My warning is based on two cases which the Massachusetts Appeals Court decided, one in September 2007 and one in January 2008. In both instances, the court found that the owner was liable for payments to the subcontractor based on representations and promises that the owner had made to the subcontractor.

In Central Ceilings, Inc. v. National Amusements, Inc., 70 Mass.App.Ct. 172 (2007), a project to build a movie theater had come to a virtual standstill due to lack of funds. At that point, the owner told the plaintiff subcontractor that the owner would pay the subcontractor if the general contractor did not. It further told the subcontractor that it needed the project done prior to Labor Day Weekend so that it could benefit from the higher movie sales that occurred on a holiday weekend. Based on the owner’s representations, the subcontractor continued with the work and completed it in a timely manner. When the subcontractor wasn’t paid, it sued the owner seeking payment; the owner denied liability. The court found that the subcontractor had been promised payment by the owner directly, and that even though the promise was oral, it was binding on the owner.

In Mike Glynn & Company v. Hy-Brasil Restaurants, Inc., 75 Mass.App.Ct. 322 (2009), the Appeals Court made a similar determination. In that case, the subcontractor and the owner of the property had been long-time friends. When the property manager ran out of funds and Glynn threatened to cease work, the owner of the property promised that he or his company would pay if the property manager did not. Like National Amusements, supra, the owner in this case insisted that the restaurant open prior to Thanksgiving. In reliance on the owner’s promise, Glynn worked over-time, incurred extra expenses by hiring additional men to work on the job. When Glynn sought payment from the property manager and was not paid, he sued the owner and the owner’s company directly. In dicta, the Appeals Court found that the facts of this case fell outside the “not ordinarily liable” rule set forth in Evans v. Multicon.
Both Mike Glynn and National Amusements are close to the hypothetical scenario that the Evans case had envisioned and therefore, it is not surprising that the Court allowed the plaintiff subcontractors to collect from the property owner. However, the timing of the promise is critical. In Rosano-Davis, Inc. v. Sastre, 2004 Mass.App.Div. 55 (2004), aff’d 65 Mass.App.Ct. 1110 (2005) (unpublished), the subcontractor argued that the owner of the property had promised to pay the subcontractor if the general contractor did not. The Appeals Court ruled that because the owner made promises to pay after the work was completed, the subcontractor did not rely on those promises to finish the work.

In the case I litigated that I discussed in my previous blog post, there were similar allegations. The subcontractor argued that the owner of the property had made promises to pay, however those promises if they were made at all (a fact my client disputes) they were not made until after the work was complete. Therefore, any argument that there was some reliance did not carry the day.

So what is an owner to do if they learn that the general contractor has not been paying the subcontractors? Do should the owner speak to the subcontractors or do you remain silent? There are several steps that must be taken. First, assess the situation. Compare the progress of the project to the payments made and determine whether the owner has paid more to the contractor than the value of the work. Or perhaps the opposite is true. Or maybe the owner and the contractor are about even when one compares the work performed and the amount paid. Consider the project and its progress. If the property is not weather-tight or exposed to the elements, then you may need to have the contractor continue. Speak to the general contractor and the subcontractors and find out everybody’s story. Don’t make any promises to anyone. Just listen. Then the owner will have to make some decisions.

If the owner and general are approximately equal in work performed and money paid or if the owner owes the general money, then the owner can make an arrangement to pay subcontractors directly. The owner can write joint checks to the general contractor and the subcontractor so that the subcontractor receives payment.
It is more difficult when the general contractor holds more money than the value of the work performed. If the owner pays the subcontractor, s/he runs the risk of paying twice; once to the general and once to the subcontractor. If the general is going to continue with the work, one might want to try to negotiate an arrangement to pay the subcontractors directly as a credit to future payments. As you can see this gets very complicated, not only in terms of determining who you should pay and when but obviously one has to deal with the personalities of the individuals involved.

Whatever the end result, put it in writing and have all the parties sign and/or acknowledge receipt. It is best if the parties can resolve the issue so that the general can continue work. In reality, it is often hard to find a new contractor willing to come in the middle of a job. Consider involving an attorney to negotiate a resolution. While it might cost the owner some out of pocket expense, the cost will be negligible in comparison to litigation costs.

In my final post, I will discuss the actual mechanics of the mechanic’s lien. As I mentioned in my first post on this subject in order to perfect the mechanic’s lien one has to take a number of steps. The last step that must be taken is the filing of a lawsuit. Whether you can actually collect even if you take all those steps and how you collect at the end of the lawsuit will be the subject of my final post on mechanic’s liens.

Mechanic's Liens Part 2 -- "Not Ordinarily Liable"

In my last post, I tried to define and explain mechanic's liens through frequently asked questions. A mechanic's lien, when properly done, allows a person who has done work on your house to put a lien on your house to secure payment. This mechanism to secure payment is not as important for a general contractor performing work on a property, as it can also sue for breach of contract and make other claims against the property owner. However, for a subcontractor, a mechanic's lien is generally the sole mechanism by which a subcontractor can recover against an owner, when that subcontractor does not get paid by the general contractor.

Prior to the enactment of the mechanic's lien law, a subcontractor who provided labor and materials generally had no right to recover from the property owner. The mechanic’s lien law changed the the common law. However, it is the sole mechanism for a subcontractor to recover from the owner but only if the subcontractor strictly adheres to the mechanic’s lien law.

Let me give you an example from a case I handled last year. I represented the owner of a commercial property where it contracted with a general contracting company to build a shopping center. The project was plagued with problems, and the general contractor essentially abandoned the job after the owner passed away. The owner had paid the general contractor quite a bit of money. Unfortunately, the general contractor had not paid all of its sub-contractors.

Many of the sub-contractors recorded mechanic's liens, but at least one did not. This particular subcontractor brought a lawsuit against the owner seeking to recover on claims of breach of contract, goods sold and delivered and quantum meruit. Unfortunately for the subcontractor, the general contractor had failed to pay it more than $150,000.00 for labor and materials. The last two claims are equity claims whereby a party asks to be compensated the fair value of its work so that the other party does not obtain a benefit for free. The breach of contract claim was dismissed at the outset because there was no contractual relationship between the property owner and the subcontractor. The goods sold and delivered and the quantum meruit claim remained.

The issue that remained was based on language from a 1991 Massachusetts Appeals Court decision. In Evans v. Multicon Constr. Corp., the Appeals Court ruled that without a lien perfected under G.L. 254, an owner who enters into a general contract for improvements on real property is “not ordinarily liable” to subcontractors whose sole contractual arrangements are with the general contractor. If a subcontractor does not follow the mechanic's lien law, it is barred from recovery, regardless of the theory. In other words, unless there was some circumstance that was out of the ordinary, without a perfected mechanic's lien, the subcontractor could not collect from the property owner.

The subcontractor vigorously claimed that the facts in our case were so unusual that this was not an ordinary case and the “not ordinarily liable” rule should not apply. I, on behalf of the owner, argued that this case was simply the all too familiar scenario of a general contractor who went out of business and did not pay subcontractors. The court agreed with the owner and the subcontractor lost. The subcontractor did obtain a judgment against the general contractor, but the chances of collection are very slim given the facts.

There are several lessons to take away from this case. First, if you are a subcontractor, consider making it a regular practice to record a Notice of Contract one every job. I am told that many general contractors do not like when this is done. However, the mechanic's lien law voids any provision in a contract that prohibits a contractor from taking steps to enforce a lien. Mass.Gen.L. ch. 254 § 32. However, what the statute says and reality may not match. In the event, it is not realistic to record a notice of contract for every job, then be mindful of payments or lack of payments. If you have finished a job and have not gotten paid, then you must take steps to protect your interests. Under the mechanic's lien law, you have 90 days once work stops at the site to record your notice of contract. If you are at the beginning of a project, you have a lot of time; if you are at the end of the project, the timing could be trickier.

Second, if you are an owner, keep track of the amount of work being down and the amount of payment being requested. As stated in my last post – you must control the money. That rule is critical regardless of whether the work is residential or commercial. If you hear subcontractors on your job are not being paid, consult legal counsel immediately. The issues are complicated and something you say or do can come back and haunt you later, including promises to pay subcontractors directly.

How, you ask? That will be subject of my next post.

Mechanic's Liens -- Part 1

It is easiest to discuss the basics of mechanic's liens via Frequently Asked Questions. I hope this answers some of basic questions about mechanic's liens. Over the next few posts, I will discuss a series of issues relating to mechanic's liens in Massachusetts. Mechanic's liens are state specific, so if the property where the work was performed is not in Massachusetts, you will need to consult a different state's laws.


What is a mechanic's lien? In Massachusetts, a person who provides labor or performs work as a general contractor or subcontractor (or subcontractor for the subcontractor) can take steps to perfect a lien on the property where the work was performed. With respect to subcontactors, the mechanic's lien law provides a critical exception to the general rule that a subcontractor cannot usually collect from the owner of the property when the contract for the work runs between the property owner and the general contractor. The steps that must be taken to perfect a mechanic's lien are different depending on whether that person was the general contractor, the subcontractor or a laborer. The laws regarding mechanic's liens can be found at Massachusetts General Laws, Chapter 254 sec. 1 and following.

Why would I file a mechanic's lien? A person or entity that performs work on someone's property may want to file a mechanic's lien to help ensure payment. If the contractor is not paid by the person who hired them, the owner of the property where the work was performed could be obligated to pay the contractor, even if there is no direct contract between them. As mentioned above, it is generally the only way that a subcontractor can collect an unpaid bill from the property owner.

What do you need to file a mechanic's lien? A perfected mechanic's lien is not just one piece of paper recorded at the registry of deeds. A contractor must take numerous steps before the lien is perfected and the steps vary depending on whether the contractor is a general contractor, a subcontractor or a laborer. In general, there must be a written contract for work to be performed at the property. Then, the contractor must record a Notice of Contract and a Statement of Accounting, with the appropriate registry of deeds. In order to perfect the lien, it will be necessary to file a lawsuit and then record the lawsuit at the registry of deeds. Depending on the applicable section of the statute, there are certain notice provisions which also must be followed. There are also time limitations which must be strictly followed. I strongly recommend that you consult an attorney. It is very easy to make an error in this process and one incorrect step will invalidate the mechanic's lien. If you are a subcontractor, this likely will eliminate your ability to collect from the property owner. If the general contractor with whom you contracted is out of business, a perfected mechanic's lien is likely the only way you can collect payment.

As the owner of the property, can I be responsible to pay a subcontractor, if my general contractor does not? Yes, you can under certain circumstances.

As the owner of the property, how do I prevent being responsible to pay subcontractors that my general contractor is supposed to pay? There are a number of things you can do. First, and probably most importantly, the homeowner MUST keep control of the money. I cannot say this enough. Do not let the contractor get too far ahead of you on the money. What do I mean by this? If your project costs $50,000.00, then you should make sure your contractor has received approximately $12,500 when the project is 25% complete and so on. If your project is only one-half done and you have paid your contractor 75% of the money, you are asking for trouble. Second, you can require that all contractors who worked on your project sign mechanic's lien releases be signed before releasing each payment to the contractor. Third, you can write joint checks to the subcontractor and general for payment. Finally, homeowners should strongly consider consulting an attorney prior to starting any construction project.

I hope this covers some general questions on mechanic's liens in Massachusetts. In my next post, I will focus on the importance of mechanic's liens for subcontractors. In the meantime, if you have specific questions, please feel free to comment or email me directly.

Piercing the Corporate Veil - part 2

In my last post I looked at the factors involved in piercing the corporate veil. Now I want to focus on how you, as a business owner or director, can protect yourself. Some of these tips might seem obvious, but I recently ran into a case in which the owners were using the company as their own personal checkbook, so I guess this is not as obvious as it appears.

1. Money

Keep the company money separate from your personal money. Not only does this mean opening up separate accounts, but also giving yourself little reminders that keep the money separate. This includes using different banks for corporate and personal accounts so you'll know which is which just by seeing an envelope. You should even choose different check colors so you don't get them confused, even accidentally.

Once you have that set, do not pay your personal expenses from the company account. I know it might seem silly to write a check from the company to you personally and then turn around and write a check for the exact same amount for say,the home mortgage, but that is how it must be done. The amount of the corporate check is part of your salary and should be noted as such. If you lend money to the company or vice versa, write a promissory note. Again, I know it seems redundant writing a promissory note where you sign on behalf of the company and sign individually, but you must keep the money straight and your records accurate and complete. In addition, balance your check book regularly and review bank statements, even if someone else is helping you with the books. As I discussed in an earlier post, check fraud can be very detrimental to a business so pay attention to the money.

On the same theory, get a separate credit card for your business. Use it only for business expenses -- no exceptions!

2. Financing

If you create a corporation or a limited liability company be sure that the entity has adequate financing. That is, the company should be able to pay its own bills from its own checking account and should not take on obligations for which it cannot pay. This may mean that the entity needs to take a loan from you or obtain funding some other way (venture capital funding, angel investors). However the funding is accomplished, appropriate paperwork should be completed, particularly if you, the sole owner will be pouring your funds into this proposition.

3. Corporate formalities

A company must observe corporate formalities, meaning that you must have annual meetings and minutes from those meetings. If you want to take action, take a vote, create a resolution. Issue stock certificates. Run your company as if there were 500 stockholders and not just one and that each position of officer and director were filled by different, unrelated people. The treasurer is the one who should be in charge of he money; the secretary should maintain the corporate minutes. All this may seem horribly obvious, but these formalities and distinctions between you and your entity can quickly fade away when you are pre-occupied with actually doing what your business does. However, you cannot forget that you have to run and maintain the business part of your business in addition to whatever your business does.

Piercing the Corporate Veil

One of the key issues with a private business is that the company and the individual often appear to be the same thing. However, in the eyes of the law a corporation is a very different entity from the person who owns it.

That separation is known in the legal world as the "Corporate Veil" and while it often offers protection for both sides, especially when it comes to issues of assets and liability, sometimes it's used as an unfair shield, forcing plaintiffs to find a way through, or, as we like to say, Pierce the Corporate Veil.

When the corporate veil is pierced, the court looks through the corporation to find either a related corporation or an individual liable for the wrongdoing of the corporation. It happens that a few unreturned bread racks are a the heart of this issue. Back in the 60s, Cumberland Farms worked out a deal with My Bread Baking Company to sell bread in Cumberland Farms' stores. When the contract was up, Cumberland Farms didn't return some racks, resulting a 1968 decision called My Bread Baking Co. v. Cumberland Farms, Inc., which states that it is appropriate to pierce the corporate veil:

(a) when there is active and direct participation by the representatives of one corporation, apparently exercising some form of pervasive control, in the activities of another and there is some fraudulent or injurious consequence of the inter-corporate relationship, or (b) when there is a confused intermingling of activity of two or more corporations engaged in a common enterprise with substantial disregard of the separate nature of the corporate entities, or serious ambiguity about the manner and capacity in which the various corporations and their respective representatives are acting. In such circumstances, in imposing liability upon one or more of a group of ‘closely identified’ corporations, a court ‘need not consider with nicety which of them’ ought to be held liable for the act of one corporation ‘for which the plaintiff deserves payment.’

The next question is why would a plaintiff try to pierce the corporate veil of a company? The answer nearly always has to do with the defendant company's inability to pay a judgment. If the plaintiff actually wants the money owed, they'll have to look for the resources. If your company is getting sued, clearly you do not want to be found liable for the company's acts or omissions.

So, how do you avoid your company's veil from being pierced? What steps can you take to minimize your individual liability?

To answer that we look to the 1991 case of Evans v. Multicon Construction Corp., which sets out 12 factors the court should consider when the trying to pierce the corporate veil.

1. common ownership
2. pervasive control
3. confused intermingling of business activity assets or management
4. thin capitalization
5. disregard of corporate formalities
6. lack of corporate records
7. no dividend payments
8. insolvency at the time of the transaction at issue
9. draining of corporate assets
10. shareholders using the corporation for transactions
11. non-functional officers and directors
12. using the corporation to promote fraud

That is a long list -- what does it mean really though? What are the practical steps that you need to take?

We'll touch on that in our next post

Protecting Your Personal Assets

You've decided to take the plunge and start your own business. You've formed an entity -- maybe its a corporation or a limited liability company -- you paid your fee at the Secretary of State's office and filed your papers. Now what? If you believe that this is all you have to do and you are protected from individual liability if your company gets sued, you are sorely mistaken.

If only it were that simple. Any type of entity, corporation, limited liability company, limited liability partnership or any other entity requires upkeep, maintenance, and attention to protect an individual from being liable. However, it is important to remember that maintaining corporate formalities does not provide absolute immunity from liability. Corporate officers are still responsible for their own torts. No corporate status will protect an officer or director who makes a misrepresentation to a third party.

The next few posts will focus on how to make sure that you, as an officer or director of a company minimize your personal exposure should your company get sued.

Check Fraud : What you need to know

Recently, I settled a case against a bank because it paid on my client's checks which were forged by an employee of my client. No sooner had I settled that case, when a new case with nearly identical facts arrived on my desk. These cases can be financially devastating. Both clients are small businesses where people tend to handle multiple roles and trust runs high between owner and employees.

The scheme set out in the Uniform Commercial Code is a complicated one. There are a number of applicable statutes and who has to prove what shifts depending on the facts. The best thing an owner to can do is to take some simple steps when managing bank accounts to prevent embezzlement in the first place.

1. Review and reconcile your statements every single month as soon as possible after the statement arrives. Check fraud is controlled by state law. Most, if not all, states have adopted the Uniform Commercial Code which as its name implies creates a model code. Therefore, the law is relatively consistent from state to state. Section 4-406 requires an account holder to promptly review statements and notify the bank within 30 days after the statement is sent about any irregularities in the statement. Irregularities would include unauthorized checks, other unauthorized withdrawals, or math errors. If you do not notify the bank within 30 days after you receive your statement, then you will have a difficult time recovering the funds from any forged check and any check subsequently forged by the same person. There are, of course, exceptions to the rule, but the burden shifts to the bank to demonstrate that the bank negligently paid the items and that it paid them in bad faith.
2. If someone besides the owner reviews and balances the statements monthly, the owner should review the statements him or herself every single month.
   
3. Keep your checks, rubber stamps and other account supplies in a locked cabinet which is located in an area other than the responsible employee's office. An account holder can be precluded from recovery if he or she contributes to the fraud by its negligent behavior. This concept is found in the UCC at 3-406.
   
4. Take care in hiring employees. Consider running background checks to determine if there is any criminal misconduct in the job candidate. Check references and be sure to determine the connection between the candidate and the individual providing the reference. Is it a relative? Someone who loaned the candidate money? Just as one must check the source of information provided on the internet because some people have agendas, you must do the same when you check references.
   
5. Maintain a good relationship with your local bank officer. In both of my cases, the embezzler was discovered because the local bank branch called to tell the owner that the business was going to bounce a check.

Despite all the precautions, check fraud may occur. However, if you are vigilant in reviewing the statements and reconciliation, you will be more likely to discover the problem early. Not only will this minimize your financial loss, but it will mazimize your chances of recovering from the bank for paying on an unauthorized check.