Beware of Payments to Contractors and Subcontractors under Assignment Agreements

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Summary

In a decision under the Uniform Commercial Code (“UCC”) that could apply in any state, the Massachusetts Supreme Judicial Court (“Court”) ruled this month that when a general contractor agrees to an assignment of payments to a subcontractor’s lender, and the general contractor mistakenly makes payments to the subcontractor, the general contractor is liable to the lender for all mistaken payments, even if all payments exceed the lender’s damages. See Reading v. Co-Operative Bank v. Suffolk Construction Company, Inc., 464 Mass. 543 (2013).

Facts:

  • Subcontractor assigned its accounts receivable to its lender.
  • General contractor signed an acknowledgement of the assignment, obligating it to make payments to lender.
  • General contractor’s accounting office was not made aware of the assignment and instead made payments directly to subcontractor totaling over $3.8 million.
  • Subcontractor subsequently went out of business with an outstanding debt to lender of approximately $1.5 million.
  • After mitigating its damages, a jury found that lender was damaged only $533,000 by general contractor’s misdirected payments.

Ruling:

  • The general contractor is liable to lender for all misdirected payments, totaling over $3.8 million. The Court applies the UCC to its findings.
  • If lender receives a windfall above its actual damages, it must remit the excess, minus collection costs, to subcontractor for distribution to subordinate creditors, including the general contractor.
  • Although there was evidence that lender may have known that general contractor mistakenly made payments to subcontractor, lender was not estopped from recovery because there was no evidence that general contractor made payments to subcontractor in reliance upon lender’s implicit consent.

Beware:

Anytime an owner or contractor acknowledges and agrees to abide by an assignment agreement affecting payment to a contractor or subcontractor, it must strictly adhere to the assignment agreement and make all parties within its organization know exactly where to send payments.

If you have any questions or comments concerning this alert, please contact any member of Saul Ewing’s Construction Practice. With its leadership spread across the firm’s footprint – co-chairs Garry Boehlert in Washington, D.C. and George "Ned" Rahn in Philadelphia and vice-chairs Doreen M. Zankowski in Boston and Don Rea in Baltimore – Saul Ewing has the ability to meet your construction needs throughout the East Coast and across the United States.