Tag: Construction Law

Open Permits, Empty Pockets

Real estate transactions can be influenced by various factors. One often-overlooked aspect is the existence of open building permits at a municipal building department. These seemingly minor components may significantly affect the dynamics of buying or selling commercial or residential properties, potentially causing delays, financial burdens, and legal complications.

UNDERSTANDING OPEN PERMITS:

Open permits refer to permits that have been issued for construction or renovation projects and that appear as uncompleted at the local building department. They may have been left open because the construction was commenced but not completed, or the contractor failed to obtain final inspections, or the required land use or operational approvals were not obtained, such as a board of health license. Such permits remain open in the property’s records until properly closed out, potentially posing significant challenges when buying or selling commercial real estate. This occurrence is especially problematic in the context of commercial real estate where a landlord may have multiple tenants who engage contractors for construction projects. Such permits may remain open without landlord’s knowledge. Landlords may also be unaware of the specific contractor undertaking the work, thus preventing landlord from directing such contractor to cause the permit to be closed. The COVID-19 pandemic exacerbated this problem, as closures of municipal offices interfered with filings and on-site inspections, and the tenants that engaged the contractors (and sometimes the contractors themselves) went out of business, resulting in numerous permits being left open.

THE IMPACT ON COMMERCIAL REAL ESTATE TRANSACTIONS:

Open permits can complicate real estate transactions in several ways. Firstly, they can signal potential safety or code compliance issues, raising concerns for buyers about a property’s integrity and potential code violations. Moreover, open permits can hinder the closings, as lenders may hesitate to provide financing; buyers may similarly be unwilling to take on the burden of owning a property subject to open permits. Resulting delays may jeopardize a deal, or result in price reductions to offset risks associated with open permits. Sellers may also be required to spend time and money to undertake necessary filings and obtain inspections. Longstanding open permits may result in fines or penalties, further complicating matters and potentially souring the deal.

MITIGATING AND PREVENTING HARM:

To mitigate the impact of open permits on real estate transactions, proactive measures are essential. For buyers, conducting thorough due diligence is paramount, including comprehensive inspections of building records at the municipal building department to identify any open permits and/or notices of building violations early in the sale process. Sellers should prioritize closing out permits before listing a property in order to streamline the transaction and enhance marketability.

Commercial landlords should take additional measures with tenants to ensure these issues do not arise in the first place. For example, landlords should include lease provisions requiring tenants to obtain landlord’s prior consent for any work requiring a permit, and require that all open permits be closed within a stated period of time (within 30 days of completion), with proof of closure furnished to landlord. Landlords can enforce such provisions by mandating that the failure to adhere constitutes an event of default under the lease. They may also stipulate in the lease that a security deposit will not be released unless and until all open permits attributable to the specific tenant are closed out.

CONCLUSION:

In conclusion, open permits can pose significant complexities in commercial real estate transactions. By taking proactive steps to address them, stakeholders can minimize disruptions and facilitate smoother transactions.

© 2024 SHERIN AND LODGEN LLP
For more news on Open Permits in Real Estate, visit the NLR Real Estate section.

Pay-When-Paid Provisions Still Unenforceable in New York State

While New York State’s Prompt Payment Act (“PPA”) provides a potential workaround for the invalid pay-when-paid provisions that appear in many construction contracts, a recent decision from the State’s Appellate Division narrows, if not closes, that loophole.

In the construction industry, it is common for a general contractor to include “pay-when- paid” or “pay-if-paid”1 clauses in its contracts with subcontractors, essentially allowing the general contractor to avoid paying its subcontractors for their work until it receives payment from the owner and forcing subcontractors to assume the risk that the owner will fail to pay the general contractor. In 1995, New York State’s highest court in West- Fair Electric Contractors v. Aetna Casualty & Surety Co. invalidated such practice, declaring that pay-when-paid provisions are void and unenforceable as contrary to public policy. 87 N.Y.2d 148, 159 (1995). The Court found that pay-when-paid provisions prevent a subcontractor from enforcing its rights under New York State’s Lien Law because if the owner failed to pay the general contractor, then payment to the subcontractor would never be due, which is a “necessary element of the subcontractor’s cause of action to enforce its lien against the owner.” Id.; see also N.Y. Lien Law § 34 (holding that “[n]otwithstanding the provisions of any other law, any contract, agreement or understanding whereby the right to file or enforce any lien created under article two is waived, shall be void as against public policy and wholly unenforceable”).

Despite the holding in West-Fair, contractors continue to include pay-when-paid in contracts, and until recently the PPA offered a workaround to validate these seemingly invalid provisions.

In 2002, the New York State Legislature passed the PPA in order to facilitate the prompt payment to contractors and subcontractors. N.Y. Gen. Bus. Law § 756-a. The PPA contains a provision, however, that seems to provide an alternative to the disallowed pay-when-paid provision in construction contracts. Section 756-a(3)(b)(i) states:

Unless the provisions of this article provide otherwise, the contractor or subcontractor shall pay the subcontractor strictly in accordance with the terms of the construction contract. Performance by a subcontractor in accordance with the provisions of its contract shall entitle it to payment from the party with which it contracts. Notwithstanding this article, where a contractor enters into a construction contract with a subcontractor as agent for a disclosed owner, the payment obligation shall flow directly from the disclosed owner as principal to the subcontractor and through the agent.

N.Y. Gen. Bus. Law § 756-a(3)(b)(i) (emphasis added).

While the provision does clearly state in its second sentence that a subcontractor is entitled to payment “from the party with which it contracts,” the third sentence concerning agency seems to provide a way around the West-Fair Court’s clear mandate that pay-when-paid provisions are void, as long as the contractor is acting as an “agent for a disclosed owner.” Id. In that situation, the PPA arguably mandates that the payment obligation to the subcontractor flows directly from the owner, and not the general contractor. This principal-agent relationship is merely a reflection of the common law rule that an agent for a disclosed principal “will not be personally bound unless there is clear and explicit evidence of the agent’s intention to substitute or superadd his personal liability for, or to, that of his principal.” Mencher v. Weiss, 306 N.Y. 1, 4 (1953). Theoretically, the agency exception should not impair a subcontractor’s Lien Law rights because it can still file and enforce a mechanic’s lien, but it shifts the responsibility for payment from the general contractor to the owner, giving the general contractor a defense to the subcontractor’s nonpayment claims.

Until recently, not much has been said about the PPA’s agency provision. In March 2022, however, New York’s Appellate Division in Bank of America, N.A. v. ASD Gem Realty LLC rejected a general contractor’s claim that it was acting as an “agent for a disclosed owner” pursuant to § 756-a(3)(b)(i), holding that the general contractor was liable to the subcontractor regardless of whether or not the owner had paid the general contractor. 205 A.D.3d 1, 8-12 (1st Dep’t 2022). In that case, an owner (ASD Gem Realty LLC and ASD Diamond Inc., together “ASD”) hired a general contractor (Sweet Construction Corp. or “Sweet”) to perform construction and renovation work at its property. Id. at 3. ASD solicited proposals for the installation of partitions for the project and selected plaintiff Arenson Office Furnishings, Inc. (“Arenson”), who then entered into a subcontract with Sweet. Id. The subcontract provided that “[a]ll work to be performed pursuant to the ATTACHED SCOPE LETTER . . . and ‘SCC General Requirements.’” Id. at 4 (alterations in original). The Scope Letter contained the following clause: “Subcontractor understands that Contractor is acting as an agent for the Owner, and agrees to look only to funds actually received by the Contractor (from the Owner) as payment for the work performed under this Subcontract.” Id.

As it so happened, ASD ran into financial difficulties and Arenson did not receive payment from either ASD or Sweet. Id. at 5. While Arenson filed a mechanic’s lien against the property and commenced a lien foreclosure action, there was no surplus available to pay either Sweet or Arenson after the construction lender obtained a judgment of foreclosure and conducted a foreclosure sale of the property. Id. Arenson then filed a complaint against Sweet for violation of the PPA, claiming Sweet failed to pay Arenson for the stated reason that Sweet had not been paid by ASD. Id.

In response, Sweet argued that it was not liable to Arenson because Sweet was acting as an agent for ASD; Sweet was merely complying with ASD’s directive to hire Arenson. Id. Sweet claimed ASD told Sweet that ASD would be responsible for paying Arenson and, citing the subcontract’s payment language, claimed that Arenson could only expect payment from ASD, not Sweet. Id. Sweet also relied on § 756-a(3)(b)(i) of the PPA, arguing that pursuant to the third sentence, Sweet was only an agent for a disclosed owner and therefore was exculpated from personal liability. Id. at 6. Sweet argued that the agency provision of this section negated the second sentence of the provision (entitling the subcontractor to payment from “the party with which it contracts”). Id. (quoting N.Y. Gen. Bus. Law § 756-a(3)(b)(i)).

The lower court rejected those arguments, holding that the subcontract language was an unenforceable pay-when-paid clause and that the exception in the PPA at § 756- a(3)(b)(i) clearly provides (in its second sentence) that a subcontractor is entitled to payment “from the party with which it contracts” (and Sweet contracted with Arenson). Id. The lower court also explained that the PPA and related case law demonstrate that an unpaid subcontractor is entitled to multiple sources of payment, perhaps explaining any conflict between the second and third sentence of § 756-a(3)(b)(i). Id. at 6.

The Appellate Division in turn held that the lower court correctly determined that Sweet was not an agent for an undisclosed principal. Id. at 7. The Court relied on the fact that the signature line in the subcontract did not “indicate that Sweet signed the contract as agent on behalf of a disclosed principal or reflect any limitations,” and that the referenced SCC General Requirements included indemnifying Sweet, obtaining liability insurance in Sweet’s favor, and recognizing Sweet’s authority to issue safety violations and correct unsafe conditions. Id. at 7-8. The Court “reject[ed] Sweet’s attempt to divide a single contract into one that creates an agency for purposes of payment but not for any other purpose,” reaffirming “that the ‘dual roles’ of general contractor and agent are inconsistent.” Id. at 8 (quoting Blandford Land Clearing Corp. v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 260 A.D.2d 86, 95 (1st Dep’t 1999)).

As for the PPA, the Court also held that § 756-a(3)(b)(i) was inapplicable because, as explained, Sweet was not ASD’s agent and its interpretation of that provision “overlooks the entire purpose of the PPA and turns the statute on its head.” Id. at 11. The Court explained that the provision is actually designed to provide the subcontractor “with the panoply of statutory benefits and remedies that ordinarily would have inured to the contractor had the contractor acted on its own behalf, instead of as the owner’s agent,” and therefore, the “subcontractor is entitled to all of the article’s benefits and remedies that would have ordinarily flowed to the contractor.” Id. at 11-12. The Court pointed out that the principles of West-Fair applied to this case as well, even if West-Fair did not involve an agent relationship, because the central issue in both cases was forcing a subcontractor to assume the risk of an owner’s failure to pay its contractor. Id. at 12.

Therefore, despite clear language that Sweet was acting as an agent for the Owner, and despite Arenson’s agreement “to look only to funds actually received by the Contractor (from the Owner) as payment for the work performed under this Subcontract,” id. at 4, the Court found that this PPA exception to otherwise invalid pay- when-paid clauses did not apply.

In sum, contractors should be wary when attempting to use § 756-a(3)(b)(i) in conditioning payment to a subcontractor on payment from an owner, especially if the contractor is really just trying to separate its payment obligations from its general contracting responsibilities. Thus far, it appears New York State courts will not be sympathetic to such an arrangement, despite any potential carve out in the PPA.

For more Construction Industry Legal News, click here to visit the National Law Review.

© 2022 Phillips Lytle LLP

FOOTNOTES

1 While there is a difference between “pay-when-paid” and “pay-if-paid,” for purposes of this article, the two phrases are used interchangeably to mean a condition in a contract in which payment by the contractor to the subcontractor is contingent on the owner first paying the contractor. See Bank of Am., N.A. v. ASD Gem Realty LLC, 205 A.D.3d 1, 6 n.3 (1st Dep’t 2022).

Bridge to Prosperity: New Bridge Between U.S. and Canada Approved

Varnum LLP

Michigan farmers are among legions of organizations expressing gratitude now that a new bridge between the U.S. and Canada has been approved by the Obama Administration, setting the stage for a sharp increase in trade between Michigan and Canada.

The presidential permit awarded by the State Department April 12 clears the way for construction to begin in Michigan on the New International Trade Crossing Bridge.  The new span  will “serve the national interest,” the State Department said in granting the permit.

Michigan is Canada’s largest trade partner, with trade in 2011 exceeding $70 billion. That’s nearly 11.7 percent of the total U.S. trade with Canada. More than 8,000 trucks currently cross the Detroit-Windsor border daily.

Called “Michigan’s Bridge to the Future,”  the New International Trade Crossing Bridge will be built near the existing Ambassador Bridge that links Detroit with Windsor. Michigan voters in November overwhelmingly rejected a ballot proposal spearheaded by Ambassador Bridge owner Matty Moroun to require voter approval for any bridge built between the U.S. and Canada.

Under a deal struck last year between Michigan Gov. Rick Snyder and Canadian Prime Minister Stephen Harper,  Canada will pay for the bridge, with construction costs repaid by Canada through tolls.  Snyder said in a statement the crossing will create jobs and get Michigan-made products to market quicker.”

From the standpoint of Michigan agriculture, this additional transportation capacity is vital to streamline and expand our access to markets in Canada,” Michigan Farm Bureau Legislative Counsel Matt Smego said in prepared remarks.

Construction has already started on the Canadian side. Michigan Gov. Snyder said he hopes for groundbreaking on the Detroit side within the next two to three years. Construction is expected to take seven years.

The city of Windsor, meanwhile,  on May 28 asked Michigan officials for more information regarding the Michigan Department of Transportation’s recommendation to open the existing Ambassador Bridge to trucks carrying hazardous materials for the first time in its 83-year history. The recommendation excludes the transportation of explosives.

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A Brave New World for Commercial Buildings: ASTM's "BEPA" Standard

Recently posted at the National Law Review by Douglas J. Feichtner of Dinsmore & Shohl LLP –   ASTM BEPA standard is expected to become the standard for building energy use data collection. 

On February 10, 2011, ASTM formally published its Building Energy Performance Assessment (BEPA) Standard – E 2797-11. This standard will enable users to measure the energy performance of a commercial building in connection with a real estate transaction. Regulatory drivers spurred the development of the BEPA standard, even in the midst of a construction recession. In the past few years, several states and local governments passed mandatory building energy labeling and transactional disclosure regulations. These disclosure regulations, combined with some building codes that are now requiring specific energy-efficiency improvements, triggered the development of a standardized methodology to assess and report on a commercial building’s energy use. The BEPA’s passage arrives at a crucial time when building certification standards face increased scrutiny, both in the market and the courtroom.

The ASTM BEPA standard includes the following five components: (1) site visit; (2) records collection; (3) review and analysis; (4) interviews; and (5) preparation of a report. ASTM is not creating or implying the existence of a legal obligation for the reporting of energy performance or other building-related information. Rather, the BEPA offers certain guidelines to the industry to promote consistency when collecting (and perhaps reporting) buildings’ energy usage data, such as:

 

  • collecting building characteristic data (i.e., gross floor area, monthly occupancy, occupancy hours)
  • collecting a building’s energy use over the previous three years (with a minimum of one year) – including weather data representative of the area where the building is located;
  • analyzing variables to determine what constitutes the average, upper limit, and lower limit of a building’s energy use and cost conditions;
  • determining pro forma building energy use and cost; and
  • communicating a building’s energy use and cost information in a report

One of the options available to users of the BEPA standard is to identify government-sponsored energy efficiency grant and incentive programs that may be available for any energy efficiency improvements that could be installed at the building (thereby increasing its value, and making it more attractive to potential buyers).

Building benchmarking (i.e., comparing a building’s energy output to its peers) is not part of the ASTM BEPA standard’s primary scope of work, but rather a “non-scope consideration.” The BEPA certainly could be used in conjunction with building certification tools already in the marketplace, such as ASHRAE, Green Globes, and U.S. Green Building Council (LEED), to name a few.

However, as the economic noose has tightened in recent years, green building standards have received increased scrutiny. Indeed, builders and landlords who sell their properties with the promise that they have some green certification (which can be expensive to obtain), and that promise for whatever reason fails to translate to the economic savings contracted for, could face liability.

The Gifford v. USGBC lawsuit currently pending in the United States District Court for the Southern District of New York crystallizes the debate over green building certification (in this case – LEED). The core allegations in the lawsuit prompt this author to see significant value for stakeholders to use ASTM’s BEPA as a supplement to applying rating and benchmarking systems like LEED.

Gifford’s primary complaint is that LEED-certified buildings are not as energy-efficient as advertised. Support for this contention rests on Gifford’s analysis of a 2008 New Buildings Institute (NBI) study comparing predicted energy use in LEED-certified buildings with actual energy use. In the study, NBI concluded that LEED buildings are 25-30% more energy-efficient compared to the national average. To the contrary, Gifford concluded that LEED-certified buildings use 29% more energy than the national average. He further emphasized that the NBI results were skewed in part because the NBI study compared the median energy use of LEED buildings to the mean energy use of non-LEED buildings.

The purpose of this article is not to comment on the merits of the Gifford lawsuit or criticize LEED. But this apples-to-oranges argument articulated by Gifford magnifies the proverbial elephant in the “green” room – the need for sufficient objective data to accurately compare the energy use and energy cost of buildings against their relevant peer groups. With such data in hand, the benchmarking and rating systems already in place can be buttressed with a greater measure of consistency and transparency (a big issue for detractors of green building certification, like Gifford). Furthermore, the more stakeholders in the real estate industry (buyers, sellers, lenders) understand how a building’s energy performance was determined, the better equipped they will be to put a price on the economic and environmental benefits of green buildings.

In sum, the ASTM BEPA standard is expected to become the standard for building energy use data collection. It can be used to quantify a building’s energy use as well as its projected energy use and cost ranges, factoring in a number of independent variables (i.e., weather, occupancy rates), by way of a transparent process. Finally, the BEPA building energy use determination can complement compliance reporting under applicable building energy labeling or disclosure obligations. In the end, ASTM’s BEPA can provide the foundation by which an apples-to-apples comparison can take place in evaluating commercial building energy performance determinations and certifications.

© 2011 Dinsmore & Shohl LLP. All rights reserved.