The Prompt Pay Act Gets a New Twist

The Prompt Pay Act Gets a New Twist

The Massachusetts Supreme Judicial Court (the “SJC”) recently issued an important decision in Business Interiors Floor Covering Business Trust v. Graycor Construction Co., Inc. interpreting the Commonwealth’s Prompt Pay Act. The Graycor decision is the SJC’s first foray into interpreting this statute, and it resolves an important issue under the Act, namely whether a failure to comply with the Act’s deadlines can result in waiver of claims or defenses.

The Prompt Pay Act

The Massachusetts Prompt Pay Act (M.G.L. c. 149, § 29E), which dates to 2010, applies to nearly all private construction projects including residential, commercial, and industrial projects where the prime contract is $3 million or more. The statute does not apply to public construction projects or residential projects involving 4 or fewer units. It is primarily intended to ensure that invoices and change order requests submitted by contractors and subcontractors are processed and paid in a timely fashion. 

To achieve that goal, the Act sets forth maximum time limits for the submission, approval or rejection, and payment of periodic payment requests. For submission, the maximum period is 30 days. For approval or rejection of the payment request, the maximum is 15 days after submission of the request, with an additional 7 days for each tier below the owner. And for payment, the maximum is 45 days after approval. The Act bars conditional payment clauses (so-called “pay-if-paid” clauses) except in limited situations, meaning that payment of a periodic payment request cannot be conditioned on receiving money from a higher tier. 

Crucially, if the owner or higher-tier contractor wants to reject the payment request, it must issue a written rejection that includes “an explanation of the factual and contractual basis for the rejection” and a certification that the rejection is “made in good faith.” If the payment request is neither approved nor properly rejected within the 15-day maximum period, it is “deemed to be approved” unless it is rejected before the due date for payment.

The Act contains similar provisions regarding change order requests (i.e., a written request “seeking an increase in the contract price”). The deadline for acceptance or rejection is 30 days after the request is submitted or the change work begins, whichever is later. Any rejection must comply with the same written explanation and certification requirements that apply to rejection of a payment request. Otherwise, the request is “deemed approved” and can be included in the next payment application.

Finally, the Act states that any contractual provision purporting to limit or waive any of the Act’s protections is void and unenforceable.

Tocci: the Prompt Pay Act means what it says

No appellate court in Massachusetts decided any case involving the Prompt Pay Act for 12 years after it went into effect. The Appeals Court finally addressed the Act in Tocci Building Corp. v. IRIV Partners LLC

In Tocci, a project owner failed to pay (in whole or in part) a series of payment applications from the general contractor. The owner contended that the contractor was not entitled to the payments claimed because its work was defective and untimely, and it was therefore in breach of the contract. The contractor argued that regardless of the validity of these claims and defenses, the owner had not properly rejected the applications in accordance with the Prompt Pay Act; the applications were therefore “deemed approved” under the Act and were due and payable.

The Appeals Court agreed with the contractor. The court found that the owner had failed to provide any response at all to some of the invoices. As to others, it had given some response, but the response did not contain an “explanation of the factual and contractual basis for the rejection” as required by the Act. Several of the responses were also not provided within the Act’s time limits. Since there had been no valid rejection of these invoices, they were “approved by operation of law and became due and payable.”

Even on the one occasion where the owner had given an explanation of the basis for the rejection of an invoice, the response did not contain a certification that it was made in good faith. The Appeals Court rejected the owner’s argument that the certification requirement was “merely ministerial.” It reasoned that it was not free to ignore a statutory requirement, and that in any event the certification was important because it “provides a clear indication to the contractor that an application has been rejected, so that the contractor can know both that some response is needed and that time periods have been triggered for invoking what remedies are available.” 

However, the Appeals Court was careful to point out that the owner’s failure to properly reject the invoices does not necessarily operate to completely waive the owner’s defenses and claims regarding those invoices. The owner is required to pay the invoices, but it “may nonetheless bring any and all claims it has for breach of contract against the [contractor] and may recoup any money it may be owed.”  

Graycor: Potential Waiver of Defenses

The Tocci case answered a number of questions about the interpretation and application of the Prompt Pay Act. However, the Supreme Judicial Court (which is not bound by the rulings of the Appeals Court) still had not weighed in on the Act, and it was not clear whether they would follow the approach taken in Tocci. Moreover, while Tocci held that an invoice (or change order request) that is not timely accepted or rejected must be paid, it left open the question of when that payment must be made, and what the consequences are if it remains unpaid. 

The SJC finally addressed the Prompt Pay Act in Graycor.  The facts in the Graycor case were simpler than those in Tocci: it was undisputed that Graycor, the general contractor for a movie theater construction project, had failed to timely accept or reject three invoices submitted by its subcontractor, Business Interiors, and that it had not paid those invoices. However, after Business Interiors sued to recover on the invoices on the basis that they were “deemed approved” under the Act, Graycor raised a common law “impossibility” defense: it argued that the owner’s movie theater business had been decimated by the Covid-19 epidemic, and as a result it had not been able to pay Graycor for the work performed by Business Interiors.  

The SJC reached basically the same result that the Appeals court reached in Tocci: if an owner or higher-tier contractor fails to properly approve or reject an application within the Prompt Pay Act deadlines, it can still raise defenses to payment, but it must “first pay the funds purportedly owed and then seek to disgorge such funds” in a lawsuit or other proceeding.

The twist is that, according to the SJC, this payment of a “deemed approved” application must be made “prior to, or contemporaneous with, the raising of any such defenses in any proceeding relating to the enforcement of such invoices.” In other words, in order to preserve defenses, you must pay the application at or before the time that you raise your defenses in a lawsuit or arbitration proceeding. Otherwise, those defenses are forever lost. In this case, Graycor had raised its defenses in the lawsuit brought by Business Interiors without having first made payment of the deemed approved payment applications, and the SJC held that Graycor permanently lost its ability to raise those defenses.

While this is a very harsh result, especially for a contractor in the position of Graycor, who had not received payment from the Owner for the work covered by the three applications, the SJC said that this was the only way to give effect to the Prompt Pay Act. “Allowing common-law defenses to be raised and pursued without paying the now ‘deemed to be approved’ invoices would render this approval to be of no import.” Therefore, according to the SJC, “the payment of the amounts due in order to raise common-law defenses is a necessary implication of the ‘deemed approved’ provision in the statute.”

Issues not resolved by Tocci and Graycor

The decisions in Tocci and Graycor brought some needed clarity to the Prompt Pay Act, but it did not answer all questions that have been raised about the interpretation of the Act. Among the issues left open for future court decisions are:

  • What if the invoice or change order request is submitted outside the contract deadlines or does not comply with the contract requirements? For example, a contract will often state that if notice of a change order is not submitted within a particular timeframe, the contractor waives its right to assert a change. If a change request is submitted late, is that waiver effective? Or is this a “defense” that must be asserted by the owner, or higher tier contractor, in a timely rejection? Neither Tocci nor Graycor dealt with such contractual requirements or contract-based defenses.
  • The Act states that if a change order request is not properly approved or rejected, it is “deemed approved” and “may be submitted for payment within the next application for a periodic progress payment.” What if the contractor fails to include it in the “next” payment application? Can it still take advantage of the Act’s benefits by including it in a later payment application of its choosing? 
  • When exactly does the clock start running on the Act’s deadlines? Sometimes it is not clear whether a request or communication from a contractor is meant as a final application for payment or request for a change. If the owner raises questions about an application for payment or request for a change or asks for additional documentation (particularly if the requested information is a contract requirement), does the clock start running with the contractor’s first submission, or later when it has submitted a complete application in compliance with contract requirements? 

Practical steps

As Graycor illustrates, permanent waiver of legitimate defenses to payment due to a Prompt Pay Act violation is a harsh outcome. It is especially tough to swallow in situations where the failure to comply with the statute might have been a mere failure to include the “magic words” of certification of good faith, or where a response is only a day or two late. And even though permanent waiver can be avoided by paying the disputed application and then pursuing recovery, this requires access to financial resources, significant time to bring the legal proceedings to closure, and puts the claiming party in the driver’s seat. 

To avoid running afoul of the Prompt Pay Act, it is important to take a few practical steps:

  • Set up systems to comply with the Act’s requirements and deadlines. This includes systems to track when the “clock” starts on payment or change order applications and when the time will expire. It also includes implementing or revising standard contract documents – particularly forms for responses to applications for payment and applications for a change order – so that they contain a dedicated space for an explanation for any rejection, along with a certification of good faith. 
  • Pay attention to all of the deadlines for action. The Act, as interpreted by the courts, gives you more than one opportunity to comply with the deadlines. For example, the Act requires a response to a payment application within 15 days after submission, but it also provides that “deemed approval” can be avoided if the application “is rejected before the date payment is due.” Similarly, while a change order request that is not acted on within 30 days is “deemed approved” and may be included in the next payment application, a failure to do so can be rescued if a rejection is made “before the date payment is due” on that application.
  • Insist on clarity. If it is not clear whether a communication from a contractor is meant to be a formal change order request or payment application (thus starting the clock for a formal response), ask for clarification in writing.
  • Educate members of your respective teams, particularly owners whose internal project management personnel may not be familiar with the nuances of the Prompt Pay Act, to monitor and abide by the timing and content requirements associated with the processing of invoices and change order requests. 

Questions?

If you have questions on how the Prompt Pay Act applies to your situation, please don’t hesitate to contact me.