Joint Check Agreements: No Two Are Alike

Nothing is ever carved in stone, so business credit professionals should always sleep with one eye open when expecting payments on construction projects. Finding a way to become more secure is always in the best interest for creditors, even if it only slightly improves the odds of being paid and being paid on time. Each security mechanism works a little different—liens, bonds, UCC filings, etc. Another avenue for creditors to improve their standing is with a joint check agreement (JCA). However, there are several important factors to understand when working with JCAs.

The recent NACM webinar, "Joint Check Agreements: Security, Guaranty & Trust Fund Options," presented by James D. Fullerton, Esq., with Fullerton & Knowles, P.C., in Northern Virginia went over a number of ways to properly use JCAs as an advantage for a creditor. "The most important thing to remember is there's no such thing as standard joint check agreement," Fullerton said.

What is important is who wrote the JCA and what is their objective. If a general contractor (GC) is building the JCA, they will do everything to have zero obligations, so it's vital to read and evaluate JCAs. Creditors/suppliers need to understand who is the "end user" and who is really buying and paying for materials and services. GCs will place JCAs in a light as an accommodation and a favor to the creditor/supplier; that it's a method to administer payment. Creditors must make sure there's some type of obligation by the end user and that the JCA doesn't do anything along the lines of waiving lien and bond rights.

The creditor will be enforcing the JCA—seeking a judgment against the owner and GC to try and make them pay twice for materials. Judges often view this as unfair, noted Fullerton, because there's no clear law unlike lien and bond laws. In reality, a JCA is a contract, but if there's no obligation for the GC and owner, it's not even a contract. Often, judges won't know what to do with JCAs and will tell creditors they should have still enforced lien and bond rights, said Fullerton.

JCAs need to have some contractual obligation for the end user to do something—at least write checks jointly. "A guarantee of payment is the single loftiest goal; it is something you want more than anything else," Fullerton said.

There are ways to have priority over other secured creditors, e.g., have a security interest or trust fund agreement. However, these are limited to the amount of debt, i.e., if the GC doesn't owe anything then the security interest is worth nothing. Another option is an escrow arrangement, which is an enhanced trust fund—less likely for mistakes, and if there's funds there, you're going to get paid. With this, there are higher transaction costs, and they are harder to get owners and GCs to agree to.

In what Fullerton calls his JCAs for creditors, "project security agreements," payments "shall" be made jointly with checks delivered to the seller. This puts an obligation on the end user. To take away the GC or owner's "accommodation" to the creditor, added in the agreement is language to make it so the materials will only be supplied if the document is agreed to. It's a consideration to supply rather than a favor to have the JCA.

Some states have trust fund statutes, making the GC and subcontractor a trustee of the payment for the creditor/supplier. This and trust fund agreements can make the life of a creditor a lot easier during bankruptcy because the allotted money is in the trust and is not the debtor's money who is now in bankruptcy proceedings. It's a terrific advantage in bankruptcy preference, said Fullerton. There's also no additional risk or cost to the GC or owner. It can be tricky to trace the money and show where it's coming from—what account and what project is the money in trust for? A trust fund agreement can be in any contract, proposals, credit agreements, subcontracts, JCAs, etc., said Fullerton. Language to keep the funds separate should be installed as well.

—Michael Miller, managing editor