Joint Checks
Where and How Joint Check Arrangements
Can Go Awry
Aaron L. Blankenship, Esq.
Technical Director & Counsel
Travelers Bond
4000 Kruse Way Place
Building 1, Suite 100
Lake Oswego, OR 97035
(503) 534-4295
Kimberly Gessner, Esq.
Deputy General Counsel
Moss & Associates
2101 North Andrews Avenue
Ft. Lauderdale, FL 33311
(954) 524-5678
Mary Joanne Dowd, Esq.
Partner
Arent Fox LLP
1717 K Street, NW
Washington, DC 20006-5344
(202) 857-6059
I. Joint Check Arrangements
Aaron L. Blankenship, Esq.
Technical Director & Counsel
Travelers Bond
Lake Oswego, OR
In an attempt to avoid this risk, the contractor may issue joint
check payments as allowed under the subcontract or enter into
formal joint check agreements with its subcontractors and the
subcontractors’ vendors. Unfortunately, for the reasons discussed
below, payments by joint check do not always insulate the contractor
from having to pay twice. A joint check arrangement can take many
forms, ranging from the issuance of a check payable to two or
more parties as co-payees (“joint checks”), to a formalized detailed
agreement between the contractor, subcontractor and their lower
tier subcontractors and suppliers (“joint check agreements”).
Joint Checks
While it may be enticing for a contractor to take the easier
route of merely issuing a joint check, depending on several
factors including the state and the project type (private vs public)
and contract terms, such action may fall short of protecting the
contractor from paying twice. For instance, if the subcontract
does not have a provision that authorizes the contractor to
issue joint checks, then unilaterally issuing a joint check may be
a breach of the subcontract. Also, consider that if the joint check
is deposited without the proper endorsements, the contractor
(and its surety) could still retain liability and thus have to “pay
twice.” Some states have adopted a “Joint Check Rule” which
may protect contractors trying to mitigate the risk from having
to pay twice.
The most advantageous approach to the contractor and its
surety issuing joint checks are those jurisdictions that follow the
“California Rule” or “Joint Check Rule”.
1
Under the California Rule,
the contractor’s issuance of a joint check discharges both the
contractor and its surety from liability to lower tier contractors/
suppliers. Absent an allocation of the payment to specific invoices
or amounts, the lower tier subcontractor’s/supplier’s endorsement
of a joint check presumes that it received all money due, even
if only some (or no) funds were actually received. Joint check
endorsement also presumes a release of lien rights. Under the
California Rule then, because a surety is entitled to assert its
principal’s (the contractor’s) defenses, the presumption of
full payment and release of lien rights will preclude lower tier
subcontractors/suppliers from recovering against the surety’s
payment bond.
The Joint Check Rule’s object is to generally provide owners and
general contractors a means to protect themselves from unpaid
subcontractors/suppliers by recognizing that the issuance of
joint checks empowers those same subcontractors/suppliers to
withhold their endorsement until satisfactorily securing payment
(e.g., receive payment prior to endorsing the check, enter into a
formal escrow arrangement). However, it is not uniformly applied
Too often, despite having already paid for completed work, a contractor learns that its payments were
pocketed by a first tier subcontractor, leaving the lower tier subcontractors and suppliers unpaid. By the time
lien and/or payment bond claims are filed the contractor may have little to no contract funds remaining under
the subcontract available to offset those claims, thereby resulting in the contractor paying for the work of those
lower tiers again. No one wants to pay twice for the same goods or services.
Joint Check
Arrangements
JOINT CHECK ARRANGEMENTS TO LOWER TIER SUBCONTRACTORS & SUPPLIERS
For specific information on a state-by-state basis as
to which states have adopted the Joint Check Rule,
please ask your agent or underwriter for Travelers’
State-by-State Survey on Joint Check Arrangements
and there is no easy way to distinguish the numerous variations of
how jurisdictions that recognize the Joint Check Rule apply it to
specific case circumstances (i.e., not applicable to surety, not the
full amount of the joint check, etc.).
2
In some jurisdictions the Joint Check Rule applies to both private
and public (non-federal) projects, whereas others limit the
rule to only private projects. Also, some jurisdictions presume
that the full joint check amount has been paid, whereas others
restrict and/or disavow that presumption and instead look to a
specific payment allocation between the co-payees (e.g., specific
dollar amount, invoice number and/or separate agreement). For
example, California, Iowa, Louisiana, Missouri, South Carolina,
Texas and Washington are among the jurisdictions that follow the
Joint Check Rule for the benefit of both the contractor and its
surety. Jurisdictions such as Arizona, Arkansas, Nevada, Oklahoma
and Utah, however, are unclear or silent as to whether the Joint
Check Rule extends to the surety, while Maryland and Ohio
specifically do not extend it to the surety. California, Montana and
Oklahoma recognize endorsement of a joint check as an effective
waiver of a subcontractor/supplier’s lien rights. However, Alabama,
Colorado, Connecticut, Idaho, Indiana, Kansas, Massachusetts,
Michigan, Minnesota and South Dakota require additional
circumstances for an effective waiver to exist. On the other hand,
Arizona, Arkansas and Oregon do not recognize a waiver, while
Delaware and Maryland find any such waiver void
and unenforceable.
Unfortunately, over half the jurisdictions are silent regarding the
impact of joint checks or specifically reject the Joint Check Rule.
In those jurisdictions, a joint check endorsement alone has an
unknown impact on the contractor’s payment obligations and
waiver of statutory lien rights, thereby leaving the contractor
and/or its surety exposed to potential further liability for non-
payment. In those jurisdictions it would be best to consult with
a construction lawyer to advise what can and cannot be done to
protect the contractor’s and surety’s interests.
Where the Miller Act is applicable, the contractor must pay special
attention because the Joint Check Rule does not apply. Federal
courts addressing the issue view such arrangements as a request
for added security, as the rights under the Miller Act are found
not to impose a specific legal obligation to deduct amounts
from a joint check. Therefore, endorsement of a joint check
alone will not release or waive a subcontractor/supplier’s Miller
Act rights.
3
Under certain circumstances, including the use of a
specific Joint Check Agreement, a contractor may be able to issue
joint checks on Miller Act projects to limit its liability. Generally,
if the specific Joint Check Agreement expressly states that a joint
payee’s endorsement shall be deemed payment in full, then such
endorsement can result in a release and/or waiver being found.
Joint Check Agreements
Instead of issuing joint checks, a contractor could put a Joint
Check Agreement – a tri-party agreement with the contractor,
subcontractor, and lower tier(s) – in place which spells out the
respective rights of the parties regarding issuance, endorsement,
and the effect of joint check payments. Among other things, a
formal Joint Check Agreement avoids later factual disputes based
on the intention of the parties. However, care should be taken
before entering into a Joint Check Agreement because a poorly
crafted one could actually expand the contractor’s liability. For
example, it must be drafted to avoid creating an independent
payment obligation on the part of the contractor and/or negating
its available statutory and/or contractual protections (e.g., strict
adherence to timely notice and/or direct contractual relationship
requirements). It is for these reasons that seeking competent
legal counsel is recommended to determine the enforceability
and benefits of a Joint Check Agreement.
Regardless of which approach is contemplated – Joint Checks
or Joint Check Agreements – contractors should be aware of
the pitfalls associated with these approaches and consult with
knowledgeable construction counsel.
When properly used joint check arrangements are a
powerful form of payment in a contractor’s toolbox that
can protect it and its surety against paying twice for labor
and materials. However, even though joint checks have a
long standing record of use in the construction industry
depending on the State, the project type and other factors,
their effectiveness will vary greatly. Careful consideration
and legal consultation should be taken to fully understand the
Joint Check Rule’s applicability before issuing such payments.
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U.S. and other countries. CP-9417 New 10-18
1
See Post Bros. Constr. Co. v. Yoder, 20 Cal.3d 1, 3, 141 Cal Rptr. 28, 30, 569 P.2d 133, 135 (1977).
2
See, Travelers, 50 State Survey, State-by-State Survey on Joint Check Arrangements (Aug. 2012).
3
See, e.g., Friedrich Refrigerators, Inc. v. Forrester, 441 F.2d 779 (5th Cir. 1971); Clark-Fontana Paint Co.
v. Glassman Const. Co., 397 F.2d 8 (4th Cir. 1968); Koppers Co. v. Five Boro Const. Corp., 310 F.2d 701
(4th Cir. 1962)
II. Joint Checks Agreements: Key Points In Drafting
And Pitfalls To Keep In Mind
Kimberly Gessner, Esq.
Deputy General Counsel
Moss & Associates
Ft. Lauderdale, FL
Joint Checks Agreements: Key points in drafting and pitfalls to keep in mind
Zero Regulation: Anything can go…
Joint check agreements have no regulation. There is no such thing as a “standard”
joint check agreement. You do not know what rights it gives you (or rights it
limits/takes away, or obligations it places on you…) until you see it.
So how should you draft? Key provisions in the Joint Check Agreement to
keep in mind:
Joint checks can be a good tool to facilitate distribution of project funds to the
intended recipient, thereby helping the project to keep moving. They also protect
a General Contractor from paying twice. However, because of the legal
ramifications, they should only be used with an agreement covering the following
points:
Identification of all three parties;
Identification of the particular project and a clear statement that the
arrangement is limited to that project;
Maximum amount paid or to be paid;
A provision that appropriate lien waivers will be issued in exchange for
the payment;
No continuing duty to issue joint checks except as expressly covered by
the agreement;
Agreement made solely as a convenience;
Agreement does not create any contractual rights in creditor/lower tier
subcontractor and General Contractor.
Be Cautious:
Joint check agreements may also arise when a supplier refuses to supply materials
to a subcontractor unless the subcontractor and the general contractor agree that
the general contractor will pay by joint check. Usually in those situations, the
supplier proposes a form of joint check agreement. General contractors must read
such forms with caution since suppliers often include other obligations in such
forms (e.g., the form may say that the general contractor will issue joint
checks and guarantee payment to the supplier). Most additional obligations will
be enforced by the courts. If a general contractor is willing to issue joint checks, it
should be sure that the joint check agreement proposed does not have additional
obligations that it is unwilling to accept.
Things to be wary of regarding joint checks:
read anything that you’re supposed to sign thoroughly;
put measures in place to avoid forgeries;
Execute a joint check agreement prior to commencement of work
Key provisions to have in your Subcontract Agreement
General contractors often include a provision in their subcontracts that gives them
the right to issue joint checks (e.g., "Contractor may, but is not obligated to, issue
joint checks to Subcontractor and any of its suppliers."). Such provisions are an
important risk-management tool, but must be drafted carefully. The prime
contractor must obtain the consent of its subcontractor before making joint
payments. The best practice is to address this issue up front with express language
in the subcontract giving the prime contractor the right, but not the obligation, to
issue joint checks if necessary. Absent express authorization in the subcontract to
issue joint checks, the prime contractor cannot relieve itself of its payment
obligations to the subcontractor by unilaterally issuing joint checks and will still
be responsible for ensuring that its subcontractor is paid in full regardless of
whether the supplier is paid.
Make clear that the right to issue joint checks does not create a duty to issue joint
checks. If a general contractor agrees to issue joint checks to the subcontractor
and its supplier (a mandatory obligation as opposed to just having the right to do
so), the supplier may enforce the agreement against the general contractor.
For example, assume a supplier requires a subcontractor to get the general
contractor to agree to issue joint checks and the subcontractor proposes the
following modification to the subcontract: "Contractor shall issue joint checks to
Subcontractor and its material supplier." If the general contractor accepts the
change but neglects to issue joint checks, the supplier will be able to sue the
general contractor for breach of contract if the supplier is not paid. The supplier is
entitled to rely on the subcontractor's subcontract with the general contractor if
the language requiring the general contractor to issue joint checks is mandatory.
Consider including a form joint check agreement as an exhibit to the subcontract
and making the subcontractor’s failure to execute the joint check agreement as to
any supplier or lower-tier subcontractor a basis for withholding progress
payments to the subcontractor.
Delivery of the Joint Check
A general contractor should also require the debtor to come to the general
contractor's office to endorse the joint check and then the general contractor
should deliver that check to the creditor. This eliminates any risk of forgery on the
check and makes sure the check is actually delivered
III. Treatment of Joint Checks in Bankruptcy
Mary Joanne Dowd, Esq.
Partner
Arent Fox LLP
Washington, DC
Treatment of Joint Checks in Bankruptcy
Introduction
General contractors, first tier subcontractors, and lower tier suppliers and
subcontractors (and, on occasion, owners) for reasons specific to a project or the
creditworthiness of an intermediate party, participate in joint check arrangements.
The critical common element in all joint check arrangements, whether done by
three party written agreement or course of conduct, is the issuance, typically by
the general contractor, of a check made jointly payable to a first tier subcontractor
and a lower tier supplier or subcontractor. The general contractor’s purpose in
issuing a joint check is to satisfy its contractual payment obligation to its
subcontractor and, at the same time, cause its subcontractor to satisfy its payment
obligation to its lower tier supplier or subcontractor. By participating in a joint
check arrangement, the general contractor may facilitate continuity of work and a
project’s progress and avoid work stoppages, project liens and bond claims.
The enforceability of joint check arrangements generally and within
bankruptcy is highly fact specific and varies by jurisdiction.
1
Within a bankruptcy case, disputes involving joint checks typically arise
in the following contexts: (i) litigation over the relative rights of a lower tier
subcontractor and a first tier subcontractor’s bankruptcy trustee or secured
creditor to receive or retain a joint check after a subcontractor files for bankruptcy
or (ii) litigation brought by a subcontractor’s bankruptcy trustee to recover
payments received by a lower tier subcontractor via joint check during the ninety
(90) day preference period prior to a subcontractor’s bankruptcy filing. As
discussed below, in both contexts, the resolution of the dispute largely turns on
the determination of the subcontractor’s property interest, or lack thereof, in a
particular joint check as a matter of state law or on whether the general contractor
had an independent obligation to pay the lower tier subcontractor.
Bankruptcy Law
Is a Joint Check Included within or Excluded
from Property of the Bankruptcy Estate?
The filing of a bankruptcy petition creates an estate consisting of “all legal
or equitable interests of the debtor in property as of the commencement of the
[bankruptcy] case.” 11 U.S.C. § 541(a)(1). The scope of property of the
bankruptcy estate is intentionally broad and includes all property “wherever
located and by whomever held.” 11 U.S.C. § 541(a). However, “[p]roperty in
1
See generally “Joint Check Arrangements” by The Travelers Indemnity Company and “Joint
Check Agreements: Key Points in Drafting and Pitfalls to Keep in Mind” by Kimberly Gessner.
which the debtor holds . . . only legal title and not an equitable interest . . .
becomes property of the estate . . . only to the extent of the debtor’s legal title . . .
but not to the extent of any equitable interest in such property the debtor does not
hold.” 11 U.S.C. § 541(d). The estate does not take a greater right or interest in
property than the debtor had. See Senate Rep. No. 989, 95
th
Cong., 2d Sess. 82,
U.S. Code Cong. & Ad. News, 5787, 5868.
In Mid-Atlantic Supply, Inc. of Virginia v. Three Rivers Aluminum Co., the
Fourth Circuit thoroughly examined the legislative history of § 541, prior case
law, and the many facts and circumstances that influence whether a joint check is
included within or excluded from a bankruptcy estate. 790 F.2d 1121, 1124 (4th
Cir. 1986). A review of the Mid-Atlantic case should be the starting point in any
bankruptcy litigation involving property of the estate, joint checks or express or
constructive trusts. The case is also a textbook guide for how best to structure a
joint check arrangement to enhance the likelihood that the arrangement will be
enforced in a subsequent bankruptcy.
In Mid-Atlantic the Fourth Circuit considered the relative rights of a lower
tier supplier and a subcontractor’s secured creditor (whose rights were derivative
of the subcontractor’s rights) to a joint check issued by a general contractor to the
subcontractor and the supplier. The Court held that the joint check, which was in
the possession of the subcontractor, was impressed with a constructive trust for
the benefit of the supplier as a matter of the applicable state law (here, Virginia).
Id. at 1124–27. Since the check was held in trust, it was excluded from the
subcontractor’s bankruptcy estate and turned over to the lower tier supplier. And
since the joint check was not property of the bankruptcy, the security interest of
the subcontractor’s lender in accounts receivable did not attach to the joint check.
Id. at 1128.
In reaching its holding in Mid-Atlantic the Court emphasized the following
facts: the supplier refused to do business with the subcontractor on credit; the
supplier, as a condition of accepting the subcontractor’s purchase order to
manufacture custom windows, required an agreement with the general contractor
and subcontractor that it would be paid by joint check issued by the general
contractor and supported by the credit of the general contractor; the parties agreed
that the joint check to the supplier would pay for the windows delivered by the
supplier and not the window installation services of the subcontractor, which
would be separately paid. The Court held that the subcontractor was a “mere
conduit” for the payment from the general contractor to the supplier. Id. at 1127.
In support of its imposition of a constructive trust on the joint check for the
supplier, the Court further held that the supplier’s reliance on payment from the
general contractor before it undertook to manufacture and deliver the windows
estopped the general contractor and the subcontractor from revoking the joint
check agreement. Id..
Notably, the Court also re-stated the general rule that once an express,
statutory, or constructive trust is established over property in the possession of a
bankruptcy trustee or chapter 11 debtor-in-possession, the “sole permissible
administrative act” of the trustee or debtor-in-possession is “to pay over or
endorse over the property to the beneficiary . . . of the trust.” Id. at 1126.
In Georgia Pacific Corp. v. Sigma Service Corp., a case which involved
similar issues but materially different facts from those in Mid-Atlantic, the Fifth
Circuit held that the joint checks at issue were property of the bankruptcy estate.
712 F.2d 962 (5th Cir. 1983). In Sigma, a general contractor unilaterally
requested that a project owner pay it and its suppliers by joint checks. Unlike in
Mid-Atlantic, the parties did not execute a joint check agreement or otherwise
discuss or agree to terms. Nevertheless, the project owner delivered joint checks
to the general contractor payable to it and certain suppliers. Unlike in Mid-
Atlantic, in Sigma there was no record evidence that the suppliers required joint
checks to perform or relied on a joint check arrangement.
In Sigma, the general contractor did not endorse the joint checks the owner
delivered to it. Instead, the general contractor asked the owner to re-issue the
checks to it alone as the sole payee. The owner declined. The general contractor
then filed for bankruptcy and, as a chapter 11 debtor-in-possession, filed a lawsuit
to compel the owner to pay it the joint check amounts. The suppliers intervened
in the lawsuit and sought to impose a constructive trust or statutory trust on the
joint checks as a matter of applicable state law (here, Arkansas and Mississippi).
The Fifth Circuit found that the general contractor’s joint check request
was revocable (unlike in Mid-Atlantic) since there was no record evidence of
supplier reliance. Not surprisingly, the Court held that the issuance of joint
checks alone is not grounds for imposition of a constructive trust. Finally, in light
of the record and applicable state law, the Court found it could not impose a
constructive trust or a statutory trust on the joint checks for the benefit of the
suppliers, and held that the joint checks were property of the bankruptcy estate.
As discussed above, specific facts and circumstances influence whether or
not a joint check is administered as property of a bankruptcy estate. The closer
the facts are to those in the Mid-Atlantic case, and the more the facts and the
applicable state law support impressing an express, constructive, or statutory trust
on a joint check, the more likely it is that a joint check will be excluded from
property of the estate and turned over to its equitable owner. Conversely, the
closer the facts are to those in the Sigma case, and the less indicia of trusts there
are, the more likely it is that a joint check will be administered within a
bankruptcy case.
Is a Payment by a Joint Check a Transfer of an Interest
of the Debtor in Property under the Preference Statute?
Bankruptcy law and policy favor equality of distribution among similarly
situated creditors. Begier v. I.R.S., 110 S. Ct. 2258 (1990). To that end, and to
discourage favoring one creditor over another during insolvency and the slide into
bankruptcy, bankruptcy law allows a bankruptcy trustee to avoid and recover for
the bankruptcy estate certain payments made prior to the filing of a bankruptcy
case. Id.; 11 U.S.C. §§ 547, 550.
The threshold element of a preference cause of action is that the transfer
was of “an interest of the debtor in property.”
2
If the property transferred was not
the debtor’s property, or property in which the debtor had an interest, the
preference cause of action fails. See e.g., Begier (transfer of tax trust funds was
not a transfer of the debtor’s property); Wolff v. U.S. (In re FirstPay, Inc.), 773
F.3d 583 (4 th Cir. 2014).
This gate-keeping element of a preference cause of action has been
litigated in numerous construction industry bankruptcy cases involving payments
by joint check. Nevertheless, as one court remarked recently, the law in this area
remains unsettled. Davis v. Kice Industries, Inc. (In re WB Services, LLC), 587
B.R. 548 (Bankr. D. Kan. 2018).
Many courts have found that the co-payee (later debtor) of a joint check
had a sufficient property interest in the joint check to satisfy this element of a
preference cause of action, reasoning that the co-payee’s relinquishment of the
right to receive a payment was a transfer of its property interest. See Code
Electric, Inc. v. Crampton, 197 B.R. 807 (D. N.C. 1996); Kice, supra; Napolitano
v. Vibra-Conn, Inc. (In re Patton Co.), 348 B.R. 618 (Bankr. D. Conn. 2006).
These courts have considered but been unpersuaded by the argument that the joint
check issuer had an independent obligation to the lower tier co-payee such that
the transfer was a transfer of its own property, not the debtor’s property. Supra.
2
The bankruptcy preference statute provides, in pertinent part, that a trustee may avoid any
transfer of an interest of the debtor in property-_[emphasis added]
(1) to or for the benefit of a creditor;
(2) for or on account of an antecedent debt owed by the debtor before such transfer was made;
(3) made while the debtor was insolvent;
(4) made—
(A) on or within 90 days before the date of the filing of the petition; or
(B) between ninety days and one year before the date of the filing of the petition, if such creditor
at the time of such transfer was an insider; and
(5) that enables such creditor to receive more than such creditor would receive if—
(A) the case were a case under Chapter 7 of this title;
(B) the transfer had not been made; and
(C) such creditor received payment of such debt to the extent provided by the provisions of this
title.
11 U.S.C. § 547(b).
See also Dal-Tile Corp. v. Reitmeyer (In re Buono), 119 B.R. 498 (Bankr. W.D.
Pa. 1990) (considering and rejecting argument that a constructive trust was
imposed on joint check payment; noting that a joint check agreement entered into
before the 90 day preference period may protect a transfer within the preference
period.).
On the other hand, in Steelvest, Inc. v. Messer and Sons Construction Co.
(In re Steelvest, Inc.), the bankruptcy court found that a three way joint check
agreement divested the debtor of its interest in property and, alternatively, that the
joint check agreement imposed an independent obligation on the general
contractor to pay the lower tier subcontractor, insulating the payment from
avoidance. 112 B.R. 852 (Bankr. W.D. Ky. 1990). See also, McShane, Inc. v.
Monumental Supply Co. (In re McShane, Inc.) 328 B.R. 430 (Bankr. D. Md.
2005) (creative use of three way settlement agreement).
As discussed above, the outcome of preference litigation involving joint
checks is difficult to predict. However, a well drafted joint check agreement
entered into prior to the 90 day preference period or at the onset of the contract,
and some degree of independent obligation, may prove to be defenses to a
preference claim.
Finally, bear in mind that there are several other elements a trustee must
establish to recover a preferential transfer and statutory defenses under the
preference statute that would likely be applicable.
Conclusion
Caution and attention to details are advisable in any joint check
arrangement. The timing of entering into the arrangement and the details of the
agreement will influence how the arrangement is viewed in a subsequent
bankruptcy.
