Vesting Property Title 2: The Sequel

John Smith and Michael Jones are two friends who enjoy fixing and remodeling homes. They decide to go into business together, to buy distressed properties through foreclosure sales, to repair and remodel them, and then to sell the remodeled homes for a profit. They shake hands and agree to proceed, with each contributing one half of all expenses, and with each sharing one half of the profits. John Smith then comes to me for advice.

I advise John that he and Michael have effectively entered into a general partnership agreement, and that Florida law does not require their agreement be in writing. I advise John, however, that their agreement needs to be in writing, to more completely set forth the parameters of their understanding, thereby avoiding many of those disputes which occur with oral agreements. I also advise John that all property acquired by the partnership should be vested solely in the partnership’s name, in order to avoid any claims of creditors against either of the partners in their individual capacities. I told John to consider the following scenario.

Two partners buy a parcel of land. Immediately after closing, one of the partners unexpectedly has to leave the state to deal with a family emergency. The second partner undertakes all the necessary improvements to the property in partner one’s absence, and upon his return the two partners sign a contract to sell the property. At closing, Second Partner insists that he be paid a greater share of the profits since he had been the only partner to work on the house. He also “reminds” his partner that they once had a phone discussion in which they had both agreed that there may be circumstances in which one partner may provide more services than the other, and that the profits would need to be adjusted accordingly. Partner One says he does not remember that conversation, and that if Partner Two refuses to split the profits evenly that he will file a lawsuit to “clear up the record.” Unless the partners can come to an amicable resolution, not only will this matter end up in court, but realistically the partnership agreement will come to an end. A properly drafted written partnership agreement could have addressed this situation, and the partners could then have looked to the partnership agreement to address their differences.

A General Partnership is defined in chapter 620 of the Florida Statutes as “an association of two or more persons to carry on as co-owners a business for profit.” Unlike most business entities that must register with the Florida Department of State, there is no registration requirement for a General Partnership. These business entities, whether oral or written, are governed in Florida by the Revised Uniform Partnership Act (“RUPA”). Under RUPA, the general partners share both the profits and the obligations of the general partnership, and each partner is jointly and severally liable for all obligations of the partnership. A person who is later admitted as a general partner, however, will not be personally liable for any partnership obligation incurred before that person’s admission as a partner.

The manner in which title is vested in the general partnership will impact the enforceability of judgments against real property owned by the partners and the partnership. The general rule is that judgments against a person who is a partner of a partnership do not attach to property vested in the partnership. Partnership property is viewed as separate and distinct from the interests of the individual partners. As a result, if John Smith and Michael Jones create the JSMJ General Partnership (“JSMJ”), and title is vested in JSMJ, a duly perfected judgment against JSMJ will be enforceable against the real property owned by that partnership. A judgment against John Smith as one of the principals of that partnership, however, would not attach to the partnership’s property.

It is therefore important to properly vest title in the partnership name, and not in the individuals creating the partnership. Let’s assume that John Smith and Michael Jones have created the JSMJ General Partnership to buy Whiteacre. Title to Whiteacre, however, is mistakenly vested in their individual names, and not in the name of the partnership. A certified copy of a $50,000.00 judgment against Michael Smith is then recorded in the public records of the county in which Whiteacre is located. The Smith judgment will then automatically attach to Michael Smith’s one-half interest in the investment property. If title had been vested in the JSMJ General Partnership, the judgment against Michael Smith would not have attached to Whiteacre.

What if a partner does not want to be personally liable for the debts of the partnership, while sharing in the profits of the business? Florida law permits the formation of a Limited Partnership, which is a form of legal entity by which there may be one or more general partners and one or more limited partners. Unlike a general partnership, a limited partnership cannot legally exist unless it is in writing and registered with the Florida Department of State. The name of the partnership itself must also end with the words “Limited Partnership”, “L.P.”, “Ltd.” or “LP”. In a validly formed limited partnership, each of the general partners will have the same rights and obligations of general partners in a general partnership. The limited partners however are passive investors (similar to shareholders in a corporation). The limited partner has no control over the partnership business, and also has no personal liability for any of the acts of the partnership. The Limited Partnership is generally the preferred form of partnership agreement for those investors who do not want to be held liable for the debts and obligations of the partnership.

Judgments against limited partnerships attach to all real property titled in the partnership name. Judgments against a person who may be either a general or limited partner in the partnership will not attach to the property that is vested in the limited partnership’s name.

In future articles we will discuss other forms of legal entities which can acquire real property, and the impact that judgment liens may have on those particular forms of ownership and their respective principals.

This Article is not a substitute for hiring an independent attorney to assist in the determination of the appropriate legal entity by which a purchaser should acquire title to real property.

Frank Pohl founded Pohl & Short, P.A. based upon the belief that a high quality small commercial law firm was needed in the Orlando, Florida area as an alternative to the large commercial law firms. He still believes that client responsiveness and satisfaction has a place in a fast changing legal profession. Frank’s legal practice has concentrated on complex real estate, tax and corporate transactions throughout Central Florida. Frank has been involved in the Central Florida community for more than thirty years. He has been a dedicated past board member of many local organizations over the years. Frank graduated magna cum laude with a B.G.S. Degree from the University of Miami in Coral Gables, Florida; attended the University College at the University of London as an undergraduate studying British literature and British history; obtained his Juris Doctorate Degree in 1979; and obtained a Masters of Law and Letters Degree (LL.M from New York University School of Law in 1980.

How Should Property Title Be Vested?

Winter Park Home Magazine / Issue 2 / 2013

Clients frequently ask how they should take title when purchasing real property. This question encompasses a consideration of the goals of each client, and if appropriate, the client’s need for asset protection.

If property is to be used as a primary residence, I generally advise that title be vested in the individuals’ names. This provides the buyers homestead protection from judgment creditors, and also allows the buyers to take advantage of the real property tax benefits associated with the homestead. If the buyers are husband and wife, and acquire title in their individual names, I typically recommend that the title be vested as husband and wife, in order to create a tenancy by the entireties. A tenancy by the entireties is a legal fiction, by which property is treated as owned by the married couple as a unit, and not in their individual capacities.

Judgments generally do not attach to homestead property. A judgment against one spouse, but not both spouses, also will not attach to entireties property. There are limited exceptions to this rule.  For example, under recent case law a federal tax lien against one spouse attaches not only to entireties property, but also to homestead property. Generally speaking, however, judgments and liens against one spouse do not attach to property owned as tenants by the entireties.

Another benefit of owning property as tenants by the entireties is the survivorship feature – at the death of the first spouse the entire interest in the property passes automatically to the surviving spouse, without the expense of probate. The only requirements to clear title in the surviving spouse is the recording of the death certificate of the deceased spouse, and the execution and recording of an affidavit establishing that the husband and wife were continuously married from the date they acquired title until the death of the deceased spouse.  

If the right of survivorship is not the couple’s intention, then an alternative form of tenancy should be recited in the deed. For example, the deed could state “to Michael Smith and Mary Smith, husband and wife, as tenants in common and not as tenants by the entireties.” In this example, Michael and Mary would each own a one-half undivided interest in the property. If Michael died, his one half interest in the property would need to be probated to determine the identity of his heirs, i.e the new owners of his one-half interest. The clearer the recitation of tenancy, therefore, the better the result. In this tenancy in common example, a judgment against either one of the spouses (unless the property is homestead) will attach to that spouse’s one-half interest in the property.

If no recitation is made concerning the form of tenancy, and the parties are married, then a tenancy by the entireties is presumed. If they are not married, and no form of tenancy is recited, the property will be owned as tenants in common. Divorce automatically terminates an entireties tenancy, and creates a tenancy in common. If the parties then remarry each other, the parties will remain as tenants in common unless a new deed from the parties to themselves is executed to recreate the tenancy by the entireties status.

A third alternative is to create a joint tenancy with full rights of survivorship, and is often used when purchasers are not married (to each other), and wish to create a survivorship benefit. For example, title is placed in Mary Smith and Amanda Johnson, as joint tenants with full rights of survivorship.  Each will own a one-half undivided interest in the property. Unlike a tenancy in common, however, if Mary Smith were to die, her interest would automatically pass to Amanda – without the need nor the expense of a probate proceeding. A judgment lien against Mary Smith, during her lifetime (again, assuming that the property is not homestead) would attach to her interest while she is alive. If a judgment creditor failed to enforce its lien against Mary during her lifetime, then the lien would be extinguished at the time of her death – due to the survivorship feature of the joint tenancy. This would also be true of any voluntary lien that Mary may place on joint tenancy property. Prior federal tax liens and estate taxes, if any, are the exceptions, and will attach to the property even after the death of Mary.

When purchasing non-homestead property, buyers often should consider the benefits of placing title in a legal entity to protect their individual assets. Examples of legal entities vary, and individuals should consult with their attorneys to determine which legal entity will best serve their purposes. Corporations, for example, are one alternative form of business ownership, and consist of shareholders, a board of directors, and officers who are appointed by the board members or shareholders. The President typically is authorized to bind the corporation, and can execute documents on behalf of the corporation.

Conceptually, only the corporation is liable for its debts and obligations. In the event of a judgment against the corporation, the shareholders, officers, and directors typically do not incur any individual liability. Judgments against the shareholders, directors, or officers of the corporation, when entered in their individual capacities, also do not attach to the property owned by the corporation. There are, of course, additional costs and fees associated with the creation of a corporation (as well as any other legal entity that may be created by the purchasers). In addition, individuals should consult with their attorneys and accountants to determine any additional income tax liability that may be imposed as a result of vesting title in a corporation, or any other legal entity.

Examples of other commonly used legal entities that can own real property are general partnerships, limited partnerships, limited liability companies, and limited liability limited partnerships. Florida law sets forth the guidelines, rules and regulations for each of these entities.

In my next article, I will describe the mechanics and benefits of these additional legal entities.

This Article is not a substitute for hiring an independent attorney

to assist in the determination of the appropriate legal entity by 
which a purchaser should acquire title to real property.

Frank Pohl founded Pohl & Short, P.A. based upon the belief that a high quality small commercial law firm was needed in the Orlando, Florida area as an alternative to the large commercial law firms. He still believes that client responsiveness and satisfaction has a place in a fast changing legal profession. Frank’s legal practice has concentrated on complex real estate, tax and corporate transactions throughout Central Florida.  Frank has been involved in the Central Florida community for more than thirty years. He has been a dedicated past board member of many local organizations over the years. Frank graduated magna cum laude with a B.G.S. Degree from the University of Miami in Coral Gables, Florida; attended the University College at the University of London as an undergraduate studying British literature and British history; obtained his Juris Doctorate Degree in 1979; and obtained a Masters of Law and Letters Degree (LL.M from New York University School of Law in 1980.

Encroachments Reflected By Surveys

Winter Park Home Magazine / Issue 1 / 2013

A grant of an easement by a property owner can often resolve disputes between neighbors resulting from encroachments of fences, driveways, and roof overhangs by one property owner onto another person’s property. An easement is a formal grant of permission by an owner of land in favor of the owner of a second parcel of land, which grants the second parcel owner the legal right to cross over and/or to utilize a portion of the first parcel owner’s land. An easement, however, also limits the rights of the parties, and in certain situations a transfer by deed may be preferable. The following example depicts certain considerations in determining whether a grant of easement or a conveyance by deed is the appropriate solution, and also emphasizes the fact that a contract purchaser should always obtain a survey prior to closing.

Five years ago Robert Smith purchased his home on Lot 1 in the XYZ subdivision. He paid cash, and opted to forego the expense of a survey. The house was situated inside the fences on the property. Mr. Smith was provided a title insurance policy at closing, and the general survey exceptions were reflected as an exception on Schedule B of his title policy. This effectively excluded coverage in his policy for any encroachments onto or from his neighbor's property that may have been reflected in a survey.

Last year Mr. Smith decided to make some home improvements, and contacted ABC Bank for a loan. The Lender indicated, as part of the loan approval process, that he would have to pay for a Lender’s title insurance policy and provide a copy of his survey. Since he never obtained a survey, Mr. Smith ordered a new survey which reflected  that the entire width of his house encroached 3 feet into Lot 2, and that the fence encroached an additional 4 feet beyond the edge of the house. The Lender then indicated that Mr. Smith's loan would not be approved unless he can establish that he owned, or had the right to use, this 7 foot strip of land.

Mr. Smith contacted me for advice. I advised Mr. Smith that he would not have a claim under his title insurance policy since the policy reflected the general survey exceptions. I also advised him that the owner of Lot 2 has no obligation to convey this strip or to grant an easement. I further advised Mr. Smith that his best case scenario is to have the owner of Lot 2 convey the 7 foot strip outright to Mr. Smith, and that the worst case scenario entailed Mr. Smith physically removing the fence and demolishing the portion of his house situated on Lot 2. In the event a portion of the house was demolished, Mr. Smith would also have to obtain permits from the building department to make the necessary changes to his home.

We then obtained title searches for each of the lots, and confirmed that Mr. Smith owns Lot 1, and that J.R. Jones owns Lot 2. The search also reflected one outstanding mortgage on Lot 2. Mr. Smith then authorized me to contact Mr. Jones directly to resolve the encroachment problem. 

Mr. Jones stated he was not aware of any encroachments, and that he would be constructing a home on his lot in the near future. He stated he was willing to convey the 7 foot strip outright, for an agreed sum, provided we obtained written confirmation from the building and zoning departments that this conveyance would not adversely impact his ability to construct a home on Lot 2. He also advised me to contact his attorney directly with the results.

The building department official indicated that each of the lots in the XYZ Subdivision are substandard in size, and that any reduction in the physical size of a lot, unless a variance was first obtained by that property owner, would result in the denial of a building permit for that lot. He could not guarantee, under the circumstances, that the variance would be approved.  I then asked whether the granting of an easement under the facts presented would require an approval by either the zoning or building departments, and he confirmed that no approval would be necessary.

I then contacted Mr. Jones' attorney, gave him the contact information for the building department, and asked him, after he talked with them, to determine whether his client would grant an easement instead of requiring a deed of conveyance. I also explained that his client had a mortgage on the property, and asked whether he would also contact his lender to obtain its consent to a grant of easement.

Ultimately Mr. Jones agreed to grant the easement, and to obtain the consent of his lender, provided Mr. Smith paid all costs and expenses incurred by Mr. Jones, and also provided Mr. Smith compensated him for the reduction in valuation of Lot 2 resulting from the grant of easement. The grant of easement that was finally approved also included language that the easement would automatically terminate in the event Mr. Smith's house were destroyed by fire or natural disaster, and that any new construction by Mr. Smith, or his successors in title, would have to be located within the platted lot lines of Lot 1.

The time and expense incurred by Mr. Smith could easily have been avoided if he had obtained a survey at the time of purchase.  Mr. Smith's predecessor in title would have been obligated to resolve these issues prior to their closing, and, if the issues were not resolved by the time of closing, Mr. Smith could have elected to terminate the contract and receive a return of his earnest money deposit.  These types of encroachments occur on a somewhat regular basis, and demonstrate the need for obtaining and reviewing a survey prior to closing. 

This Article is not a substitute for hiring an independent attorney

to prepare an easement or deed across real property.

Frank Pohl founded Pohl & Short, P.A. based upon the belief that a high quality small commercial law firm was needed in the Orlando, Florida area as an alternative to the large commercial law firms. He still believes that client responsiveness and satisfaction has a place in a fast changing legal profession. Frank’s legal practice has concentrated on complex real estate, tax and corporate transactions throughout Central Florida.  Frank has been involved in the Central Florida community for more than thirty years. He has been a dedicated past board member of many local organizations over the years. Frank graduated magna cum laude with a B.G.S. Degree from the University of Miami in Coral Gables, Florida; attended the University College at the University of London as an undergraduate studying British literature and British history; obtained his Juris Doctorate Degree in 1979; and obtained a Masters of Law and Letters Degree (LL.M.) from New York University School of Law in 1980.

Use of Easements

Winter Park Home Magazine / Issue 3 / 2012

An easement is a grant of permission by the owner of land (known as the subservient estate) in favor of the owner of a different parcel of land (known as the dominant estate) to cross over and/or use a portion of the subservient estate. Since it transfers an interest in real property, it must be executed and recorded with the same formalities as a deed (i.e. before two witnesses and a notary public), and be signed by all parties having a record interest in the subservient estate. This article addresses the procedural steps to be undertaken when adjoining property owners have determined that an encroachment exists, and the parties have agreed overall to the terms and conditions of the easement to be granted.

First, the parties need to determine whether there is a need for an easement. For example, John Smith and Mary Smith own Parcel A, and Michael Jones owns the adjoining Parcel B. Mr. Jones' concrete driveway encroaches two feet in width into the Smiths' property. There is no prior grant of easement of record authorizing this encroachment. Previously the Smiths verbally consented to Mr. Jones' use of the encroaching driveway area. Mr. Jones, however, is concerned whether he will be able to continue to use this encroachment area, especially if the Smiths were to later sell their property.

The Smiths can withdraw their verbal permission at any time, and under the facts presented, the Smiths have no obligation to continue to grant him permission to use the encroaching portion of the driveway. Absent a written grant of easement, the Smiths could bring a judicial action to make Mr. Jones remove the encroaching portion of the driveway. The Smiths are willing to execute and record a written grant of easement.

First, a title search of the Smiths' property should be performed and reviewed in order to confirm that the Smiths are in fact the owners of Parcel A, and also to determine whether there are any mortgages or other liens against the Smiths' property. In the event there are any mortgages or liens existing against the Smiths' property, those lenders or lien holders will need to provide their consent and subordinate their interests to the grant of easement. Otherwise, for example, if there is a prior mortgage on the Smiths' property and the lender’s consent is not obtained, a subsequent foreclosure of that mortgage would extinguish the grant of easement by the Smiths.

After review, the title search report confirms that the Smiths own Parcel A. The title report also reflects one mortgage on the property. Mr. Smith has spoken with his mortgage loan officer, and he does not anticipate any problem in obtaining the requisite consent.

The parameters and scope of the easement need to be determined. It is not sufficient to merely recite that there is an encroachment – its exact location must be established on the public record. A complete legal description of the easement area should be provided by a licensed surveyor – to be included in the grant of easement. A survey of Mr. Jones’ property was obtained at the time of purchase. Mr. Jones will need to contact his surveyor and obtain the appropriate legal description of the encroachment area.

The Smiths intend to impose limitations on the grant of easement. They not only want Mr. Jones, and his successors in interest, to maintain the driveway at all times in its current condition, but also the Smiths want the right to use this 2-foot strip in conjunction with their own abutting driveway. This is a reasonable request, especially in light of the fact that Mr. Jones property is the one encroaching on the Smiths’ property. This might create some logistical problems when, and if, it becomes necessary for Mr. Jones to resurface his driveway. Language will need to be included in the easement document describing all of the conditions requested by the Smiths.

In conjunction with this maintenance requirement, the Smiths also want the easement to automatically terminate if Mr. Jones fails to properly maintain his portion of the driveway. The better practice would be to provide specific language by which an examiner on the public record can determine whether the easement remains in full force and effect. Although various options are available, it is determined that the easement will provide that the parties must execute and record a formal termination of the easement if the easement is no longer needed by Mr. Jones, or if the driveway is not properly maintained.

It is readily apparent there are many factors to consider in preparing and recording an easement across real property. All interested parties should consult with a qualified real estate attorney to protect their interests before executing any document which impacts their respective interests in land that they own.

This Article is not a substitute for hiring an independent attorney to prepare an easement across real property.

Frank Pohl founded Pohl & Short, P.A. based upon the belief that a high quality small commercial law firm was needed in the Orlando, Florida area as an alternative to the large commercial law firms. He still believes that client responsiveness and satisfaction has a place in a fast changing legal profession. Frank has been involved in the Central Florida community for more than twenty-five years. He has been a dedicated past board member of many local organizations over the years. Frank graduated magna cum laude with a B.G.S. Degree from the University of Miami in Coral Gables, Florida; attended the University College at the University of London as an undergraduate studying British literature and British history; obtained his Juris Doctorate Degree in 1979; and obtained a Masters of Law and Letters Degree (LL.M.) from New York University School of Law in 1980. Frank is a member of The Florida Bar, the California Bar, and the District of Columbia Court of Appeals. He is also admitted to the U.S. Supreme Court. He has served on the Orange County Bar Association Real Estate Committee and is a member of the The Florida Bar’s Real Property and Corporation and Business Law Section. He has also served on the Florida Bar Grievance Committee.

Minors and Conveyances

Winter Park Home Magazine - Issue 2 - 2012

Mary Smith contacted me to assist her in the sale of a vacant lot owned by both Mary and her son, Michael. Mary originally went to a local title agency and was advised that she cannot complete the sale because her son is a minor – i.e., under the age of 18 years. Mary owns a 50% interest in the property, and her 17 year old son, Michael, owns the remaining 50% interest. They have a Buyer ready to purchase the lot for $25,000.00.

Initially, I explained that minors do not have certain contractual legal rights. Florida law provides that only individuals 18 years of age or older are deemed “sui juris,” which means that only those individuals 18 years of age or older have the full ability (i.e., are not under any legal disability) to execute contracts or to sign a deed conveying real property. Property can be transferred to and owned by a minor. The problem is that a conveyance executed by Michael, as a minor child, could subsequently be set aside by Michael after he turns 18. Existing case law would allow a minor to set the deed aside as long as seven years after the minor reaches his eighteenth birthday, unless that individual ratified the deed once he turned 18. Additionally, if he has already spent the money from the sale, there would be no obligation for the “minor” to pay the money back.

Florida law provides certain exceptions to this ability of a minor to subsequently set aside a conveyance. Specifically, the disability of nonage (lack of legal age) of a minor is removed if the minor is now, or ever has been married. Additionally, a circuit court has jurisdiction to remove the disabilities of nonage of a minor age 16 or older who resides in Florida based upon a petition filed by the minor’s natural or legal guardian. Alternatively, a guardianship proceeding could be filed with the circuit court, and an order authorizing the sale of the property by the guardian could be obtained, in order to transfer Michael’s interest in the property. Michael has never been married, and neither of these judicial proceedings has been undertaken to date. The cost of these proceedings might sometimes be justified, but fortunately there is a much simpler and less costly approach to remedy the absolute conveyance of Michael’s interest in this vacant lot.

Florida law provides that if the minor’s net interest in the property is less than $15,000.00, the natural guardian of the minor may execute a deed on behalf of the minor. The mother and father of the minor are the “natural guardians” of the minor. If both parents are still alive, both parents would have to sign the deed. If one of the parents dies, the surviving parent acts as the natural guardian. Mary’s husband and Michael’s dad, John Smith, is deceased. As a result, Mary has full power to execute a deed as the natural guardian for Michael – since Michael’s 50% interest in the property, $12,500.00, is less than the statutory maximum of $15,000.00. Although it will be necessary to document on the public record the fact that Mary and John are Michael’s parents, that John is now deceased, and that no guardianship or adoption proceedings have subsequently been filed, we will now be able to complete the sale of the property. The signature section on the deed for Michael’s one-half interest will read: “Michael Smith, by Mary Smith, his natural guardian.” The deed itself, for Michael’s one-half interest in the property, will be signed by Mary in her representative capacity, and not by Michael. The deed cannot be subsequently set aside by Michael.

Conveyances to minors, generally speaking, are potentially problematical when it is time to convey the property from the minor. Formal guardianships can be created on behalf of the minor, and property conveyed to the guardian on behalf of the minor. Guardianships are formal legal proceedings, and the guardian will only be able to sell the property after the court has entered an order authorizing the sale and conveyance of the minor’s interest in the property.

A minor’s interest in property can also be created under the Florida Uniform Transfers to Minors Act (“FUTMA”). Under FUTMA, property is conveyed to a natural (adult) person as a custodian of the minor child. The authority of the Custodian, unlike the “natural guardian” example above, is not subject to any monetary limitation. FUTMA, however, is extremely technical, and an attorney should always review the facts and determine the appropriate format of the deed. There may also be different time periods during which the Custodian may act on behalf of the “minor.” In certain situations, the authority of the Custodian ceases at the eighteenth birthday of the minor, and in other situations that authority will remain until the 21st birthday of the minor.

There are numerous variations to the examples that are set forth above. Any person wishing to vest title in a minor needs to be aware of the logistical problems that are created by transferring title to an individual who has not yet reached the age of 18, and should consult with his/her legal counsel to determine the appropriateness of such transfers.

This Article is not a substitute for hiring an independent attorney to determine the appropriateness of transferring property to a minor. 

Frank Pohl founded Pohl & Short, P.A. based upon the belief that a high quality small commercial law firm was needed in the Orlando, Florida area as an alternative to the large commercial law firms. He still believes that client responsiveness and satisfaction has a place in a fast changing legal profession. Frank has been involved in the Central Florida community for more than twenty-five years. He has been a dedicated past board member of many local organizations over the years. Frank graduated magna cum laude with a B.G.S. Degree from the University of Miami in Coral Gables, Florida; attended the University College at the University of London as an undergraduate studying British literature and British history; obtained his Juris Doctorate Degree in 1979; and obtained a Masters of Law and Letters Degree (LL.M.) from New York University School of Law in 1980. Frank is a member of The Florida Bar, the California Bar, and the District of Columbia Court of Appeals. He is also admitted to the U.S. Supreme Court. He has served on the Orange County Bar Association Real Estate Committee and is a member of the The Florida Bar’s Real Property and Corporation and Business Law Section. He has also served on the Florida Bar Grievance Committee.

Integrated Project Delivery: Changing the Insurance Landscape

ProNetwork News  - April 2012

With more project owners demanding the use of Building Information Modeling (BIM), project delivery is necessarily carried out through greater contributions of design input by the general contractor and the major trade subcontractors. The design professionals are no longer the sole authors of the project design. This collaborative project delivery method has been called integrated project delivery (IPD). The contribution of design input from each of the various project players using IPD is a significant break from the traditional division of responsibility recognized in the standard design-bid-build project delivery method. Players who never participated in the project design now face potential risk of professional liability. Additionally, the new, cutting-edge technologies being used for BIM expand the types of risks born by the design professional if there are errors and omissions within the computer modeling system or the improper management of the computerized data.

What is BIM?
BIM involves computerized design software tools that help create a model that reflects all of the building components' geometric and functional qualities. The general contractor and trade subcontractors provide product-specific information for building components and that data is inputted into the model, including performance specifications, connection details and cost data. However, the model is more than a mere representation of the design in a three-dimensional computer graphic. Embedded within the design programs are rules that define each of the components' relation to the other components. The model is dynamic. If there is a change to one component, then the computer program would automatically and immediately revise the design to accommodate the ripple effect caused by the change. During the pre-construction phase, the project team can input different design options to facilitate value engineering and budgetary decisions, material estimation, and even long-term maintenance costs of the facility. In theory, assuming that the information provided by the various project players is accurate and the rules embedded in the model are correct, BIM should reduce errors and omissions, resulting in an aggregate reduction in professional liability and errors & omissions claims. Additionally, it should reduce the demand for change orders during the project, as the design should have fewer ambiguities and inconsistencies. Yet, if the assumptions embedded in the computerized model prove false, then the result would be a costly problem that all concerned should hope is covered by insurance.

Increasing Industry Acceptance:
IPD using BIM technology is becoming more prevalent with many predicting that it will become standard. In 2003, the U.S. General Services Administration's (GSA) Public Building Service set a goal to require BIM on FY06 projects and beyond in support of improving design quality and construction delivery. One reason for the use of BIM was a lack of GSA staffing to review design documents and to ensure conformance to building standards. Additionally, GSA was concerned with anticipated sustainability goals for federal buildings with respect to energy efficiency and long-term maintenance costs. GSA sought to rely upon the new BIM software tools to provide solutions to these problems. Since that time, GSA has employed BIM successfully on numerous projects. The GSA is not the only project owner to use IPD using BIM technology. General Motors has constructed at least six projects using this delivery method. Also, the United States Coast Guard and the United States Army Corp or Engineers has implemented BIM software in its recent projects. The expected industry trend is that this delivery method will not be reserved only for complex projects, but rather will start being used for simpler projects on a wider scale.

Evolving Contractual Relationships:
The construction industry is only beginning to catch up with the contractual liability issues that arise from the non-traditional roles played by the various project participants. For example, there has been the 2008 release of the ConsensusDOCS 300 Series for use on IPD projects using BIM technology. Also, the American Institute of Architects (AIA) has developed IPD Agreements AIA C196-2008 Standard Form of Agreement between Single Purpose Entity and Owner for Integrated Project Delivery and AIA C197-2008 Standard Form of Agreement between Single Purpose Entity and Non-Owner Member for Integrated Project Delivery. The AIA contractual agreements incorporate a separate Exhibit (AIA Document E202 – 2008) that might also be used with their other, more traditional contract documents on IPD projects using BIM technologies. The new AIA documents allow the parties to define the standard of care for BIM, as such would be difficult to define given the short history of this technology. They also attempt to allocate responsibility for managing the computer model, e.g. data storage, transferring model files, granting and withholding access to model files, validating completeness and usability of files, among other things. Also, the Exhibit provides a chart listing standard building components that is to be filled out by identifying who will author each listed element of the model design. These contractual means of defining the standard of care and allocating responsibility may impact a design professionals' liability for professional negligence.

Professional Liability Concerns for General Contractors and Trade Subcontractors:
The collaboration of general contractors and trade subcontractors in the design on IPD projects may result in liability exposure arising from errors in each parties' contribution that result in defects in the project design. Accordingly, these parties must approach the IPD similarly to a design-build project and obtain professional liability coverage and errors & omissions insurance. Moreover, the general contractor must recognize that it would face contractual liability to the owner for the errors contributed solely by its subcontractors – errors which could be very difficult to detect by the general contractor. Thus, the general contractor would be well advised to demand in its subcontracts that those subcontractors who contribute to the project design obtain coverage. Yet, the specific type of coverage that expressly contemplates the allocation of responsibility and risk inherent in IPD may not yet be on the market.

Expanded Liability Concerns for Design Professionals:
The consensus seems to be that IPD using BIM technology will result in an overall reduction in design errors. Yet, to the technophobe, an over-reliance on computer models with decreasing human over-sight could also spell disaster. What responsibility should the design professional have for errors in the data inputted by the various parties? What if there are errors in the rules embedded in the model or the internal mechanisms for transferring data or any other number of possible computer glitches? The contract with the company creating the modeling software likely limits liability for such errors to an amount far less than the damage that could be created by the error. The design professional must consider insuring that gap. To address these questions and issues, the design professional should discuss the potential IPD exposures with their broker and to what extent they are insured for same.

IPD not only requires additional contributions to design from the contractor, but may also involve greater involvement by the design professionals on the construction side. Design professionals may find themselves more active in the development in the means and methods of construction given the overall integrated approach on these types of projects. "Means and methods" are often excluded in professional liability policies. This raises the question of whether the design professional should purchase general liability insurance to cover damages resulting from negligent construction practices.

Conclusion:
IPD using BIM technology is changing the relationships between the various players on such construction projects. As a result, the standard construction contracts and their allocation of responsibility and risk may no longer be equitable or reflect reality. Accordingly, before participating in this type of project, all parties should consult with their attorney to review their contracts to address these issues. In addition to the need for revised construction contracts for these types of projects, all parties are strongly advised to meet with their insurance brokers and discuss the new risks arising from this project delivery method.

Visit our website for more information on this subject.

Frank Pohl founded Pohl & Short, P.A. based upon the belief that a high quality small commercial law firm was needed in the Orlando, Florida area as an alternative to the large commercial law firms. He still believes that client responsiveness and satisfaction has a place in a fast changing legal profession. Frank has been involved in the Central Florida community for more than twenty-five years. He has been a dedicated past board member of many local organizations over the years. Frank graduated magna cum laude with a B.G.S. Degree from the University of Miami in Coral Gables, Florida; attended the University College at the University of London as an undergraduate studying British literature and British history; obtained his Juris Doctorate Degree in 1979; and obtained a Masters of Law and Letters Degree (LL.M.) from New York University School of Law in 1980. Frank is a member of The Florida Bar, the California Bar, and the District of Columbia Court of Appeals. He is also admitted to the U.S. Supreme Court. He has served on the Orange County Bar Association Real Estate Committee and is a member of the The Florida Bar’s Real Property and Corporation and Business Law Section. He has also served on the Florida Bar Grievance Committee.

Right of Set-Off on Unrelated Projects

Architects/Engineers Professional Network - April 2012

 Frequently, general contractors will work with the same subcontractor or supplier on two separate, unrelated projects. When that happens, the situation may arise that on the first project (Project A), the subcontractor defaults on its contract, resulting in a back-charge that exceeds the subcontractor's contract balance, i.e. the subcontractor owes the general contractor money. On the second project (Project B), the subcontractor satisfactorily completed its work and is due money from the general contractor. It may seem obvious that the general contractor would have a right of set-off, allowing the general contractor to deduct the amount due from the subcontractor on Project A from the amount that the general contractor otherwise owes the subcontractor on Project B. Seemingly, the general contractor should only have to pay the net difference or be able to avoid paying the subcontractor anything if the back-charge on Project A exceeds the amount due on Project B. However, as outlined in this article, that seemingly straight-forward right to "net out" the competing claims might not always be available.

There are several different factors that can frustrate the general contractor's right of set-off. In some jurisdictions, state statutes may prohibit the general contractor from withholding from the subcontractor the amounts received from the owner for the subcontractor's work, such statutes holding that those funds are held in trust for the benefit of the subcontractor. Some states might even find the withholding of funds received by the owner for the subcontractor's work to be statutorily criminal. On projects covered by a payment bond, courts in some jurisdictions have held that even if the general contractor has a contractual right to set-off, the Surety may not. As a result, in those jurisdictions, notwithstanding the contractor's contractual right of set-off, the subcontractor may be entitled to recover the full amount on Project B (from our scenario above) from the Surety without any deduction of the amounts the subcontractor owes on Project A. Given that the general contractor must almost always indemnify the Surety, such a result has the practical effect of eliminating the contractual benefit of a right of set-off. Additionally, in certain circumstances, by the discretion afforded to judges under the rules of civil procedure, courts have required the two competing claims to be handled by separate lawsuits independently and without regard to the general contractor's claim of set-off. This article discusses these scenarios and others that impact the right of set-off.

Projects Protected by Payment Bonds

Basic surety law holds that a surety assumes only the liability of its principal and generally has the same defenses against a subcontractor suing on a payment bond as the principal/ general contractor. So, it would seem that if a general contractor has a contractual right of set-off against amounts otherwise owed to a subcontractor on a bonded project, the surety's liability to the subcontractor on that bonded project should be reduced by the amount of the set-off. However, a federal district court in Virginia disagreed when addressing that situation on a federal project on which a federal Miller Act payment bond was issued. In U.S. ex. rel. Accoustical Concepts, Inc. v. Travelers Casualty and Surety Company of America,635 F. S. 2nd 434 (E.D. Va. 2009), the court held that general principals of suretyship law that conflict with the Miller's Act's terms and purposes (i.e. ensuring that subcontractors are paid promptly for labor, materials and services furnished on federal construction projects) must give way to the Act.

In Accoustical Concepts, a subcontractor sued the surety on a Miller Act payment bond to recover amounts due on a federal project. The general contractor (the principal on the bond) had a claim against the same subcontractor on an unrelated non-federal private project. Accordingly, the general contractor and its surety set-off those claims against the amounts otherwise due on the federal project. In doing so, the general contractor and surety relied upon a provision in the subcontract on the federal project that expressly stated that the general contractor had the right to do so. Specifically, the contract provision stated:

 Before paying any amount due to the Subcontractor as provided hereinabove, the Contractor is hereby authorized to deduct therefrom and offset an amount equal to any and all sums or obligations owing by the Subcontractor to the Contractor and ... any and all claims liquidated or unliquidated, by the Contractor against the Subcontractor , arising hereunder, under any other contract or agreement between the Subcontractor and the Contractor.... 

Again, the court rejected the surety and general contractor's argument, based in part on its determination that neither the Miller Act nor the subject payment bond made any reference to the contractual set-off provision or its effect. The court reasoned as follows:

Were defendants [general contractor and Surety] allowed to interpose a setoff defense involving facts and circumstances relating to a non-federal project, plaintiff subcontractor would be forced to litigate with defendant sureties a dispute that plaintiff has with its general contractor that is nowhere a part of the payment bond or the Miller Act. The result can only be the kind of delay and complexity the Miller Act was designed to avoid. By contrast, preventing sureties from asserting a setoff defense leads to the sensible result - contemplated by the Miller Act - that a subcontractor [on a federal construction project] receives timely payment for providing labor and materials to [that project]. Defendant sureties may then seek to recover from [its principal] the full amount paid to plaintiff [subcontractor], and [the general contractor/principal] may then litigate the unrelated, non-federal dispute with plaintiff. In other words, the result reached here maintains a sharp division between the Miller Act's remedy for subcontractors on federal construction projects and disputes between subcontractors and prime contractors arising from non-federal construction projects that are not governed by the Miller Act. 

The argument can be raised that courts would apply this same reasoning in cases involving the states’ various Little Miller Acts on non-federal public projects or with respect to projects protected by statutory private payment bonds.

State "Trust Fund" Statutes

Several states have enacted statutes that hold that money received by the general contractor from the owner for the labor, materials, and services provided by subcontractors and suppliers (and lower-tiered subcontractors and suppliers) are held by the general contractor in trust for their benefit. The purpose of such legislation is to ensure that the subcontractors and suppliers that actually provide the work get paid. They may also potentially result in the frustration of the general contractor's right of set-off. The New York Lien Law, Article 3A §§70-79 is an example of a state trust fund statute. Section §70, states as follows:

The funds … received by a contractor under or in connection with a contract for an improvement of real property, or home improvement, or a contract for a public improvement in this state … shall constitute assets of a trust…. (Emphasis added.)

The New York Lien Law then outlines a statutory cause of action to enforce such a trust.

This statute was addressed in the New York federal case of Universal Maintenance, Inc. v. Amherst Painting, Inc. 1997 WL 160157 (W.D.N.Y.). In that case, the subcontractor sued the general contractor for amounts due on Project A – amounts that the general contractor had already received from the owner for the work performed by the subcontractor. The subcontractor argued that the funds received by the general contractor were held in trust pursuant to the New York Lien Law. The general contractor filed a counterclaim and raised as a defense that it had a right of set-off for back-charges arising from that same Project A, as well as, a back-charge arising from an unrelated subcontract on Project B. The court ruled that the general contractor indeed had a right of set-off as it related to the back-charges arising from the same Project A, holding: “the relief available in a Lien Law trust action encompasses the contractor’s right as trustee to offset against the trust fund amounts sums due from the subcontractor to the contractor with respect to the project.” Id. at 7 (Emphasis added). However, the court struck the general contractor’s counterclaim and defense of setoff for back-charges arising from the unrelated Project B, holding as follows: “The policy reasons for allowing the contractor to set off sums due from the subcontractor apply only to claims for sums due with respect to the project in question, not unrelated projects.” The court reasoned that a set-off claim arising from the unrelated Project B was not a compulsory counterclaim (i.e. one that must be brought in the same lawsuit pursuant to the rules of civil procedure) and can be pursued in another forum. 

New Jersey has a similar trust fund statute which applies to public projects (“The New Jersey Trust Fund Act”) which states as follows:

All money paid by the State of New Jersey … or by any county, municipality or school district in the state, to any person pursuant to the provisions of any contract for any public improvement ... shall constitute a trust fund in the hands of such person as such contractor, until all claims for labor, materials and other charges incurred in connection with the performance of such contract shall have been fully paid.

N.J.S.A. §2A:44-148.

The federal district court of New Jersey addressed that statute in the context of this article’s two-project set-off scenario in a March 27, 2008 opinion and order granting a motion for partial summary judgment filed by the subcontractor in Atlantic City Associates, LLC v. Carter & Burgess Consultants, Inc. Civil Action No.: 05-3227. In that case, we again have the scenario of the general contractor having a back-charge claim against the subcontractor on Project A and, as a result, claiming a right of set-off against amounts the general contractor otherwise owes to the subcontractor on Project B. Also, the general contractor was paid in full by the public owner for the work performed by the subcontractor on Project B. Further, the following contractual provision was contained in the governing subcontracts that expressly granted the general contractor this right of set-off on unrelated projects:

The Subcontractor agrees … that Contractor shall have the right to set off against any moneys due Subcontractor under this Subcontract any claim or claims against Subcontractor, whether arising under this Subcontract, or any other Subcontract or Subcontracts between the parties hereto.

Notwithstanding an express contractual right to do so, the federal district court rejected the general contractor’s claim to a right of set-off on unrelated projects as a matter of law. The court reasoned, in part, as follows: “The Trust Fund Act provides that ‘… the funds in the hands of the prime contractor constitute a trust fund to inhibit their diversion for purposes unconnected with the public project.’”

In an attempt to circumvent The New Jersey Trust Fund Act, the general contractor argued that the above-cited contractual right to set-off on unrelated projects constituted a waiver by the subcontractor of any rights otherwise bestowed by the Act. However, the court rejected that argument stating that the contract language was not "clear and unmistakable" evidence of the subcontractor’s knowing waiver of its statutory rights, in part because the contractual provision did not reference the statutes. It should be noted, however, that the case holding suggests that, with more specific waiver language, a subcontractor can waive such statutory rights.

Set-off as a Felony Crime?

It would be difficult to be more severe than Florida which makes the misapplication of construction funds a statutory felony. Florida Statute §713.345(1)(a) states as follows:

(1)(a) A person, firm, or corporation, or an agent, officer, or employee thereof, who receives any payment on account of improving real property must apply such portion of any payment to the payment of all amounts then due and owing for services and labor which were performed on, or materials which were furnished for, such improvement prior to receipt of the payment. This paragraph does not prevent any person from withholding any payment, or any part of a payment, in accordance with the terms of a contract for services, labor, or materials, or pursuant to a bona fide dispute regarding the amount due, if any, for such services, labor, or materials.
(b) Any person who knowingly and intentionally fails to comply with paragraph (a) is guilty of misapplication of construction funds, punishable as follows: 1. If the amount of payments misapplied has an aggregate value of $100,000 or more, the violator is guilty of a felony of the first degree, punishable as provided in s. 775.082 [i.e. by a term of imprisonment not exceeding 30 years].

This provision arguably limits a general contractor’s right to withhold payment for a back-charge (i.e. a bona fide dispute regarding the amount due) to only the project on which that back-charge arose. This is because the statute limits bona fide disputes to “disputes regarding the amount due, if any, for such services, labor, or materials”. A strong argument can be made that this language could be interpreted to mean “such” services, labor, or materials provided on that project only. If so, there would not be any right to set-off on unrelated projects if the contractor has received payment for the work by the subcontractor on the unrelated project on which the subcontractor performed satisfactorily; it would be criminal to withhold such payment because of a claim on an unrelated project. A general contractor could try to argue otherwise, but at the risk of committing a statutory felony crime punishable by jail time.

Rules of Civil Procedure – Court’s Discretion to Require Separate Trials

The rules of civil procedure might also assist a subcontractor to avoid a general contractor’s right of set-off on unrelated projects. If the subcontractor sues a general contractor for amounts owed on a project, and the general contractor has a back-charge arising from that same project, the general contractor must assert the back-charge through a counterclaim in that same lawsuit; it is deemed a compulsory counterclaim. However, the same is not true for a back-charge arising from a separate contract. In such instances, the general contractor’s counterclaim is deemed a permissive counterclaim. It is within the court’s discretion whether a permissive counterclaim is to be addressed in the same lawsuit or separately.

This scenario was addressed in Turner Construction Co. v. E&F Contractors, Inc., 939 So. 2d 1108 (Fla. 3rd DCA 2006). In that case, the general contractor conceded that the subcontractor was due the amounts sought, but for the general contractor’s claim to a right of set-off for back-charges arising from three other unrelated projects. Importantly, the subcontractor had filed four separate lawsuits – one for each of the projects. In the lawsuit at hand, the general contractor claimed that its back-charges on the other three projects exceeded the amount that the subcontractor was owed on the subject project. Accordingly, the general contractor filed a counterclaim and affirmative defense in the subject lawsuit, asserting a claim of set-off arising from its back-charges on the other projects.

The trial court struck the general contractor’s defense of set-off and entered a final summary judgment in favor of the subcontractor. The appellate court affirmed that decision holding as follows:

The affirmative defense of set-off in the instant case is in the nature of a permissive counterclaim, and is the subject of other pending suits between the parties…. It is within a trial judge’s discretion to sever a permissive counter-claim from the main claim if there is no evidence of prejudice…. Here, the trial court’s order does not prejudice [the general contractor] because [the general contractor] still has the opportunity to fully litigate its set-off claims in the pending lawsuits arising out of its other subcontracts with [the subcontractor]…. Furthermore, the trial court’s order striking the set-off claim promotes the interests of judicial economy, and avoids the potential of inconsistent rulings.

Based upon the results of this case, legal counsel for subcontractors facing this scenario may want to consider filing separate lawsuits. The lawsuit concerning the project on which the back-charge arose may take years to litigate given the likelihood of numerous contested factual issues that must be investigated through discovery. Conversely, the lawsuit concerning the project on which the amount due is undisputed (but for the set-off claim arising from the other project) could be won through summary judgment much sooner. The subcontractor might be able to collect quickly on the undisputed project, allowing it to build its legal war chest to fight the battle on the disputed project.

Conclusion

While it may seem absurd to require Party A to pay Party B when Party B owes Party A, the courts may nonetheless require it depending upon which states’ law governs, whether the job is bonded, or other circumstances. Accordingly, when there are set-off claims arising from separate and unrelated projects, it is strongly recommended that parties consult and retain local counsel.

View our website for more information on this subject.

Frank Pohl founded Pohl & Short, P.A. based upon the belief that a high quality small commercial law firm was needed in the Orlando, Florida area as an alternative to the large commercial law firms. He still believes that client responsiveness and satisfaction has a place in a fast changing legal profession. Frank’s legal practice has concentrated on complex real estate, tax and corporate transactions throughout Central Florida. Frank has been involved in the Central Florida community for more than thirty years. He has been a dedicated past board member of many local organizations over the years. Frank graduated magna cum laude with a B.G.S. Degree from the University of Miami in Coral Gables, Florida; attended the University College at the University of London as an undergraduate studying British literature and British history; obtained his Juris Doctorate Degree in 1979; and obtained a Masters of Law and Letters Degree (LL.M.) from New York University School of Law in 1980.