REVISITING "CONDITION PRECEDENT" CLAUSES IN SUBCONTRACTS
AS UNENFORCEABLE:
WHERE DO WE GO FROM HERE?
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Gordon Hunt, Esq.
Hunt Ortmann, Blasco, Palffy & Rossell, Inc., A Professional Corp.

1.  Introduction

2.  Civil Code Says Ok to Cash

3.  UCC Says Don't Cash

4.  Conclusion - What To Do                                                                             
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1. INTRODUCTION

The California Supreme Court, in a case decided June 26, 1997, held that "condition precedent" payment clauses in subcontracts are unenforceable. The California Supreme Court had the occasion to address this issue in the case of William R. Clarke Corporation v. Safeco Insurance Company of America (June 26, 1997) 15 Cal.4th 882.

In that particular case, Keller Construction Co. Ltd. ("Keller"), as general contractor, entered into a contract with an owner of a commercial building to do rehabilitation work on the building. Keller, in turn, entered into subcontracts with various subcontractors containing a "pay if paid" provision in one subcontract and an addendum reiterating that the "pay if paid" limitation did not waive the subcontractors' Mechanic's Lien rights. It made the subcontractors' Mechanic's Lien right their "sole remedy" in the event the owner failed to pay Keller. The contract between Keller and the owner required Keller to obtain a labor and material payment bond from Safeco Insurance Company of America ("Safeco") to protect the owner from Mechanic's Lien claims by subcontractors or material suppliers. The bond was a payment bond as defined in Civil Code §3096 and recited that it had been executed to comply with the Mechanic's Lien law. The bond stated that Keller, as principal, and Safeco, as surety, were bound to any and all persons who performed labor upon or furnished materials used in the project. The condition of the bond was that if the principal (Keller) paid the persons performing labor or furnishing materials, then the bond would be void, otherwise it would remain in full force and affect. In other words, if Keller, the principal on the bond, failed to pay the claims of subcontractors and suppliers, Safeco, the surety on the bond, would be obligated to do so.

2. CIVIL CODE SAYS OK TO CASH

In 1987, the Legislature enacted Civil Code §1526, which provides that where a claim is disputed or unliquidated, and a check is tendered by the debtor in settlement of the claim and the words "payment in full" or other words of similar meaning are notated on the check, the acceptance of the check does not constitute an "accord and satisfaction" if the creditor totally protests against accepting the tender in full payment by striking out or otherwise deleting that notation or if the acceptance of the check was inadvertent or without the knowledge of a notation. In other words, if there was a dispute between the creditor and the debtor and the debtor tendered a check with the notation "payment in full", all the creditor had to do was strike out those words and could go ahead and sue the debtor for the balance that was in dispute, notwithstanding the cashing of the check.

This code section was enforced in the courts. For example, in the case of Red Alarm, Inc. v. Waycrosse, Inc., C.A.9 (Cal.) (1995), 47 F.3d 999, a dealer sent a check to a manufacturer stating that it was payment in full of the manufacturer's claim. The check was deposited in the manufacturer's lock box, the manufacturer being unaware of the statement that the check was being tendered as payment in full. When the manufacturer determined that the check had such restrictive language, it promptly notified the dealer that it did not consent to the terms upon which the check was offered. The court held that the manufacturer was not bound by the release language.

Further, in the case of In Re Van Buren Plaza LLC, Bkrptcy. C.D. Cal. 1996, 200 B.R. 384, the Bankruptcy Court held that the debtor properly protected itself under this code section by sending a letter to the maker of the check indicating that it was accepting the check only in part payment of obligations between the parties and therefore, cashing the check with the words "full payment" on it did not bind the creditor. Specifically, in that bankruptcy case, the court noted that the California statute authorized a creditor to retain and use the check while still preserving its rights against the maker of the check even when the check contains "payment in full" language because the statute was designed to prevent the debtor from making payment on the debt which is clearly a minimal amount owed to the creditor which forces the creditor into a compromise of an otherwise legal entitlement.

3. UCC SAYS DON'T CASH

In 1992, the Uniform Commercial Code was amended to provide in Section 3311 that if a person against whom a claim is asserted proves that:
(1) that person in good faith tendered an instrument to the claimant as full satisfaction of the claim,
(2) the amount of the claim was unliquidated or subject to a bonafide dispute, and
(3) the claimant obtained payment of the instrument,
the claim is discharged if the person against whom the claim is asserted proves that the instrument or accompanying written communication contained a conspicuous statement to the effect that the instrument was tendered as full satisfaction of a claim.

This provision of the Uniform Commercial Code is in conflict with and contrary to Civil Code §1526. This dilemma was presented to a court in 1998. In the case of Directors Guild of America v. Harmony Pictures, Inc. (1998) 32 F.Supp.2d 1184, a check was tendered to the Directors Guild of America which was marked "full and final settlement for the audit period 6/1/90 to 5/31/94". The Directors Guild of America crossed out that language before cashing the check and mailed Harmony Pictures, Inc. a letter stating that the payment was not a full settlement. The suit by Directors Guild of America was for pension and health fund contributions plus interest, audit fees, and liquidated damages. The court looked at the familiar rule of statutory construction that states that where there is a conflict between statutes, they should be reconciled if reasonably possible. The court, in effect, recognized that these two statutes could not be reconciled. The court then turned to another rule of statutory interpretation to the effect that a statute enacted later in time should prevail. The court concluded therefore that since Uniform Commercial Code §3311 was enacted later than Civil Code §1526, that Uniform Commercial Code §3311 should prevail and therefore, Directors Guild of America, having cashed the check marked full and final settlement as noted above, constituted an "accord and satisfaction" and prevented Directors Guild of America from recovering the balance in dispute.

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