Purchasing Materials for a Subcontractor has Risks

Oct 11, 2017

Advice on how general contractors can protect their interest in this material

All general contractors know it is best not purchase materials for a subcontractor or fabricator. This rule is often overlooked when the inability of a sub to purchase material contained in its contract threatens to hold up progress on a project.

Usually a contractor purchases equipment or lends money to buy the material because the subcontractor agrees to repay the cost of the material once it is paid for work on the job. This is a red flag that the sub may be in financial difficulty and may not be able to repay the loan.

What recourse does the prime contractor have when this occurs? An article in Construction Law Now by Marion A. Kornilowicz and Anthony M. Bottenfield addresses this issue.

“To minimize this risk, contractors can take certain steps to protect their investment in the material.” One is the securing of a “purchase money security interest (PMSI) in the material.” Another is obtaining proof that they “and not the subcontractor/fabricator, own the material.”

The authors emphasize that although both of these steps e improve a prime contractor’s legal position, neither provides absolute protection.

“A PMSI in inventory requires (a) the filing of a UCC-1 financing statement prior to delivery of the materials, and (b) notice to all lenders that hold a security interest in the inventory. The UCC-1 must be filed in the state of formation or incorporation of the subcontractor/ fabricator…” The PMSI gives the contractor a priority position in legal proceedings.

According to Mr. Kornilowicz and Mr. Bottenfield, establishing ownership of inventory is difficult to accomplish. They suggest a “properly drafted and executed bailment agreement or bill of sale with the subcontractor/ fabricator.” The material must be labelled as the property of the contractor and stored apart from material belonging to the subcontractor.

The authors’ final advice to general contractors is “to consult with an attorney” before providing funds to purchase material for a subcontractor or supplier.

Source—

Contractors: Protect your Investment in Materials, Marion A. Kornilowicz and Anthony M. Bottenfield, Construction law Now, Oct. 2, 2017.