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The Smartest Tool in the Shed
By Procore Editorial staff
July 24, 2016
More than one subcontractor or material supplier has lost money for nonpayment on construction projects. Because there are often a flurry of bonds you become party to when taking on a project, you might incorrectly assume you have recourse other than litigation when you don’t get paid. But subtle wording in bonding documents, strict requirements for filing mechanic’s liens, and evolving case law and state statutes can leave you out in the cold.
While payment bonds and performance bonds often come as a package, they have two very different purposes:
Payment bonds guarantee payment to subcontractors and suppliers if the general contractor defaults, while performance bonds guarantee the successful completion of the project.
The two are usually bundled together, but it’s the payment bond that affects your ability to get paid. On private projects, the payment bond serves to reduce or eliminate using mechanic’s liens. On public projects, payment bonds are always required along with the performance bond because liens are not allowed on government properties. The payment bond allows subcontractors and material suppliers to get paid by the bonding company if the general contractor fails to do so.
Contractors, subcontractors and material suppliers all have a lot of faith that they’ll get paid. The best defense for all parties is a good offense, and that entails knowing who they’re in business with from the history of completed contracts to timely payments.
However, construction is full of risks and invariably something goes wrong. When that happens, project participants may find that they don’t have the money to pay their dues. In other instances, participants may see this as an opportunity to get ahead at the expense of others and simply ignore their legal and ethical responsibilities. It is therefore common to rely on mechanic’s liens to try to recoup what’s owed when the unexpected happens.
Mechanics liens, however, can sometimes cost more than the amount in dispute. This happens when there are previous mortgages on the property that have liens. It also happens when previously filed liens aren’t settled. In many cases, you might not collect on your lien when the property forecloses because there are so many past liens that there isn’t enough money to pay all of them. Another sticky situation is when you’re collecting on liens on a property with multiple owners. In this case, you might have to place your claim against hundreds of people.
There are many other unattractive aspects about liens. With the multitude of state rules and filing standards, you could lose your right to place a lien if you don’t follow the correct procedures. There are also time limits for filing liens and when you need to collect for new work on previously completed work, you might have to file multiple liens. Consequently, it’s understandable that many construction project participants would rather avoid the lien process altogether, which is where payment bonds come in.
But, even though working on a project that has payment bonds is more reassuring than having to rely on mechanic’s liens to get paid, there can be unexpected outcomes when disputes get decided by courts. In some cases, courts have wide latitude in interpreting laws related to payment bonds. There are also situations in which bonding statutes are evolving opposite case law.
A recent Pennsylvania construction dispute shows the latitude courts have when interpreting the law related to payment and performance bonds. A general contractor was building a school and hired a subcontractor to do the foundation work. The subcontractor bought materials from a supplier and didn’t pay for them. The material supplier sued the bonding company to collect what was owed. The bonding company, however, claimed that since the general contractor had paid the subcontractor in full, it was not liable to pay the material supplier. The bonding company was depending on a provision in the state’s procurement laws called “safe harbor.” Under that provision, if a contractor pays a subcontractor in full, the law assumes that everyone got paid, including the vendors supplying materials to the subcontractor.
In effect then, the bonding company is off the hook for those amounts. The lower court agreed with the bonding company. However, when appealed to the higher court, the interpretation came out in favor of the material supplier. According to state law, the bond must stay in effect until everyone is paid. In this case, language in the bond document effectively waived the “safe harbor” provision, leaving the bonding company open to payments even after the general contractor paid everyone.
Not only are the laws regarding payment and performance bonds open for interpretation based on specific wording in the bond documents, but they’re also evolving. For example, a proposed bill in the Connecticut legislature went against recent case law. Some trial court decisions had ruled against the statute and denied bonding companies the right to challenge claims if they didn’t pay or deny those claims within 90 days. The proposed change to the statute would allow bonding companies to keep their rights to defense and to challenge the merits of any claims beyond 90 days. Still, according to Robert Barrack, with Robinson+Cole Construction Law Zone, the subject will remain open to judicial interpretation, which aptly describes the ever evolving construction litigation landscape.
The best case scenario is that whenever you complete work according to contract standards, you get paid timely. When that doesn’t happen, your first lines of defense before using litigation are mechanic’s liens or payment bonds. Since there is wide variability in how jurisdictions treat mechanic’s liens and payment bonds, it’s a good idea to consult with attorneys who deal with these kinds of issues. These statutes are evolving sometimes along with case law, and sometimes opposite case law. Having someone in your corner who has the experience and skills in the area can help to make sure your rights are preserved, and you eventually get paid.
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