Payment-Bond Claims: An Alternative Way to Ensure Contractors are Paid

All too often, unfortunately, many construction subcontractors do not get paid for labor or materials.

In order to receive payment, most subcontractors resort to filing a Mechanics Lien. The governing statutes contain a thicket of requirements that are strictly construed by the courts and must be followed to the letter, and collection efforts may be frustrated if the defaulting contractor posts a separate bond, commonly referred to as “bonding off” the lien.

The subcontractor may also file a lawsuit against the defaulting construction contractor, claiming breach of contract and diversion of trust funds. The diversion claim is based on a law providing that funds received in connection with an improvement to real property, or for public improvements, are the assets of a statutory trust. They are to be held for the purposes set forth in Lien Law §71, including payment of subcontractors, laborers, and building-materials suppliers. Although diversion of trust funds is a larceny, the harsh reality is that sometimes the money has been spent elsewhere.

A sometimes-overlooked third option is a payment-bond claim. It should be investigated and pursued if available, either solo or in conjunction with liens and a lawsuit against the defaulting contractor.

A payment bond is a three-way contract between the owner (the obligee), the bonded contractor, and the surety. The surety is typically an insurance company.

The payment bond protects the owner in the case of claims made by unpaid subcontractors and materials suppliers. The contractor and the surety are signatories to the agreement. They bind themselves to the owner to pay for equipment, materials, and labor provided in the performance of the contract.

 

Early steps — Investigation and notice

Private projects

On private projects, the contract documents describe any bonding requirements. The general contractor should promptly furnish a copy of the bond to any potential claimant upon demand. If the contractor delays, contact the owner or owner’s representative.

Claims on private construction projects are governed by the terms of the payment-bond document and any referenced provisions in the underlying contract. Claim rules differ depending upon whether the claimant has a direct contract with the bonded contractor. Typically, direct claimants must give written notice (claim and the amount) to the surety with a copy to the owner.

Claimants who do not have a direct contract with the bonded contractor usually have additional requirements. This is logical when you realize that a general contractor may not know that a sub-subcontractor or materials supplier has not been paid.

It is essential to obtain a copy of the bond to determine the notice requirements in your particular case. Typical additional requirements include written notice of non-payment to the general contractor with a copy to the owner within a time period defined in the bond.

If the claim is rejected in whole or in part, or the contractor fails to respond within a defined period — often 30 days — usually the next step is written notice to the surety, again with copy to the owner. It is important not to delay; sitting back on an unpaid invoice may cause the demise of a claim.

 

Public Improvement Projects

New York State Finance Law §137 requires payment bonds for all but the smallest public improvement contracts. If your company is providing labor or materials on a public project, chances are there is a payment bond. You can obtain a copy from the head of the department or bureau having charge of the public improvement, comptroller, or other appropriate official. The bond is open to public inspection.

The same statute governs claims on public-improvement projects. The courts have held that its provisions are a minimum standard to be read into any public improvement bond. The bonding company cannot dilute the statutory protections. A direct subcontractor not paid in full within 90 days after its last labor performed or materials furnished, has the right to sue under the bond.

A sub-subcontractor must give an additional written notice to the bonded contractor within 120 days after claimants’ last labor was performed or materials furnished. This notice must be delivered personally to the contractor or mailed by registered mail. It is important to understand that 120 days is not the same as four months. The notice requirements must be followed precisely. They are a condition to a suit under the bond.

Sending the surety a copy of the notice may spark negotiations. Bond claims can place significant pressure on the contractor to resolve the dispute. In addition to paying the premiums on the bond, the principals of the bonded contractor have often signed personal guarantees, or company assets may have been pledged. Once the surety pays claimants, it will demand reimbursement for the claim(s) and associated legal costs.

 

Next Steps if Still Not Paid

If the required notice(s) are served and payment is not made, a lawsuit against the surety is the remedy. The statute of limitations on a public bond is one year from the date when the public improvement is completed and accepted. In the case of a private bond, the document terms govern. Typically, there is a one year statute of limitations, commencing as defined in the bond. The date of claimant’s last labor, or materials provided and/or the date of notice are common factors.

On a public improvement bond claim, interest and attorneys’ fees are potential elements of damages, and may factor into the pressure to settle a claim.

Any bond claim, public or private, must be documented. The bond and contract documents describe the requirements. Each part of the claim, including change orders, must be substantiated. Surety has all the contractor’s defenses in addition to some of its own. If the claimant’s work or materials did not meet the specifications, the surety will dispute the claim.

When appropriate, a payment-bond claim is an important tool that can be used to secure payment to a subcontractor or materials supplier. A payment-bond claim should be investigated promptly if an invoice is not paid within terms.

 

Lorraine Rann Mertell is a litigation attorney and partner at Mackenzie Hughes LLP, with a variety of experience in civil-litigation matters. Contact her at (315) 233-8282 or email: lmertell@mackenziehughes.com