Public Works and the Importance of the Payment Bond

Law Talk

In a public works contract, what happens if the County failed to obtain a payment bond from the now bankrupt general contractor who has not paid his subcontractor? Does the subcontractor get paid? By whom? A recent case that was decided by the California Court of Appeal addressed this very question.

In 1998, N.V. Heathorn, Inc. ("HEATHORN") entered into a contract with Nielsen Dillingham Builders, Inc. ("NDBI"). NDBI was "acting in the capacity of a general contractor on a public works project" - namely improvement work on the San Mateo County Health Center. HEATHORN was the subcontractor providing labor and materials for this project. By mid 2001, NDBI owed HEATHORN over $400,000 for HEATHORN's contributions to the project. Therefore, HEATHORN filed a lawsuit against NDBI. In turn, NDBI filed for bankruptcy, which relieved them of their obligation to pay.

Under Civil Code section 3247, the public entity must require the original contractor to file a payment bond if the project is for more than $25,000. The County of San Mateo ("COUNTY") did not do so in this case. Therefore, HEATHORN was now left without a payment source.

In February 2003, HEATHORN submitted a claim to the COUNTY seeking damages it should have been able to recover from NDBI. The COUNTY rejected this claim making the following arguments: First, HEATHORN has not demonstrated an "injury" under the Government Tort Claims Act; and second, the action was time-barred.

The Government Tort Claims Act allows someone to recover against a public entity for injuries suffered only if the injury is of a nature that would be actionable if caused by a private individual. That is to say, the court cannot hold the government liable for causing harm to this subcontractor, if a regular person, in the government's shoes, would not be held liable. Moreover, the injury must be caused by the COUNTY's failure to exercise a duty-here, the duty to require a payment bond. In response, if the public entity can show that "it exercised reasonable diligence to discharge the duty," the public entity will not be liable. The trial court agreed with the COUNTY's first argument and found in favor of the COUNTY.

We have previously written about the importance of mechanic's lien rights and their constitutional authority. However, government projects are not subject to mechanic's liens because of sovereign immunity. Sovereign immunity is the doctrine that bars an action against the government without its consent. The only remedies available on public works are stop notices and actions on the payment bond. Thus, the payment bond is essentially the equivalent of a mechanic's lien where the stop notice is inadequate due to insufficient funds.

As Heathorn emphasizes, 'the lien rights of those who provide labor and materials is protected through constitutional mandate in both the public and private spheres.' Our state Constitution guarantees that "laborers of every class shall have a lien upon the property upon which they have bestowed labor or furnished material for the value of such labor done and material furnished; and the Legislature shall provide, by law, for the speedy and efficient enforcement of such liens.'

With these considerations in mind, the Court of Appeal disagreed with the trial court and found in favor of HEATHORN, the subcontractor. The Court found the harm caused by the COUNTY's failure to obtain a payment bond from NDBI and neglecting its statutory duty, "qualifies as an 'injury' to support a cause of action."