Another Victory For The Subcontractors

Law Talk

By this time, anyone who is in the construction business is aware that the "Pay if Paid" clause has been held to be unenforceable. This is a win for subcontractors and material suppliers. Our office was involved in the California Supreme Court case that rendered this decision.

Another recent case also helped subcontractors. This case had to do with public works projects and the fact that sureties on public works projects would be held responsible to pay a penalty imposed by the Public Contract Code. Although the factual and procedural background of this case deals with public works, it is possible that the same body of law can be used in the private works arena.

Several years ago our legislature enacted a body of law which has become known as "Prompt Pay" legislation. Our office worked on and supported the legislation. Essentially these statutes state that contractors, upon receipt of money from owners, have a time certain in which to pay their subcontractors. The failure to pay within the prescribed time can subject the contractor to a two percent (2%) per month penalty and the recovery of attorney fees and cost, should one party be required to sue the other party to collect the money owed.

The two percent (2%) penalty is two percent (2%) of the amount due per month for each month that payment is not made. As you can see, the penalty could be quite large.

The question recently answered by our Appellate Court was whether a surety who issued a payment bond would be held responsible for the two percent (2%) penalty when the bonded contractor fails to make the payment called for in the "Prompt Pay" statutes. The answer was a resounding "yes."

Green Coast, a general contractor, entered into a contract with Caltrans for work to be performed on Highway 150. Green Coast then entered into a subcontract with Backlund whereby Backlund was to perform clearing, grubbing, excavation and grading services for the sum of $269,650.00. Through the course of the work of improvement, the contract between Green Coast and Backlund was increased to the sum of $953,641.04. Although Green Coast had received payments from Caltrans, Green Coast failed to pay its subcontractor Backlund. Backlund filed a Stop Notice. Green Coast then misrepresented to Backlund that Caltrans had not paid Green Coast for any of Backlund's work and further was contesting Backlund's claim for such work. Green Coast then negotiated with Backlund telling Backlund that if they would accept a lesser sum of money, Backlund would get paid immediately by Green Coast in exchange for a release of the Stop Notice. Backlund agreed to this, but Green Coast defaulted on this agreement and Backlund subsequently discovered the deception. Backlund filed a lawsuit seeking to recover on its contract and further sought to recover the two percent (2%) interest penalty for failure to make timely payment. By the time Backlund filed its complaint, Green Coast had filed for bankruptcy. The complaint was filed by Backlund and against Washington International Insurance Company ("Washington"), the surety who issued the payment and performance bond.

Washington filed a motion to strike the portion of the complaint that sought the two percent (2%) interest penalty. Washington contended that under its bond, it was only required to pay Backlund for the labor and materials used or consumed on the work of improvement and not for the two percent (2%) penalty per month. It further claimed that this two percent (2%) penalty did not represent an out-of-pocket expense or an actual outlay of money.

The Appellate Court said that while no case law exists as to the meaning of the word "claims" in this scenario, the fact is that claims include all amounts owed to an unpaid subcontractor, which would include not only money owed for the value of work put in place, but for the penalty imposed by the law. The Court cited Civil Code Section 3226 which states in relevant part that any bond issued will be construed most strongly against the surety in favor of all persons for whose benefit such bond is given. Here, the bond was given for the benefit of Backlund and therefore the bond should be construed most favorably to Backlund.

The Court held that claim for recovery of the two percent (2%) per month penalty is a valid claim. What happened at the actual trial is unknown. It is important to keep in mind that in order to be able to recover this two percent (2%) penalty, the subcontractor must be able to prove that the actions of the contractor violated California's "Prompt Pay" laws.