Getting Paid on a Construction Project

INDUSTRY INSIGHT

In this two-part article, we have attempted to identify some tools that are available to contractors, subcontractors and suppliers who are facing a payment dispute on a construction project. In last month’s issue, we discussed mechanic’s liens and demonstrated why they can be a powerful and effective part of your collection strategy. This article will discuss two other tools, payment bonds and Prompt Payment Statutes, and show why they can be useful and effective tools for an unpaid contractor or supplier who is looking to secure payment.

Bond Claims – Third Party Guarantees that Can Provide an Additional Source of Potential Recovery

Cautious owners and producers sometimes require prime or general contractors on construction projects to provide payment bonds. Payment bonds guarantee the prime contractor or “principal’s” payment to those that supply labor or material under a construction contract. Under appropriate circumstances, an unpaid subcontractor or supplier can secure payment from these types of bonds when the principal/contractor is insolvent or refuses to pay without a reasonable or legitimate excuse.

Significantly, the sureties that issue these payment bonds typically require the management and/or owners of a principal/prime contractor and their spouses to sign agreements of indemnity. These agreements require the owners/management to indemnify or reimburse the surety for any payments made under the bond. Management’s exposure to potential personal liability can therefore provide an additional incentive for a contractor to pay the amounts that are owed.

In addition, general contractors are required to supply payment and performance bonds before they can perform work on most public and many large commercial construction projects. The ability to supply these bonds or “bonding capacity” is crucial to a contractor’s eligibility to bid and perform work on most public and many commercial projects. Claims against a bond limit or have a negative effect on bonding capacity. This effect on a contractor’s bonding capacity can add an additional incentive for a defaulting contractor to settle.

Does this mean a claim against a payment bond is a surefire way to receive immediate payment on a disputed claim? Unfortunately, the answer is no. Sureties, like insurance companies, have claims departments that must complete an investigation of any claim against a bond before any claim can be paid. These investigations take time. In addition, if the principal disputes the claim, the surety will typically deny the claim and tender the defense of the claim to the contractor. If this occurs, the subcontractor or supplier must pursue a lawsuit against the surety, oftentimes in federal court.

Does this mean that a bond claim is ineffective or not worth pursuing as part of your collection strategy? The answer is no. When you are involved in a payment dispute, there is always the risk that the withholding contractor is insolvent. If a non-paying contractor is insolvent, it could file a bankruptcy petition or be forced into bankruptcy through a petition by one of its other creditors. Depending on the number of other creditors, the possibility of a quick recovery or full recovery in a bankruptcy proceeding is typically remote, particularly if the debtor is unsecured or if there are other creditors whose liens have priority. A contractor could also be “judgment proof,” meaning it doesn’t have assets available to recover against even if you obtain a judgment against it. In these situations, a bond claim can be beneficial if not crucial alternative source of recovery.

Finally, it is also important to remember that the terms of a bond generally determine a claimant’s right to recover. Bonds often include specific notice requirements and dictate what type of proof is required to recover under the bond. They also typically identify the types and amounts of recovery that can be made under that bond. It is therefore important to obtain a copy of and carefully read any bond before asserting a claim.

Prompt Payment Statutes – An Additional Tool that is Available in Some States that Can Help Contractors and Subcontractors Get Paid

Another often-overlooked tool that is available to an unpaid contractor, subcontractor or supplier are State Prompt Payment Statutes. These statutes impose additional statutory obligations on owners/contractors that can serve as another proverbial hammer to hold over the head of non-paying owners and contractors.

For example, Pennsylvania has enacted its own Prompt Payment Act, which is known as the “Contractor and Subcontractor Payment Act”, 73 P.S. §§ 501 et seq. ("CSPA”). CSPA sets specific deadlines for an owner’s payment to a contractor, providing that “except as otherwise agreed by the parties, payment of interim and final invoices shall be due from owner within …20 days after delivery of the invoice [to the Owner]” i . CSPA also provides that if payment by the owner to the contractor is delayed, the owner shall pay the contractor interest at the rate 1% per month or fraction of a month or 12% per annum on the balance that is at the time due and owing ii .