PCCA Journal|4
th
Quarter 2010
21
T
he current economic
decline has hit the stage
when those who were just
hanging on by their finger-
nails are starting to fail and
fall. While contractors must
always be attentive to ensure that
subcontractors are passing along
payments to lower-tier subcon-
tractors, the impact of the current
economy now requires that contrac-
tors be ever more vigilant in protect-
ing themselves and their sureties
from bond claims and mechanic’s
liens by reason of payments diverted
by an upper-tier subcontractor that
should have been passed on to a
lower-tier subcontractor. I have
seen a disturbing trend of claims
from sub-subcontractors and suppli-
ers against the general contractor’s
bonding company or of mechanic’s
lien claims against the owner, based
upon the fact that although the
initial subcontractor was paid for the
work performed, the subcontractor
never paid its sub-subcontractors or
suppliers. Few object to paying once,
but everyone objects to paying twice
for the same service.
The Problem: Paying Twice
for Subcontract Work
On public works construction proj-
ects, under the Federal Miller Act
and the Little Miller Acts adopted by
virtually every state in the United
States, contractors are required to
furnish payment and performance
bonds. Subcontractors and suppli-
ers, including lower-tier subcon-
tractors that have no contract with
the general contractor, who are not
paid for their contribution of labor,
equipment, supplies, and the like,
have a claim against the contractor’s
payment bond. Even on large private
projects, payment and performance
bonds are routinely required to
cover the same obligation; that is, to
ensure that subcontractors, sub-sub-
contractors, and suppliers are paid
for their contribution to the project.
Additionally, on private projects,
even if no bond is required, nearly
every jurisdiction has a mechanic’s
lien statutory scheme under which
unpaid sub-subcontractors and
suppliers have claims against the
project owner (who in turn will have
indemnity claims against the general
contractor) for unpaid labor, materi-
als, and equipment on the project.
What this all means is that in most
instances, and with a few procedural
hurdles, the general contractor (and
the indemnitors on the bonding line)
are ultimately liable for a “busted”
sub’s failure to pay its subcontrac-
tors and suppliers. Read that last
sentence again as it is the source of
a substantial amount of angst and
frustration to a general contractor
who has never considered the pos-
sibility of this type of liability.
True, there are many hoops
through which mechanic’s lien
claimants and bond claimants have
to jump in order to preserve and
perfect their rights, but once they’ve
been burned once, they tend to
become skilled at complying with
the bond claim and mechanic’s lien
statutes. Therefore general contrac-
tors need to be equally skilled at
avoiding paying twice for the same
service through proper management
of subcontractors.
With increasing frequency, lower-
tier subcontractors are not paying
their bills. While there is a time
during which the “robbing Peter
to pay Paul” system works for the
subcontractor who is slowly rolling
down the economic hill, the scheme
comes tumbling down when there is
no future project to pay past debts.
Similarly as jobs become more
scarce, subcontractors lower their
prices to garner work priced below
cost. Many unpaid lower-tier sub-
contractors who face more demands
on their construction funds than
the funds will allow will frequently
operate for many, many months
before claims for unpaid work are
turned into judgments, bond claims
are filed, or mechanic’s lien claims
are asserted. The general contrac-
tor may be completely unaware that
its subcontractor is failing because
the work is getting done and be-
cause the subcontractor is assuring
Managing Subcontractors in
the Midst of Economic Meltdown
By Gregory T. Spalj
Legal Watch
Continued on page 22
Authors note:
For simplicity, this article examines the problems caused by downstream
subcontractors not paying their subcontractors from the perspective of the general contractor.
The principles discussed, however, would be the same and the solutions posed would have
applicability to a higher-tier subcontractor managing its lower-tier sub-subcontractors.