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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.