Introduction:
There are unique remedies available for unpaid subcontractors and materialmen on government construction jobs. Mechanics liens are available on private projects but are not available on public projects since one cannot “foreclose” on realty owned by the government. Instead, the California government provides for two remedies: the Stop Notice and the claim on the Payment Bond.
On all government construction projects valued at more than $25,000, California Civil Code § 3247 requires a payment bond be posted by the contractor. Any subcontractors or suppliers who are unpaid for work or materials furnished to a state or county construction project can bring a claim against the payment bond as well as file a Stop Notice.
The Stop Notice, if properly filed with the correct timing, requires the government agency to withhold from the next payment due the contractor the amount of the claim plus twenty five percent. This can be a catastrophic event for the contractor who suddenly has the cash flow hindered in the midst of a job.
Unlike a private job, in which the claimant must post its own bond to have an effective Stop Notice, no bond is required of the claimant on a public works job. Simply by filing the right paperwork, along with the twenty-day preliminary notice, the public agency must withhold for the claimant 125% of the claimed amount. While a suit to enforce the Stop Notice must be filed soon thereafter, the fact is that the payment stream is halted entirely for the amount of the claim and the contractor often faces economic hardship.
The Bond Claim is put on the bonding company who will then be liable to the claimant if the contractor is found liable but does not pay. The bonding company, itself, normally has a contract with the contractor that requires payment from the contractor to the bonding company if it is required to defend and/or pay out. That potential claim from the bonding company is critical to the contractor since no future bonding company will bond the contractor if the bonding company is not repaid. The contractor must protect the bonding company or faces inability to bid on future jobs.
Thus, both the Stop Notice and the Bond Claim are powerful tools available to the claimant.
The Stop Notice and the Bond Claim are completely separate, and unpaid subcontractors or suppliers can file both a Stop Notice and a Bond Claim, or either of them alone. While each can be filed independently of one another, it is essential to both claims that a 20-day Preliminary Notice be delivered to qualify to file either.
Bond Claims must be filed directly with the prime contractor and the bonding company (“surety,”) and must be sent to them at any time after the claimant has furnished its services or materials, but no later than 6 months after the Stop Notice deadline as discussed below.
A contractor, in the middle of a construction project, pressed for time and money, can suddenly find significant sums withheld and a government agency annoyed at having to withhold money. Further, the bonding company, vital to the continued success of the contractor, suddenly has a Bond Claim filed and will look to the contractor to make good on the claim if any sums need to be paid out.
But there are remedies available to the contractor in bonding around the Stop Notice, as further discussed below.
The Stop Notice Remedy and the Release Bond
California is one of the few states that statutorily provides for a Stop Notice filing. A subcontractor or supplier who is unpaid for services or materials sends off a Stop Notice to the public entity commissioning the work and the prime contractor, and upon receipt, the public entity is required to discontinue payments to the prime contractor in an amount sufficient to satisfy the claimant’s claim.
To file a Stop Notice on a California state project, a subcontractor or supplier must have delivered the required 20-day Preliminary Notice within 20 days of first furnishing labor or materials to the project. Thereafter, it must use the proper Stop Notice form, and send it certified mail with return receipt requested to the public entity commissioning the work and to the prime contractor.
Stop Notices must be filed within the earlier of: (a) 30 days from the recording of a “Notice of Completion” for the project; or (b) If this notice is not recorded, within 90 days from the actual completion. (Note: for a claim on the bond, the claimant must file suit against the surety if the claim remains unpaid, and suit must be brought no later than 6 months from the expiration of the Stop Notice period.)
California code requires withholding of funds due to a contractor or materials supplier when the owner of a project or construction lender receives a Stop Notice from a claimant. But there is a remedy for the contractor suffering the filing of a stop notice and that is to obtain a Stop Notice Release Bond.
A Stop Notice Release Bond is an efficient mechanism for nullifying the notice and starting cash flow commencing again. The Release Bond is only effective if the public entity so allows but most entities readily accept the Release Bond since it takes the responsibility away from the public entity to withhold the sums. Pursuant to California Civil Code Section 3196-3205, Article 5, "If the original contractor or subcontractor disputes the correctness, validity or enforceability of a stop notice, the public entity may in its discretion, permit the original contractor to file with the public entity a stop notice release bond."
The Stop Notice Release Bond must be issued by a surety company licensed to do business in California and written in an amount no less than one hundred twenty five percent (125%) of the claim as identified in the Stop Notice. The surety's obligation is to guarantee the payment of any sum which the claimant may recover on the identified claim and the costs of any lawsuit filed in the matter. The process and financial assurance requirement mirrors those of a California mechanic's lien release bond but counter-stop notice procedures generally apply to public entity owners rather than private parties. On receipt of a Release Bond, the public entity will not withhold funds from the prime contractor pursuant to the Stop Notice.
The California Stop Notice Release Bond must provide that should the claimant in the matter receive judgement in any action brought on said claim, the bond holder should pay said judgement and costs to claimant in an amount not exceeding the sum specified in this undertaking.
The remedy of the Stop Notice Release Bond only pertains to the Stop Notice claim. But note that only the Stop Notice hinders cash flow during the project. Any payment bond claim made does not stop cash flow to the contractor and the contractor can fight the validity of the bond claim in court. The purpose of the Release Bond is to allow the contractor to continue funding the project without interruption. It does not in any way contest the validity of the claim.
Practicalities:
It is vital for the contractor using the bond to realize that at some expense the contractor is simply reestablishing cash flow, not resolving the claim. And the expense is major. The bond is an expense and the bonding company, if it pays out, will want to be repaid not only the bonded amount but the cost of defense incurred. The bonding company must be satisfied that it is made whole, or the contractor will find that no further bonds can be purchased from other bonding companies. Thus, the public jobs are now out of reach for the contractor.
Further, the underlying claim remains intact and if the claimant is not satisfied in some way, the costs of that litigation will soon ensue.
One contractor put it well in an email to the writer: “I am buying time, no more, no less. If I can finish the job, I can pay the other subs and have enough to take on this claim without it destroying my job.” From the point of view of the claimant, the claim plus 25% is now fully secured and many subcontracts award attorney’s fees to the prevailing party, thus the subcontractor who has a good claim is in a good position. The contractor now not only faces the cost of the bond, but the cost of defense and, if not the winning party, paying the costs and attorney’s fees of the other party.
If the claim can be settled reasonably, the wise contractor, before buying the bond, will seek a resolution with the subcontractor or supplier filing the Stop Notice. If the contractor can handle losing 125% of the claim in cash flow, an alternative solution is simply to have the public entity withhold the amount, pay the ongoing costs of the job, and know that cash flow will begin again once the 125% is withheld. The Stop Notice and any payment bond claim must end up in court or are nullified, so trial on them can be expected in a year or two. If the claim is invalid, the contractor will get the withheld money, the payment bonding company will not face liability on the bond and the attorney fees will be repaid to the contractor if the subcontract so provides.
Using a Stop Notice Release Bond is thus the third option to be considered by a wise contractor. Settle if you can. If you cannot, can you cover the 125% withheld by your own resources? If it is a negative to both alternatives, decide on the bond and shop around, but quickly since the money will be withheld absent a prompt posting of a bond. (And recall that the public agency does not have to allow bonding around the stop notice. Find out what their policy is before purchasing any bond.)
Conclusion:
It can come as a shock to contractors and owners that a claimant can lien property, stop progress payments or force posting of a bond without a court hearing or obligation to do more than fill in some forms in a timely manner. There is no other area in the law in which a person making a claim can infringe on the property of another without a full court hearing.
Our firm went to the United States Supreme Court on the constitutionality of liens and Stop Notices as to that very issue. Our opponents argued that the lien and Stop Notice were a “taking” of property without due process, without a hearing having to prove the claimant’s claim. What we argued and the courts upheld was that the unique economics of the construction industry required such an unusual process.
The average subcontractor, the core of the United States construction industry, and the average supplier do not have sufficient resources to sell on credit the large amounts required for even a medium sized construction project. Without some means of fast and easily obtained security, the small operator in construction would be out of business in a matter of months. The liens and Stop Notices make it possible for the small companies to obtain bank financing when necessary and to know that sums owed to them will be eventually paid because secured. The courts commented that only the giant entities would be left in the United States absent this unusual form of protection for the small builder and supplier.
The reverse side of that coin is that the owner and the prime contractor need to be well versed in construction remedies available and have a plan ahead of time as to how to handle Stop Notices, Bond Claims and, if private, mechanics liens. It is as necessary to learn that skill as to learn how to do your trade.