May  4, 2001



Bulletin #46: The Missing Bond

ZZZ Sheet Metal was in the middle of its busiest construction season ever when the office received a phone call from a local general contractor. The general contractor was about to begin a repair and renovation project on a large nursing home and had just lost the subcontractor for the HVAC system. Apparently, the designated subcontractor had obtained a much larger job, and informed the general contractor that it could not handle both jobs at once. The general contractor pleaded for ZZZ to step in and indicated that the work was to commence immediately. In part, as a favor to the general contractor, ZZZ accepted the job.

The project was a wild scramble from the beginning. Materials and equipment had to be ordered for immediate delivery, and the ZZZ fabrication shop and site crews began working overtime on a regular basis. A project manager, already handling two other jobs, was asked to cover the nursing home project. It was very much of a stretch for the subcontractor’s operation.

Fortunately, the architectural/engineering firm involved with the project was playing an unusually active role. At the weekly construction meetings, the architect’s representative seemed to be functioning almost as a construction manager in addressing various scheduling and delay issues, dealing with unforeseen conditions, assisting with re-design of components, etc. At the same time, the project manager for the general contractor was periodically absent and generally uncommunicative.

Several months into the project, it occurred to the ZZZ project manager that there should be a formal contract in place, even though the project was moving along reasonably well. However, the “paper work” always seemed to be a low priority in the midst of the other pressing issues. (Of some comfort to ZZZ was the fact that the general contractor had apparently been required to obtain a bond in securing the bid.) A subcontract was finally signed four months into the job. ZZZ had already submitted several pay requests, and was awaiting its first progress payment. The subcontractor had no reason to believe that it would not get paid.

Matters changed dramatically as the project entered its sixth month (with ZZZ yet to be paid). At the weekly construction meeting, the project manager for the general contractor revealed that the general contractor was filing bankruptcy. It had lost a lawsuit concerning another job, and its operating accounts had been seized in enforcement of the judgment against it. The general contractor could not pay its own staff or any other parties to which payment was owed. The subcontractors sat in stunned silence holding months’ worth of unpaid invoices.

ZZZ management ordered that work on the project be suspended immediately. It was now “damage control” time. A demand was made for a copy of the payment bond so that ZZZ could submit a claim against the bond. Unfortunately, there was no bond. In breach of its contract with the owner, and contrary to its assurances to the subcontractors, the general contractor had not obtained the payment bond. (In fact, it had been unable to obtain the bond largely because of the pending lawsuit.) It had procured a bid bond in order to procure the work, but did not follow-up with the required payment bond.

Desperately seeking a “deep pocket,” ZZZ focused first on the architect (and its insurance company). The architect had played a very active role in the project, and must have had some duty to the subcontractors and the owner to make certain that the general contractor had obtained the payment bond. The architect was also contractually obligated to review and approve pay requests, and should presumably have stepped in to deal with the problem of subcontractor non-payment long before the project collapsed. The possibility of recovery against the architect looked promising.

A second potential target was the bonding company that had issued the bid bond. In issuing that bond, the surety certainly knew that the project also required a payment bond. It also knew or should have known that subcontractors and suppliers would be relying upon the existence of a payment bond. Arguably, its failure to issue the payment bond, or to notify the other interested parties of the absence of the bond, constituted legally actionable misconduct as to both the owner and the subcontractors. ZZZ also considered the possibility of a fraud claim against the general contractor and its management personnel, but the prospect of collection on such a claim looked dim.

As a final matter, the subcontractor filed a mechanic’s lien against the project, but found itself behind several mortgages, and multiple other contractor and supplier liens. If ZZZ was to be paid, the claims against the architect and/or the surety would have to be successful.

At trial, the architect pointed to language in its agreement, with the owner stating that the architect had no duty of any kind to the subcontractors. There was no language in the ZZZ subcontract that would give it a contractual claim against the architect. However, ZZZ asserted that the architect’s level of involvement with the project had become so great that it had, in essence, become a construction manager. In that role, it had arguably undertaken additional duties and responsibilities beyond those originally contemplated in the architectural agreement. The subcontractors had reason to rely upon the architect’s competence in its performance of its construction manager-type responsibilities. The failure of the architect to verify the existence of the bond should certainly be considered negligence, and permit recovery by the subcontractors. ZZZ also argued that the surety had a legal obligation to issue the payment bond knowing that the subcontractors would be relying upon that bond. The surety presented evidence that the general contractor had made little effort to pursue the payment bond after an initial negative response from the surety, and that no attempt had been made by any party to verify the existence or non-existence of a payment bond until the general contractor had filed bankruptcy. The surety asserted that it had no affirmative obligation to issue the bond or to notify any party of its unwillingness to issue the payment bond.

ZZZ was stunned when it received the court’s decision. The judge ruled that the architect had no contractual or other duty to the subcontractors, and that ZZZ had the ability to protect itself by verifying the existence of the payment bond before it started work on the job (or at least prior to the time that it signed the subcontract document). The court also found that the surety had no obligation to issue a payment bond on a project where its underwriting criteria had not been met, and that it had no duty to issue a payment bond simply because it had previously issued a bid bond. While the subcontractors may have believed that there was a bond, the courts indicated that such belief was “misplaced,” and that the subcontractors’ erroneous conclusions as to the existence of the bond were either a result of subcontractor negligence or self-deception (since none of the subcontractors had wanted to walk off the job while there was still a hope of payment). ZZZ had struck out.

Can something along these lines actually happen to a subcontractor? In fact, the scenario described above closely parallels an actual case in which the subcontractor was left to scramble for a remedy when the general contractor could not pay, and the payment bond was “missing in action.” Obviously, when a project goes bad, it is appropriate that the subcontractor and its legal counsel consider all possible remedies, claims, and sources of payment. However, avoiding the “train wreck” is an even better alternative. The subcontractor should not allow itself to be dragged into a significant job with no contract. It should try to have some sense of the financial circumstances of the general contractor, as well as the funding source for the project. If the subcontractor is ultimately relying on a payment bond and the project is at all substantial, the existence of the bond should be confirmed at the beginning of the project.

In summary, a subcontractor should never assume that some other party is protecting the subcontractor’s interests. Ultimately, the only party that can effectively protect the interests of the subcontractor is the subcontractor itself. 

 

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