September  24, 1999

Bulletin # 31: Collection Issues on Public Projects

Subcontractors that survive for any sustained period of time need to be proficient in bidding and the performance of their work. However, while completing the work is always a challenge, getting paid can present an even greater obstacle. On private projects, the availability of mechanics’ lien rights under state law can be one of the subcontractors’ most useful tools in protecting its right to payment. That tool is not available on public construction, since mechanics’ lien rights cannot typically be enforced against government property.

The non-availability of lien rights would obviously place the subcontractor at a serious disadvantage on a public project. It would also presumably discourage bidding on such projects and increase the cost to the federal government for construction work. The federal government’s response to this problem was the enactment of the Miller Act (40 U.S.C. Section 270a, et. seq.) in 1935. The Miller Act requires a general contractor to procure and maintain performance and payment bonds as a prerequisite to obtaining federal government construction work. As the Miller Act currently stands, the contracting officer for the federal government has some leeway as to the payment protection to be provided on contracts under $100,000, but the payment and performance bond requirements are clearly applied above that level. The payment bond is to be for one-half of the total amount on contracts of up to a million dollars. For contracts of over a million dollars but not more than five million dollars, the payment bond is to equal to 40% of the contract amount. On contracts above five million dollars, the payment bond is to be in the amount of $2,500,000. The payment bond makes a source of funds available to subcontractors and suppliers if the general contractor cannot or will not pay. However, even though the existence of a payment bond provides reassurance to a subcontractor on a public project, issues as to payment can still exist.

The experience of the hypothetical subcontractor, ZZZ Sheet Metal, illustrates some of these issues. ZZZ had been solicited to bid on the installation of an HVAC system on a federal prison project. It had some familiarity with the general contractor, but had not done a lot of government work. When ZZZ’s project manager contacted the general contractor as to project bonding requirements, he was informed that a payment bond had been procured to satisfy the bonding requirements for a federal project under the Miller Act. ZZZ did not request a copy of the bond (or the general contract), but accepted the assurances of the general contractor’s representative. ZZZ then entered into a guaranteed maximum price subcontract for its work with a "savings clause." ZZZ was to receive additional compensation equal to twenty percent of the amount by which the cost of its work came in below the guaranteed maximum price. The subcontractor promptly went to work squeezing the maximum possible savings out of the project.

Through favorable pricing negotiations with its suppliers, efficient management of its work, and some degree of luck, ZZZ brought its work in $300,000 under the guaranteed maximum price. It had received a number of progress payments during the course of project, but a large portion of its project compensation was to come out of the final payment request, including all retainage and its portion of the project savings. After the final payment request was submitted, the general contractor began raising issues as to whether the work had been appropriately completed, whether the HVAC system functioned as designed, and whether certain changes in the work were within the scope of the contract or were additional items. (If the changed items fell under the base scope of work, the additional costs would diminish the amount of the "savings" payment to ZZZ. If these items were changes to the work for which additional compensation was payable, they would not diminish the savings payment amount and would be paid over and above the guaranteed maximum price.) As a result of the difficulties in closing out the contract, the final payment was still pending almost three months after ZZZ had substantially completed its work. Increasingly impatient, ZZZ demanded that its final payment request be paid in full and threatened to initiate a lawsuit against the general contractor if it did not promptly receive payment.

It was only at this point that ZZZ learned of the general contractor’s shaky financial status. The contractor had been entangled in a lawsuit on another project for a number of years and while the contractor tussled with ZZZ, an adverse judgment was entered against the contractor for over ten million dollars. The general contractor’s primary lender, learning of the judgment, froze the general contractor’s line of credit and operating accounts. The general contractor’s operation toppled like a line of dominos and at the other end of the line was ZZZ. It became apparent to ZZZ that its final payment request was not going to be paid any time soon.

The subcontractor had previously requested a copy of the payment bond from the general contractor, but its request was refused. In speaking with another subcontractor, ZZZ learned that, under the Miller Act, it could obtain a copy the bond and the general contract from the government agency contracting for the work. ZZZ forwarded the required request and affidavit to the government agency and received a certified copy of the bond and a copy of the general contract. With a copy of the bond and contract in hand, ZZZ commenced an action in federal court against the surety demanding payment for its work. The surety raised a number of defenses under the terms of the bond, as well as the ZZZ subcontract. It specifically denied any obligation for payment of the contract savings.

The resulting federal court case turned upon the language and intent of the Miller Act as to the obligation of the surety issuing the payment bond to pay the subcontractor for "labor or materials in the prosecution of the work provided for in . . .(the) contract." The surety argued that any amount payable under the savings clause was a bonus and was not actually attributable to the cost of labor or materials provided by ZZZ to the project. The court found that the Miller Act required a surety to pay amounts owing in accordance with the terms of the subcontract and ordered payment of the amount owing to ZZZ for labor and materials, as well as the amount it was entitled to under the savings clause. As intended by the Miller Act, the subcontractor had been made whole through the payment bond. The subcontractor also received an award of pre-judgment interest at the rate provided under state law.

The Miller Act and its bonding requirements can be of crucial importance to a subcontractor working on a federal government project. However, the subcontractor should try to independently verify that the general contractor has actually procured the necessary bond. There is established legal precedent that if a government agency fails to require the posting of payment and performance bonds by the general contractor, even though such failure is a breach of the Miller Act, the subcontractor has no recourse against the federal government. Also, if there is any issue as to the existence or scope of the bond, the subcontractor should make certain that the subcontract contains provisions giving it timely and meaningful remedies in the event of nonpayment. Finally, it should be kept in mind that the amount of the bond may not be sufficient to satisfy all claimants in the event of a general contractor’s financial collapse.

The subcontractor should also make certain that any suit on a payment bond provided under the Miller Act is brought in United States District Court for the district in which the contract is to be performed and that the suit is commenced within one year after the last day on which the subcontractor provided labor or materials. (The right to sue on the bond first accrues to the subcontractor ninety days after the subcontractor has provided its last labor or materials to the project.) There are also some special pleading requirements under the Miller Act and the subcontractor should consult with its legal counsel as early as possible in the claims process to avoid jeopardizing its right to payment on the bond because of an error in how it asserts its claim.


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