Subcontractor Payment Risk
There are few businesses that rival construction as to the risk of non-payment. A typical trade supplier might extend twenty days credit to its customers.
An equipment supplier may require a downpayment or, if the purchase is large enough or involves overseas shipment, may require a letter of credit.
On the other hand, a contractor or subcontractor may put sixty days of labor and materials (or more) into a project without receiving its first payment.
When the payments do come, they may be subject to retainage of up to 10%. Payments to a subcontractor may be delayed because of a dispute between the general contractor and the owner that has nothing to do with the subcontractor’s work. A subcontractor’s financial exposure on a construction project is almost always a source of worry and, in some instances, can make or break its business.
Recognizing the unique risks inherent in construction, the states have enacted a variety of mechanics’ lien laws. While these laws vary from state to state, the general intention is to give general contractors, subcontractors, and suppliers a "hook" on property on which they have worked (and/or contributed materials) to provide some leverage and a possible remedy in the event that they are not paid on a timely basis. While the availability of lien rights is not an absolute assurance that a party will get paid (particularly if the construction mortgage is in priority to the mechanics’ liens), it is certainly better than having no remedy at all.
Bonding Under The Miller Act
In working on a public project, the subcontractor faces many of the same financial risks, but does not have lien rights available. Recognizing that this situation would discourage competitive bidding on public projects, the U.S. Congress passed the Miller Act effective August 24, 1935. The Miller Act established, as a prerequisite to a general contractor’s obtaining a construction contract on federal projects, the delivery of a performance bond in such amount as the contracting officer deemed adequate and a payment bond. The payment bond was to be for the protection of all persons supplying labor or materials under the general contract. The Miller Act established a sliding scale as to the amount of the payment bond running from one-half of the total contract amount on contracts up to $1 million, with a maximum payment bond requirement of $2,500,000 on contracts of more than $5,000,000. The contracting officer was also given authority to require additional security where he or she deemed it appropriate and could waive the bonding requirement as to work performed in a foreign country.
The Miller Act allowed for commencement of a legal action by subcontractors or suppliers on the payment bond no less than 90 days after the day on which their last labor was performed or materials furnished. Parties not in a direct contractual relationship with the general contractor (i.e. third-tier subcontractors and suppliers) were required toprovide written notice to the general contractor within 90 days after their last labor or materials were furnished as a prerequisite to bringing an action on the payment bond. Suit on the bond was to be initiated in the United States District Court where the work was performed and any such suit was to be commenced within one year of the date on which the last labor was performed or materials were furnished.
The Miller Act also gave any subcontractor or supplier the right to obtain a certified copy of the bond and the general contract upon supplying an affidavit to the contracting agency. The affidavit must state that the party requesting a copy of the bond has supplied labor or materials on the project and that payment has not been made. With the bond and contract in hand, the subcontractor (or supplier) would be in a position to pursue its right to payment. The details as to bringing an action on a payment bond are beyond the scope of this Contract Bulletin. However, it is advisable, where a payment issue exists on a federal project, that the subcontractor immediately consult with its legal counsel to make certain that the necessary notices are provided and the action is commenced within the required time period and in the proper court and pursued in accordance with the required procedures.
Miller Act Amendments
The Miller Act has been amended periodically since its enactment, but changes approved in August of this year are among the most significant. These changes were incorporated in legislation referred to as the "Construction Industry Payment Protection Act of 1999" adopted effective August 17, 1999.
The amendments to the Miller Act fall primarily into three categories:
1. Bonding Requirements. The sliding scale as to the amount of the payment bond has been eliminated and the Miller Act now requires that the payment bond be equal to the total amount of the contract unless the contracting officer makes a written determination supported by specific findings that a payment bond in that amount is impractical, in which case the bond is to be set in an amount determined by the contracting officer. In no event can the amount of the payment bond be less than the amount of the performance bond.
2. Notice Procedures. The procedure for delivery of notice has been updated to take into account modern communication options. While the Miller Act had previously required the use of registered mail, it now permits notices by "any means which provides written, third-party verification of delivery." This would allow the use of messenger or over-night delivery services in providing notice of a claim.
Whether or not facsimile delivery of notice would satisfy the statutory requirements is not clearly specified in the amendments.
3. Waiver of Rights. Any waiver procured by the general contractor of the subcontractor’s right to sue on the payment bond will be considered void, unless it is in writing, signed by the party whose right has been waived, and is executed after that party has first furnished labor or material for use in the performance of the contract. This is intended to eliminate the use of pre-construction waivers as part of the bidding process (which would tend to under-cut the intent of the Miller Act). This provision also tracks with many states’ mechanics’ lien laws which do not permit pre-construction waivers.
4. The amendments to the Miller Act will require revisions to the Federal Acquisition Regulations.
Under the new law, these revisions are to be published not later than 120 days after the date of enactment of the new law and there is to be not less than 60 days provided for public comment. Final regulations are to be published not less than 180 days after the enactment of the new law and are to be effective 30 days after publication. Therefore, contractors and subcontractors can expect to see the effect of the amendments to the Miller Act in March or April, 2000. It would appear that these changes, once fully implemented, should work to the benefit of subcontractors and suppliers on federal projects.