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Construction Project

Surviving Your First Construction Project
The following is an overview of two important topics that one should be aware of when embarking on a new construction project.

Mechanic's Liens and Stop Notices

A. Mechanic's Liens
1. Mechanic's lien law is purely statutory, and every state has a mechanic's lien statute. The fundamental purpose is an equitable one: If a contractor improves an owner's property, to prevent the unjust enrichment of the owner, the contractor should have a lien on the property until paid.
2. Since subcontractors and material suppliers also have lien rights, a problem arises. An owner who has already paid the contractor can catch a lien from a subcontractor or supplier. This is the "double payment" problem.
3. The ultimate end result of the foreclosure of a mechanic's lien is for the sheriff to sell the owner's property at public auction and use the proceeds of the sale to pay off the lien.

The best protection for the owner is a qualified, experienced and financially sound contractor. It is the prime contractor who protects the job against liens.

a. Payment bond also protects owner.
b. Owner also may protect the job by carefully processing progress payments so that no payment is made to the prime contractor until potential lien claimants have been identified and paid. To process progress payments in such a way requires highly trained personnel.
5. Most lien statutes include notice provisions, relatively short deadlines, statutes of limitations and documents that can be recorded by owners to cut down the period for recording liens. Owner may tender the defense of a mechanic's lien foreclosure suit to the prime contractor for defense, but care is required. The owner may find the contractor's interests are more aligned with those of the claimant than with those of the owner.
B. Stop notices. A stop notice is ancillary to the mechanic's lien remedy. It enables claimants, usually subcontractors and suppliers, to attach construction funds in the hands of project owner or construction lender. The owner or lender must withhold the funds from the prime contractor pending resolution of the claim in court.
1. In most states mechanic's liens are not allowed on public property, and, therefore, the stop notice substitutes for the mechanic's lien remedy on public jobs.

On private jobs, the stop notice and the mechanic's lien remedies may be asserted at the same time. Stop notice usually is considered to be more effective and in most situations, it is. Well-advised claimants pursue both remedies at the same time.

  C. Payment bonds. The payment bond remedy also protects claimants who have mechanic's lien and stop notice rights. Payment bonds usually are in place on all public jobs and large private projects. They usually are not provided on smaller projects. Payment bond surety undertakes that all parties who have mechanic's lien and stop notice rights will be paid in full.
D. Self help. Owners, contractors and potential claimants need to understand lien, stop notice and payment bond laws in states where they operate. The mechanic's lien statutes for all states are available in a single book.

Construction Contract Bonding

A. Performance bond. The surety undertakes that the principal (usually a contractor or a subcontractor) will perform the contract. (Performance bonds are usually held to cover contractual warranties and may apply to construction defects discovered many years after completion of the project.)
1. Claims against the bond. There is no specific format for making claims against a performance bond. The best policy is to promptly inform the surety in writing, with adequate backup.
2. Position of surety. The surety will refer a claim to the principal (the contractor). If the contractor disputes the claim, the surety is caught in the middle.
a. For obvious reasons, the surety is likely to favor the contractor's version. This is because if it pays a claim over the contractor's objection, it will have to sue the contractor for reimbursement.
b. When the surety denies a claim, the owner will find itself fighting both the contractor and the surety.
B. Indemnity agreements. Surety will have required the principal or its officers and directors to sign agreements to indemnify the surety against loss and expense. The surety, therefore, will look to the principal or its officers and directors to reimburse any loss. The surety, thus, is motivated to cultivate a good relationship with them. So, the surety's natural desire to curry favor with the indemnitors creates conflicts of interest with the owner.
C. Bonding requirements. Performance and payment bonds are required on all public jobs and on most major private projects. For smaller projects, they are seldom required. Smaller contractors do not have the bonding capacity, and many owners resist incurring the expense of paying the bond premium.
D. Taking over the job. If contractor defaults, there are three basic alternatives for the surety.
1. Surety finances the contractor to finish the job.

Surety employs a new contractor to finish the job.

3. Owner employs a new contractor to finish the job and claims reimbursement from the surety.
  E. Strategic considerations from the standpoint of the surety:
1. If the owner finishes the job using a replacement contractor, maximum liability is the penalty amount of the bond; if we take over the job or finance the contractor, we "blow the bond penalty."

If we finance the job or if we take over the job and use the same contractor to finish it, we save the expense of orienting a new contractor to the job.

3. If we let the owner finish the job, we lose control of costs.
F. Strategic considerations from the owner's point of view:
1. We don't want the same contractor: he is a proven incompetent.

If we finish the job ourselves, we'll probably have to sue the surety for a settlement.

3. If the surety employs a fresh contractor, it may turn out to be a stooge for the defaulted contractor. Any fresh contractor will take time to mobilize and may try to cheapen the job.
G. Bad faith. In some states, sureties may be liable for punitive damages for bad faith in processing claims.
H. Provisions of the bond. As a general rule, owner should carefully scrutinize bond provisions because most of them will be loopholes for the bonding company. Owner should not accept such provisions.
I. Reports to surety. Performance bond sureties usually have a form letter by which they request monthly reports from owner. Owner should have a policy not to respond. If owner criticizes contractor, contractor may claim defamation; if owner fails to criticize contractor, surety may claim waiver. Owner should be diligent in reporting actual problems to the surety but not necessarily as a response to a form letter inquiry.
J. Surrendering the bond. A year or two after completion of job, the contractor may request that the owner surrender (or release) the bond, pleading that the contractor's bonding capacity is reduced as long as the bond remains open. Owner should never release the bond.
K. Payment bonds. The purpose of a payment bond is to protect an owner against mechanic's lien and stop notice claims.
1. The surety agrees to see to it that subcontractors, material suppliers and others who could assert mechanic's lien or stop notice claims on the project will be paid.

Here, the obligee is not only the owner. Potential mechanic's lien and stop notice claimants also are obligees. They make their claims directly against the bonding company.