N.C. Liens/Bonds, They Are A-Changin’ Part III: Double Payment Protection for GC’s

For North Carolina general contractors, the big prize in last year’s lien and bond law legislation was protection from double payment exposure on bonded public contracts.  Carolinas AGC lobbyist Dave Simpson has said on numerous occasions that he spent the better part of two decades pushing the N.C. General Assembly for double payment protection.   In a similar vein, Carolinas AGC member Susie Shaw of Beam Construction added that “this has been an issue I have heard about from my father since I was a young child.  It took a long time, but I am glad it is coming to pass in my lifetime.”

This post explains the “double payment” provisions of the new lien/bond laws in-depth, focusing on how prime contractors are exposed to double payment liability on public projects, how the new statute provides protection from that exposure, and the limits of the new legislation. 

How does a general contractor, construction manager at-risk, design-builder or other prime contractor become exposed to double payment liability on bonded public projects?

When the payments they make to first-tier subs don’t reach second- or third-tier subcontractors (who I refer to as “remote subs”).  When that occurs, the unpaid remote sub might assert a payment bond claim (i.e., a so-called “Little Miller Act” claim) against the prime contractor and its bonding company.  Bear in mind that in order to obtain bonding capacity in the first place, the prime contractor likely has provided its surety with an indemnity agreement requiring the prime contractor (and very likely the individuals who control it, plus their spouses) to reimburse the surety for any losses incurred under the bonds it issues.  As a result, a solvent prime contractor in receipt of a valid payment bond claim will typically pay it, rather than reimburse its bonding company for doing so.  In either event, the prime contractor is financially on-the-hook for paying the remote sub after having already paid the first-tier sub monies that should have been floated downstream.

What does the new legislation do to protect GC’s from double payment liability?

It creates a system of notices to ensure that prime contractors know who is supplying labor and materials to their first-tier subs.  A remote sub who fails to comply with the new notice obligations timely will find its payment bond rights significantly limited, as will be discussed below.

What obligations does the new legislation place on prime contractors?

The first of the notices to be served is the “Contractor’s Project Statement,” which the prime contractor must provide to each of its first-tier subs.  The Contractor’s Project Statement should set forth the name of the project, the physical address of the project, the name of the contracting body, the name of the prime contractor, the contact info for the prime contractor’s agent designated to accept requests for the payment bond, and the contact info for the surety company providing the bond.  A template form prepared by the Lien Law Committee of the North Carolina Bar Association’s Construction Law Section can be found here (this form is for educational purposes only; you should contact an experienced construction law attorney to ensure you’re completing the form appropriately).

What obligations are placed on subs and suppliers?

First-tier subs must pass the statement down to their second-tier subs, and second-tier subs must pass the statement down to third-tier subs.  (Note that North Carolina’s public bond statute makes no reference to fourth-tier or more remote subcontractors).  All second- and third-tier subs must then furnish the prime contractor with a “Notice of Public Subcontract,” setting forth the name and address of the sub providing the notice, a general description of the real property on which labor and/or materials are to be furnished, a general description of the sub’s contract (including the names and addresses of the parties thereto), and a general description of the labor and/or materials to be furnished pursuant to that contract.  A template form prepared by the Lien Law Committee of the NCBA’s Construction Law Section can be found here (same caveat as above: this form is for educational purposes only, and you should contact an experienced construction law attorney to ensure you’re completing the form appropriately).

What if the Contractor’s Project Statement is not furnished down to all remote subs with potential bond rights?

If you’re a second- or third-tier sub who has not received a copy of the Contractor’s Project Statement from the party immediately above you in the contractual chain, that party cannot enforce its deal against you.  Presumably — but subject to judicial interpretation — that means you have no obligation to furnish labor and/or materials pursuant to your contract until the Contractor’s Project Statement is received, even if your non-performance delays the project.

If a remote sub doesn’t receive a copy of the Contractor’s Project Statement but performs anyway, does it still have to comply with the Notice of Public Subcontract requirements?

Probably, but that’s an open question the courts may have to resolve some day.  Personally, the only remedy I think the statute provides when a remote sub doesn’t receive a copy of the Contractor’s Project Statement is excuse from performance, as I’ve discussed above.  If, however, a remote sub elects to waive that remedy and perform anyway, I don’t see language in the statute excusing that sub from complying with the new Notice of Public Subcontract requirements.

That being said, the courts conceivably could interpret the provision of the Contractor’s Project Statement as a condition precedent to the provision of the Notice of Public Subcontract.  Still, you don’t want yours to be the test case.  So if you’re a second- or third-tier sub and you perform despite not receiving the Contractor’s Project Statement, you should strongly consider serving the Notice of Public Subcontract within 75 days of your first furnishing, as the hypothetical immediately below demonstrates.

What happens to the payment bond rights of second- or third-tier subs when they don’t provide a Notice of Public Subcontract timely?

The new statute limits payment bond recovery to labor or materials provided within 75 days of the remote sub’s provision of the Notice of Public Subcontract to the prime contract.  There’s a $20,000 “safe harbor,” so that any claim of $20,000 or less is not subject to the Notice of Public Subcontract requirement; further, for claims greater than $20,000, the new requirement will only apply to that portion of the claim in excess of $20,000.

A quick hypothetical will illustrate these limits.  Awesome Aggregates Co., a second-tier sub to first-tier Successful Sitework Corp. on a large public university project, furnishes $50,000 in stone materials on Day 1, an additional $40,000 in stone materials on Day 60, and its Notice of Public Subcontract to Perfect Prime Contractor Co. on Day 80.  Successful Sitework has a less-than-successful year, folds up shop, and files for bankruptcy protection, leaving AA completely unpaid on both shipments.   Unfortunately for AA, its first furnishing on Day 1 was 79 days prior to its service of its Notice of Public Subcontract.  That means the new statute prevents AA from seeking anything greater than $20,000 against PPC’s payment bond in connection with the first shipment.   AA is left with a payment bond claim for the first $20,000 on its initial shipment, plus a claim on the entire $40,000 second shipment, for a total claim against PPC’s payment bond of $60,000.  AA would have had a $90,000 claim, had it only furnished its Notice of Public Subcontract more timely.

I want a copy of the prime contractor’s payment bond.  Can I get it directly from the prime contractor under the revised statute?

Yes, so long as the request is in writing and served on the prime contractor via one of the statutorily approved methods — which include certified mail, but NOT email.

What happens if the prime contractor fails to comply?

The statute provides that if the prime contractor fails to respond within seven (7) calendar days of the request, the remote sub’s payment bond claim will not be limited, even if the sub failed to provide the Notice of Public Subcontract timely.   That means a remote sub who fears its Notice of Public Subcontract might be late has a possible “escape hatch” — making a request for a copy of the payment bond with the hope that it’s provided late, or not at all.  So heads-up, general contractors: furnish a copy of your payment bond IMMEDIATELY upon receipt of a request for same.

Let’s assume everyone in the contractual chain provides the notices required by the new statute timely.  How does that protect the prime contractor from the risk of double payment?

Candidly, it doesn’t.  In that situation, the prime contractor is only armed with information, and nothing more.

So if the statutory protection is limited, what else can prime contractors do to protect themselves from double payment liability on bonded public contracts?

There are several additional tools in a prime contractor’s double payment risk mitigation toolbox:

• Consider periodically calling all of the second- and third-tier subs who provided you with a Notice of Public Subcontract to ensure your payments to first-tier subs are reaching them.
• Consider making execution and delivery of partial lien waivers a condition precedent to all payments you make to your first-tier subs, and consider requiring your first-tier subs to include a similar requirement in all of their agreements with second-tier subs.
• Consider entering into joint check agreements, particularly where you have reason to fear payments to first-tier subs might not reach all folks downstream.
• Consider requiring performance and payment bonds from your most critical first-tier subs.

What is the effective date of the legislation?

The statute, codified at N.C. Gen. Stat. § 44A-27(b-f), took effect on January 1, 2013 and applies to all bonded public projects for which the initial building permit issued on or after that date.