By Daniel F. McLennon and Matthew T. Porter of Smith, Currie & Hancock LLP
Published April 30, 2020
Earthshaking Decision in Favor of Public Works Subcontractors—Subcontractors May Now Recover All Amounts Earned from Payment Bond Before the Direct Contractor May Complete Recovery from the Owner, and Perhaps even Before the Project is Complete or Retention is Due. (Crosno Construction, Inc. v. Travelers Casualty and Surety Company of America (2020) _____ Cal.App.4th _____.)
The Court of Appeal held void and unenforceable industry-standard subcontract, “pay-when-paid” terms defining “reasonable time” for payment to the subcontractor as no “less than the time Contractor and Subcontractor require to pursue to conclusion their legal remedies against Owner or other responsible party to obtain payment ….” The Court of Appeal affirmed the trial court’s determination that enforcing the “pay-when-paid” clause would run afoul of Civil Code 8122 and would impermissibly “affect or impair” the subcontractor’s bond claim rights by postponing the right to recover under the payment bond for an indefinite time period.
Clark Bros., Inc. (“Clark”), the general contractor on a public works project for the North Edwards Water District (the “District”), subcontracted work to Crosno Construction, Inc. (“Crosno”) on the project. After Crosno completed most of its work, the project came to a halt due to a dispute between the District and Clark. Clark sued the District, and Crosno sued Clark and its surety, Travelers Casualty and Surety Company of America (“Travelers”), to recover payment for its work under Clark’s public works payment bond. Travelers protested that Crosno’s suit was premature because its time to be paid had not arrived, since the District had not yet paid Clark. The trial court disagreed and held that Crosno could recover on the payment bond while the action between Clark and the District was pending. The surety appealed, and the Court of Appeal affirmed.
The “Pay-When-Paid” Clause
The subcontract contained a “pay-when-paid” clause that stated Clark would pay Crosno within a reasonable time after receiving payment from the District. The subcontract also stated, however, that this “reasonable time” “in no event shall be less than the time Contractor and Subcontractor require to pursue to conclusion their legal remedies against Owner or other responsible party to obtain payment ….” The question confronting the court was whether the surety could rely on this “pay-when-paid” provision to delay its obligation to pay Crosno until some unspecified time when litigation between Clark and the District concluded.
The “Pay-When-Paid” Clause Impermissibly Affects and Impairs Crosno’s Right to Recover under the Payment Bond
The Court determined that the “pay-when-paid” provision attempted to define as “reasonable” a period of time that was indefinite and could extend for years. The Court cited the California Supreme Court case of Yamanashi v. Bleily & Collishaw, Inc. (1972) 29 Cal.App.3d 457, 462–463 as having already determined that an indefinite time for payment is unreasonable.
The Court also viewed the “pay-when-paid” provision as an attempt to circumvent claims protections contained in California Civil Code sections 8122, 8124, and 8126, without a proper waiver or full payment. Section 8122 provides in relevant part: “An owner, direct contractor, or subcontractor may not, by contract or otherwise, waive, affect, or impair any other claimant’s rights under this part, whether with or without notice, and any term of a contract that purports to do so is void and unenforceable unless and until the claimant executes and delivers a waiver and release under this article [sections 8124 and 8126].” (Emphasis added.)
The Court noted that by invoking the subcontract’s “pay-when-paid” provision, the surety was attempting to impose indirectly a limit on the right of recovery on a bond that would be unenforceable under California Civil Code section 8152 if the same term had been included in the payment bond itself. The Court would not allow the surety to do indirectly that which it could not legally do directly.
Surety Defenses Unavailing
The Court rejected the surety’s usual defenses, noting that the “sole conditions of recovery are that the person is an authorized claimant who has not been paid the claim in full. (§ 8154, subd. (c).)” Moreover the Court emphasized that a purpose behind the statutory payment bond framework is to provide subcontractors like Crosno “a quick, reliable and sufficient means of payment.” Therefore,
- it would not suffice to allow Crosno to sue on the bond then to stay the action pending resolution of Clark’s action against the District, because that would “affect or impair” recovery on the bond;
- by requiring payments by direct contractors to subcontractors within 7 days of receipt of payment by the direct contractor from the owner,
- the prompt payment statutes do not inherently incorporate the time for pursuit of recovery from the owner as part of the bond claim scheme;
- the payment bond scheme does not unfairly favor subcontractors over direct contractors, in fact, the law was designed to do just that, “The law has created a preferred position for persons who perform labor or supply materials for the improvement of real property.”;
- the surety may not rely on the direct contractor’s subcontract provisions to avoid paying on the bond—rather, the surety owes an independent, statutory obligation to the subcontractor; and
- “Although Travelers complains that affirming the trial court’s ruling will effectively make direct contractors and their sureties ‘financers of public works projects when the owner delays making payment,’ that is precisely the point. A payment bond shifts the risk of nonpayment from subcontractors to direct contractors and their sureties by affording public works subcontractors the equivalent of a mechanics lien remedy available in private works projects.”
Importantly, the Court of Appeal stated that to prevail on a bond claim, the subcontractor must prove “a valid compensation claim, not ‘a separate payment obligation, contractual or otherwise’ for payment by the bond principal.” (Emphasis in original.) It is enough that the subcontractor performed work for which it has not been paid.
Comment
The impact of this case will be huge. Travelers correctly points out a “parade of horribles” may follow this case because it likely will be used to challenge and potentially invalidate a number of important subcontract terms that “affect or impair” the subcontractor’s bond claims, including pass-through provisions, prelitigation dispute resolution clauses, notice requirements (especially those that impose waivers of claims), retention provisions, and liquidated damage clauses.
Certainly Crosno will spawn much litigation. For example, early finishing trades—such as excavators, foundation contractors, and structural steel erectors—may be expected to bring bond claims for unpaid progress payments and retention as soon as their work is complete and accepted. Crosno considered that at the outside, an action against a surety on the payment bond must be filed within six months of when a stop notice may be filed, which in turn may be filed 30 or 90 days after cessation of work, depending on whether a notice of acceptance has issued. Crosno was concerned that enforcing the “pay-when-paid” clause as written could effectively nullify the bond whenever the direct contractor’s litigation with the owner extended beyond the limitations period.
But the subcontractor’s bond rights are also affected and impaired if the subcontract terms prevent the subcontractor from making a bond claim on the inside. That is, under Civil Code section 9558, the subcontractor is permitted to sue on the payment bond any time it has ceased to provide work. Under the rationale of Crosno, such claims must be permitted, whether or not the direct contractor has been paid progress or retention payments for the early finishing trade’s work.
Similarly, subcontractors may be expected to sue bond sureties while change order requests are pending. Subcontractors often complain that they perform change order work as directed, only to have no way to bill for the work because processing the change order is held until the end of the job. Under the rationale of Crosno, subcontractors may assert that they performed the work at the direct contractor’s instruction, the direct contractor accepted the work, and the direct contractor should now pay for the work—and if it refuses, the bond surety may be compelled to pay.
On the other hand, the Crosno court pointed out that direct contractors and their sureties may still pursue substantive defenses to their obligations to pay subcontractors. For example, “Travelers could still assert other defenses to the bond claim if, for example, ‘Crosno failed to timely and properly perform its scope of work.’”
Prime contractors and their sureties now have a lot to consider. Threats and arguments over whether subcontractors have waived claims by failing to give notice of claims within strict contract time periods may have lost their force entirely. Crosno will incentivize direct contractors to pressure public owners to provide early retention release for early-finishing trades, to process subcontractor change orders quickly, and to use statutory claims processes aggressively.
Daniel F. McLennon is a Partner in the San Francisco office of Smith Currie. He represents public entities, general contractors, subcontractors, suppliers, premises owners, manufacturers, professionals, corporations, and individuals. He practices in the areas of commercial and construction litigation. He can be reached at dfmclennon@smithcurrie.com or 415.394.6688.
Matthew T. Porter is an associate in the Atlanta office of Smith Currie. He concentrates his practice in the areas of construction law and litigation, including representation of contractors, construction managers, major trade contractors, sureties, architects, and engineers. He can be reached at mtporter@smithcurrie.com or 404.521.3800.