Today's economic environment has created challenges in construction, particularly for subcontractors. The construction industry recession has led to insolvency of builders and general contractors. When builders do not pay subcontractors, remedies available for a subcontractor become challenging. Typically, a subcontractor has no contractual relationship with the owner as it contracts only with a general contractor. Absent a proper lien (Preliminary 20-day Notice), a subcontractor has few remedies against the owner.
One remedy for a subcontractor is to recover against the insolvent contractor's surety bond. A contractor's surety bond is not an insurance policy. It does not afford the protections of an insurance policy. Limits of recovery for the surety bond are $7,500 for contractors and $12,500 for owners. There are several factors to consider:
Statute of Limitations (Time Limitations)
It is important to commence a lawsuit within two years from expiration of the bond. The claim procedures could take several months to resolve. Also, payment on the bond is first come, first served. Therefore, a speedy claim procedure is necessary.
Burden of Proof
Recovery against the contractor's surety bond is set forth in California Business and Professions Code § 7000-7120. A surety's liability is established by statute. Liability of a surety bond is premised upon a proven violation of Bus. & Prof. Code § 7000. There are two primary violations when a subcontractor is not paid: (a) Diversion of Funds, and (b) Willful and Deliberate Failure to Pay.
A. Diversion of Funds
To establish "Diversion of Funds," a subcontractor is required to show the owner paid the contractor in full and these funds were specifically marked to pay for the work of this subcontractor. (Bus. & Prof. Code § 7108.) Depending upon the surety, the burden of proof can be challenging. A subcontractor will need the assistance of the owner to show evidence of payment.
B. Willful and Deliberate Failure to Pay
Another method to establish liability is to show "willful or deliberate" acts of failure to pay. "Willful or deliberate failure to pay" money due for services when a contractor has sufficient funds, establishes liability by statute. (Bus. & Prof. Code § 7120.) However, a surety will deny a claim if one fails to establish "willful or deliberate" acts by the defaulted contractor. For example, a contractor may plan to pay the subcontractor, but it is unable to pay because of unforeseen circumstances. This contractor may have received sufficient funds, but the surety may deny the claim because there was no "willful and deliberate" act required by statute. Regardless, if a contractor was paid in full for the project, it will be difficult for the surety to argue later that the defaulted contractor's failure to pay was not a "willful and deliberate." However, some sureties take the above stance.
Multiple Surety Bonds
A defaulted contractor may have multiple bonds over a length of time or changed sureties. If the damage occurred during multiple bond periods, a subcontractor may be eligible to seek recovery against multiple bonds. However, the dates of damage by the subcontractor will need to occur within these dates.
Making a claim on a bond must be carefully considered. The subcontractor may have remedies against the defaulted contractor's license bond and multiple bonds may exist. If a subcontractor has properly served a Preliminary 20-Day Lien on the project, Mechanic's Lien and/or Stop Notice procedures against the owner should be first considered. However, recovery of the surety bond against a defaulted contractor can be a wise method to reduce a subcontractor's loss.