Payment problems in the construction industry are not uncommon. The industry has created several options to protect contractors, subcontractors and suppliers from the risk of non-payment.
Depending on what type of project it is, options might be limited. Here are the three most common options to getting paid.
1. Mechanics Lien
How It Works: When work is completed on a project but payment has not been received, contractors, subcontractors and suppliers can file a mechanics lien against the improved property. A mechanics lien attaches to the title of the property and prevents the title owner from selling, transferring or taking out additional loans on the property.
Who Can File: Anyone who improves a property by providing labor, materials or services has the right to file a mechanics lien.
- Mechanics liens are quick and efficient. Because a mechanics lien attaches to both the structure and the land that the property is on, it forces the title owner to address the payment issue before any further action involving the property is taken. In short, a mechanics lien often yields quick results.
- Mechanics liens are usually quite responsive. Mechanics liens come with a deadline and in some states this deadline can be extended.
- Mechanics liens are difficult to challenge. Title owners cannot simply claim payment isn’t due. For a mechanics lien to be deemed invalid there must be a technical or procedural error.
- Mechanics liens are limited. They can only be filed on private projects; they cannot be filed on state, county or federal projects.
- Guidelines for filing a mechanics lien can be strict and time sensitive. There are four deadlines involved when filing a mechanics lien:
- the preliminary notice deadline;
- notice of intent deadline;
- mechanics lien deadline; and
- lien enforcement deadline
- All deadlines are state-specific. File any piece of the puzzle incorrectly and it could result in the forfeiture of lien rights.
2. Payment Bond Claim
How It Works: When work is completed on a project but payment has not been received, subcontractors and suppliers can make a claim with the surety company who issued the payment bond. A payment bond is a type of insurance policy that contractors obtain to ensure all parties are paid for their work. If a claim is determined to be valid, the payment bond will cover any financial losses.
Who Can File: Parties that have a direct relationship with the general contractor can file a payment bond claim. This includes subcontractors and suppliers that have a written or implied contract with the contractor.
- Claims, if valid, get paid. Payment bonds are posted in an amount equal to the construction contract. This means that even if multiple people make claims against the bond, the bond would be sufficient to cover those claims. No claim goes unpaid.
- There is substantial help from the surety. The surety is essentially a co-signer for the bonded contractor, promising that if payment is not made they will step in and take over. The surety doesn’t want this to happen, so it works hard to ensure payment is made by the contractor. The surety is heavily involved and completes a thorough investigation, offering options to ensure the contractor does not default.
- Payment bond claims are only available if there is a payment bond in place. Payment bonds are often used on larger federal projects (over $30,000.)
- The bond claim attaches to the payment bond, not the contracted property, which means the property itself is not encumbered. This can result in further action to the property with still no sign of payment.
3. Stop Payment Notice
How It Works: A stop payment notice is a notice to the party paying for a work of improvement. When a stop payment notice is issued, it forces the lender or owner of the project to withhold the amount claimed in the stop notice from the general contractor until payment is made to the lower-tiered individuals.
Who Can File: Anyone involved in a work of improvement can serve a stop payment notice, but depending on who is serving the notice, they might be limited on who they can serve the notice to. Direct contractors can only serve stop payment notices on the construction lender. Subcontractors, material suppliers and laborers can serve stop payment notices on construction lenders and owners.
- Stop payment notices are not limited. They can be used on public or private projects.
- Stop payment notices trap funds, not property. This can be useful when the property itself is not valuable enough to file a mechanics lien.
- Stop payment notices are only available in some states: California, Alaska, Arizona and New Mexico.
- Stop payment notices are only effective for money that is still in the owner or lender’s control. If the owner or lender has already paid the general contractor for the project, a stop payment notice would be useless because there would be no funds to trap, regardless if the general contractor paid the subcontractors and suppliers. Stop payment notices are only useful and effective if they are filed before payment has been made.
- Similar to a payment bond claim, a stop payment notice only affects the funds of the project, not the property. This could mean less leverage for the person filing.
When a contractor, subcontractor or supplier is not getting paid, they need to know when a mechanics lien, payment bond claim or stop payment notice is appropriate. Generally, only one action will be best. Choosing that right action could be the difference between getting paid and working for free.