Court Broadly Defines Subcontractors Who Qualify For Payment Bond Claims

by Sheppard Mullin Richter & Hampton LLP

[authors: Edward Lozowicki and Scott Vignos]

Can a supplier of construction materials be considered a "subcontractor" for purposes of enforcing its claim on a public works payment bond? The answer is "yes" according to a recent decision of the California Court of Appeal. In Eggers Industries v. Flintco, Inc., et al., 201 Cal. App. 4th 536 (3d Dist. 2011), rev. denied (Feb. 15, 2012). The Court affirmed the rule that a "subcontractor's status as a subcontractor must be determined based on what the subcontractor agrees to do, not what it actually ends up doing," citing a fifty year-old California Supreme Court decision. In so holding, Eggers provides important guidance regarding the scope of recovery against a public works payment bond permitted by Civil Code sec. 3248 and its replacement, the newly chaptered Civil Code sec. 9554, which takes effect in July 2012.

In Eggers, defendant Flintco, Inc. ("Flintco"), the general contractor on a public works project, hired Architectural Security Products ("ASP") to provide custom doors for the project. Subsequently, ASP hired Eggers to manufacture and deliver the doors to the worksite. When ASP failed to pay the full amount for the doors, Eggers brought suit seeking recovery of the unpaid amount against the public works payment bond Flintco had obtained for the project as required by law.

The primary issue for the trial court was whether ASP was a subcontractor or a materialman to the project. This characterization was dispositive to Eggers bond claim. Pursuant to Civil Code sec. 3248(b), only a materialman who was to be paid by the contractor or a subcontractor on the project may recover against a public works payment bond. By contrast, a material supplier who was to be paid by a materialman to the project may not recover. Eggers argued that since ASP was charged with furnishing a significant amount of custom products in accordance with the project plans and specifications, it should be deemed a subcontractor. Flintco took the opposite position, arguing that because ASP did not install any of the doors for the project, it was merely a materialman to the project, cutting off any potential recovery by Eggers.

On appeal, the Court agreed with Eggers. In its decision, the Court relied on a factually similar Supreme Court case for guidance. Theisen v. County of Los Angeles, 54 Cal. 2d. 170 (1960). In Theisen, a company agreed to supply doors to a public works project, but in fact subcontracted for production of most of the doors to another supplier. The Theisen court interpreted the meaning of subcontractor broadly, finding a subcontractor need only agree with the general contractor to perform a substantial portion of the work of construction in accordance with the specific plans under which the general contractor is bound. Applying this rationale, the Eggers court recognized that to be a subcontractor "one need not actually construct any part of the project, whether on or off site," only its agreement to do so is required. Therefore, despite the fact that ASP did not manufacture any of the custom doors called for in the plans and specifications for the project, its agreement to do so with Flintco established its role as a subcontractor to the project. On this basis, summary judgment in favor of Eggers was upheld.

Effect on General Contractors

The Eggers case provides important guidance for contractors seeking to limit exposure of the public works payment bond to claims by downstream suppliers. In its arguments, Flintco pointed out that affirming Theisen could "potentially give lien rights to second and third tier suppliers who might fabricate a custom product pursuant to specification requirements." This, Flintco argued, would require general contractors to inquire into the scope of work for all tiers of suppliers involved in a public work to determine potential exposure of the public works payment bond. The Eggers court found this fear without merit. "To protect itself," the Court noted, "all the general contractor has to do is condition its payment to the subcontractor on proof of releases by the subcontractor's suppliers." Moving forward, general contractors on public works should consider the Court's advice to require releases from all suppliers to subcontractors prior to payment to avoid unnecessary exposure to its public works payment bond.

Impact of New Statutes Effective July 1, 2012

In 2010, the California Legislature passed Senate Bill ("SB") 189, a major rewriting of Civil Code provisions governing works of improvements. Under SB 189, Civil Code sec. 3248(b), the statute interpreted by the Eggers court, was repealed and its replacement, Civil Code sec. 9554(b), will go into effect on July 1, 2012. In passing SB 189, the California Legislature stated that court decisions construing repealed portions of the Civil Code maintain their force with respect to new statutes that restate and continue their predecessors. Importantly, the operative language of Civil Code sec. 3248(b) is restated in essence in Civil Code sec. 9554(b). The latter statute provides that "[t]he payment bond shall provide that if the direct contractor or a subcontractor fails to pay … the surety will pay the obligation." This provision suggests that the Eggers and Thiesen interpretations remain applicable. 

Edward Lozowicki is a partner in Sheppard Mullin's San Francisco office and specializes in construction and energy law. Scott Vignos is an associate in that office and member of the Firm's Construction Industry Team.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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