Ready To Settle With The General Contractor Or Its Bankruptcy Trustee, Subcontractors Should Proceed With Caution

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The subcontractor did everything right:  it did the work, but did not get paid, and thereafter properly perfected a lien.  Now, the subcontractor has an opportunity to settle with the general contractor or even its subsequent bankruptcy trustee.  The subcontractor needs to proceed with caution to avoid losing its lien against the owner.

In Texas, a subcontractor enjoys no direct lien against the owner’s property but must instead rely upon its statutory, derivative rights to collect funds due by the owner to the contractor or, failing that, to impose a lien on the property.  There are two statutory schemes for recovery against the owner:  (1) funds trapping, and (2) retainage.  To recover under either scheme, the subcontractor must establish an existing debt owed by the general contractor to the subcontractor.  Thus, when a subcontractor settles, releases, and discharges its claim for payment against the general contractor, the subcontractor cannot sustain a lien claim against the owner predicated on the alleged nonpayment.

The case of Stolz v. Honeycutt, 42 S.W.3d 305 (Tex. App.—Houston [14th Dist.] 2001, no pet.) is instructive.  Thereunder, a general contractor contracted with the owner for certain work and later subcontracted a portion of the project.  After completing the work, the general contractor failed to pay the subcontractor, and the subcontractor provided the owner notice of the non-payment.  At a subsequent meeting between the owner, general contractor, and the subcontractor, the subcontractor accepted a post-dated check from the general contractor and signed a document purporting to release all claims against the general contractor.  The check subsequently bounced, and the subcontractor then pursued claims against the owner under both funds trapping and retainage theories. 

The Fourteenth Court of Appeals held that a subcontractor could not recover against the owner following the release.  As recognized by the court, under the funds trapping statute, an owner may trap funds not yet paid by the owner to the contractor, but the owner’s obligation to trap funds is extinguished if the claim against the general contractor for payment is paid or settled.  Where the claim for payment against the general contractor ceases to exist, the derivative claims also cease to exist.  The settlement with the general contractor similarly barred the subcontractor’s retainage claim.  The settlement extinguished the lien rights even though the subcontractor never collected payment. 

Thus, before a subcontractor agrees to generally release the general contractor, the subcontractor must ensure that it received all compensation it intends to recover for the work.  The subcontractor cannot settle, release, and discharge the general contractor and hope to later recover something more from the owner. 

Bankruptcy presents a particular pitfall for subcontractors who recognize that little may be recoverable from the general contractor.  Although there may be value in reaching a settlement with the general subcontractor’s bankruptcy trustee, the subcontractor should not release the general subcontractor in settling with the trustee, if it wants to still seek recovery against the owner.  Moreover, if the lien is the basis of a proof of claim, the subcontractor should proceed with caution in agreeing to reduce or waive the claim.

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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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