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Who is a “Subcontractor” for Purposes of Mechanics Lien, Stop Notice and Payment Bond Claims?

In This Issue

Understanding and Negotiating Your Construction Contract
Speakers: William L. Porter, Esq. and Conor H. McElroy, Esq.
Jan. 24, Mar. 22 & May 8

Construction Collections
Speaker: William L. Porter, Esq.
Feb. 21, April 19 & June 21
SRBX, Sacramento

SRBX, Sacramento

Cost: $25 SRBX members,
$45 non-members
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In the construction industry, the proper legal classification of an entity in contract with a prime contractor can be of crucial importance. Whether one in contract with a prime contractor is a subcontractor or a material supplier determines the class of potential claimants for mechanics’ liens, stop notices and payment bond claims. Generally, those in contract with subcontractors have the ability to assert mechanics liens, stop notices and payment bond claims against the owner, general contractor and/or sureties. On the other hand, those in contract with material suppliers are generally not entitled to assert mechanics lien, stop notice and payment bond claims.

The proper classification of an entity as either a subcontractor or a material supplier can be difficult. Simply because a prime contractor hires a licensed contractor to furnish labor, materials, equipment or services on a project does not mean that the licensee is actually a “subcontractor” as a matter of law. Conversely, even though a material supplier may not have a contractors’ license, he may still be classified as a subcontractor based on his scope of work. Based on recent case law, the method of determining whether an entity is a subcontractor or a material supplier has been clarified to rely upon the scope of work that the entity actually agreed to perform on the project.

California’s Third District Court of Appeal recently clarified the difference between a subcontractor and a material supplier in Eggers Industries v. Flintco, Inc., et al., (2011 Cal. App. LEXIS 1513), Dec. 5, 2011. In Eggers, Flintco had been awarded a public works contract for the construction of the Robert Mondavi Institute for Wine and Food Science at the University of California-Davis. Flintco hired Architectural Security Products (“ASP”) to furnish several hundred custom architectural wood doors for the project. ASP, in turn, hired Eggers to manufacture the doors. ASP did not perform any labor either onsite or offsite in the manufacture of the doors but rather passed portions of the contract on to other subcontractors, suppliers and manufacturers. While Flintco paid ASP much of what it was owed on the Project, ASP failed to pay Eggers. Flintco failed to obtain lien releases from ASP prior to making payment, likely assuming that ASP was a material supplier and could not make a stop notice or payment bond claim. Eggers had, however, timely served a Preliminary 20-Day Notice to Flintco. Eggers subsequently filed suit against ASP for breach of contract and against Flintco and the Sureties on the Public Works Payment Bond in an effort to recover the money owed to it for the manufactured products which had been incorporated into the project. ASP’s financial troubles left Eggers with the sole remedy of pursuing Flintco and the Sureties on the Payment Bond.

From the outset, Eggers relied upon the rule of law established in J.W. Theisen v. County of Los Angeles (1960) 54 Cal. 2d 170. Theisen relied on a fact pattern very similar to that in Eggers. There, Theisen, as the prime contractor, hired Petterson to furnish 64 custom made doors for a construction project. Petterson in turn hired Durand to manufacture 20 of the doors. When Durand was not paid, it brought suit against the general contractor and public entity on its Public Works Stop Notice. The public entity paid Durand and later sought reimbursement from Theisen. Theisen challenged its obligation to reimburse the public entity, arguing that Durand was not a proper claimant on the Stop Notice, as it was a “second-tier” material supplier, and that the public entity should therefore not have paid Durand. The California Supreme Court ruled against Theisen, holding that an entity who agrees with the prime contractor to perform a substantial specified portion of the work of improvement pursuant to the architect’s plans and specifications is a subcontractor as a matter of law. As a result, Petterson, who agreed with Theisen to supply 64 custom made doors was a subcontractor, and Durand, as one in contract with a subcontractor, was a proper claimant.

On appeal, Flintco argued that in order for one to be a subcontractor under Theisen, the entity had to actually self-perform some portion of the work. Flintco relied on a sentence in Theisen which stated that the essential feature that makes one a subcontractor is that “in the course of performance of the prime contract…he constructs a definite, substantial part of the work of improvement in accord with the plans and specifications of such contract …” Eggers, in contrast, argued that the defining characteristic that makes one a subcontractor rather than a material supplier is the scope of work that the entity agrees to perform, not what it actually does perform. Eggers relied upon different language in the Theisen opinion which stated, “one who agrees with the prime contractor to perform a substantial specified portion of the work of construction which is the subject of the general contract in accord with the plans and specifications by which the prime contractor is bound has ‘charge of the construction’ of that part of the work of improvement and is a subcontractor…” Theisen, p. 183.

The Court, in its analysis of Theisen, determined that the critical fact in Theisen “was what Petterson agreed to do -- furnish 64 custom doors -- not whether Petterson actually manufactured some of those doors itself rather than contracting with another entity for the manufacture of some of the doors.” Eggers, supra at 16-17. The “charge of the construction” language, they said, was consistent with the statutory framework upon which the Theisen decision was based. “It is the agreement to provide part of the construction, not who actually performs that part of the construction, that gives one “charge of” that part of the construction and thus makes one a subcontractor.” Eggers, supra at 18.

The Third District Court of Appeals ultimately concluded that one who contracts with a prime contractor is a subcontractor where it “agrees with the prime contractor to perform a substantial specified portion of the work of construction which is the subject of the general contract in accord with the plans and specifications by which the prime contractor is bound,” regardless of whether it actually constructs any part of the project, onsite or offsite. Eggers, supra at 2. The subcontractor does not lose its status as a subcontractor as a result of subcontracting work to others.

ASP was deemed to be a subcontractor, rather than a materialman, because it agreed to furnish the manufactured custom doors that were required by the architect’s plans and specifications for the project. Under this agreement, ASP remained “in charge” of that scope of work regardless of who actually performed the work and ASP was a subcontractor for purposes of Civil Code Section 3248. Consequently, Eggers, who furnished the custom doors, was a proper claimant on the Payment Bond.

The precedent set by this case is important as it reaffirms a legal principle that has existed for some time but had perhaps been overlooked or misunderstood within the construction industry. General Contractors must be aware of the scope of work contained in the contracts that they execute with those furnishing labor, materials, equipment and services on their construction projects. Further, they must recognize the potential claimants that may be created from those contracts. General Contractors cannot simply use form “purchase orders” or “purchase contracts” in an effort avoid the subcontractor designation. Vendors of building products such as electrical equipment, pre-cast concrete, architectural wood, and custom metal, which are built pursuant to project plans and specifications are likely subcontractors as a matter of law. Manufacturers constructing significant component parts of a work of improvement per plans and specifications are potential lien, stop notice and bond claimants. General Contractors needs to protect themselves by using conditional and unconditional lien releases and paying by joint check. It would be wise for General Contractors to err on the side of caution when they receive Preliminary 20-Day Notices.

As for those persons furnishing the actual labor, materials, services and equipment to a work of improvement, vendors and manufacturers of custom components for construction projects are reminded that they may be proper lien, stop notice and payment bond claimants. Potential claimants need to timely assert those remedies, both by serving Preliminary 20-Day Notices, when required, and by filing claims and/or commencing civil lawsuits. Claimants should always monitor the progress of construction projects to ensure that their rights do not expire, and contact experienced construction counsel for assistance in protecting their rights.

*As of the date of this publishing, Flintco and the Sureties have filed a Petition for Review with the California Supreme Court, seeking to have the Appellate Court’s decision reversed.

Conor H. McElroy is a Partner with Porter Law Group, Inc. in Sacramento, California, a construction law firm assisting contractors in all phases of their business. Mr. McElroy was the primary attorney handling the trial court action and appeal on behalf of Plaintiff and Respondent Eggers Industries. He can be reached by telephone at (916) 381-7868 or email at cmcelroy@porterlaw.com.

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