What To Do If Your Contractor Doesn’t Pay A Subcontractor

How To Know Your Rights

When a contractor fails to pay a subcontractor, it is essential for the subcontractor to understand his or her legal and financial rights in each situation. First, the subcontract may contain a specific provision specifying that payment is due within a certain number of days after a contractor is paid by the property owner (also known as milestone payment schedules). States, such as California, have passed prompt pay construction legislation that can have the effect of requiring a contractor to issue an appropriate payment to a subcontractor based on this milestone payment schedule. Second, if a milestone payment schedule is not in effect and payment is due directly from the contractor under the subject subcontract, the subcontractor can use a "suspension of performance" to obtain the payment by ceasing work on the project until a payment is made. "Suspension of performance" is typically accomplished by issuing a "notice of suspension" and demanding payment in that notice. While a contractor may be able to recover for damages for a work stoppage due to a subcontractor’s "suspension of performance , " it might be more probable than not that the subcontractor can exercise this right without fear of exposure to a damage claim. The reason for this is that a contractor is only entitled to damages as a result of a subcontractor’s "suspension of performance" if the contractor can show that: "(i) the subcontractor willfully failed to provide the contractually required notice, or (ii) the subcontractor willfully failed to perform after said notice." Absent one or both of these willful failures, the subcontractor is well within its rights to "suspend performance" to obtain a payment. Of course, an unpaid subcontractor may also exercise statutory rights, such as lien claims or stop notice claims, to obtain payment from the property owner, even if no payment can be obtained from the contractor.

Communicating Your Concerns

Communicating with the contractor is a crucial aspect of resolving non-payment issues on construction jobs. Open, transparent, and timely communication is key to helping your Contractor understand what went wrong and why, and to helping you get on the right track to getting paid. Talking with the contractor can also help you learn about his perspective on the problem, and it may open the door to resolving the issue amicably, outside of court or formal arbitration.
A lot of times, the problem on a job doesn’t develop out of one huge issue – instead, it’s a series of smaller issues that built up over time. Open and honest communication is essential in situations like this. When a subcontractor discovers a problem with a contract and communicates it to the general contractor, it allows him to address it early in the process, before it snowballs into something much more complicated.
Early in the job, when a subcontractor communicates and documents the issues he or she is observing on the job, it allows the project manager and other decision makers to address them promptly and properly. Doing so can really help a subcontractor in the end, because if he or she has observed the issues right from the start, it goes a long way towards showing that subcontractors and contractors are working together as team players to solve a problem.
But if a subcontractor doesn’t immediately communicate and document the problems he or she is seeing on a job, it can be difficult to backtrack later on, especially if the subcontractor hasn’t kept proper documentation and records. A subcontractor can show that problems were discovered before a project got out of control, but this requires good documentation and a clear communication record to prove that he or she brought problems to the attention of the contractor early on in the job.
A contractor has an obligation to pay subcontractors in a timely fashion and to treat subcontractors like valued members of a construction team. Mutually beneficial communication should always be the goal. Subcontractors should keep in mind that, just like contractors must be proactive in paying subcontractors, subcontractors have to be just as proactive in keeping the contractor informed about any job problems and about any problems they are seeing with payment, as well.

Keeping Records

Regardless of which avenue is pursued, having documentation in support of the payment claim will be important. In most cases, the prime agreement will state that the contractor is responsible for payment to the subcontractor for all work performed under the subcontract. A contractor may not want to pay a subcontractor, alleging that it did not complete work or that the work it completed was defective. In either case, it may be tricky to bring a claim against a contractor that is refusing to pay.
Having records of how much time an employee or subcontractor spent on a job and how that time breaks down in terms of labor rate to support work performed will be essential. Thorough records of billings and payments to the subcontractor or subcontractors from the prime contractor or other subcontractors are also vital. In addition to documenting the performance of the work by demonstrating the work that was done, supporting documentation can also assist in showing the level of skill with which a subcontractor performed and the particular costs associated with the work. Where subcontractors complete their own record-keeping and submit their own invoices, the contractor should review those and ensure that the subcontractor is billing for its work properly before submitting invoices and payment requests from the project owner to the subcontractor so that discrepancies can be raised and reconciled before they become disputes.
With regard to documents that demonstrate there is proof of payment by the prime contractor to the subcontractor, it will be important for the contractor to show that it paid the subcontractor or should have paid the subcontractor. If the contractor is looking to file a bond claim, showing that the subcontractor was paid will require that the contractor provide proof that it paid the subcontractor. Examples of proof include cancelled checks or other proof of wires/cash transfers. If proof cannot be provided, the contractor should consider whether there is evidence from which the payment can be inferred. For example, if the contractor already submitted a payment application that contains information on invoices submitted to the contractor by the subcontractor and the contractor was then paid by the owner, but there is no proof of payment to the subcontractor, it may be possible to show proof of payment where the contractor can demonstrate that both invoices were submitted at the same time to the owner and the amount of the invoices matches the amount that the contractor was paid for that pay application from the owner.

Filing A Mechanics Lien

A mechanics lien can be a subcontractor’s best chance at securing payment. A mechanics lien is a legal claim against property. The actual claim is filed in the county in which the property is located. It is recorded with the county clerk and indexed in the deed records. The mechanics lien states that someone owes the contractor or subcontractor who files the mechanics lien money for improved property. For example, the improved property could be a road, a sewer line, a building, or other type of structure. A mechanics lien is basically a $60 tool that helps enforce the subcontractor’s right to payment.
There are three exceptions to a subcontractor’s ability to file a mechanics lien:
Under Texas law, a general contractor has to notify an owner of a subcontractor’s right to file a mechanics lien. The notification must state that the owner may refuse to discharge his obligation under the owner’s contract without requiring the general contractor to pay any subcontractor. The notification must state that the owner can refuse to require a subcontractor to pay the general contractor for work performed by an unpaid subcontractor, who has given notice to the owner. The notification also must contain the name and address of the subcontractor for whom the mechanics lien is being filed. Failure to notify an owner undermines a subcontractor’s right to payment since the general contractor may simply tell an owner not to pay the subcontractor.

Requesting Mediation or Arbitration

Most construction contracts have some type of alternative dispute resolution (ADR) clause that mandates mediation or arbitration, usually in the event the parties cannot amicably resolve an issue. If a contractor is not paying a subcontractor, you may want to consider mediating or arbitrating the issue instead of going the more traditional route of filing a lawsuit. If you fail to comply with the contract’s requirement that the parties mediate the issue and don’t have a substantial reason for the noncompliance, the court may grant the contractor’s motion to dismiss. In that case, the court will not have jurisdiction over the non-compliant party and will not hear the subcontractor’s breach of contract action against the contractor. If the court grants the contractor’s motion to dismiss, the subcontractor has essentially forfeited any chance of recovering the amount owed.
Several cases have discussed whether non-payment on a construction project can be enforced through ADR, such as a court-ordered mediation or arbitration . Ohio case law favors settlement through mediation whenever possible, and therefore the courts are likely to look favorably upon parties who have made a good faith effort to resolve the dispute amicably prior to filing a lawsuit. Courts have consistently held that they will not interfere with the binding meditation or arbitration process unless there has been a waiver by acquiescence, or the agreement is unconscionable or void. However, the Ohio Supreme Court has held that a subcontractor could not proceed directly to arbitration, absent the contractor’s consent to arbitrate. That could have been a fatal mistake if either party had appealed the case, as the Ohio Court of Appeals held that the trial court should have required the parties to go through the arbitration process before proceeding with the case. Therefore, care should be taken to ensure that a subcontractor has complied with the arbitration agreement and contract’s requirements before a lawsuit is filed.

Taking Legal Action

If a contractor fails to pay a subcontractor despite considerable effort by the latter to collect, then there is little choice but for the subcontractor to take legal action. A subcontractor’s options for initiating legal action are: (1) small claims court; (2) lawsuit. The subcontractor should first consider whether the amount of money in dispute justifies the time and expense of commencing legal action.
In most states, an action in small claims court can be pursued if the amount in dispute is under $2,000. It is common for a party to sue in small claims court without being represented by an attorney. In many states, a corporation must be represented by an attorney in a small claims action.
In some states, there is one small claims court that hears all small claims cases, whereas in other states, there may be multiple different small claims courts, and a defendant may be able to get a case dismissed for improper venue if an action is not commenced in the correct division of the small claims court.
A lawsuit may be required if the amount in dispute exceeds the small claims threshold. If a lawsuit is filed in the wrong court, it can be dismissed and re-filed in the proper court. In some states, a motion for summary judgment is an option, but often it takes months for the motion to be resolved.
Unless both parties are attorneys, depositions are highly unlikely in small claims actions and lawsuits, and discovery is very limited or non-existent. Parties will only be required to participate in court-ordered mediation or arbitration in rare cases.
Once in court, a subcontractor will have to prove the facts underlying the claim against the contractor. Sometimes, the allegations in the complaint and the subcontractor’s testimony about what the contractor did will be sufficient to establish a claim. In other cases, however, the subcontractor may need to present evidence such as the deposition testimony of witnesses and relevant documents.

How To Prevent This In The Future

While subcontractors have limited recourse in some situations with regard to a prime contractor’s payment, or non-payment, a subcontractor can mitigate their exposure by taking certain steps when negotiating future contracts with general contractors.
Here are some of the steps that subcontractors can take:
Make Sure Your Contract is Well-Written
Subcontractors should be aware of their right to file a lien pursuant to Pennsylvania’s Mechanics’ Lien Act. Mechanics’ liens trump all other liens and encumber the real estate. To preserve the right to file a lien, you must have a written contract with the general contractor, and the contract must be signed before the first day you perform your work. The price of a well-written contract is worth the expense. The contract should, at a minimum, provide: With this groundwork, you should have some protection and a clear understanding of the rights and obligations between the parties.
Obtain Additional Insured Coverage
Many general contractors require that their subcontractors obtain additional insured coverage. When a lawsuit is filed after there is a catastrophic event at a job site, the general contractor can attempt to have its insurance company defend them with regard to the lawsuit with only one caveat: the loss must occur during the period of time between the coverage start date and end date. If the subcontractor has an additional insured provision, not only will the general contractor’s insurance company defend the general contractor, but it will also defend the subcontractor who is listed as an additional insured . This is valuable because even though the general contractor’s insurance policy will have a large deductible which the subcontractor will have to pay $5,000, $10,000 or even $25,000, at least the subcontractor will have coverage with regard to defending the lawsuit. A subcontractor can also purchase builder’s risk insurance. This covers a building and materials while they are being constructed, and filled with tools. If the subcontractor is required to have builder’s risk insurance, or obtains builder’s risk insurance without being required to do so, the insurance company should be willing to extend additional insured coverage for the general contractor and other parties.
Utilize Mechanics’ Lien Insurance
Many subcontractors may not be aware of mechanics’ lien insurance and its availability. A subcontractor can procure mechanics’ lien insurance from a licensed insurance agent. This insurance protects the subcontractor from a lien being placed on the property. When a subcontractor procures mechanics’ lien insurance, it can procure enough money so that if it does not get paid, it will have enough money in a special account to pay off the lien before the lien attorney files a complaint to foreclose the lien. In other words, it will protect it from exposure in the amount of the mechanics’ lien, plus additional money. This is a good way to protect yourself if you do not expect to be paid. However, legitimate lien claims must be paid too, so this type of insurance covers the subcontractor in the very limited situation where it was not paid. The caveat here is that the price of the insurance may be prohibitive for most subcontractors.