May 2008 - the Intricate Web of Personal Liability and Construction Project Debts

• Jurisdiction: Colorado,United States
• Citation: Vol. 37 No. 5 Pg. 41
• Pages: 41
• Publication year: 2008

37 Colo.Law. 41 Colorado Lawyer 2008.

2008, May, Pg. 41. May 2008 - The Intricate Web of Personal Liability and Construction Project Debts

The Colorado Lawyer
May 2008
Vol. 37, No. 5 [Page 41]

Articles
Construction Law
The Intricate Web of Personal Liability and Construction Project Debts
by Stephen A. Hess

Construction Law articles are sponsored by the CBA Construction Law Section.

Article Editor

James W. Bain of Benjamin, Bain & Howard, L.L.C Greenwood Village - (303) 290-6600 jamesbain@bbhlegal.com

About the Author

This month's article was written by Stephen A. Hess who practices construction law as a member of Sherman & Howard, LLC's Colorado Springs office - shess@shermanhoward.com.

This article discusses how personal liabilities provide important considerations in the collection of debts related to construction projects. Although construction companies often are incorporated to protect the owners' assets, the structure of construction contracts often compels those owners to incur personal debts.

Collection claims in construction projects frequently raise more issues than mere breaches of contract. Even a modest claim by a material supplier may bring into contention interlocking rights and responsibilities involving the owner, the general contractor, and lower-tier subcontractors, laborers, and materialmen. Any attorney involved in collection efforts in the construction industry must understand the rights and responsibilities of these parties, as well as how the threat of personal liability drives many collection efforts.

Mechanics' Liens and Construction Contract Claims

The Mechanics' Lien Act(fn1) complicates collection issues. The following discussion is based on the accompanying "Hypothetical Fact Pattern."

Without the Mechanics' Lien Act, Subcontractor's failure to pay Materialman would lead to a breach of contract claim and, if Materialman did not pay, Guarantor would be liable. Contractor would not be liable to Materialman, because it had no contract with Materialman. Similarly, Materialman could not pursue a third-party beneficiary (contract) or unjust enrichment claim against Contractor or Owner, because both paid for the flux capacitors and thereby discharged their contractual obligations.

Mechanics' liens provide the right to foreclose the lien on Owner's property to ensure payment for participating in improving the property.(fn2) The mechanics' lien law reflects the legislature's policy decision that persons who contribute to the improvement of real property should be paid for their efforts, even if it results in the owner paying twice. Owners want to protect themselves against the risk of paying twice.

Accordingly, owners often try to protect themselves from this risk, which significantly affects the structure and administration of construction contracts. Specific effects on construction contracts are discussed below.

Hypothetical Fact Pattern

The following fact pattern will be used to help explain the complexity of collections in the construction process.

Owner, a private utility company, contracted with Contractor to construct a power plant. Contractor retained Subcontractor to furnish and install equipment assemblies. Subcontractor purchased $70,000 of flux capacitors from Materialman.

Sophisticated owners would require Contractor to secure a labor and material payment bond from Surety. Similarly, Subcontractor frequently would be required to furnish the personal guarantee of its owner(s) (Guarantor) to secure payment of open orders for materials. The contractual interrelationship is:

Contractor's payment application included the $70,000 in flux capacitors and Contactor executed a general lien release, representing that all of the lower-tier subcontractors had been paid and purporting to release their lien rights, as well. Materialman has not been paid and has not waived its lien rights. Subcontractor used the $70,000 to cover other expenses and then went out of business. Materialman served Owner with a $70,000 Notice of Intent to File Lien Statement.

Labor and Material Payment Bonds

Owner may require that Contractor obtain a labor and material payment bond to ensure that lower-tier subcontractors and suppliers are paid.(fn3) In exchange for issuing the labor and material payment bond, Surety will require an indemnification agreement from Contractor.(fn4)

Contractual Promises to Clear Liens

Even if no bond is required, Owner frequently will include a provision in the general contract that obligates Contractor to keep the property free from any liens and to defend Owner against any lien claims. Contractor typically will include such a provision in each of its subcontracts.

Lien Waivers and Releases

Because of the threat of mechanics' liens, Contractor should structure its payment process to require that Materialman list all of its subcontractors and materialmen on the project. Contractor also should require that Materialman submit a lien waiver and release with each payment application from Materialman, in which Materialman represents that all lower-tier subcontractors and suppliers have been paid for the work and materials included in the payment application.

Trust Fund Statute

Finally, another provision in the Mechanics' Lien Act may provide protection for the owner. Colorado's "trust fund" statute directs each recipient of contract payments to satisfy obligations to lower-tier subcontractors and materialmen, and makes it a Class 3 felony to keep any portion of a contract payment when lower-tier creditors have not been paid. The trust fund statute is discussed in more detail below.

Typical Construction Payment Claims

The additional contractual and statutory obligations associated with mechanics' liens increase the number and types of claims available to the parties in the scenario above. Some of these claims are discussed below.

Subcontractor's/Materialman's Claims

Materialman has many claims beyond a...