Guest Editorial by Henry Brown, Nexsen Pruet
Occasionally, old news is new news. The topic of notice by subcontractors and suppliers to preserve their lien and bond payment rights is discussed more often than may be necessary, but inattention or carelessness in regard to such notices is an effective way to turn a collectable debt into something uncollectable. The effort to give notice is simple in theory, sometimes technical in nature, and often difficult to accomplish consistently. The circumstances in which notice gets overlooked are usually the circumstances that matter.
The readers of this article are both South Carolina and North Carolina enterprises, but crossing the border for business opportunities is common. So, this discussion of recently encountered anomalies in South Carolina law should be of interest to both sides of the state line. The issue to be discussed is the shopworn concept of the “Notice of Project Commencement” and the responsive “Notice of Furnishing.” The fairly new wrinkle on this issue is its application to payment bond claims and the potential loss of rights under a payment bond.
For a long time, South Carolina mechanic’s lien law placed the General Contractor (GC) in a position as guardian of the various debts generated by a construction project. This was accomplished by the provision that subcontractors and suppliers to the GC could only collect on the lien claims to the extent of the unpaid balance owed by the Owner to the GC on the date the notice of a claim is given. A third tier subcontractor or supplier’s claim was valid against the remaining funds, even if the GC had paid the second tier subcontractor in full. The payment defense applied only to the debt from the Owner to the GC and payment in full by the GC to the subcontractor did not matter. Understandably the GC’s did not appreciate this position, and, through effective lobbying, they achieved an amendment of the South Carolina mechanic’s lien statute to provide for a “Notice of Project Commencement” (NPC), a designated form to be filed in the applicable courthouse and posted at the job site. The NPC, if filed within 15 days of the commencement of work, gave the GC a payment defense against remote claimants (third tier subcontractors and suppliers). Those claimants with contracts directly with the GC were unaffected, but suppliers to third tier subcontractors and suppliers would have their lien rights extinguished by the GC’s payment in full to its subcontractors. The remote claimant is required to comply with all the same non-payment notice requirements (i.e., 90 days from the date of last furnishing), but the NPC gave the GC a payment defense similar to that afforded the Owner.
The change to the mechanic’s lien statute gave remote claimants a way to avoid the GC’s new payment defense – the submittal of a “Notice of Furnishing” (NF) to the GC at the beginning of a project. The NF is not notice of a claim; it merely reveals to the GC the existence of third tier subcontractors and suppliers. If the NF is provided, then the payment defense remains at primary level (Owner-GC) and not the secondary level (GC-Subcontractor). This provision requires the GC to take whatever action it needed to protect itself from the consequences of its subcontractors not paying the tertiary level subcontractors and suppliers. Providing the NF at the beginning of any South Carolina project is a prudent step by any party furnishing labor or material downstream of the GC.
So, for third tier subcontractors and suppliers, two notices are required: (1) the NF, which says, “Hey, I’m providing labor or materials to this job, so look out for me when you pay the party to whom I’m contracted,” and (2) the notice of non-payment, which must be given within 90 days of last furnishing and says, “Now, I have a specified unpaid debt and am proceeding to enforce my mechanic’s lien rights.” This system has been well-known and well-discussed, and no one should be surprised about its existence or requirements.
The more obscure and harder to understand requirement is the statutory application of this system to payment bonds. The application of the NF requirement to payment bond claims was likely the result of very effective (and probably “under the radar” lobbying) that has materially increased the ability of the payment bond surety’s to avoid claims.
SC Code Section 29-5-440 was an amendment to the mechanic’s lien statute. It provides, in pertinent part, as follows:
Every person who has furnished labor, material, or rental equipment to a bonded contractor or its subcontractors in the prosecution of work provided for in any contract for construction, and who has not been paid in full…shall have the right to sue on the payment bond for the amount…unpaid at the time of the institution of such…
A remote claimant shall have a right of action on the payment bond only upon giving written notice by certified or registered mail to the bonded contractor within ninety days from the date on which such person did or performed the last of the labor or furnished or supplied the last of the material or rental equipment upon which such claim is made. However, in no event shall the aggregate amount of any claim against such payment bond by a remote claimant exceed the amount due by the bonded contractor to the person to whom the remote claimant has supplied labor, materials, rental equipment, or services, unless the remote claimant has provided notice of furnishing labor, materials, or rental equipment to the bonded contractor. Such written notice to the bonded contractor shall be personally served or sent by fax or sent by electronic mail or sent by registered or certified mail, postage prepaid, to the bonded contractor at any place the bonded contractor maintains a permanent office for the conduct of its business, or at the current address as shown on the records of the Department of Labor, Licensing and Regulation. After receiving the notice of furnishing labor, materials, or rental equipment, no payment by the bonded contractor shall lessen the amount recoverable by the remote claimant. However, in no event shall the aggregate amount of claims on the payment bond exceed the penal sum of the bond.
For purposes of this section, “bonded contractor” means a contractor or subcontractor furnishing a payment bond, and “remote claimant” means a person having a direct contractual relationship with a subcontractor of a bonded contractor, but no contractual relationship expressed or implied with the bonded contractor.
The unusual (and unexplainable) aspect of this statutory amendment is the insertion of a payment defense into a payment bond when no such defense was ever inserted into a payment bond form by a surety. On the face of every payment bond form is a promise to pay debts noticed and proven based on the requirement of the bond. Buried in the text of the South Carolina mechanic’s lien statute (and practically unknown to many consumers of payment bonds) is the statutory amendment that takes away the guaranty of payment on the face of the bond and replaces it with a guaranty of payment of the funds that might be owed by the bond principal to the entity with whom the claimant contracted. Remote claimants have significantly fewer rights than before.
Complicating this issue is the existence of a ruling by a South Carolina circuit judge, finding that the protection afforded to the bond surety exists even if no NPC was filed by the bond principal or any other person on the job. The judge found that the statute applies as written – the NF must be given by remote claimants to avoid the payment defense by the bond surety, even if no NPC is filed.
This interpretation results in the payment bond surety being given greater rights than a GC under the mechanic’s lien statute. For the GC, there is no payment defense if the NPC is not filed, and third tier subcontractors and suppliers do not have to file the NF in that case. However, the payment bond surety always has the payment defense, regardless of the NPC, and the NF must always be filed by third tier subcontractors and suppliers.
It is our understanding that the judicial finding discussed above is under appeal, and it may be reversed. But, for now, subcontractors and suppliers should be extremely conservative and exercise great prudence when extending credit on South Carolina construction projects. The NF should always be filed by any party who does not have a direct contract with the Owner or the GC in South Carolina. The NF, followed by careful attention to the usual lien perfection rights, is more important than ever. Read More.