What happens when state laws conflict with a bond’s terms?
Wednesday, December 07, 2016
Payment bonds always have specific terms that purportedly must be followed to make a successful claim on the bond for payment. In a significant number of cases, however, the requirements for making a bond claim are also simultaneously regulated by state statute.
When the bond's requirements conflict with the state regulations, it can result in a legal battle pitting freedom of contract, public policy and statutory authority against each other. Too often, this can lead to an expensive and time-consuming legal black hole.
Brief overview of payment bonds
Before a discussion about which set of requirements control the bond claim process would make sense, it's important to understand what a payment bond is and when they show up.
A payment bond provides security to parties furnishing labor or materials to a construction project by providing a "pile of money" against which unpaid participants can make a claim. This takes the place of a lien claim in circumstances in which the underlying property is not subject to a lien.
In the event of nonpayment, the participants below the party providing the bond on the contracting chain can make a claim directly against the bond. This acts to protect the claimant, but also insulates other participants against such claims.
Parties rarely post a payment bond voluntarily. Instead, they are generally required to post the bond as a requirement of the project, arising either from statute (i.e., the law requires the bond) or contract (i.e., a party like an owner or general contractor requires the bond). While some private projects (generally large projects) utilize payment bonds, they are most often required on state, county and federal projects — since the law disallows mechanics liens as protection on these projects, and there is a strong public policy in providing some payment security.
To find out which rules apply, a project participant should take a couple proactive steps to prepare in the event a claim is required.
Step 1: Determine whether specific payment bond laws apply
Every payment bond has associated terms — the legal requirements printed on the reverse side or on pages accompanied with the bonding paperwork. However, in two general circumstances, payment bonds may also be regulated by state or federal statutes:
- If the project requires a payment bond by application of statute, statutory provisions will apply to the bond; or
- If the state has laws that regulate voluntary payment bonds, statutory provisions may apply to the bond.
When a payment bond is in play, it's important for parties to determine whether the statutory requirements, if any, will apply to a potential bond claim.
State and federal improvement projects present the most common circumstances when a payment bond is legally required. Keep in mind, however, that state and federal laws only require the general contractor to post a payment bond. If other parties on the project also obtain a payment bond (i.e., subcontractors) on the same project, those bonds are technically the product of contractual agreements, and not law.
Nevertheless, even those payment bonds that exist because of contractual agreement may be regulated by statute. Florida's law provides one example where private payment bonds are subject to statutory control (F.S. § 713.23 et seq.).
If statutory requirements do not apply, the claimant's job is relatively easy: review the bond's terms and comply. However, when there are potentially applicable statutory requirements, the important question becomes which set of regulations control.
Does the state law override the payment bond’s terms, or vice versa? And what if the bond's terms and the state law do not actually conflict, but instead present unique complementary requirements — must a payment claimant meet both the statutory and contractual requirements?
Step 2: Resolve conflicts between state regulations and bond terms
When a payment bond is required or regulated by statute, the general legal rule across the United States is that the statutory provisions apply and completely override whatever the bond's contractual terms may be. In other words, you can act as if the bond's terms never existed and simply comply with the state or federal law.
Easy situations to which this rule applies are projects governed by the U.S. Miller Act, which regulates general contractor payment bonds on federal improvement projects. For bond claims on these projects, it's a pretty safe practice to ignore the bond's actual terms and just follow the requirements set out by the Miller Act.
This being construction law, however, there are, of course, a few exceptions. This article separates the exceptions into three categories.
Category 1: States that allow bond terms to override state law when the terms expand the claimant's rights
Rhode Island's law provides an example of this first exception. In that state, the law sets forth a standard two-year bond claim foreclosure period, but authorizes a payment bond to include terms that alter the period in favor of the claimant.
Rhode Island Statute §37-12-5, states that "[n]o suit instituted ... shall be commenced after the expiration of two (2) years, or under the maximum time limit as contained within any ... payment bond ... whichever period is longer." (emphasis added)
Category 2: States that allow bond terms to completely override state law
Kentucky's law provides an example of this second exception to the general rule. Unlike most states, Kentucky does not establish a general payment foreclosure period. Therefore, the state's general contract statute of limitations period of 15 years applies to bond claims unless the terms of a payment bond restrict the time period for suit, in which case, the terms of the bond will be honored.
Thus, Kentucky payment bond claimants must keep careful track of the foreclosure periods set forth in any applicable bond's terms, as these periods will control their claim's lifespan.
Category 3: States with no rule/guidance, the legal gray area
The third exception to the general rule is the worst kind. When the state law and jurisprudence is completely silent regarding what happens in the event of a conflict, claimant can be thrown into a legal twilight zone. Perhaps unsurprisingly, given the complex and sometimes confused nature of construction lien/bond claim law, this is the case in quite a few jurisdictions.
While a true gray area exists in these cases, it is probably more likely than not that the state — given the absence of explicit instructions otherwise — would apply the general rule that the legal requirements override the bond's terms. This is due to the public interest in providing construction participants standard and knowable payment security for furnishing labor or materials to a project.
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