Getting Coverage for Subcontractors on Performance Bonds - It Can Be A Challenge

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December 28, 2007

Public works projects typically contain many tiers of parties. The owner contracts with the general contractor, which contracts with a subcontractor, which contracts with a subsubcontractor, which contracts with a supplier, which contracts with a manufacturer. If a construction company goes bankrupt or becomes insolvent, those impacts can be felt across several tiers.

A recent case before the Indiana Supreme Court makes clear that lower tiered parties have less rights the farther they get contractually from the owner and general contractor. In this case, the third-tier subcontractor, who manufactured prefabricated bridge components, failed to get paid by a second-tier subcontractor on the redesign and reconstruction of a bridge. The manufacturer then submitted a claim on the performance bond that had been posted pursuant to Indiana's statutory requirement for public works projects. The court ruled that the rights to recover against this bond did not extend beyond parties who have a contract with either a first-tier subcontractor or the general contractor. The court concluded that the statutory language requiring bonds was not meant to cover lower tier claims and that courts could not extend that coverage - only the legislature can do that by changing the law.

Given the corresponding limitations in public works projects that prevent contractors from exercising rights and tools like mechanics' liens, this ruling can have devastating consequences for lower tier contractors and suppliers. To protect itself from these risks, a lower tier contractor in a public works project needs to carefully document its dealings with public works subcontractors and to provide for being paid contemporaneously (or nearly so) with the delivery of goods and services. Otherwise, the lower tier carrier can deliver goods and services in a public works project and still be left holding an empty bag when it is time to be paid.

Citation for lawyers: Alberici Constructors, Inc. v. Ohio Farmers Ins. Co., 866 N.E.2d 740 (Ind. 2007).

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