17 of 19: Addressing Stop Notices, Liens and Contractor Claims

Part 17 of Our Series on Construction Project Management Skills

XVII. Addressing Stop Notices, Liens and Contractor Claims

A. Dealing with the Unbonded Stop Notice on a Private Project

On both public and private projects, stop notices are used by subcontractors and material suppliers to place a claim upon the construction fund, such as the money that a public entity sets aside for construction, or, on a private project, the amount set aside by the construction lender for the construction.

A significant difference between stop notices on public and private projects is the issue of bonding. On public projects, bonding is not required. Once a valid stop notice is received, the public entity cannot pay the funds that have been set aside until the stop notice is released. Civil Code section 3186.

On private projects, however, the construction lender is not obliged to set aside funds due to the contractor upon receipt of a stop notice, unless the claimant has posted a stop notice bond. The cost of stop notice bonds is usually a percentage of the claim amount. Many claimants find the cost of a stop notice bond to be prohibitive, particularly with large claims. If an unbonded stop notice is received by the construction lender, the construction lender has the right to ignore the stop notice entirely.

The issue for project managers on private projects is whether unbonded stop notices should be ignored. In most cases, the answer is emphatically, "no." A stop notice is a signal to a project manager that at least one of the participants in the project is having trouble getting paid. Project managers should contact the prime contractor immediately upon receipt of any stop notice, and demand to know why it is that a stop notice was received. Progress payment requests should be reviewed to determine whether payment for the claimant's work has already been paid to the contractor.

The reason why stop notices require project managers immediate attention is that stop notices are one of the early indicators of a contractor going into default.

B. Amounts Withheld Under Stop Notice

On receipt of a stop notice, the public entity is required to set aside sufficient funds to address the claim and anticipated litigation costs. Civil Code section 3186 The majority of public entities set aside125% of the amount of the claim. This amount comes from Civil Code section 3196, which references the amount that a stop notice release bond must be.

Where there are multiple claims and limited funds, the amount retained in stop notice funds are distributed on a pro rata basis to each of the claimants, based on the size of the claim presented. For example, if there is a claim for $150,000, a claim for $100,000, and a claim for $50,000, but only $100,000 left in the construction fund, the $150,000 claimant would receive half of the fund, or $50,000, the $100,000 claimant would receive one third, or $33,333 and the $50,000 claimant would receive one-sixth, or 16,666. See Civil Code section 3190.

C. Challenges to Stop Notices

Claimants may sometimes present stop notices that are subject to challenge by the contractor. There is a procedure that a contractor may use to challenge a stop notice in court on an expedited basis. If a contractor elects to use this procedure, the owner will receive notification that papers have been filed with the Court. In response, the has no obligation to do anything other than to set aside funds under the stop notice until the owner receives a Court order, directing the owner whether to maintain the stop notice or release the money. See Civil Code section 3196-3205.

D. Strategies to Release Project Liens

When liens or stop notices are recorded against a project, there are several immediate concerns that should be addressed. The receipt of liens or stop notices may be the first indication that a contractor is in financial trouble. In addition, the recordation of a lien may be a basis for the lender to consider the owner to be in default under its loan.

If the contract contains a "lien free" provision, requiring the Contractor to post a bond, the project manager should immediately send notification to the contractor that a lien has been received, that the contract requires the contractor to post a bond, and that the contractor has so many days to post a bond or be declared in default under the contract. In addition, an immediate meeting to discuss the claim with the contractor is a good idea.

If the contractor fails or refuses to post a bond, immediate action should be considered. This includes reaching agreement with the contractor for the owner to make direct payments to the claimant, directing the claimant to make a stop notice claim, and directing the claimant to make a claim on the contractor's payment bond.

If the contract provides the owner with audit rights, the project manager should consider whether now is the time to get to the contractor's financial records to determine whether there should be concern about the contractor's ability to finish the project.

E. Closing the Deal

Assuming a resolution has been reached, the terms of the settlement should be put in writing at the time a settlement has been reached. It is essential to avoid additional claims that the settlement terms include a statement ending the introduction of new claims. The following is an example of language that could be used to eliminate any further claims arising before a particular date:

"This is a settlement of all claims relating to performance of the project through (date), and the Contractor waives all claims for extra work, delay, disruption, and other claims for compensation, and that upon payment of the agreed sum, the Contractor will sign an Unconditional Release of [Final or Progress] Payment in accordance with Civil Code section 3262, and will identify the amount of disputed claims for extra work in such release as ‘zero.'"

Use similar language in change order documentation to ensure a complete release of all claims. An attorney will likely recommend additional language to address the particulars of a given settlement.

On public projects, there are additional limitations on the public entity's ability to obtain releases. Public Contract Code section 7100 provides as follows:

Provisions in public works contracts with public entities which provide that acceptance of a payment otherwise due a contractor is a waiver of all claims against the public entity arising out of the work performed under the contract or which condition the right to payment upon submission of a release by the contractor of all claims against the public entity arising out of performance of the public work are against public policy and null and void. This section shall not prohibit a public entity from placing in a public works contract and enforcing a contract provision which provides that payment of undisputed contract amounts is contingent upon the contractor furnishing the public entity with a release of all claims against the public entity arising by virtue of the public works contract related to those amounts. Disputed contract claims in stated amounts may be specifically excluded by the contractor from the operation of the release.

Consequently, if a public entity tries to obtain a release from all claims from a contractor arising out of the work performed, the release provided may not be enforceable. Consulting an attorney concerning the appropriate terms for a release is recommended.