For purposes of seeking payment on a construction related project in the California construction industry, the proper legal classification of the party seeking payment is of key importance. Whether one in contract with a prime contractor is a subcontractor or a material supplier determines the availability for mechanics’ liens, stop payment notices and payment bond claims. Generally, those in contract with subcontractors have the ability to assert mechanics liens, stop payment notices and payment bond claims against the owner, general contractor and/or sureties. On the other hand, those who supply materials to material suppliers are generally not entitled to assert a mechanics lien, stop payment notice or payment bond claim. The “rule” has generally been stated as: “A supplier to a supplier has no lien rights.” However, this rule is not always true.
The proper classification of an entity as either a subcontractor or a material supplier can be difficult. Simply because a prime contractor hires a licensed contractor to furnish labor, materials, equipment or services on a project does not mean that the party hired is actually a “subcontractor” as a matter of law. Conversely, even though a material supplier may not have a contractors’ license, he may still be classified as a subcontractor based on his scope of work. Based on recent case law, the method of determining whether an entity is a subcontractor or a material supplier has been clarified. The classification will depend on the scope of work that the hired party actually agreed to perform on the project.
In a case argued to success by Porter Law Group, California’s Third District Court of Appeal clarified the difference between a subcontractor and a material supplier in Eggers Industries v. Flintco, Inc., et al., 201 Cal App 4th 536 (2011)*. In Eggers, Flintco had been awarded a public works contract for the construction of the Robert Mondavi Institute for Wine and Food Science at the University of California-Davis. Flintco hired Architectural Security Products (“ASP”) to furnish several hundred custom architectural wood doors for the project. ASP, in turn, hired Eggers Industries to manufacture the doors. ASP did not perform any labor either onsite or offsite in the manufacture of the doors but rather passed portions of the contract on to other subcontractors, suppliers and manufacturers. While Flintco paid ASP much of what it was owed on the Project, ASP failed to pay Eggers. Flintco failed to obtain lien releases from ASP prior to making payment, perhaps assuming that ASP was a material supplier and Eggers, as a material supplier to a material supplier, could not bring a successful stop payment notice or payment bond claim. Eggers had earlier timely served a Preliminary Notice to Flintco to preserve their rights. Eggers subsequently filed suit against ASP for breach of contract and against Flintco and the Sureties on the Public Works Payment Bond in an effort to recover the money owed to it for the manufactured products which had been incorporated into the project. ASP’s financial situation left Eggers with the sole remedy of pursuing Flintco and the Sureties on the Payment Bond.
From the outset, Eggers relied upon the rule of law established in J.W. Theisen v. County of Los Angeles (1960) 54 Cal. 2d 170. Theisen relied on a fact pattern very similar to that in Eggers. There, Theisen, as the prime contractor, hired Petterson to furnish 64 custom made doors for a construction project. Petterson in turn hired Durand to manufacture 20 of the doors. When Durand was not paid, it brought suit against the general contractor and public entity on its public works stop payment notice. The public entity paid Durand and later sought reimbursement from Theisen. Theisen challenged its obligation to reimburse the public entity, arguing that Durand was not a proper claimant on the stop payment notice, as it was a “second-tier” material supplier, and that the public entity should therefore not have paid Durand since, they argued, “a supplier to a supplier” has no right to a stop payment notice. The California Supreme Court ruled against Theisen, holding that an entity who agrees with the prime contractor to perform a substantial specified portion of the work of improvement pursuant to the architect’s plans and specifications is a “subcontractor” as a matter of law. As a result, Petterson, who agreed with Theisen to supply 64 custom made doors, was legally a subcontractor, and Durand, as one in contract with a subcontractor, was a proper claimant.
On appeal in the Eggers case, Flintco argued that in order for one to be a subcontractor under Theisen, the entity had to actually self-perform some portion of the work. Flintco relied on a sentence in Theisen which stated that the essential feature that makes one a subcontractor is that “in the course of performance of the prime contract…he constructs a definite, substantial part of the work of improvement in accord with the plans and specifications of such contract …” Eggers, in contrast, argued that the defining characteristic that makes one a subcontractor rather than a material supplier is the scope of work that the entity agrees to perform, not what it actually does perform. Eggers relied upon different language in the Theisen opinion which stated, “one who agrees with the prime contractor to perform a substantial specified portion of the work of construction which is the subject of the general contract in accord with the plans and specifications by which the prime contractor is bound has ‘charge of the construction’ of that part of the work of improvement and is a subcontractor…” Theisen, p. 183.
The Court of appeal, in its analysis of Theisen, determined that the critical fact in Theisen “was what Petterson agreed to do — furnish 64 custom doors — not whether Petterson actually manufactured some of those doors itself rather than contracting with another entity for the manufacture of some of the doors.” Eggers, supra at 16-17. The “charge of the construction” language, they said, was consistent with the statutory framework upon which the Theisen decision was based. “It is the agreement to provide part of the construction, not who actually performs that part of the construction, that gives one “charge of” that part of the construction and thus makes one a subcontractor.” Eggers, supra at 18.
The Third District Court of Appeals ultimately concluded that one who contracts with a prime contractor is a subcontractor where it “agrees with the prime contractor to perform a substantial specified portion of the work of construction which is the subject of the general contract in accord with the plans and specifications by which the prime contractor is bound,” regardless of whether it actually constructs any part of the project, onsite or offsite. Eggers, supra at 2. The subcontractor does not lose its status as a subcontractor as a result of subcontracting work to others.
ASP was deemed to be a subcontractor, rather than a materialman, because it agreed to furnish the manufactured custom doors that were required by the architect’s plans and specifications for the project. Under this agreement, ASP remained “in charge” of that scope of work regardless of who actually performed the work and ASP was a subcontractor for purposes of Civil Code Section 8046. Consequently, Eggers, who furnished the custom doors, was deemed a supplier to a subcontractor and a proper claimant on the payment bond.
The precedent set by this case is important as it reaffirms a legal principle that has existed for some time but had perhaps been overlooked or misunderstood within the construction industry. Direct contractors must be aware of the scope of work contained in the contracts that they execute with those furnishing labor, materials, equipment and services on their construction projects. Further, they must recognize the potential claimants that may be created from those contracts. Direct contractors cannot simply use form “purchase orders” or “purchase contracts” in an effort avoid the subcontractor designation. Vendors of building products such as electrical equipment, pre-cast concrete, architectural wood, and custom metal, which are built pursuant to project plans and specifications are likely subcontractors as a matter of law. Manufacturers constructing significant component parts of a work of improvement per plans and specifications are potential lien, stop payment notice and bond claimants. Direct contractors needs to protect themselves by using conditional and unconditional lien releases and paying by joint check. It would be wise for direct contractors to err on the side of caution when they receive preliminary notices.
As for those persons furnishing the actual labor, materials, services and equipment to a work of improvement, vendors and manufacturers of custom components for construction projects are reminded that they may be proper lien, stop payment notice and payment bond claimants. Potential claimants need to timely assert those remedies, both by serving preliminary notices, when required, and by filing claims and/or commencing civil lawsuits. Claimants should always monitor the progress of construction projects to ensure that their rights do not expire, and contact experienced construction counsel for assistance in protecting their rights.
* Rehearing denied by the California Supreme Court.
Article written by The Porter Law Group, Inc. in Sacramento, California, 2014.
The firm can be reached by phone at (916) 381-7868.