Subcontractors and suppliers working on federal projects need to understand their recourse in the event they remain unpaid–the Miller Act payment bond (40 USC s. 3131 – 3134). Prime contractors, likewise, need to know how far down stream their Miller Act payment bond applies. In other words, if a subcontractor hires a sub-subcontractor or supplier, does the Miller Act payment secure nonpayment to the sub-subcontractor or supplier? YES! What about a sub-sub-subcontractor or supplier (third tier entities) to a sub-subcontractor? NO!
Simply put, the Miller Act payment bond is not designed to protect third tier or more remote entities. The Miller Act provides in relevant part:
(2) Person having direct contractual relationship with a subcontractor.–A person having a direct contractual relationship with a subcontractor but no contractual relationship, express or implied, with the contractor furnishing the payment bond may bring a civil action on the payment bond on giving written notice to the contractor within 90 days from the date on which the person did or performed the last of the labor or furnished or supplied the last of the material for which the claim is made. The action must state with substantial accuracy the amount claimed and the name of the party to whom the material was furnished or supplied or for whom the labor was done or performed. 40 USC s. 3133(b)(2).
A third tier subcontractor, by way of example, that does not have a direct relationship with a subcontractor (engaged by the prime contractor) does not have recourse against the Miller Act payment bond. See J.W. Bateson Co. v. United States ex rel. Board of Trustees of National Automatic Sprinkler Industry Pension Fund, 434 U.S. 586 (1978) (explaining that congress knew the difference between subcontractor and sub-subcontractor when drafting statute so those remote parties not in privity with the subcontractor have no recourse against the bond).
The recent decision in U.S. f/u/b/o M&M Insulation, Inc. v. International Fidelity Ins. Co., 2014 WL 1386452 (W.D.Okla. 2014), illustrates that the Miller Act payment bond does not provide protection to a sub-sub-subcontractor (third tier subcontractor).
In this case, the following contractual relationship is important:
Owner = United States
Prime = Nationview/Bhate Joint Venture III (joint venture entity)
Subcontractor = Bhate Environmental Associates (entity that was part of joint venture prime)
Sub-subcontractor =Jennings Service Company
Sub-sub-subcontractor = M&M Insulation (claimant- third tier subcontractor)
The claimant, M&M Insulation, argued that it is really a second tier subcontractor (sub-subcontractor) that has rights under the Miller Act bond because the prime contractor and subcontractor Bhate Environmental Associates (“Bhate”) were in reality one-in-the-same and should be treated as a single entity. To support this, the claimant argued that (i) there was not a written subcontract between the prime contractor and Bhate; (ii) Bhate identified itself as the prime contractor in its subcontract with Jennings Service Company (second tier subcontractor); (iii) Bhate shared the same office as the prime contractor; and (iv) Bhate was not listed as a subcontractor in the government’s records (probably because the joint venture never identified Bhate as a subcontractor in its proposal/bid). In other words, the claimant argued that the prime contractor was a sham entity controlled by Bhate and, thus, they should be regarded as a unitary contractor which would make Jennings Service Company the subcontractor and M&M a sub-subcontractor protected under the Miller Act.
Unfortunately for the claimant, the Western District of Oklahoma did not buy the argument. The Court was not going to simply disregard corporate formalities because the joint venture subcontracted a portion of the work to one of the entities that made up the joint venture. The joint venture was the prime contractor and there is nothing in the record that was sham about the fact that the joint venture hired Bhate as a subcontractor even though there was not a written agreement memorializing the subcontract. Although the Court was willing to give the claimant an opportunity to provide additional documentation to support its theory that the prime contractor was a sham entity, the Court’s ruling reflects the unlikely scenario of the claimant actually proving this relationship.
Based on the Court’s ruling, the claimant’s recourse was against the sub-subcontractor that engaged it in a breach of contract action. If the sub-subcontractor had pay-if-paid language in the subcontract, then this could pose an issue for the claimant. The key is to know the recourse for nonpayment before undertaking work. For instance, if you know you are a third tier entity that does not have recourse against the Miller Act payment bond, perhaps you need to negotiate the contract with that in mind (removing pay-if-paid language or negotiate other language and accept certain risks).
Please contact David Adelstein at firstname.lastname@example.org or (954) 361-4720 if you have questions or would like more information regarding this article. You can follow David Adelstein on Twitter @DavidAdelstein1.