By John McGill, Attorney at Law, Archer Norris
The Stop Payment Notice, aka the Stop Notice, is a valuable tool for contractors especially on private works projects. If you are not being paid, and you want to make sure that you will get paid at least some part of what you are owed, you need to file and serve a Stop Payment Notice. And not just any Stop Payment Notice, but a bonded Stop Payment Notice. Those are the only kind with any real affect, and you want affect with your Stop Notice. There may be others out there that want that money, so you need to secure your place in line with the bond.
Construction funding is usually provided through a lender and lenders want to make money on their loans. But lenders cannot pay themselves out of the construction funds for the fees and costs that they incur if doing so will diminish the amount of funds available to pay Stop Notice claims. In Brewer Corporation v Point Center Financial Inc the court ruled that the contractors had a priority right to funds that were earmarked for construction. In its decision, the court also explained other aspects of the Stop Notice rules that contactors need to understand.
In Brewer the construction lender received bonded Stop Payment Notices from a number of subcontractors on a condominium project that eventually concluded with the owner filing bankruptcy. The lender, Point Center Financial, agreed to provide the financing for the project and as part of the lending agreement was allowed to take prepayment of fees and points on a monthly basis. As the project neared completion there was not enough money to pay the contractors and, as a result, the contractors began filing bonded Stop Notices to secure their right to payment from whatever funds remained. Point Center argued that there were no undistributed funds left and therefore there was nothing left to pay out. The court disagreed.
The first issue the court reviewed was whether the agreement to prepay fees and points was an assignment of those fees to the lender. An assignment is simply an agreement whereby the parties agree that an obligation owed to one can be obtained by the other instead. The problem with the Point Center assignment is that California law prohibits those kinds of assignments and they do not have priority over the rights of contractors and suppliers. The law does not prohibit the assignment but it does prohibit the lender from claiming a superior right to the funds available under the bonded stop notice. It also does not matter when the assignment is made, whether before or after the Stop Notice is filed; in either event, the Stop Notice has priority. In this case, the funds that Point Center had prepaid to itself had to be returned to the construction fund and thereafter paid out to the contractors.
The lender also argued that it did not receive a proper Preliminary Notice from one of the subcontractors and therefore that subcontractor could not make any claim on the amounts that might still be available. The subcontractor claimed that 1- it had a direct contract with the owner and therefore did not have to file a Preliminary Notice and 2- even if it did have to file a Preliminary Notice, it was excused because it started work before Point Center was involved.
With respect to the first claim regarding its status as a direct contractor, the court reviewed the statutes and concluded that even if the subcontractor had a direct relationship with the Owner, it still had to serve Preliminary Notice on the Lender. This is important and all contractors need to be aware of the rule: if you have a direct contract with the Owner, but there is a Construction Lender, you must give the Lender notice. Do not forget!
The subcontractor’s second argument was not decided but went back to the trial court for further review about when the sub’s work commenced. In this particular case, the issue was complicated still further because apparently there was another phase of the project and the Lender claimed that the subcontractor worked on that phase, not the phase that involved the construction funds at issue, and therefore the subcontractor had to serve the Preliminary Notice on the Lender for the phase of work that was the subject of the dispute. If the sub’s work was started before Point Center was involved, then there was no need for the Preliminary Notice; if it was not, or if there was an earlier phase, then the subcontractor had to serve the Notice on the Lender.
Finally, Point Center argued that because there was no Notice of Commencement of Action filed within 5 days of the filing of the lawsuit to foreclose and perfect the Stop Notice rights that the case should be dismissed. According to the Lender, the failure to file this pleading within the time limits barred the subcontractor’s claim. The court saw it differently.
First, and as a practical matter, the Notice of Commencement is filed after the Stop Notice action is filed so that Point Center in this case would already know about the litigation and would know to hold the funds. According to the court, the Notice of Commencement was intended as a “safeguard to alert persons withholding funds that the funds are claimed and should not be prematurely released”. It is only in circumstances where the Lender is prejudiced by the failure of the contractor to file and serve the Notice of Commencement that the omission will have any real consequence. If there is no prejudice then there is no consequence; no harm, no foul.
Stop Notices are important documents and they should be used to secure your rights to payment. Even if there are insufficient funds to pay for all of the money owed, the funds that do remain are distributed pro rata. The only way to preserve this right is to use the bonded Stop Notice. Before that though, you need to send your Preliminary Notice to the Lender and to everyone else if you are not a direct contractor. Finally, make sure that when you file your lawsuit to perfect your rights that you file a Notice of Commencement so that the Lender knows that you have filed and that they need to hold the money and not give it away. After that, it’s off to the races as you work your way through the legal system, and good luck with that!
John McGill, Atorney at Law, Archer Norris, can be reached at (925) 930-6600.