There are four separate forms, each customized to a different situation based on status of work completed and payment: (1) Conditional Waiver and Release on Progress Payment; (2) Unconditional Waiver and Release on Progress Payment; (3) Conditional Waiver and Release on Final Payment; and (4) Unconditional Waiver and Release on Final Payment. They can be found at Texas Property Code §53.284. 

There are important distinctions between these forms.  They are not to be used interchangeably.  The new lien waiver and release laws, and the requirement to use forms that substantially comply with the forms contained in the Texas Property Code, apply to contracts executed on or after January 1, 2012.  There is a grace period in effect for lien waivers and releases in attempted compliance with the new law, which expires on August 31, 2012.  

Don’t be caught using forms that do not comply. Update your forms today. For more information, read A Construction Attorney’s Guide to the New Lien Waivers.

The fact situation can play out in a million ways, but for our purposes let's just dial back to the 1980s to illustrate the point.  The economy is booming.  Demand has spiked for commercial real estate – especially office buildings and retail centers.  City centers are being transformed by new trophy buildings that pierce and alter the skylines of Dallas and Houston.

XYZ L.L.C., a single purpose entity that plans to construct a 34-story office tower in the heart of the downtown area, enters into a contract with you to furnish the glass panels for the building. It all looks so promising until, half way through the process, the great recession of 1980 hits, the market tanks and XYZ L.L.C. cannot pay your bill. 

Fast forward to today.  History can and does repeat itself – whether you have committed time, labor and material to a high profile commercial project or simply to the owner or developer of a single family home.

You may not have full recourse – or even any recourse at all - against the party with whom you contracted because he, she or it may be flat-out broke.   

And, if you contracted with a corporation, a limited liability company, a limited partnership, or a limited liability partnership, you may be flat out of luck.  This is because generally the statutory and legal underpinnings of these corporate and partnership forms shield the shareholders, limited members, or limited partners from individual liability for the partnership or corporate debt. 

But like everything in life, there are exceptions to the general rule.      

For one, there are certain egregious circumstances that have provoked the courts to disregard the corporate form to allow a creditor to collect from a non-contracting party.  This is often referred to as “piercing the corporate veil.”

However, a word of restraint is warranted because, in order to successfully employ this theory, the creditor has to prove that the corporate form was used by a shareholder, a beneficial holder or an affiliate (such as a parent or sister corporation) for the purpose of perpetrating an actual fraud for the direct benefit of that shareholder, beneficial holder, or affiliated company. 

This is a high hurdle, but one might clear it with the right facts. Suppose, for instance, that the shareholder or affiliated corporation stripped the contracting corporation of its assets and transferred them to a new entity for the purpose of defeating the creditor’s claims.  Further suppose that these shenanigans, in fact, did mislead you to your financial detriment.  Under those circumstances, you might be allowed to reach the assets of the affiliate or a shareholder who had a hand in the fraud.     

Similar veil piercing theories arguably might be applied to limited liability companies, limited partnerships and limited liability partnerships were a compelling factual scenario to exist.  

General Rule Against Liability - Exception: Doctrine of Joint Enterprise

Can Someone Please Pay Me? (Part 2)

Another possible exception to the general rule against liability might be borrowed from tort and personal injury cases where courts apply the doctrine of joint enterprise as a means of imposing  vicarious liability on a party who did not do anything wrong.  Joint enterprise is simply a judicial theory which allows each member of the joint enterprise to be regarded as the agent of the other.  This theory might apply in your case if the elements of a joint enterprise can be proved.

Here is the rub.  In order to prove the existence of a joint enterprise, a creditor has to demonstrate: 1) that the members of the alleged joint enterprise shared a common purpose; 2) that that they shared a “community of pecuniary interest” in achieving that common purpose; and 3) that each shared an equal right of control. 

A potentially profitable business relationship between two parties is not enough to demonstrate a community of pecuniary interest; however, the sharing of monetary benefits such as profits might suffice. 

Again, the hurdle is high, but one can imagine any number of business scenarios where a joint enterprise could exist provided the required equal right of control, common purpose and community of pecuniary interest were present. 

Each of these theories provides a possible avenue to explore if you suspect that the business entity you are dealing with was formed for the purpose of defrauding you, and in fact did, and/or you have reason to believe that elements of a joint enterprise did exist between the party with whom you have a contract and another party.  Whether you can recover under either will depend on whether you have sufficient proof to have your claim tried before a jury and whether the jury makes a factual determination in your favor on each of the required elements of proof for either theory.

The basic rule is that the clock begins ticking when an owner is aware of enough facts that apprise the owner of a right to seek a judicial remedy.  In many cases, this will be obvious.  For example, if nearly all of the windows leak every time it rains then chances are that the owner will be found to be on notice that there was a problem and therefore the clock began ticking with the first water intrusion event.  But, what happens when the owner did not and could not have known there was a problem because the signs were not obvious, such as random and seemingly unrelated water leaks?  This is where the exception to the rule, or the “discovery rule,” comes into play. 

When courts apply the discovery rule, they give an owner the benefit of the doubt up until the owner learns of a wrongful injury.  That is, once the owner has knowledge of facts that would cause a reasonably prudent person to make an inquiry that leads to the discovery of the cause of action.  So, in our example of the owner experiencing random minor water leaks, the clock will not begin ticking on the statute of limitations until the owner knows of enough leaks to indicate that the problem is not isolated.  But be aware that all benefits of the doubt do not go to the owner.  It will depend on the circumstances.  For instance, having the contractor out to fix the leaks will not extend the discovery rule.  And, the discovery rule does not linger until an owner learns of actual causes and possible cures, and does not continue until all the problems are known. 

You can see that statute of limitations issues can be fact-intensive, and while owners might catch a break on the running of the statute of limitations for a time, it will not last forever.

Naturally, contractors have looked to the Texas state legislature for protection and have had some success, particularly in the area of residential construction.  The legislature passed the Residential Construction Liability Act, which imposes certain notice and inspection related conditions and time constraints on homeowners that must be satisfied before their ability to pursue contractors attaches.  They also passed legislation forming the Texas Residential Construction Commission, now extinct, which further imposed conditions and time constraints on homeowners, and even shortened the period in which a homeowner could take action against a contractor.  Although these measures have been pitched as laws protecting homeowners, many view these statutes as contractor-friendly, and simply traps and pitfalls for the unwary and uninformed claimant.

In the 2011 legislative session, contractors are once again looking for more statutory protection.  Senator Jeff Wentworth and Representative Paul Workman, both Central Texas legislators, have introduced identical bills aimed at eroding the Texas statute of repose for construction defect claims.  The statute relates to construction defect actions and provides that all claims must be brought within 10 years from the date of substantial completion of the project. The proposed bills are S.B. 561 (Wentworth) and H.B. 958 (Workman).  In pertinent part, the proposed legislation provides:

The amount of actual damages for the cost to cure a construction defect that might otherwise be awarded in a claim subject to this section is reduced by 10 percent for each anniversary of the date of substantial completion of the construction or repair that occurs before the date the action asserting the claim is filed.  An award of exemplary damages, multiplied damages, or other damages that is computed on the basis of the amount awarded as damages for the cost to cure the construction defect must reflect any reduction of that amount under this section. 

Contractors, through this legislation, are trying to gradually eliminate damages recoverable for construction defects.  In short, the proposed legislation would deprive the project owner 10 percent of the amount recoverable on a construction defect claim for each year after substantial completion before suit is filed.  This reduction in damages would be required regardless of any legal or equitable reasons that would usually work to toll time-based defenses, such as the discovery rule in analyzing the statute of limitations.  Thus, even if the owner was completely unaware of a latent construction defect and did not discover it until several years after substantial completion of the project, the owner would nonetheless lose 10 percent of its potential recovery for each year that passed before filing its lawsuit.

Does the proposed legislation go too far?  It is certainly important that the law governing construction projects adequately protect all interested parties from stale or meritless claims.  However, the proposed legislation in S.B. 561 and H.B. 958 provides no protection for owners in situations involving latent defects and penalizes owners who diligently pursue investigation of their claims and settlement before filing suit.  The statute could even encourage more litigation by forcing owners to seek recourse at the courthouse quickly.  This result may be good for lawyers, but may also impose unreasonable burdens on owners, and engender a waste of resources for the construction industry.

In 2003, the Texas legislature enacted a statute requiring plaintiffs suing a licensed engineer or architect to provide a “certificate of merit” from another licensed architect or engineer setting forth at least one negligent act, error, or omission claimed to exist.  Initially, the statute applied only to actions “for damages alleging professional negligence.”  Tex. Civ. Prac. & Rem. Code § 150.002(a)(2003). 

In 2005, the legislature broadened the statute in two respects.  First, it made the certificate of merit applicable not just to lawsuits, but to arbitration proceedings as well.  It also purported to expand the applicability of the statute to any action for damages “arising out of the provision of professional services by a design professional.”  Id. (2005).  In other words, not just claims for professional negligence, but any claim arising out of the provision of professional services would require a certificate of merit supporting such a claim. 

But the legislature did not, in 2005, change what the certificate of merit needed to include, so that the affidavit was still required to set forth “at least one negligent act, error, or omission claimed to exist.”  Id. § 150.002(b) (emphasis added).  Because the certificate of merit affidavit still purported to address only negligent acts, errors, or omissions, several courts concluded that even with the attempt by the legislature to expand the scope, the statute still only applied to negligence claims, and not to non-negligence claims such as fraud, breach of contract, breach of warranty, or violation of the Texas Deceptive Trade Practices Act. 

One interesting note is that the legislature also, in 2005, expanded the definition of “the practice of engineering” to include “providing an engineering opinion or analysis related to a certificate of merit.”  Tex. Occ. Code § 1001.003(c)(11).  So an engineer providing a certificate of merit affidavit to support a plaintiff’s claim is practicing engineering by doing so. 

In 2009, the legislature put this issue to rest by ensuring that the statute would apply to any claim arising out of the provision of professional services, and not just negligence.  It did so by clarifying that the certificate of merit affidavit must set forth “the negligence, if any, or other action, error, or omission of the licensed or registered professional in providing the professional service, including any error or omission in providing advice, judgment, opinion, or a similar professional skill claimed to exist.”  Id. §150.002(b) (emphasis added).  This appears to broaden the applicability of the certificate of merit requirement beyond just negligence claims, as long as the action, error, or omission arises out of the provision of professional services.

The 2009 amendments will apply to any action commenced on or after September 1, 2009.  But what if an architect or engineer is added as a defendant to an already pending lawsuit after that date?  Recently, the Austin Court of Appeals, sitting en banc, concluded that the version of the statute in affect when an action is originally commenced applies to later-added defendants, even if a defendant is added after the effective date of one of these amendments.  S&P Consulting Engineers, PLLC v. Baker, No. 03-10-00108-CV (Tex. App.—Austin, Feb. 18, 2011, no pet. h.).  So if a case has been pending a while, a newly added defendant may still come under an older version of the statute.  But another part of the holding in S&P Consulting would make that irrelevant.  The court concluded that even under the 2005 statute, the certificate of merit requirement applied to non-negligence claims as well as to negligence claims, disagreeing with several other courts of appeals that had concluded otherwise.  The Texas Supreme Court has yet to address these issues. 

The trend, therefore, in both Texas courts and legislative history, has been to require certificates of merit for any claim arising out of the provision of professional services by a licensed architect or engineer, not just negligence claims.  This will certainly remain true with respect to any new action commenced after September 1, 2009.

Payment and performance bonds are creatures of statute and contract law. On Texas public projects, they are in a form approved by the Attorney General of Texas and the Texas Department of Insurance. On Miller Act Projects, they are generally in a form approved by the Federal Acquisition Regulation System.

A.        Ipso Facto Clauses, the Automatic Stay & Adequate Protection Issues

Upon learning that a general contractor or a first-tier subcontractor on a bonded project has commenced a bankruptcy case, a surety should immediately take precautions. The first questions to be considered are the surety’s rights and remedies and how such rights and remedies are impacted by the Bankruptcy Code. Often, sureties are provided the right, in the event of a default by the general contractor, to take over and complete the project. An immediate question will be whether the automatic stay prevents the surety from taking such action on either the payment or performance bonds.

The first question will be whether the bonds are executory contracts governed by section 365 of the Bankruptcy Code. An executory contract is defined as “a contract under which the obligation of both the bankrupt and the other party to the contract are so far unperformed that the failure of either to complete performance would constitute a material breach excusing performance of the other.” Countryman, Executory Contracts in Bankruptcy, Part 1, 57 MINN. L. REV. 439, 460 (1973). See, e.g., Lubrizol Enterprises, Inc. v. Richmond Metal Finishers, Inc., 756 F.2d 1043, 1045 (4th Cir. 1985) (relying on Countryman’s definition), cert. denied, 475 U.S. 1057, 89 L. Ed. 2d 592, 106 S. Ct. 1285 (1986); see also N.L.R.B. v. Bildisco & Bildisco, 465 U.S. 513, 522 n. 6 (1984). The author was unable to find a definitive answer as to whether payment and performance bonds are executory contracts under section 365. However, reported decisions have certainly treated and analyzed them as such. See, e.g., In re Wegner Farms Co., 49 B.R. 440, 443 (Bankr. N.D. Iowa 1985).

Alternatively, a number of cases have held that a surety bond is not even property of the bankruptcy estate. In re Apache Construction, Inc., 34 B.R. 415, 417 (Bankr. Or. 1983); In re Jay Forni, Inc., 33 B.R. 538 (Bankr. N.D. Cal.1983); In re Fintel, 10 B.R. 50, 51 (Bankr. Or. 1981); In re Buna Painting & Dry Wall Co., 503 F.2d 618, 619 (9th Cir. 1974). Nonetheless, these decisions seem really to be about whether the debtor has an interest in the penal sums intended for the benefit of the third-party claimants under the bonds at issue, and are not about whether a debtor has a legal or equitable interest in the bonding agreement. These decisions are much like insurance policy decisions that have held that the policy is an asset of the estate, but not the payments on claims. See, e.g., Equinox Oil Co. v. Official Unsecured Creditor’s Comm. (In re Equinox Oil Co.), 300 F.3d 614 (5th Cir. 2002). If the debtor has an interest, the stay applies to prevent unilateral termination of the bond by a surety. To the extent that these decisions could be construed as holding that the debtor as a contracting party to the bonding agreement has no legal or equitable interest in the contract, they would seem to be wrong. See In re Wegner Farms Co., 49 B.R. at 443. This is at best, at this point, a murky area of law. Assuming the stay applies, cause, such as an existing default under the bond or a lack of adequate protection, would need to be present to seek to modify the stay. This should and will always require an analysis regarding the equity remaining in the project above outstanding claims and costs of completion.

Generally speaking, ipso facto clauses (by which a contract is terminated as a result solely of the debtor’s insolvency or bankruptcy) are disfavored, if not expressly void, under the Bankruptcy Code. See, e.g., In re James Cable Partners, L.P., 154 B.R. 813, 816 (M.D. Ga. 1993) (referring to “a basic bankruptcy policy that abhors the operation of so-called ‘ipso facto’ clauses [that] trigger a default, forfeiture or termination upon the happenstance of bankruptcy”); In re Hutchins, 99 B.R. 56, 57 (Bankr. D. Colo.1989) (“bankruptcy default clauses are not favored and are generally unenforceable under the Bankruptcy Code.”). See also 11 U.S.C. § 363(1) (permitting use, sale or lease of property notwithstanding ipso facto clause), § 365(e)(1) (providing that an executory contract or unexpired lease may not be terminated under an ipso facto clause), and § 541(c)(1) (providing that an interest of the debtor in property becomes property of the estate notwithstanding any ipso facto clause). Thus, the presence of such a clause in the bonding contract will not, in the usual case, satisfy the “cause” standard of § 362(d)(1). The bond forms approved by the Texas Attorney General and the Miller Act bond forms do not currently have ipso facto clauses.

However, there are so-called “financial accommodation” agreements, which recognize that certain kinds of contracts that might otherwise be classified as executory are nonetheless incapable of assumption by the estate, so that termination might be a legitimate remedy for a surety party. See 11 U.S.C. § 365(e). However, most, if not all reported decisions, require modification of the stay to allow termination. See In re Wegner Farms Co., 49 B.R. 440 (Bankr. N.D. Iowa 1985) (concluding that Congress did not intend to exempt actions to terminate a surety bond from the automatic stay, and that bringing such contracts within the scope of the stay ensures that the decision that an executory contract may be terminated comes within the proper forum after briefing and a hearing; motion to lift stay was thus held to be a prerequisite for such unilateral termination by the non-debtor.); In the Matter of Edwards Mobile Home Sales, Inc., 119 B.R. 857 (Bankr. M.D. Fla. 1990) (also involving a surety contract, cites Wegner in holding that a motion to lift stay is a prerequisite to unilateral termination); accord In re El Paso Refinery, L.P., 220 B.R. 37 (Bankr. D. Tex.1998). The better-reasoned opinions appear to be those that require cause for modification of the stay beyond an ipso facto default. Accordingly, a surety will not likely avoid its duties and obligations under a payment bond, and cannot take over a project simply because a bond contains a bankruptcy default provision. However, its practical ability to collect, fully or otherwise, on its indemnity claim, including its post-petition indemnity claim, against the general contractor debtor will obviously be at risk in the bankruptcy scenario. Courts continuing the imposition of the stay have noted that an administrative claim exists to protect such risk. See In re Wegner Farms Co., 49 B.R. at 443. That may or may not be sufficient.

Sections 362, 363, and 364 of the Bankruptcy Code allow a party in interest to request the court to determine whether its interest in property is adequately protected. See 11 U.S.C. § 362, 363 and 364. When a general contractor files bankruptcy, its incomplete construction contracts, and its own subcontract agreements related thereto, are clearly executory contracts that may be assumed or rejected. If these contracts relate to federal or state public works contracts, payment bonds will exist related to each. If ultimately rejected, many unpaid subcontractors will assert payment bond claims both against the general contractor debtor and the payment bond surety. The surety’s ability to collect on its indemnity will be at great risk during the post-petition period. Thus, it should be clear that a payment bond surety would be entitled to adequate protection, particularly for post-petition work performed which may result in a bond claim. See, e.g., United States Fid. & Guar. Co. v. Maxon Eng’g Servs. (In re Maxon Eng’g Servs), 332 B.R. 495, 498 (Bankr. D.P.R. 2005); see also In re Glover Constr. Co., 35 B.R. 233 (Bankr. D. Ky.1983). Disputes can arise between secured lenders and sureties over who shall have a priority in rights over contract funds payable from the owner.

Progress payments due to a debtor-in-possession under bonded construction projects are generally considered property of the estate under 11 U.S.C.S. § 541. In re Universal Builders, Inc., 53 B.R. 183 (Bankr. D. Tenn.1985). However, a surety’s interest may be superior to that of any other parties claiming an interest in the contractor’s receivables because the surety is subrogated to the contractor/creditor’s right to the contract funds. See Pearlman v. Reliance Ins., Co., 371 U.S.132 (1962). If a general contractor debtor has defaulted on the construction contracts which it requests to assume, a surety may claim its priority rights pursuant to the subrogation doctrine. See In re RAM Constr. Co. Inc., 32 B.R. 758 (Bankr. W.D. Pa. 1983) (holding that surety had priority in accounts receivables over secured party when the debtor was in fact in default). Generally, though, an event of default is required for the surety’s right to vest in the contract funds. See International Fidelity Ins. Co. v. United States, 949 F.2d 1042 (8th Cir. 1991) (holding that surety had priority as to IRS liens filed after contractor defaulted, but not as to IRS liens filed before contractor defaulted); American Fire and Casualty Co. v. First Nat’l City Bank, 411 F.2d 755, 758 (1st Cir. 1969) (surety cannot recover payments from bank, which were earned and paid out to the bank prior to default of the contractor). Thus, a party representing a surety in a chapter 11 proceeding of a general contractor should not generally yield post-petition replacement liens to a secured creditor. A surety may also seek to require that all post-petition progress payments during the chapter 11 case be paid by joint check to the debtor and its subcontractors. Ultimately, in any construction bankruptcy, the court will look to balance all of the competing interests to determine whether to allow the debtor to continue to perform under bonded projects.

B.        Co-Debtor Issues

One of the principal rights a surety will have is found in Bankruptcy Code section 509. Assuming a general contractor debtor, a surety, as an entity that is liable with the debtor on, or that has secured, a claim of a creditor against the debtor, and that pays such claim, shall be subrogated to the rights of such creditor to the extent of its payment. 11 U.S.C. § 509. Thus, it is clear that a surety paying a claim held against the debtor will be subrogated to such rights under section 509. This ties into Bankruptcy Rule 3005, which provides that:

(a) Filing of claim. If a creditor does not timely file a proof of claim under Rule 3002(c) or 3003(c), any entity that is or may be liable with the debtor to that creditor, or who has secured that creditor, may file a proof of the claim within 30 days after the expiration of the time for filing claims prescribed by Rule 3002(c) or Rule 3003(c) whichever is applicable. No distribution shall be made on the claim except on satisfactory proof that the original debt will be diminished by the amount of distribution.

(b) Filing of acceptance or rejection; substitution of creditor. An entity which has filed a claim pursuant to the first sentence of subdivision (a) of this rule may file an acceptance or rejection of a plan in the name of the creditor, if known, or if unknown, in the entity’s own name but if the creditor files a proof of claim within the time permitted by Rule 3003(c) or files a notice prior to confirmation of a plan of the creditor’s intention to act in the creditor’s own behalf, the creditor shall be substituted for the obligor with respect to that claim.

FED. R. BANKR. P. 3005. Pursuant to section 509 and Bankruptcy Rule 3005, care should be taken by a surety under a payment bond that has received notice of a claim from a claimant to ensure that a proof of claim against the general contractor debtor is filed by such claimants. In the event no proof of claim is filed by the claimant, the surety should file a proof of claim “in the name of” such claimant under Bankruptcy Rule 3005. This will ensure that, upon payment of the claimant’s claim, the surety will at least be entitled to receive the distribution from the debtor’s estate to which the claimant would be entitled, and will be entitled to vote the claimant’s claim in connection with any plan. Each of these can be important tools to a surety in seeking to minimize potential risk.

Conclusion

A bankruptcy filing by a general contractor can lead to serious risk of financial loss to a surety. In effect, if steps are not taken to prevent exposure, the surety can become an involuntary lender to the debtor with little or no protection. An immediate evaluation must be conducted by the surety to determine the costs-of-completion versus the undistributed contract funds. In addition, the debtor's ability to manage construction funds and successfully complete pending projects are of paramount importance to avoid increased exposure post-petition. The careful practitioner representing a surety will begin immediately to consider, from an evidentiary perspective, whether the competing interests of the surety, the debtor, the owner, and subcontractors support continued operations of the debtor.

Claimants asserting bond claims must take great care to properly perfect such claims. The first step any surety will take in analyzing such claims is to determine if a claim may be denied for failure to properly perfect. Under the Texas Insurance Code, a surety has specific duties and obligations to investigate, accept or reject, and, if perfected, pay a bond claim. Specifically, with respect to investigation,

(a)  a surety company that has issued a construction payment bond shall, not later than the 15th day after the date of receipt of notice of claim under the bond:

(1)  acknowledge receipt of the claim;

(2)  begin any review or investigation necessary to determine whether the surety company is obligated to satisfy the claim under the bond; and

(3)  request from the claimant each document, item of information, accounting, statement, or form that the surety company reasonably believes, at that time, will be required from the claimant.

(b)  If a construction payment bond provides an address to which a notice of claim under the bond should be submitted, the notice is effective on the date the notice is received at that address.

(c)  This subchapter does not exempt a claimant from complying with any applicable statutory or contractual notice requirement.

TEX. INS. CODE § 3503.054.

With respect to acceptance or rejection, a surety shall notify a claimant in writing of the acceptance or rejection of a claim not later than the 30th day after the date the surety company receives all documents, items of information, accountings, statements, and forms requested by the surety company as required by Section 3503.054. TEX. INS. CODE § 3503.055(a). If the surety company rejects all or part of the claim, the notice of rejection must state in specific terms the reasons for the rejection known to the surety at that time. TEX. INS. CODE § 3503.055(b). If a surety is unable to accept or reject the claim within the period specified by Subsection (a), the surety shall provide written notice to the claimant, not later than the 30 days required under Subsection (a), that the surety is unable to accept or reject the claim within that period. The notice provided under this subsection must: (1) state the reasons for which the surety company needs additional time to accept or reject the claim; and (2) include a request for any additional information reasonably needed by the surety company to process the claim. TEX. INS. CODE § 3503.055(c).

If additional time and information is requested under Subsection (c), the surety company shall accept or reject the claim in writing not later than the 30^th day after making the request for information. If the surety company rejects all or part of the claim, it shall state in specific terms the reasons for the rejection known to the surety company at that time. TEX. INS. CODE § 3503.055(d).

In addition to any other contractual or statutory basis for denying a claim, the surety company may reject all or any part of a claim: “(1) that is the subject of a legitimate dispute between the principal obligor and the claimant; or (2) for which the claimant has failed to provide supporting documents or information the company reasonably requested.” TEX. INS. CODE § 3503.055(e).

If a surety company notifies a claimant under Section 3503.055 that the company accepts a claim or part of a claim, the company shall pay the claim not later than the 15th day after the date of the notice. TEX. INS. CODE § 3503.056(a). If payment is conditioned on the execution of a document or performance of an act by the claimant, the surety company shall pay the claim not later than the seventh day after the date it receives the executed document or evidence that the act has been performed. TEX. INS. CODE § 3503.056(b). Payment occurs when the surety company puts the check in the mail to the claimant. TEX. INS. CODE § 3503.056(c).

The bankruptcy of a general contractor or first tier subcontractor of a construction project, presents specific issues for a surety company. When a surety company is faced with this situation, it should take immediate action to protect its rights. This topic will be discussed more thoroughly in Part 3.

A typical construction project involves many players, such as the owner, owner’s representative, investors, lenders, design professionals, contractor, subcontractors, suppliers, consultants, attorneys, and bonding/insurance companies. In the current economic climate, construction projects are often risky business, and the stakes are high.

Because of the significant financial risks inherent in construction projects, participants commonly seek the strength of financial institutions to insure or bond against those risks. Generally, both liability and casualty insurance is obtained to cover the project, and design professionals typically carry professional liability coverage to insure against losses resulting from any failure to meet the standards of their professions. Bonds may be obtained to guarantee the payment and/or performance obligations of various participants. An important distinction between the obligation of the surety on a bond and that of an insurer is that the surety will seek reimbursement from its insured. The insurer, however, is generally subrogated to any claims of its insured against third parties who are responsible for the loss. The cost and terms of the bonding arrangements and insurance coverage can have material effects on the project.

Every participant in a construction project in Texas, from the owner to consultants, plays its role within the limitations and specifications of a framework of legal rules. The primary mechanisms for protecting rights on private property construction projects in the State of Texasare the 10 percent retainage requirement, fund trapping provisions contained in Chapter 53 of the Texas Property Code, and surety bonds, both voluntary and mandatory, which exist on certain projects to provide protection to claimants. The following are the bond claims under which a surety may have liability for projects within the State of Texas:

A. Federal Miller Act Bond Claims.

The Miller Act of 1935 (the "Miller Act") is the federal law that generally requires performance and payment bonds for any construction contract exceeding $100,000 involving property owned by the United States. See generally 40 U.S.C. §§ 3131 et seq. (2006).

B. Texas McGregor Act Bond Claims.

Similar to the Miller Act, the McGregor Act, codified within the Texas Government Code, is the Texaslaw that generally requires payment bonds for any construction contract exceeding $25,000 involving property owned by the state, a county, a municipality, a department, board, or agency of the state, a school district or a subdivision of a school district within Texas. See generally TEX. GOV'T CODE §§ 2253.001 et seq.

C. Voluntary Texas Property Code Bond Claims.

In addition to the protections of the Miller and McGregor Acts, under Subchapter I of Chapter 53 of the Texas Property Code, an original contractor with a written contract with an owner may furnish a payment bond for the benefit of claimants. These bonds are occasionally required when the owner of a project is concerned about liens being filed against its property and has sufficient leverage to require the general contractor to acquire bonding protection. If a valid bond is recorded with the county clerk as required by section 53.203, a claimant may not file suit against the owner or the owner's property and the owner is relieved of any obligations under subchapter D and E of Chapter 53. TEX. PROP. CODE § 53.201.

Under section 53.202, the bond must be in a penal sum at least equal to the total of the original contract price, be in favor of the owner, and be executed by the original contractor as principal and a corporate surety authorized and admitted to do business in Texas. Once filed with the county records, a purchaser, lender or other person acquiring an interest in the property is entitled to rely upon the record of the bond and the contract as constituting payment of all acclaims as each claimant had filed a complete release and relinquishment of lien rights. TEX. PROP. CODE § 53.204. The notice requirements of perfecting a bond claim are set forth in section 53.206 of the Texas Property Code. They are:

(a) To perfect a claim against a bond in a manner other than that prescribed by Subchapter C or K for fixing a lien, a person must:

(1) give to the original contractor all applicable notices under the appropriate subchapter; and

(2) give to the surety on the bond, instead of the owner, all notices under the appropriate subchapter required to be given to the owner.

(b) To perfect a claim under this section, a person is not required to:

(1) give notice to the surety under Section 53.057, unless the claimant has a direct contractual relationship with the original contractor and the agreed retainage is in excess of 10 percent of the contract;

(2) give notice to the surety under Section 53.058(b) or, if the claim relates to a residential construction project, under Section 53.253(c); or

(3) file any affidavit with the county clerk.

(c) For the claim to be valid, a person must give notice in the time and manner required by this section, but the content of the notices need only provide fair notice of the amount and the nature of the claim asserted.

(d) A person satisfies the requirements of this section relating to providing notice to the surety if the person mails the notice by certified or registered mail to the surety:

(1) at the address stated on the bond or on an attachment to the bond;

(2) at the address on file with the Texas Department of Insurance; or

(3) at any other address allowed by law.

TEX. PROP. CODE § 53.206.

Section 53.207, in turn, governs the notice an owner must provide to the surety on a project with a Subchapter I bond. It states:

(a) If the owner receives any of the notices or a lien is fixed under Subchapter C or K , the owner shall mail to the surety on the bond a copy of all notices received.

(b) Failure of the owner to send copies of notices to the surety does not relieve the surety of any liability under the bond if the claimant has complied with the requirements of this subchapter, nor does that failure impose any liability on the owner.

TEX. PROP. CODE § 53.207. A claimant may sue the principal and surety on the bond, either jointly or severally, if his claim remains unpaid for 60 days after the claimant perfects the claim. TEX. PROP. CODE § 53.208(a). The claimant may sue for the amount of the claim and court costs. TEX. PROP. CODE § 53.208(b). If the bond is recorded at the time the lien is filed, the claimant must sue on the bond within one year following perfection of his claim. TEX. PROP. CODE § 53.208(d). If valid bond claims against the bond exceed the penal sum of the bond, each claimant is entitled to a pro rata share of the penal sum. TEX. PROP. CODE § 53.209.

In addition to the voluntary bonds governed by Subchapter I of the Texas Property Code, if a lien, other than a lien granted by the owner in a written contract, is fixed or is attempted to be fixed by a recorded instrument under Chapter 53 of the Texas Property Code, any person may file a bond to indemnify against the lien. TEX. PROP. CODE § 53.171(a). This is generally called "bonding around" a lien. Most typically this is a step taken by a property owner with disputed lien affidavits filed against its property to satisfy conditions imposed by a title company when the property is being sold. The requirements of such a bond are set forth in section 53.172 of the Texas Property Code. Such a bond must:

(1) describe the property on which the liens are claimed;

(2) refer to each lien claimed in a manner sufficient to identify it;

(3) be in an amount that is double the amount of the liens referred to in the bond unless the total amount claimed in the liens exceeds $40,000, in which case the bond must be in an amount that is the greater of 1 1/2 times the amount of the liens or the sum of $ 40,000 and the amount of the liens;

(4) be payable to the parties claiming the liens;

(5) be executed by:

         (A) the party filing the bond as principal; and

         (B) a corporate surety authorized and admitted to do business under the law in this state and licensed by this state to execute the bond as surety, subject to Section 1, Chapter 87, Acts of the 56th Legislature, Regular Session, 1959 (Article 7.19-1, Vernon's Texas Insurance Code); and

(6) be conditioned substantially that the principal and sureties will pay to the named obligees or to their assignees the amount that the named obligees would have been entitled to recover if their claims had been proved to be valid and enforceable liens on the property.

TEX. PROP. CODE § 53.172. After such a bond is filed, the county clerk shall issue notice of the bond to all named obligees. TEX. PROP. CODE § 53.173. The party making or holding a lien claim against such a bond may not sue on the bond later than one year after the date on which the notice by the county clerk is served or after the date on which the underlying lien claim becomes unenforceable under section 53.158. TEX. PROP. CODE § 53.175.

In Part 2 of this series, we will address, from the surety’s perspective, what actions it must take once a bond claim has been made.

What is a copyright?

A copyright is a legal concept that gives the author, creator, or developer of an original work exclusive rights for a certain time period in relation to that work, including its publication, distribution, and adaptation.  In the context of architectural works, copyrights enable an owner to prevent unauthorized use of the protected design, including “copycat” building.  The author of a work is ordinarily its owner, but if the work was prepared by an employee in the scope of employment or by an independent contractor, the employer or contracting firm may own the copyright. Owners can sell or transfer their rights under a copyright.

What is protected?

Protected architectural works include “the design of a building as embodied in any tangible medium of expression, including a building, architectural plans, or drawings. The work includes the overall form, as well as the arrangement and composition of spaces and elements in the design, but does not include individual standard features.” A building can be a house or office building, and other structures such as churches and pavilions. Bridges, dams, highways or walkways are not “buildings.”

Scope of protection

A copyright owner is entitled to prevent infringement by others against the owner’s rights. This is done by suing in federal court.  An owner can bring suit requesting two general types of relief: injunctions and damages.

By requesting an injunction, an owner is seeking a court order forcing the infringer to stop all activities that infringe on the copyright. Injunctions can be temporary or permanent, and can even include seizure of materials being used to produce copies of the infringing products.

In addition to seeking an injunction, a copyright owner can also sue for money damages. Those damages include actual losses suffered by the copyright holder, as well as profits gained by the wrongdoer from the infringement.  If actual damages are too small or difficult to prove, then an owner can seek statutory damages, which can range from a few hundred dollars to hundreds of thousands of dollars per work.  Attorney’s fees may also be recoverable.

Besides civil penalties, a person infringing on a copyright may also be prosecuted for criminal violations. Criminal penalties for copyright infringement can include fines not to exceed $500,000 or five years in prison for the first offense.

What that means

As a design professional, your architectural works are valuable, and you should take steps to ensure the protection of your rights. Once an author creates a work, the copyright is automatic, but in the United States it is important to take an extra step and register the copyright with the U.S. Copyright Office.  Doing so will improve your position in any potential litigation over your work.  It is also important to mark all copies of your work with a copyright notice.  For example, © 2010 Brown McCarroll, L.L.P.

Copyright ownership has a host of implications that should be considered in contract negotiations as well. When entering into a contract, pay careful attention to whether the client or the designer will retain ownership of the design work, whether the rights are being transferred or licensed, whether a consultant’s work will be commissioned as “work for hire,” and whether any insurance policies include or exclude claims for copyright infringement. As with any legal matter, securing your rights under copyright law can be a very complex endeavor, it is a good idea to consult an attorney when doing so.

Step 1:                        Determine your status—original contractor or subcontractor?

Are you an “original contractor” or a “subcontractor?”  An original contractor, commonly referred to as a “general contractor,” is a laborer or supplier who has a direct contract with the owner of the project.  There can be more than one original contractor.  Conversely, a subcontractor is a laborer or supplier who does not have a direct contract with the owner of the project.  Rather, a subcontractor is hired by an original contractor or by another subcontractor (known as a sub-subcontractor). 

Your status will dictate what requirements you must satisfy to “perfect,” meaning legally secure, your lien.  Generally, subcontractors must jump through more hoops in order to perfect their liens.  There are more traps and pitfalls that await subcontractors, which can be avoided by understanding what they are and when they apply.

Step 2:                        Figure out when the indebtedness to you accrued.

As discussed in Step 4 below, you must eventually file a lien affidavit in the official public records claiming your lien.  The date by which you must file your lien affidavit depends upon when the indebtedness to you accrues.  Again, this depends upon whether you are an original contractor or a subcontractor.  Indebtedness accrues to an original contractor at a different time than when indebtedness accrues to a subcontractor. 

Indebtedness to an original contractor accrues on the last day of the month in which the original contract has been terminated in writing, completed, finally settled, or abandoned.  The focus is on the conclusion of the contract between the original contractor and the owner of the project.

Indebtedness to a subcontractor accrues on the last day of the last month in which the labor was performed or the supplies were furnished by the subcontractor.  The focus is on the time when the subcontractor performed the labor or provided supplies, rather than on the conclusion of the original contract between the owner and the original contractor.  Indebtedness to a subcontractor, therefore, could accrue well before the original contract is completed.  For example, indebtedness to a subcontractor tile supplier could accrue half way through an office building construction project, whereas indebtedness to the original contractor would not accrue until the project concludes.

Step 3:                        If you are subcontractor, mail your notices of non-payment.

Subcontractors must mail notices of non-payment to the original contractor and to the owner of the project via registered or certified mail.  This is a step that an original contractor is not obligated to take.  It applies only to subcontractors.

If the work or supplies were ordered from the subcontractor by the original contractor, only one notice of non-payment need be sent.  The subcontractor who is claiming a lien must give written notice of non-payment to the owner, with a copy to the original contractor, no later than the 15^th day of the third month following each month in which all or part of the labor was performed or supplies were delivered.

If the work or supplies were ordered from the subcontractor by another subcontractor, the subcontractor who is claiming a lien must give two written notices of non-payment.  The subcontractor must give written notice of non-payment to the original contractor no later than the 15^th day of the second month following each month in which all or part of the labor was performed or the supplies were delivered.  The same notice must be given to the owner and the original contractor no later than the 15^th day of the third month following each month in which all or part of the labor was performed or the supplies were delivered.  Thus, if the work was performed in January, the subcontractor who was claiming a lien must provide the original contractor notice of non-payment by March 15^th, and also provide the same notice both to the owner of the project and to the original contractor by April 15^th.

There is no specific form that the notice of non-payment must take.  A copy of the statement or billing for the work for supplies in the usual and customary form is sufficient.

Step 4:                        File your lien affidavit.

In order to “perfect” a mechanic’s lien, you must file a “lien affidavit” with the county clerk of the county in which the property is located claiming a lien.  The lien affidavit must be filed no later than the 15^th day of the fourth calendar month after the day on which the indebtedness accrues.  Thus, it is important to determine whether the indebtedness accrued at the time the entire project ended (which is applicable to an original contractor) or when the work or supplies were delivered (which is applicable to a subcontractor).

The lien affidavit must contain certain information and be signed by the person claiming the lien.  Specifically, the lien affidavit must contain substantially: (1) a sworn statement of the amount of the claim; (2) the name and last known address of the owner or reputed owner; (3) a general statement of the kind of work done and materials furnished by the claimant and, for a subcontractor, a statement of each month in which the work was done and materials furnished to which payment is requested; (4) the name and last known address of the person by whom the claimant was employed or to who the claimant furnished the material and the labor; (5) the name and last known address of the original contractor; (6) a description, legally sufficient for identification, of the property sought to be charged with a lien; (7) the claimants name, mailing address, and, if different, physical address; and (8) for a subcontractor, a statement identifying the date each notice of the claim was sent to the owner and the method by which the notice was sent.

Step 5:                        Mail notice that your lien affidavit  has been filed.

Once you have filed your lien affidavit, you must send a copy of it by registered or certified mail to the owner at the owner’s last known business address no later than the 5^th day after the date the affidavit is filed with the county clerk.  Additionally, a subcontractor must send a copy of the affidavit to the original contractor at the original contractor’s last known business address within the same period.

Step 6:                        Sue to foreclose your lien.

A mechanic’s lien may be foreclosed only on judgment of a court foreclosing the lien and ordering the sale of the property subject to the lien.  The lawsuit to foreclose the lien must be brought within 2 years after the last day you may file your lien affidavit or within 1 year after completion, termination, or abandonment of the work under the original contract under which the lien is claimed, which ever is later.  If the lawsuit is not brought within this time period, any future lawsuit to foreclose the lien will be barred by limitations.  The court may award costs and reasonable attorneys fees for any proceeding to foreclose the lien.

It is important to follow these steps when pursuing your lien rights.  If they are not followed, you could lose your lien rights and enter into dangerous territory by filing an invalid lien.  An owner suing to remove a lien from its property could request attorney’s fees and costs in doing so.  To be safe, you should consult an attorney to determine the status of your lien rights as well as other options available for obtaining payment.