In the recently decided case of Crosno Construction, Inc. v. Travelers Casualty & Surety Company of America, No. D075561, 2020 WL 1899278 (Cal. Ct. App. Apr. 17, 2020) the California Court of Appeals issued a victory for subcontractors’ and suppliers’ payment rights by holding that a subcontract “conditional payment” clause may not be relied on by a surety as a defense to a payment bond claim.

The underlying dispute arose out of a project in which the general contractor (Clark Bros., Inc.) contracted with a public owner to build an arsenic removal water treatment plant (the “Project”). The GC hired Crosno Construction as a Subcontractor to build and coat two steel reservoir tanks.

The parties’ Subcontract included a conditional payment clause providing that payments to the Subcontractor “shall be made within ten (10) days after receipt by Contract of payment from Owner for work performed by Subcontractor as reflected in Contractor’s applications for payment.” The Subcontract added that if the owner delayed in paying for the subcontractor’s work, the “Contractor and its sureties shall have a reasonable time to make payment to Subcontractor. ‘Reasonable time’ shall be determined according to the relevant circumstances, but in no event shall be less than the time Contractor and Subcontractor require to pursue to conclusion their legal remedies against Owner or other responsible party to obtain payment …” (emphasis added).

Between March and November 2014, the Subcontractor furnished labor, materials, equipment and services to the Project. Over that time, it submitted invoices for payments, but was only paid for its first invoice. Meanwhile on November 6, 2014, due to a dispute between the Owner and General Contractor, the Subcontractor was directed to stop work, cease operations and leave the site. At the time its subcontract was terminated, the Subcontractor had less than one week of work remaining and was owed $562,435.65, including retainage.

Meanwhile, the General Contractor sued the Owner, and the Subcontractor made a payment bond claim. The bond surety denied the bond claim, principally citing two things:

  1. The Subcontract payment clause definition of “reasonable time” as the time for the General Contractor and Owner to conclude any litigation over payment disputes.
  2. The fact that the General Contractor and Owner were still in litigation.

The Subcontractor sued the Surety in August 2017, almost three years after the Subcontractor left the site, and the trial court granted summary judgment to the Subcontractor on its bond claim. The trial court noted that the bond obligation was one of statute (the project was a public project) and “is enforceable without reference to any contract between the contractor and the materialman.”

Stating that “the obligation of the surety is to supply to persons in the class of respondent a quick, reliable, and sufficient means of payment,” the trial court held that “any attempt to limit, nullify, or render ineffectual the bond or any of its terms would be against public policy.”

The trial court rejected the Surety’s argument that its liability was only to answer for its principal’s default, stating that the “fallacy of this reasoning … is that it considers only [the principal’s] contractual liability under the subcontract, while ignoring [the principal’s] separate and independent liability as principal and co-obligor on the payment bond.” The trial court wrote that the “default for which [the surety] promised to answer was [the contractor’s] default under the bond and not [the contractor’s] default under the subcontracts.

The Surety appealed. On appeal, the issue was whether the Subcontract “pay-when-paid” provision precluded the Subcontractor’s payment bond rights until the Owner and General Contractor’s lawsuit was concluded.

The American Subcontractors Association (“ASA”), for whom this firm is general counsel, filed an amicus (friend of the court brief) in the Crosno case urging the Appeals Court to affirm the decision and advocating for the Subcontractor’s position.

The appellate court agreed with ASA and the Subcontractor. It affirmed the decision below, finding that the Surety could not rely on the “pay-when-paid” language as a defense to the bond claim. Among other things, the appeals court noted that enforcing the conditional payment subcontract language to apply to bond rights would require the Subcontractor to wait for an “indefinite time” until the General Contractor and Owner’s disputes were legally resolved. The Appeals Court found that the proper understanding of a “reasonable time” for payment under the pay-when-paid clause was that the touchstone for reasonableness was based upon the Subcontractor’s performance.

The appellate court added that the primary thing the surety should have been concerned with for purposes of determining if the bond claim was valid was whether the subcontractor “furnished material and performed labor that was used in the construction,” not whether there was a technical contractual defense to payment on a contract claim that would not directly involve the Surety.

Though the Crosno decision will directly apply only to disputes under California law, the case is a victory for subcontractors and suppliers across the nation. This is because the decision gives potential bond claimants a persuasive argument that subcontract payment provisions that define “reasonable time” in a manner that could delay payment by years cannot be used to undermine the intent of the bond and bond statutes.