The Requirement for Private Payment Bond or Security on Large Projects

We first advised many of our clients in 2002 about a new law that required owners to provide a payment bond or other collateral on large projects to all firms with which the owner contracts as a prime contractor, whether a contractor or design professional. There was not a ground swell of interest at the time, but in this troubled economy where most projects are owned by limited liability companies, design firms should take a second look at this statute. Retain a Los Angeles construction lawyer if you would like to discuss your unique situation.

This law does not apply where the project is entirely owned by one person or entity in fee simple and the amount of the contract is less than five million dollars. Presumably, in such a case, the prime contractor can protect itself by employing mechanic liens and bonded stop notices. Significantly, unlike mechanics lien rights, since the language only addresses contracts for works of improvement, there is no requirement that construction be commenced, and the law apparently applies to services for drawings on projects where the ground is never broken.

Civil Code Section 8700 applies to many construction projects over one million dollars, whether for new construction or addition or repair of existing property, other than single-family residences. If a lending institution is providing a construction loan, the owner must provide the amount of the loan and a certified copy of the construction mortgage or deed of trust recorded with the county recorder.

Posting Security

If the contracting owner owns a fee simple absolute interest and the value of the project is more than five million dollars, or if the contracting owner owns less than a fee simple absolute interest and the value of the contract is more than one million dollars, the owner is required by law to provide one of the following methods of security:

• A payment bond in the amount of either 25 % of the total amount of the contract if the contract provides for work to be substantially completed within six months, or at least 15% of the total contract sum for longer contracts. The payment bond is due if the amount due is undisputed and payable for over 40 days.
• An irrevocable letter of credit from a financial institution. The amount of the LOC shall be according to the 25%/15% formula set forth in paragraph one.
• A "construction security escrow account" with a licensed escrow agent. The account must be located in California. The amount of the account shall be according to the 25%/15% formula set forth in paragraph one. However, the contracting party is not required to accept such an escrow account unless the owner has granted the prime contractor a perfected, first priority security interest in the account. In addition, if the contract provides for retention, all amounts withheld as retention must be deposited in this account. If the contract amount is not a fixed price, the amount of security is determined with respect to the guaranteed maximum price, or if there is no maximum, the prime contractor's good faith estimate as to the total cost anticipated to be incurred.

This law does not apply to a qualified publicly traded company or a wholly owned subsidiary of such a company if the public parent company guarantees payment. It is against the law and public policy to waive this section, so all specified owners must comply or they are breaking the law.

Call a Los Angeles construction lawyer if you have any questions.