Issue: Impact of a pay-when-paid clause in the context of subcontractor’s payment bond claim. Crosno Construction, Inc. v. Travelers Casualty and Surety Company of America. Court of Appeal, California (2020), by Hugh Anderson

Summary: Clark Bros., Inc., was the general contractor on an arsenic removal water treatment plant project for the North Edwards Water District in Kern County, California. Clark furnished a payment bond issued by Travelers. Clark entered into a subcontract with Crosno Construction under which Crosno was to fabricate, erect, and coat two 250,000-gallon welded steel reservoir tanks. Crosno began work in March 2014. In early November Clark ordered Crosno to suspend its work because a dispute had arisen between Clark and the District. By then Crosno had completed all
of the subcontract work except final field coating of the tanks. Clark had not yet paid invoices from Crosno totaling $562,435.

The Clark-Crosno subcontract contained a payment clause with the following features:

Payment to sub within 10 days of Clark’s receipt of payment from Owner
If Owner delays in making payment to Clark, then payment to sub within a
“reasonable time.”

“Reasonable time” shall not be less than the time needed for Clark to pursue
its legal remedies against the Owner “to conclusion.”

Crosno sued Clark for breach of contract (failure to pay) and Travelers for recovery under the payment bond. The trial court ruled that Travelers could not rely on the subcontract’s payment clause to put off its obligations as surety under the bond. Travelers appealed.

Decision: The court of appeal affirmed the trial court’s decision. The most direct reason for the decision was a conclusion that the payment clause set up an openended and indefinite timeframe for payment. A dispute between the general contractor and owner might take years to be resolved. Under California case precedent, the payment clause was unreasonable, unenforceable, and void.

The court’s reasoning relied in part on California statutes that required payment bonds on public works projects for the benefit of unpaid subcontractors and suppliers, and strongly disfavored bond clauses or practices that would waive subcontractors’ rights to payment. The court held that the legislature’s anti-waiver provisions would be ineffective if a subcontract payment clause were allowed to function as a de facto waiver of payment rights:

Pursuant to [the California bond statutes], Travelers could not
insert a condition in the [payment] bond limiting a
subcontractor’s bond recovery to those claims as to which
litigation against the owner had concluded. It follows that
Travelers may not indirectly achieve the same result by
applying the subcontract’s definition of “reasonable time” to
avoid its bond obligation while Clark’s lawsuit was pending.

Travelers protested that a ruling in the subcontractor’s favor would shift payment risks onto the general contractor, and make contractors and sureties “financers of public works projects.” In response the court of appeal pointed out that under existing law those who perform labor or supply materials already have a preferred position, under longstanding lien and bond law. Shifting the financial burden to contractors and their sureties, and away from subcontractors, suppliers, and laborers, is “precisely the point” of lien and bond laws. The court noted with approval the “statutory aim to give subcontractors ‘a quick, reliable and sufficient means of payment’” by requiring payment bonds.

Travelers also argued that its obligations under the bond could not be greater than the contractor’s obligations under the subcontract. However, the court of appeal cited precedent for the rule that a bond provides a separate and distinct statutory remedy, such that the obligation of the bond is enforceable without reference to the underlying subcontract.

Comment: The Crosno decision has been labeled “earthshaking” and as having “major implications” for when subcontractors obtain payment. However, from a national perspective there have long been limitations on a payment bond surety’s ability to use payment clauses as a way to avoid the fundamental obligations under a bond. This case does emphatically confirm the benefits of a payment bond to subcontractors and suppliers.

EJCDC publishes a standard Construction Subcontract (EJCDC® C-523 2018) as part of its Construction Series of documents. The payment provision simply requires payment within 10 days of receipt of payment from owner. In most jurisdictions this will be interpreted as an enforceable provision that is subject to a reasonableness limitation—if no payment from owner is forthcoming within a reasonable time, the contractor must pay the subcontractor. Users of this and other standard documents are of course encouraged to modify such clauses to incorporate specific state and
local requirements.