Owners and general contractors are applauding a recent decision from the Fifth Circuit Court of Appeals in Noatex Corp. v. King Construction, et al., Slip Op. 12-60385, Dkt. No. 00512403459 (5th Cir. Oct. 10, 2013). Subcontractors, on the other hand, lost one of their only options to ensure they get paid when an owner or general contractor does not pay (or pay on time).
The Facts of the Case
Auto Parts Manufacturing Mississippi (“APMM”), the owner, contracted with Noatex Corporation (“Noatex”), the general contractor, to construct a manufacturing facility in Guntown, Mississippi. Noatex subcontracted with King Construction of Houston, L.L.C. (“King Construction”) to provide materials and labor on the project. A billing dispute arose between Noatex and King Construction, in which Noatex questioned some of the invoices submitted by King Construction. King Construction notified the owner, pursuant to Mississippi’s Stop Notice statute, that Noatex owed King Construction $260,410.15, and, therefore, King Construction was filing a “Laborer’s and Materialman’s Lien and Stop Notice” in Mississippi chancery court. The effect of King Construction’s notice was that funds in the amount of $260,410.15 were “bound in the hands” of APMM. APMM later deposited the $260,410.15 in the registry of the chancery court.
The Stop Notice Statute
Mississippi’s “Stop Notice” statute, Miss. Code Ann. § 85-7-181 (“Stop Notice statute”) provides:
When any contractor [employed by an owner] . . . shall not pay . . . the amount due by him to any subcontractor therein, . . . [subcontractor] may give notice in writing to the owner thereof of the amount due [to subcontractor] and claim the benefit of this section; and . . . the amount that may be due upon the date of the service of such notice . . . shall be bound in the hands of such owner for the payment in full . . . of all sums due such . . . subcontractor . . . who might lawfully have given notice in writing to the owner hereunder.
Generally, Section 85-7-181 gave a subcontractor or materialman who had not been paid by the contractor the right to send notice of non-payment to the owner of the property, thereby binding any money the owner owed to the general contractor in the hands of such owner. Once the notice was served, the subcontractor or materialman could sue the owner.
On appeal, the general contractor (Noatex) argued that the Stop Notice statute deprived it of property without due process of law. The State of Mississippi intervened in the lawsuit seeking to defend the constitutionality of its statute.1 The State argued that the deprivation of property under the Stop Notice statute was appropriate because, among other things, the statute had sufficient procedural safeguards and the State had a significant interest in providing a mechanism to protect subcontractors.
Ultimately, the federal appellate court held that the “Stop Notice statute deprives the contractor of a significant property interest, the right to receive payment and to be free from any interference with that right” because the statute “authorizes the withholding of monies earned from the contractor for an indefinite period of time and could prevent a contractor from paying its ordinary business obligations.” The federal appeals court went further to outline the Stop Notice statute’s procedural safeguard deficiencies including, but not limited to, the lack of: (i) any pre-deprivation notice or hearing; (ii) requirement for posting a bond; (iii) requirement for a showing of exigent circumstances; and (iv) requirement for an affidavit or attestation setting forth the facts of the dispute of legal basis for the attachment. As a result, the federal appeals court concluded that Mississippi’s Stop Notice statute was unconstitutional and upheld the earlier determination made by the district court.
Under Mississippi law, contractors who do not have a direct contractual relationship with the owner are not afforded lien rights. In the event a subcontractor or materialman had not been paid by the prime contractor, the subcontractor would assess its rights to, among other potential remedies, stop work, file suit, make claim on any private bond or bond for public works, and/or, historically, send notice of non-payment to the owner of the property. The Noatex decision eliminates this right. Monies owed by the owner to the general contractor will no longer be “bound in the hands” of the owner; thus, limiting the liability of an owner to a subcontractor. Likewise, the general contractor is no longer subject to deprivation of its right to receive payment from the owner by virtue of a subcontractor’s stop payment notice.
Further, the Noatex case will likely result in the Mississippi legislature looking for new ways to protect a subcontractor’s right to payment. Owners, general contractors, and subcontractors would be wise to pay close attention to proposed legislation in this arena during the next legislative session. In the interim, subcontractors should review their standard contracts to consider whether additional language could be inserted to protect their interests. Owners and general contractors should also closely review their contracts to ensure they are consistent with this decision and the principles discussed.
1 Interestingly, the subcontractor, King Construction, and its owner Carl King did not file any briefs on appeal for the court to consider. In fact, the subcontractor tried to withdraw from the appeal and proceeded without an attorney.