July 19, 2018
The stop payment notice is a demand for the owner or construction lender (or other holder of funds) to withhold funds due the direct contractor so that the claimant can be paid. A “construction lender” is defined to include “[a]n escrow holder or other person holding funds provided by an owner, lender, or another person as a fund for with which the cost of all or part of a work of improvement is to be paid.” Civ. Code § 8006. Thus, the stop payment notice can be given to a variety of persons or entities, arguably including insurance carriers where work is being performed to repair damage covered by insurance claims.
Upon receipt of a stop payment notice the owner or construction lender has a duty to act accordingly. The scope of duty, however, depends upon the circumstances, including such things as the status of the claimant, whether the stop notice is served on an owner or lender, whether a payment bond exists and was properly recorded, and whether the stop notice is accompanied by a bond.
With limited exception, when an owner receives a proper stop payment notice, bonded or unbonded, the owner must withhold sufficient funds. Civ. Code § 8522(a). Only if the owner previously required a payment bond, and recorded the same along with the prime contract, may an owner choose not to withhold funds pursuant to a proper stop payment notice. Id.; and Civ. Code § 8600 (allowing an owner to record a payment bond in order to reduce potential stop notice and mechanics’ lien liability). Under those circumstances, if the owner chooses not to withhold funds pursuant to the stop notice, the owner must, within 30 days after receipt of the stop payment notice, give notice to the claimant that a payment bond has been recorded and provide the claimant a copy of the bond. Civ. Code § 8522.
a. Bonded vs. Unbonded Stop Payment Notices
Unlike an owner, a lender who receives a proper stop payment notice must withhold sufficient funds only if the stop notice is accompanied by an adequate bond (commonly referred to as a “bonded stop notice”). If the lender receives an unbonded stop notice, the lender may withhold funds, but is not obligated to do so. The lender also need not withhold funds if the claimant is someone other than the direct contractor and a payment bond is recorded before receipt of the stop notice. Civ. Code § 8536.
If the claimant does not include a bond with its notice to the lender, the claimant may make a written request for notice from the lender of its election not to withhold funds. Civ. Code. § 8538. If a payment bond exists and is the reason for the lender’s decision not to withhold funds, the lender must provide the claimant a copy of the bond. Id.
If, however, the stop notice is accompanied by a bond equal to 125 percent of the amount of the claim (and no payment bond was recorded) the lender must withhold sufficient funds. The stop notice bond is intended to protect the parties, including the owner, the lender, and the direct contractor, against damages resulting from improper service of a stop notice. Civ. Code § 8532. “The bond shall be conditioned that if the defendant recovers judgment in an action to enforce payment of the claim stated in the stop payment notice or to enforce a claim of lien recorded by the claimant, the claimant will pay all costs that are awarded the owner, direct contractor, or construction lender, and all damages to the owner, direct contractor, or construction lender that result from the stop payment notice or recordation of the claim of lien, not exceeding the amount of the bond.” Civ. Code § 8532.
If, for any reason, the lender objects to the bond provided by the claimant with its stop payment notice, Civil Code section 8534 requires the lender to provide the claimant notice and an opportunity to cure the purported deficiency.
b. Penalty for Serving False Stop Notice – Private Works
A claimant “that willfully gives a false stop payment notice or that willfully includes in the notice a demand to withhold for work that has not been provided forfeits all right to participate in the distribution of the funds withheld and all right to a [mechanics’] lien …” Civ. Code § 8504.
c. Owner’s Right to Demand Stop Payment Notices
An owner may want to ensure that claimants file stop payment notices, possibly in lieu of, or prior to mechanics’ liens. In such cases, an owner may provide notice to potential claimants demanding that “a person that has a lien right … give the owner a stop payment notice.” Civ. Code § 8520. “If the person fails to give the owner a bonded or unbonded stop payment notice, the person forfeits the right to a lien ….” Id. By demanding that claimants file stop notices, claimants can be identified before an owner fully pays the direct contractor, thereby ensuring that claimants are paid and mitigating the potential for mechanics’ liens.
d. Amount Withheld
Where funds are withheld pursuant to a stop payment notice, the party withholding must withhold all sums due the claimant demanded in the stop notice that accrued up to the date of the stop notice. That is, a stop notice claimant cannot demand, and an owner or lender is not obligated to withhold any amounts that accrue after the date of the notice.
“If funds are withheld pursuant to a stop payment notice given to a construction lender by a direct contractor or subcontractor, the direct contractor or subcontractor may recover only the net amount due the direct contractor or subcontractor after deducting any funds that are withheld by the construction lender pursuant to the claims of subcontractors and material suppliers that have given a stop payment notice for work done on behalf of the direct contractor or subcontractor.” Civ. Code, § 8542. “In no event is the construction lender required to withhold … more than the net amount” due to a claimant after subtracting amounts withheld for the claimants subcontractors or suppliers. Id. A construction lender cannot be liable for failing to withhold more than that net amount on receipt of a stop payment notice. Id.
If an owner or lender improperly disburses funds when it should have withheld pursuant to a proper stop payment notice, the owner or lender who improperly disbursed funds is personally liable to the stop notice claimant. The extent of the owner’s or lender’s liability, however, is limited to the amount of the funds that had been improperly disbursed, which is not necessarily the amount of the claimant’s stop payment notice. Additionally, if the stop payment notice is bonded, a lender may not disburse to itself loan costs and interest. This is true even with respect to loan costs and interest that the lender may have disbursed to itself prior to the date of the stop payment notice. A bonded stop payment notice has priority over all amounts paid to the lender from the loan fund, even those amounts that may have accrued and were disbursed prior to the date of the stop payment notice.5
5 Familian Corp. v. Imperial Bank (1989) 213 Cal. App. 3d 681, 686–688.