Payment and Performance Surety Payment and Performance Surety Bonds - - PowerPoint PPT Presentation

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Payment and Performance Surety Payment and Performance Surety Bonds in Construction Projects

Asserting or Defending Surety Bond Claims to Maximize Recovery or Protect Rights and Interests

T d ’ f l f

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific THURSDAY, OCTOBER 20, 2011

Today’s faculty features: Gina M. Vitiello, S hareholder, Chamberlain Hrdlicka, Atlanta Glenn C. Kennett, S enior Associate, Pillsbury Winthrop Shaw & Pittman, Washington, D.C.

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PAYMENT BONDS

Gina M. Vitiello gina.vitiello@chamberlainlaw.com 404.588.3426 404.588.3426

PAYMENT BONDS PAYMENT BONDS

• Joint and several liability of contractor and

Joint and several liability of contractor and surety

• Payment of “downstream” parties who

y p provide labor and/or materials and/or equipment

• So in addition to contract claim against

contractor, there is a separate bond claim against contractor and surety against contractor and surety

• Privity usually not required—notice issues

6

TYPES OF PAYMENT BONDS

• Miller Act (40 U.S.C. § 3131 et seq.)

Miller Act (40 U.S.C. § 3131 et seq.)

– Generally contract of $100,000 or more (Payment bond = contract amount; performance bond = “adequate” amount). – Exclusions/opt outs include (1) some cost- plus contracts marine contracts etc (40 plus contracts, marine contracts, etc. (40 U.S.C § 3134); and (2) possibly on foreign contracts if “impracticable” (40 U.S.C. p ( § 3131(e)). – Approved corporate sureties at htt // f t / 570/ 570 ht l http://www.fms.treas.gov/c570/c570_a-z.html.

7

TYPES OF PAYMENT BONDS

• State Little Miller Acts

State Little Miller Acts

– Generally required for contracts of certain $$ size or more – If bonds are required, contract not valid If bonds are required, contract not valid without them

• Private Bonds (AIA A312 is very common)

8

PAYMENT BOND CLAIMANTS

• Miller Act payment bond

Miller Act payment bond

– Intended to protect “all persons supplying labor and material” 40 U S C § 3131(b)(2) As labor and material 40 U.S.C. § 3131(b)(2). As applied: – 1st tier sub/supplier: YES 1 tier sub/supplier: YES – 2d tier sub/supplier of 1st tier sub: YES – 2d tier sub/supplier of 1st tier supplier: NO 2d tier sub/supplier of 1 tier supplier: NO – 3d tier: NO

9

PAYMENT BOND CLAIMANTS

• Little Miller Act payment bonds

Little Miller Act payment bonds

S h b d th f d l t – Some have broader coverage than federal act – Example: a supplier to a second tier sub is a claimant under the GC’s bond

10

PAYMENT BOND CLAIMANTS

• Private payment bonds

Private payment bonds

– View them as contracts with claimants as intended beneficiaries – Language of the bonds controls as to who may make a claim AIA 312 anybody who has a contract with contractor – AIA 312 – anybody who has a contract with contractor posting bond or a subcontractor to furnish “labor, materials or equipment” plus anybody else who could assert lien under controlling statute – Private bond will also (usually) dictate when and how to make the claim to make the claim

11

Statutes of Limitation/Notice

• Miller Act payment bonds (41 U.S.C § 3133)

Miller Act payment bonds (41 U.S.C § 3133)

– If not paid within 90 days of last providing labor/material can sue (venue=where job is but see labor/material, can sue (venue=where job is . . .but see recent case discussed below) Suit must be filed within 1 year of last providing – Suit must be filed within 1 year of last providing labor/material A i d b t d 91 d 365 t – A window between days 91 and 365 to sue

12

Statutes of Limitation/Notice

• Miller Act payment bonds (41 U.S.C § 3133)

Miller Act payment bonds (41 U.S.C § 3133)

– If not in privity with contractor providing bond, must give written notice to that contractor within the first 90 give written notice to that contractor within the first 90 days – A waiver of Miller Act rights is only valid if written A waiver of Miller Act rights is only valid if written, signed by party waiving rights and signed after that party furnished labor/materials=waiver in subcontract

• void. . . Lots of contradictory/conflicting cases re how

y g to treat “pay if/when paid” clauses and clauses requiring subcontractor to allow general contractor to exhaust administrative remedies. Are they unenforceable waivers? Answer later unenforceable waivers? Answer later.

13

Statutes of Limitation/Notice

• Private payment bonds:

Private payment bonds:

– State law will control Private bonds will often contain shortened – Private bonds will often contain shortened limitations periods – Some states allow a bond to establish a – Some states allow a bond to establish a limitation period that is shorter than the statutory period; other states say it is against y p ; y g public policy, and ignore the shorter period contained in the bond

14

Statutes of Limitation/Notice

• Notice requirements in private bonds are no different

than notice requirements in a contract. So failure to l t i k if f il t f ll comply exposes you to same risks as if you fail to follow contract notice provisions

• AIA A312 Payment Bond

– Must submit “claim” to surety before filing suit; also, if no privity with party providing bond, notice to that party within 90 days of last labor/materials is required last labor/materials is required – Surety responds to claim in 60 days (2010 version, contrasted with 45 days in 1984 version which is still being used), or may be d ’ f exposed to attorneys’ fees

15

Costs covered under Miller Act t b d payment bonds

Labor

• Labor
• Union dues
• Supervision
• Supervision
• Lodging
• Materials

Materials

• Rental equipment
• Extra work
• Extra work
• Including reasonable profit on

extra work

16

Costs covered under Miller Act payment bonds

• Delay Damages
• Historically not recoverable because they

Historically not recoverable because they were not viewed as labor and materials incorporated into the project p p j

• Now some jurisdictions allow increased

Now, some jurisdictions allow increased labor and materials due to delay

17

Costs covered under Miller Act payment bonds

• Delay Damages
• U.S. ex. rel. Pertun Construction, Co. v. Harvesters

h

Group, Inc., 918 F.2d 915 (11th Cir. 1990) “We hold that the Miller Act allows recovery from the surety for increased out-of-pocket costs caused by surety for increased out of pocket costs caused by delay and that the subcontract provision regarding no damages for delay does not preclude recovery under th i t ” these circumstances.”

• Lost profits on delay damages not allowed
• Lost profits on delay damages not allowed

18

Costs covered under Miller Act payment bonds

Interest

• Permitted to recover if provided for by state

Permitted to recover if provided for by state law or contract

19

Costs not covered by Miller Act payment bonds

• Insurance premiums
• Lost profits

p

• Capital equipment costs/use
• f owned equipment
• Attorneys’ fees
• Unless provided for by federal

statute or contract between claimant and principal

20

Surety Defenses

• Defenses to payment bond claims:

Defenses to payment bond claims:

– Surety may assert any defenses available to the principal the principal

• Payment
• Offset
• Defective work by subcontractor
• Other breaches by claimant causing principal to

incur damages

21

Surety Defenses

• Defenses to payment bond claims:
• F il

t f ll ti i t

• Failure to follow notice requirements
• Limitations periods
• Limitations periods
• Limitations period in bond for bringing action may

be shorter than statute of limitations be shorter than statute of limitations

22

Surety Defenses

• Defenses to payment bond claims:

Defenses to payment bond claims:

• “Pay-if-paid” clause

Miller Act:

• N.D. Ga. has held that contingent payment clauses will not be

a defense to a surety under a Miller Act claim, citing cases from 9th and 5th Circuit

• U.S. ex. rel. McKenney’s, Inc. v. Gov’t. Technical Services,

LLC, 531 F.Supp.2d 1375 (N.D. Ga. 2008)

“Where subcontract terms [affect] the timing of recovery or the [ ] g y right of recovery under the Miller Act, enforcement of such terms to preclude Miller Act liability contradict the express terms of the Miller Act.” 23

Surety Defenses

• Defenses to payment bond claims:

Defenses to payment bond claims:

• “Pay-if-paid” clauses

Georgia Little Miller Act: g

• Contingent payment clause in subcontract will be defense to

surety under Georgia Littler Miller Act

• St. Paul Fire & Marine Ins. Co. v. Georgia Interstate Elec.
• St. Paul Fire & Marine Ins. Co. v. Georgia Interstate Elec.

Co., 187 Ga. App. 579, 370 S.E.2d 829 (1988)

“A provision in a contract may make payment by the owner a condition precedent to a subcontractor's right to payment if 'the contract between the general contractor and the subcontractor [contains] an express condition clearly showing the intention of the parties.” 24

Surety Defenses

• Defenses to payment bond claims:

Defenses to payment bond claims:

• “Pay-if-paid” clauses
• Private bonds: If the bond incorporates the
• Private bonds: If the bond incorporates the

claimant’s contract and there is a contingent payment clause, it will likely be enforced

• Practice tip:
• some contractors are including language in

b t t th t “ t b d h ll subcontract that says “surety on any bond shall have the benefit of this clause”

25

RECENT CASES RECENT CASES

26

U.S. ex. rel. Roc Carter Co, LLC v. Freedom Demolition, Inc., 2009 WL 3418196 (M.D. Ga. 2009) , ( )

– U.S. leased federal property to a corporation for the purpose of constructing operating and maintaining a military housing facility constructing, operating and maintaining a military housing facility – Lease limited government’s liability to that of a lessor and stated construction was a private undertaking – Corporation enters into design-build contract to construct military housing housing – Contractor provided payment and performance bonds naming United States and project lender as co-obligees – Second-tier sub sued contractor and surety under Miller Act for labor and materials provided to the project and materials provided to the project – District Court dismissed subcontractor’s suit, holding that the Miller Act did not apply because U.S. was not a party to the design-build contract and it was not a contract to construct a “public work” Three elements to have a “public work” contract: (1) construction – Three elements to have a public work contract: (1) construction contract, (2) U.S. must be a party to the construction contract; and (3) contract must require Payment and Performance bonds that are in favor of U.S. 27

Artistic Stone Crafters, Inc. v. Safeco Ins. Co.

• f America 2010 WL 317472 (S D Ga 2010)

– Payment bond surety was entitled to enforce

• f America, 2010 WL 317472 (S.D. Ga. 2010)

Payment bond surety was entitled to enforce a forum selection clause contained in the claimant’s subcontract without regard to whether the subcontract was expressly incorporated into the bond. – Court also found that Miller Act venue provision (where the subcontract was to be performed) was not controlling because it was performed) was not controlling because it was waived by the subcontract’s forum selection clause clause.

28

U.S f/u/b Sigler v. AMC and E.C. Scarborough, 2010 WL 5100913 (D. Nev.)

• 2d Tier Supplier v Surety

2d Tier Supplier v. Surety

• Payment bond stated (“sort of”) that it was limited to 1st

year of project.

• Individual (not corporate) surety collected premium for
• Individual (not corporate) surety collected premium for
• nly one year.
• Supplier didn’t even deliver materials until year 2.

Supplier argues (1) limitation impedes purpose of Act;

• Supplier argues (1) limitation impedes purpose of Act;

and (2) GC violated Act.

• Held: Surety’s motion for summary judgment GRANTED:

“The Court cannot hold a surety liable for coverage that it The Court cannot hold a surety liable for coverage that it did not intend to provide.”

– Court ignores statutory requirement that bond is for protection of those who supply labor/materials for “carrying out the work provided for in the contract”, and that surety effectively provided a bond it knew to be non- compliant. 29

U.S f/u/b Sigler v. AMC and E.C. Scarborough, 2010 WL 5100913 (D. Nev.)

• What could supplier have done? Not much:
• What could supplier have done? Not much:

– Get copy of bond via FOIA (or by asking GC) pre- performance, so he would be “smart”. Try to get from CO (Miller Act only requires CO to – Try to get from CO (Miller Act only requires CO to give bond if request made via affidavit post performance).

Court throws a bone to supplier by allowing him

• Court throws a bone to supplier by allowing him

to maintain a QM claim against contractor to extent he can show GC didn’t pay subcontractor (d i i d ’t t h th h i (decision doesn’t suggest whether showing can be made).

• GC’s price must have reflected “savings” from

GC s price must have reflected savings from

• ne-year bond—craziness!

30

U.S. f/u/b Vining v. Carothers, 2010 WL 1931199 (M D Ga ) (M.D. Ga.)

• Surety is not compelled to arbitrate where not a
• Surety is not compelled to arbitrate where not a

party to the subcontract, bond does not incorporate subcontract and subcontract doesn’t incorporate bond incorporate bond

• Court stays case as to surety, and compels

y y, p arbitration between GC and sub

31

U.S f/u/b WFI v. Gray 701 F. Supp. 2d y 1320 (N.D. Ga. 2010)

• Where surety is aware of arbitration, is invited to

voluntarily participate, and chooses not to, award will be binding on him, subject to special surety defenses, even g , j p y , where GC didn’t show up and defend at arbitration

• Arbitration award included attorneys’ fees, and since

Arbitration award included attorneys fees, and since those are not generally available against surety under the Miller Act, judgment against surety excluded fees awarded against GC in arbitration.

32

• Conclusion:

– Surety chooses not to participate in arbitration at its

• wn peril

– In WFI, surety counsel had been very involved, and seems to have made a conscious decision to stay on sidelines It is strange that surety took this risk

• sidelines. It is strange that surety took this risk,

particularly given that principal was a no-show at the hearing

33

PERFORMANCE BONDS Glenn C Kennett Glenn C. Kennett

glenn.kennett@pillsburylaw.com 202.663.8375

34 |

Basic Structure

Tripartite relationship:

• Surety (the Obligor) guarantees performance of a promise made by another (the

Principal) to a third party (the Obligee).

• The rights, duties, and obligations of the parties are determined by contract: (1)

the subcontract / prime contract and (2) the performance bond the subcontract / prime contract and (2) the performance bond.

35 |

Purpose

• Designed to protect the owner / prime contractor (Obligee) from the

inability or refusal of the contractor / subcontractor (Principal) to complete its contractual obligations

• Provides protection to the “penal sum” of the bond, i.e., the face

amount of the bond (often the amount of the prime contract / subcontract)

36 |

Types of Performance Bonds

• AIA A312-1984 Performance Bond (Revised in 2010)
• AIA A311-1970 Performance Bond
• Federal Standard Form 25 Performance Bond
• Federal Standard Form 25 Performance Bond
• Custom Performance Bonds

37 |

AIA A312

38 |

AIA A312

Surety obligations:

• The Surety and Principal are jointly and severally liable for “the performance of the

Construction Contract”

• The Construction Contract is “incorporated herein by reference ” making the bond

The Construction Contract is incorporated herein by reference, making the bond

• bligation coextensive with the Construction Contract
• Surety obligations do not arise so long as “the contractor performs the construction

contract”

39 |

AIA A312

Surety obligations arise if:

• The owner itself is not in default
• The owner has notified both the contractor and the surety that it is considering

d l i th t t i d f lt declaring the contractor in default

• The owner has requested a conference with the contractor and the surety to

discuss methods of performing the contract

• The owner has declared the contractor to be in default and formally terminated the

y contractor’s right to complete the contract; and

• The owner has agreed to pay the balance of the Contract Price to the surety or to

another contractor selected to perform

40 |

AIA A312

Surety options on contractor default:

• Arrange for the contractor (with owner consent) to continue performance through

surety financing; T k d l t th t t

• Take over and complete the contract;
• Tender a substitute contractor, with new bonds acceptable to the owner, and

payment to owner of any excess costs of completion up to the penal sum;

• Tender payment to the owner “the amount for which it may be liable”; or

p y y ;

• Deny liability in whole or in part and with explanation

41 |

AIA A312

Scope of Surety Liability:

• Completion of the Contract
• Correction of defective work
• Delay costs resulting from contractor’s default including additional legal and design
• Delay costs resulting from contractor s default including additional legal and design

fees

• Liquidated or actual damages caused by delayed performance / non-performance

42 |

AIA A312

2010 Revisions to AIA A312:

• Conference Not Required
• Waiting Period Reduced

Waiting Period Reduced

43 |

AIA A311

44 |

AIA A311

The surety’s obligations arise only if:

• The principal is in default
• The obligee declares the principal to be in default
• The obligee itself has not breached the contract

45 |

AIA A311

• No Express Requirement that there be a notice of default as a condition

precedent to an action on the bond precedent to an action on the bond

• Inconsistent application:
• Walter Concrete Const. Corp. v. Lederle Laboratories, 788 N.E.2d 609 (N.Y. 2003)
• Colorado Structures, Inc. v. Insurance Co. of the West, 167 P.3d 1125 (Wash. 2007)
• Hunt Const. Group, Inc. v. National Wrecking Corp., 542 F. Supp.2d 87 (D.D.C. 2008)

46 |

Federal Standard Form 25 Performance Bond

• 48 CFR § 53.301-25
• Provides for “payment” as the only performance option
• CO’s are nevertheless authorized to consider alternative options to

allow surety to complete the work (48 CFR § 49.401 et seq.)

• 48 CFR § 49.402-3(h) provides that upon issuing notice of termination, the surety

should be requested to advise if it desires to arrange for completion of the work

• 48 CFR § 49.404 provides for Surety-takeover Agreements

47 |

Surety Rights Surety Rights

48 |

Surety Rights

• Surety’s liability is secondary and contingent

U til th t t i f d i d f lt th t ’ i ht i th j t d t t

• Until the contractor is found in default, the surety’s rights in the project do not vest
• Grounds for Default
• Failure to complete the work within the time for the contract or any extension
• “Failure to make progress”
• Repudiation by the contractor
• Contractor’s failure to perform its obligations under the contract

Contractor s failure to perform its obligations under the contract

• Failure to provide adequate assurances that performance will proceed
• Failure to continue performance during a dispute

49 |

Surety Rights

• Upon termination, the surety’s rights are co-extensive with that of the

principal (performance by one constitutes performance by the other)

• Rights above and beyond rights those enjoyed the Principal
• Rights above and beyond rights those enjoyed the Principal

50 |

Surety Rights

Notice

• Most bonded contracts require some form of default notice by the obligee to the

surety (e.g. A312 Bond requires 20 days notice prior to declaration of default)

• Allows surety to minimize liability and mitigate damages
• Lack of proper and timely notice
• Dragon Constr., Inc. v. Parkway Bank & Trust, 287 Ill. App.3d 29 (Ill. App.

1997)

• When Is notice not Required?

51 |

Surety Rights

Declaration of Default

• Surety has no obligation to perform until there is a proper declaration of

default

• Declaration of default must be clear and unambiguous
• L&A C

t ti C S th C t S i I 17 F 3d 106 (5th Ci 1994)

• L&A Contracting Co. v. Southern Concrete Services Inc., 17 F.3d 106 (5th Cir. 1994)
• 2010 Revisions to A312 (conference is no longer required before declaration of default

52 |

Surety Rights

Wrongful Termination

• May be a material breach of contract, discharging the surety’s

performance obligations under the bond

• Absent express bond language to the contrary the surety’s liability
• Absent express bond language to the contrary, the surety s liability

does not arise if the owner is itself in default

• A312 Bond: “If there is no Owner Default, the Surety’s obligation under this

Bond shall arise ….”

• A311 Bond: Whenever a Contractor shall be, and declared by Owner, to be in

default under the Contract, the Owner having performed Owner’s obligations thereunder, the Surety may promptly remedy the default ….”

53 |

Surety Rights

Owner Default

• A312 / A311 - Absent express bond language to the contrary, the

surety’s liability does not arise if the owner is itself in default

• A312 Bond: “If there is no Owner Default, the Surety’s obligation under this Bond

shall arise ….”

• A311 Bond: Whenever a Contractor shall be, and declared by Owner, to be in

default under the Contract, the Owner having performed Owner’s obligations thereunder, the Surety may promptly remedy the default ….” , y y p p y y

54 |

Surety Obligations Surety Obligations

55 |

Surety Obligations

Duty to Investigate

• “Reasonable” investigation into the merits of the alleged default of the

principal

• Determine whether propriety of the default
• Determine available surety options to cure default
• Determine available surety options to cure default
• Respond to Obligee
• Expressly stated or silent

“R bl ” i d f ti

• “Reasonable” period of time
• Seaboard Surety Co. v. Town of Greenfield, 266 F.Supp.2d 189 (D. Mass. 2003)

(“[S]ureties have been credited a reasonable amount of time for investigating and selecting from performance options . . . . [T]ime spent investigating a claim and f l ti th i t f th bl t f f formulating the proper response is part of the reasonably prompt performance of the surety”)

• Failure to Investigate

56 |

Surety Obligations

Performance Options

• Buy back the Bond
• Takeover the work
• Finance the principal
• Do nothing (allow obligee to complete)

57 |

Surety Obligations

Buying Back the Bond

• The surety seeks a full release from the obligee by purchasing back its

performance bond by paying the obligee an amount up to the bond’s penal sum

• Potential Risks

58 |

Surety Obligations

Takeover and Complete

• Surety agrees to takeover and complete the project through a completion

contractor

• Potential Risks
• Take Over Agreements

59 |

Surety Obligations

Financing the Principal

• Surety provides financial assistance to principal to enable the principal to

complete the project as economically and quickly as possible

• Potential Risks

60 |

Surety Obligations

Do Nothing (Allow Obligee to Complete the Project)

• Obligee completes work; surety pays difference between the total

contract balance and the cost to complete the work (not in excess of penal sum)

• Potential Risks

61 | Presentation Title

Surety Defenses

62 |

Surety Defenses

Surety “stands in the shoes of its Principal” Surety specific Defenses

• Material alteration / cardinal change
• Material alteration / cardinal change
• Overpayment to principal
• Time limitations on commencement of suit
• Fraud / misrepresentation

p

• Release of the principal

63 |

Surety Defenses

Material Alteration / Cardinal Change

• Test: If an alteration to the bonded contract imposes materially different risks

than those the surety undertook at the outset, the surety may be entitled to a complete discharge (or discharge to the extent of prejudice shown)

• Examples:
• Unduly increase the cost of the work
• Unreasonably alter the character of the work

C tit t di l d t f th i i l t t

• Constitute a radical departure from the original contract

64 |

Surety Defenses

Overpayment to Principal

• Obligee pays for work that is either not completed or patently defective
• Surety must prove actual prejudice as a result of overpayment

65 |

Surety Defenses

Time Limitations on Commencement of Suit

• A311 Bond
• Suit within 2 years from the date final payment was due
• A312 Bond
• Suit within 2 years after contractor default, or within 2 years from when surety refuses

S y , y y performance, whichever occurs first

• Public Projects
• Statute controls (1 year under the Miller Act)

66 |

Surety Defenses

Fraud or Misrepresentation

• Obligee intentionally misstates / conceals material or fraudulent information

regarding the principal; potential discharge of the surety

• Restatement (Third) of Suretyship & Guaranty § 12, discharge upon the

following:

• The misrepresentation is fraudulent or material
• The misrepresentation induced the surety to issue the bond; and
• The surety reasonably relied on the misrepresentation
• The surety reasonably relied on the misrepresentation

67 |

Surety Defenses

Release of the Principal

• Obligee’s release of claims against the principal = release of claims against

the surety

• Kiski Area School Dist. v. Mid-State Surety Corp., 967 A.2d 368 (Pa. 2008)

y p ( )

• Exceptions:
• Where surety consents to its on-going liability; or
• Where obligee expressly reserves its rights against the surety

68 |