Annual survey of fidelity and surety law, 1999.

• Author: May, Ronald A.
• Position: Part 2

This roundup of recent cases covers public and private construction bonds, fidelity and financial institution bonds, and sureties' remedies

Edited by Charles W. Linder Jr.

1. PUBLIC CONSTRUCTION BONDS

   1. Bonds under Federal Laws

      Federal courts lack jurisdiction to hear case challenging state court judgment that university operating federal research facility was liable for its failure to obtain Miller Act bond on construction of facility.

      This interesting decision by a federal district court in California involved construction at the Stanford Linear Accelerator Center, a federal research facility operated by Stanford University. Stanford engaged a contractor to do the work but did not require a Miller Act bond. When the contractor went into bankruptcy, a group of subcontractors completed the work and sued Stanford in federal court for failure to obtain a bond.

      The action was dismissed, the court holding that the absence of a bond kept it from having jurisdiction under the Miller Act. It suggested that the subcontractors file suit for breach of contract in state court. They did so, and the state court found Stanford liable and ordered it to pay damages to the subcontractors. The state court also found that Stanford had an obligation to obtain a Miller Act payment bond. The state court action was affirmed on appeal, after which Stanford filed suit in federal court seeking declaratory relief and an injunction to bar enforcement of the state court judgment.

      The U.S. District Court for the Northern District of California dismissed Stanford's claims with prejudice, holding that federal district courts do not have jurisdiction over challenges to state court decisions, even where those challenges raise federal constitution issues.

      Board of Trustees of Leland Stanford Junior University v. Modual A/C Systems Inc., 54 F.Supp.2d 965 (N.D. Cal. 1999).

   2. State and Local Bonds

      1. Jurisdictional

         Action by surety against principal and obligee dismissed when principal realigned as plaintiff, and diversity thereby was destroyed.

         This was a diversity action filed by a surety against its principal and a public authority operating a waste water treatment plant in Mobile, Alabama. The surety sought a declaratory judgment as to the rights and obligations of its principal and the public authority. Those two defendants asserted cross-claims against each other, and the public authority counter-claimed against the surety, although the principal did not.

         The federal district court in Alabama found that it had responsibility to align the parties properly. The opinion acknowledges that there is a split in the circuits as to the manner in which this proper alignment is to be achieved. One group of cases applies the "principal purpose" or "primary issue" test and looks beyond the pleadings to identify the primary matter in dispute. Another group of decisions holds that realignment is proper only when there are no actual conflicts between the parties.

         The court in this case found that, since the principal had not sought relief against the surety, it would apply the "principal purpose" test, and doing so, it found that the principal should be aligned in this action with the surety, thereby destroying diversity.

         Federal Insurance Co. v. Bill Harbert Construction Co., 82 F.Supp.2d 1331 (S.D. Ala. 1999).

         Motion to dismiss action by surety against indemnitor where another action in federal court between same parties did not justify abstention.

         In American Home Assurance Co. v. Roxco Ltd., 81 F.Supp.2d 674 (S.D. Miss. 1999), a serious controversy arose between a contractor and its surety. The contractor claimed the surety had fraudulently and negligently misrepresented that it would underwrite the contractor's "future surety needs." The contractor also alleged that it had been defamed and that the surety and others had converted property and funds belonging to the contractor. It requested a declaratory judgment that an indemnity agreement entered into by the contractor and various individuals be declared void. Damages were sought as well.

         The case was removed to federal court by the surety, claiming fraudulent joinder to prevent diversity jurisdiction and that there was federal question jurisdiction. The surety filed a separate action in another division of the federal court. At this point the original plaintiff's sought to have the second action dismissed or stayed on account of the earlier removed case still pending in the other division of the federal court.

         Acknowledging that the U.S. Supreme Court has authorized abstention where a state offers an adequate alternative forum to resolve the dispute, the U.S. District Court for the Southern District of Mississippi concluded that this doctrine not applicable in the case before it because the state action in this case had become a federal court action. The fact that a motion to remand was pending in the other action did not constitute such "exceptional circumstances" that would warrant either abstention or a postponement of its ruling on abstention. The court further noted the possibility that the two actions could be consolidated under the Federal Rules of Civil Procedure.

      2. Procedural

         Venue of subcontractor's Little Miller Act claim filed in where part of work was performed transferred to county where public project located.

         A North Carolina case involved a large construction contract for the Warren County School System in that state. The general contractor entered into a subcontract with the school system to design and build a particular roof system for three county schools. Much of the work on the roof system was performed in the subcontractor's own county.

         When the general contractor refused to pay the final amount due on the contract, the subcontractor filed suit in his own county against the general contractor and its surety. The defendants filed motions to dismiss or to remove the action to Warren County, where the projects were located. The trial court denied the motion, and the defendants took an appeal.

         The North Carolina payment bond statute is similar to the federal statute and is characterized by the court in this case as a "Little Miller Act" and similar to the Miller Act. It provides that an action on a payment bond shall be brought in the court in the county where the construction contract or any part thereof is to be performed. Since part of the work was performed in the county where the action was pending, the plaintiff claimed that venue was correct.

         But the North Carolina intermediate appellate court found that the federal courts overwhelmingly had held venue to be proper where the project, which is the subject of the prime contract, is located. So the case was reversed and remanded.

         McClure Estimating Co. v. H.G. Reynolds Co., 523 S.E.2d 144 (N.C.App. 1999).

         One-year limitation on actions against surety starts when subcontractor demands final payment from general contractor, and that time period is not tolled by any contract provision.

         This case arose from construction at a healthcare facility in a correction institute in New York. The prime contractor started work on the project, but the state terminated the prime contract about a year later. This resulted in the termination of a subcontract, leading to this claim.

         The subcontractor originally sought arbitration against the prime contractor, and an award was granted against the prime contractor, following which a judgment was entered against the prime contractor. Unfortunately for the subcontractor, the prime contractor was now insolvent, and the subcontractor sued the surety. Since the action was started more than a year after the time when the subcontractor had demanded final payment, the surety claimed that the action was barred by limitations set forth in the New York statute.

         The lower court refused to go along with this and held that contractual provisions in the bond itself allowing arbitration should prevail over the statutory time limit. But New York's highest court, the Court of Appeals, reversed, stating that to follow the lower court decision would "countenance a sympathetic escape hatch for a particular subcontractor's claim" and that this would "unjustifiably damage the desirable definiteness fabric and principle of this statutory formulation."

         Windsor Metal Fabrications Ltd. v. General Accident Insurance Co. of America, 722 N.E.2d 58 (N.Y. 1999).

      3. Substantive

         Union pension funds' claims against general contractor and surety not preempted by ERISA.

         This action was brought by four pension and benefit funds maintained on behalf of a particular union in New York. The union had collective bargaining agreements with a contractor performing contracts in public improvement projects in that state. The contractor failed to make the contributions agreed on, and the pensions funds filed suit against the surety.

         It was first argued that the Employee Retirement Income Security Act preempted the claims asserted. In a careful analysis of other federal court opinions, the U.S. District Court for the Eastern District of New York found that there was no preemption and that there was no further duty for the court to remand the action to state court. There was no dispute as to the sums owed, and the court analyzed the terms of the collective bargaining agreements. It concluded that, notwithstanding some breaches of those agreements by the unions, the funds themselves were not barred from recovery. Summary judgment was granted to them as against the bonding company.

         Cement and Concrete Workers District Council Welfare Fund v. Frascone, 68 F.Supp.2d 166 (E.D.N.Y. 1999).

         Claim by subcontractor's employees for "double wages" under_Missouri prevailing wage statute were valid against general contractor and its surety.

         A Missouri statute requires that contractors on public works construction projects pay no less than the prevailing rates of pay for such work. Failure to comply enables employees to recover double the amount of...