Annual survey of fidelity and surety law, 1999.

• Author: May, Ronald A.
• Position: Part 1

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

      1. Substantive

         Federal Prompt Payment Act permits recovery of penalties and attorney's fees in Miller Act claims.

         In a Miller Act claim before a federal district court in Louisiana, the plaintiff has sought penalties and attorney's fees. The defendant prime contractor and its surety filed a motion for partial summary judgment on that claim. The motion was denied, the court holding that the 1998 amendments to the Prompt Payment Act (31 U.S.C. [sections] 3905(j)) effectively terminated previous holdings that penalties and attorney's fees were not covered by the Miller Act.

         The succinct opinion goes on to say: "Congress may have indeed `entrenched' itself into the field of federal project contracting and subcontracting to the extent that all state law regarding the matter is now preempted. That being said, Congress may `taketh' from litigants, but it may also `giveth.'" Cal's A/C & Electric v. Famous Construction Group.(1)

         Full recovery of delay damages allowed even though prime contractor only party responsible for delays.

         In another Miller Act case related to the construction and remodeling of Air National Guard buildings in St. Louis, the prime contractor failed properly to issue revised construction schedules, causing substantial delay damages to its electrical subcontractor. A federal district court in Missouri found that the government and the prime contractor shared responsibility for the delays but awarded the subcontractor damages compensating it in full for the delays.

         On appeal, the prime contractors and its surety argued that they were only partially at fault for the damages and that their responsibility should be limited. The Eighth Circuit found that other circuits had allowed full recovery and followed the reasoning of those cases. As a side issue, the court refused to allow recovery of damages for lost profits, holding that a separate breach of contract claim under state law would be necessary to apply for such relief. Consolidated Electrical & Mechanicals v. Biggs General Contracting.(2)

      2. Procedural

         Non-arbitrable Miller Act claims stayed pending arbitration of separate equitable claims.

         In Tanner v. Daco Construction Inc.,(3) the subcontract sued on provided for arbitration but specifically excluded from arbitration any claim under the Miller Act. When a controversy arose, the federal district court for Oklahoma found that separate equitable claims asserted by the subcontractor were subject to arbitration but held that it would be "grossly inefficient" to have the parties arbitrate and litigate at the same time. Consequently, it stayed the Miller Act case until the arbitration had been concluded.

   2. STATE AND LOCAL BONDS

      1. Substantive

         Interest on claim under bond due from date of default to date of notice of default.

         In a claim under the Massachusetts payment bond statute, the surety filed an answer admitting liability and tendered the amount of the claim. The subcontractor-claimant argued that he was entitled to interest from the date of default. The surety said that it should have to pay only from the date it was notified of the default.

         The Massachusetts Appeals Court stated that it had been long settled in that state that in the absence of a provision in the bond to the contrary, it was up to a compensated surety to keep itself informed of any defaults. Interest was awarded from the date of the default. The court went on to affirm judgment for attorney's fees in addition to interest. John W. Egan Co. v. Major Construction Management Co.(4)

         Obligation of bond does not cover claim for extra interest rate, late penalties and attorney's fees.

         In a Wyoming case, the prime contractor and its surety conceded that it owed the claim of a supplier to a subcontractor. In addition, the supplier claimed interest at the rate of 2 percent per month, more than the statutory rate, along with late penalties and attorney's fees.

         Noting that the general contract and the bond did not include any obligation to pay such fees, the Wyoming Supreme Court refused to authorize them. In doing so, it declined to follow the precedent of the federal Miller Act, notwithstanding that the Wyoming statute was based on that act. Vaughn Excavating and Construction v. P.S. Cook Co.(5)

         Acquisition of supplies by state not covered by bond.

         In a suit under the Illinois Public Construction Bond Act, a claim was made by the supplier of paint to the state's procurement services division. The Illinois Appellate Court noted that the plaintiffs wanted to interpret the term "public work" so broadly as to encompass virtually any state contract. It declined to do so and held that the bond did not cover the claim. Chemco Industries v. Employer's Mutual Casualty Co.(6)

      2. Procedural

         Bid bond for 5 percent rather than 10 percent was a material variance allowing the city to reject a bid.

         The City of Champaign, Illinois, issued a request for bids that contained a condition that bids be accompanied by a 10 percent bid bond. The low bid was made by a contractor that submitted only a 5 percent bid bond. The city held a pre-award meeting and awarded the contract to the next low bidder, which indeed had provided a 10 percent bid bond.

         The Illinois Appellate Court concluded that the city had discretion to act in the manner it did and affirmed the lower court decision. Bodine Electric v. City of Champaign.(7)

         County liable to claimant where it excused failure to require bond by declaration of emergency after the contract was awarded.

         In a case similar to Bodine, the Oregon intermediate appellate court had to deal with a somewhat more complicated set of facts. A county housing authority had excused the contractor from furnishing a bond as required by the county's first solicitation for bids. It was authorized to do so if it issued a declaration of emergency.

         It turned out, however, that the declaration of emergency did not take place until after the contract had been awarded. In accordance with state procedures, that late declaration was not sufficient to immunize the county from liability for a claim by the subcontractor. Plant Electric Supply v. JC Northwest.(8)

2. PRIVATE CONSTRUCTION BONDS

   1. Liability of Surety

      In event of principal's bankruptcy, automatic stay of 11 U.S.C. [sections] 362(a) does not stay actions against surety. Automatic stay has no effect on declaration of default by obligee of principal's performance, as surety's obligations are determined not by termination of contractual rights of its principal but rather by declaration of default by obligee.

      In Am-Haul Carting Inc. v. Contractors Casualty and Surety Co.,(9) the surety provided a payment and performance bond pursuant to the Miller Act for a subcontractor on a government job. The findings of the court are equally applicable to an action involving a private construction bond.

      In May 1997, the subcontractor filed a Chapter 11 bankruptcy petition but did not notify the general contractor of its action at any time. In September 1997, the general contractor declared the subcontractor to be in default and terminated the subcontractor's contract. A copy of the default letter was sent to the surety with a cover letter notifying the surety that the general contractor expected the surety to fulfill its obligations under the performance bond.

      As a defense, the surety argued that the letter from the general contractor violated the automatic stay provisions of the Bankruptcy Code. The U.S. District Court for the Southern District of New York rejected this contention. First, the court held that the provisions of the automatic stay protected only the debtor, property of the debtor, or property of the state, and not non-debtor parties or their property. Therefore, the stay did not apply to actions against guarantors or sureties. The court cited Advanced Ribbons and Office Products Inc. for this position.(10)

      The court went on to hold that even if the Bankruptcy Code voided the termination of the contract, this would have no impact on the surety's obligations, since the declaration of default, not the termination of the...