Annual Survey of Fidelity and Surety Law, 2000.

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

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

1. PUBLIC CONSTRUCTION BONDS

   1. Bonds under Federal Laws

      1. Substantive

      Revisions of terms in prime contract are no bar to recovery by subcontractor from Miller Act surety

      A contractor agreed to construct an industrial waste treatment complex for the U.S. Navy in Hawaii. The defendant issued a payment bond pursuant to the Miller Act. The general contractor entered into a subcontract with International Business Machines Co. to furnish and install an instrumentation and control system. Later the general contractor requested and got a modification of the payment clause in IBM's contract because it was experiencing financial difficulties and could not pay IBM under the normal provisions of the initial subcontract. In addition, IBM agreed to furnish additional services amounting to $175,000.

      When the general contractor was unable to pay IBM, it sued the Miller Act surety. The surety defended on grounds that the contact revisions constituted a new contract. The federal district court granted summary judgment in favor of IBM, holding it was undisputed that IBM supplied labor and materials for the project, that IBM had not been paid in full, and that the labor and materials were intended for the project.

      The court went on to hold that any rule of suretyship absolving a surety from liability because of an alteration in the contract is not applicable to Miller Act bonds, where the surety has deliberately contracted for an uncertain obligation. It also held that no notice to the surety of contract revisions was necessary, since the surety had expressly waived such notice. The court did not grant full summary judgment, since further evidence would be required to show the amount due under the subcontract.

      International Business Machines Corp. v. Hartford Fire Insurance Co.(1)

   2. State and Local Bonds

      1. Procedural

         Punch list work did not extend time for giving notice under bond statute

         In this Illinois case, the statute on public bonds required that demands on sureties be made less than 180 days after the "last work" was completed. The plaintiff, a subcontractor on a general public contract, completed its work on June 6, 1995, sending an invoice to the general contractor at that time for the full amount due. In December 1996, the subcontractor received a punch list from the city's project director. It proceeded to do that work and on January 17, 1997, filed its claim for a lien against the city and the general contractor. On January 28, 1997, the bonding company received a copy of the claim against it.

         In state court litigation in Cook County, the trial court granted judgment in favor of the claimant, but on appeal this was reversed. The intermediate appellate court found that the term "last work" was not defined in the statute, so it looked to decisions under the Miller Act for guidance and found that federal authorities held corrective or repair work was not considered in determining a date on which a contractor supplied its "last work." It held that the 180-day limitations period commenced in May 1995 and that the notice in January 1997 was untimely.

         MQ Construction Co. v. Intercargo Insurance Co.(2)

         Judgment following trial on issues could not be annulled on account of settlement agreement reached between owner and surety

         In Livingston Parish Sewer District v. Miller's Mutual Fire Insurance Co.,(3) the improvement district filed suit against the surety on the construction project based on allegedly faulty construction by the general contractor for which the surety had issued a performance bond. Thereafter the parties executed a written settlement agreement that provided, however, that if the parties could not agree on liability, the issue was to be submitted to a trial court. Ultimately, the trial court found in favor of the district in an amount exceeding the face amount of the surety's bond. The surety then filed a petition seeking to have the judgment annulled under a unique procedural provision in Louisiana law.

         The intermediate appellate court found that the petition filed by the surety was procedurally defective and affirmed the lower court's refusal to amend the judgment. It would appear that the precedential value of this case for litigants outside of Louisiana would be minimal.

         Bond provisions stating no notice required is binding on surety and excuses claimant's failure to give notice

         In William J. Templeman Co. v. United States Fidelity and Guaranty Co.,(4) an Illinois regional transportation authority entered into a construction contract for a commuter train layover facility. USF&G furnished a payment bond to the prime contractor. The Illinois statute on public construction bonds required that notice of claim be given to the surety. The trial court found that the notice given in this case was insufficient because it did not state an amount claimed.

         On appeal, the Illinois Appellate Court reversed because of language contained in the bond that specifically exempted those having direct contract with the principal from giving written notice to the principal of an intent to make a claim under the bond. In summary, the court held: "In effect, USF&G asks to be permitted to issue a bond that provides no notice is required prior to suit, but when a claimant relies on that language, to avoid payment by invoking the Bond Act, which contains a notice requirement. This we refuse."

         Arbitrability is issue for court, not arbitrator, to resolve

         A New Jersey contractor submitted a successful bid for plumbing work on a new elementary school. Its bid included an agreement to provide a bond executed by General Accident Insurance Co. When the contract was executed, the contractor submitted a bond executed by Amwest Surety Insurance Co. The record in the case did not state why this substitution had taken place. When a controversy developed between the board of education and the contractor, the board filed an action to compel arbitration.

         After some complicated procedural gyrations, the lower court entered an order denying the motion to compel arbitration but leaving open the question of whether the board could have this resolved in the arbitration proceeding itself. On appeal, the Appellate Division of the New Jersey Superior Court found that the appeal was interlocutory but that leave to appeal should be granted "in the interest of justice." It went on to reverse the summary judgment in favor of the surety and remanded the case to the court for further proceedings, presumably including the board's demand for arbitration.

         Gloucester City Board of Education v. American Arbitration Ass'n.(5)

      2. Substantive

         Terms of bond not in accord with statutory bond form or bid documents are not enforceable

         In the Gloucester City case, the court resolved another issue against the bonding company. The surety had argued that it was not liable under its performance bond because the board had not declared a default as required by the provision of the bond, and the board had not instituted proceedings against the surety within the time period set forth in the bond itself. Neither of these requirements are in the New Jersey bonding statute or in the bid documents that gave rise to the contract. The court held: "When a surety bond is issued to satisfy the requirements of a statute, the bond will be construed in conformity with the legislative mandate."

         Claimant under payment bond entitled to recover notwithstanding work under contract performed before issuance of bond

         A charter township in Michigan entered into a contract for environmental improvement work involving two fire stations. The contractor then entered into two subcontracts for excavation and related activities. This work was performed, and the prime contractor was billed for it. Some weeks later, the prime entered into a contract with the township that amended the original contract under which the excavation work had been performed, and at this time the prime was compelled to get payment bonds, which it did.

         The prime contractor went into bankruptcy and failed to make payment to the plaintiff for the earlier work. The plaintiff then filed suit against the surety for the full amount of its debt. The surety moved for summary judgment, arguing that the prime contractor had not received payment from the township and was, on that account, not obligated to pay for the excavation work. The plaintiff also filed for summary judgment, and in response the bonding company raised an additional argument, contending that the plaintiff could not be protected by the payment bond because all of its work had been completed before the bond was issued.

         This position was accepted by the trial court, but on appeal its decision was reversed by the Michigan Court of Appeals. It held that because this was a public works construction bond, the fact that the plaintiff had completed its job before the bond was issued did not exonerate the surety from liability under the bond. The default, according to the court, occurred when the prime contractor failed to pay the subcontractor so that, in the court's view of things, there was no retrospective application of the payment bond. The court found no Michigan authority addressing the issue; it relied on decisions from other states.

         Leonard C. Carnaghi Inc. v. Amwest Surety Insurance Co.(6)

         Surety's obligation under developer's performance bond is enforceable, although no lots had been sold by developer

         Town of Southinghton v. Commercial Union Insurance Co.(7) involved the interpretation of a Connecticut statute governing the development of real estate subdivisions. The municipality, through its planning and zoning commission, had approved an industrial subdivision. The developer procured a "subdivision bond" but failed to complete the improvements required by his agreement with the town and declared bankruptcy. None of the...