Annual survey of fidelity and surety law - 2003, Part I: this roundup of recent cases covers public and private construction bonds, financial institution bonds and sureties' remedies.

• Author: Brownstein, Bettina E.

1. PUBLIC CONSTRUCTION BONDS

   1. Bonds under Federal Laws

      Arbitration award on Miller Act claim against general contractor not subject to entry of judgment against surety, since award essentially was default judgment and surety had no opportunity to defend itself at arbitration hearing.

      In Frontier Construction Inc. v. Tri-State Management Co., (1) the U.S. District Court for the Northern District of Illinois ruled that an arbitration award on a Miller Act claim against a general contractor was not preclusive against the surety, since the award was essentially a default judgment and the surety did not have the opportunity to defend itself at the arbitration bearing.

      Tri-State was the general contractor on a U.S. Postal Service contract to expand a post office building, and it obtained a payment bond from North American Specialty Insurance Co. Frontier Construction was a subcontractor providing labor, equipment and material to Tri-State on the project. Frontier filed a Miller Act claim against Tri-State and North American for payment of $41,450, plus interest and attorneys' and arbitration fees. It made a contemporaneous demand for arbitration, based on the subcontract between it and Tri-State. After an arbitration at which Tri-State failed to appear, the arbitration panel entered an award against Tri-State. Frontier moved the court to confirm the award and enter judgment against both Tri-State and the surety.

      Tri-State also failed to appear in court to respond to the motion. North American appeared and, while not objecting to the confirmation of the award, did object to entry of judgment against it. Frontier conceded that North American was not bound by the subcontract to arbitrate and that the arbitration award did not mention the surety. However, Frontier advanced the preclusion doctrine, as developed in some federal decisions, in which subcontractors on public works projects obtained arbitration awards against general contractors. In subsequent Miller Act suits, the courts held the sureties liable for these awards.

      The Illinois federal court found that the preclusion doctrine was not well developed under either federal or Illinois law and that federal law was unclear as to whether and in what circumstances a Miller Act surety would be subject to the doctrine. It noted that the general rule is that a surety is bound by any judgment against its principal when the surety had knowledge of the action and an opportunity to defend it. But in this instance, while North American had notice of the arbitration, its lack of opportunity to present defenses, coupled with the fact that the award against Tri-state was in effect a default judgment, persuaded the court not to apply the preclusion doctrine.

      The court confirmed the arbitration award against Tri-state and entered judgment against it, but declined to do either as to North American.

   2. State and Local Bonds

      Combination of verbal and faxed information from subcontractor's supplier to general contractor was adequate to satisfy liberal notice requirement of Georgia Little Miller Act.

      Southern Electric Supply Co. v. Trend Construction Inc. (2) involved Georgia's Little Miller Act performance and payment bonds statute, O.C.G.A. [section] 36-82-1000 et seq. (repealed and re-enacted as O.C.G.A. [section] 13-10-60 et seq.).

      Trend Construction was the general contractor on a project to renovate a testing lab and lecture hall for Georgia Perimeter College Testing Center and Computer Training Center. It obtained performance and payment bonds from U.S.F. & G. under Georgia's Little Miller Act. Southern Electric, a supplier to a subcontractor, Georgia Electrical Contractors Inc., made a claim under the payment bond for Georgia Electric's failure to pay it for electrical supplies.

      The trial court denied Southern Electric's claim on the grounds that it had failed to provide proper written notice of its claim to Trend under the act and that the claim was time-barred because not filed within one year of the date the project had been substantially completed and accepted. Southern Electric appealed, and the Georgia Court of Appeals, conducting a de novo review, reversed.

      Southern Electric had submitted evidence that it had provided both verbal and faxed notice to George Electric that it owed Southern Electric $34,843. The faxed information included a list of invoices for materials ordered for use in the project.

      The court found that case law required the notice requirement to be liberally construed and that there was sufficient and timely notice (within 90 days of the last day on which Southern Electric furnished supplies) when there was written notice (not necessarily signed) from which, in connection with oral testimony, the nature and state of the indebtedness was made known to the contractor. Under this standard, Southern Electric's notice was adequate.

      In addition, the court held that there was a question of fact as to whether Southern Electric's lawsuit was timely. Under the state Little Miller Act, suit had to be instituted within one year from the completion of the actual construction work and the acceptance of the public work by the proper public authorities. There was conflicting evidence as to whether Trend had completed its original contract work more than one year before Southern filed suit. So summary judgment was not appropriate.

      General contractor-obligee on payment bond issued pursuant to Arizona's Little Miller Act not entitled to payment under bond for work it completed for defaulting subcontractor.

      Withers Construction was the general contractor in American Casualty Co. of Reading v. D.L. Withers Construction, (3) an obligee on a payment bond issued by American Casualty on behalf of an HVAC subcontractor, 1st Mechanical Inc., in connection with the construction of an Arizona high school. The payment bond defined "claimant" as "one having a direct contract with [Mechanical] for labor, material, or both, used or reasonably required for use in the performance of the contract."

      When Mechanical fell behind the construction schedule, Withers contracted with Midstate Mechanical to complete the HVAC system. American Casualty then filed a declaratory judgment action seeking a determination that Withers was not a proper claimant under the bond for its payments to Midstate because it also was a bond obligee. The trial court ruled that an obligee is not entitled to payments for labor and material when it completes the contract after a default.

      On appeal, the Arizona Court of Appeals discussed the purpose of a payment bond--to protect the obligee against the claims of unpaid subcontractors or suppliers--and contrasted it with a performance bond, which indemnifies the obligee for the principal's failure to perform a contract fully. The court affirmed that the type of bond does not determine who may make a claim against it; rather the bond terms control its beneficiaries. Analyzing the language of American Casualty bond, the court found that it could not be construed to serve also as a performance bond since it solely addressed a subcontractor's failure to pay laborers and materialmen and not a failure to perform the subcontract.

      In addition, the court decided that the bond's definition of "claimant" could not be construed to mean Withers, because the general contractor did not fit the definition of one having "direct contract" with Mechanical to supply labor or material to Mechanical. In fact, the court found Withers had the opposite of such a contract, and it affirmed the ruling of the trial court.

      Final settlement under North Carolina law occurs when amount proper government authority required to pay general contractor administratively fixed.

      In Cencomp Inc. v. Webcon Inc., (4) the North Carolina Court of Appeals affirmed a decision by the lower court denying the claims of subcontractors Cencomp and Ted Cihos against a payment bond obtained by the general contractor Webcon in connection with a city sewer line construction project, on the basis that they had not commenced their lawsuit within the time restrictions of Section 44A-28(b) of the North Carolina General Statutes, which states:

      No action on a payment bond shall be commenced after the expiration of the longer period of one year from the date on which the last of the labor was performed or material was furnished by the claimant, or one year from the day on which final settlement was made with the contractor. Under this statute of repose, as a condition precedent to any recovery, Cencomp and Cihos had the burden of proving that their claims were brought within the time constraints. They contended they had met this burden in that a settlement reached between Webcon and the city in September 1999 was not a "final" one since the city had retained approximately $50,000.

      The court disagreed, turning to federal law, including the Miller Act, for guidance to determine the meaning of "final settlement." The court found that the U.S. Supreme Court has decided that final settlement is not synonymous with final payment and instead occurs when the amount the government is required to pay is "administratively fixed" by the proper authority. (5) Applying this principle to the case before it, the court held that when the city administratively fixed the amount to pay Webcon in September 1999, this was a final settlement, and the fact that retainage was withheld past that date did not alter the situation. Since the subcontractors had not filed suit until December 2000, their claims were time-barred.

      Subcontractor failed to state claim under Pennsylvania law for constructive trust against surety since complaint failed to allege unjust enrichment and res to which surety had title or possession.

      Two elements must be pleaded to state a claim for constructive trust, according to the U.S. District Court for the Eastern District of Pennsylvania: unjust enrichment and an identifiable res to which the defendant holds title or...