Annual survey of fidelity and surety law, 1998 -- part II.

• Author: Linder, Charles W., Jr.

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

         Subcontractor entitled to collect from surety amounts due under subcontract's savings clause.

         The excavation and foundation work subcontract on a federal project included a savings clause providing that if the total subcontract amount did not exceed a certain sum, any savings realized would be divided equally between the contractor and the subcontractor. A rather substantial saving was accomplished, but the surety on the prime contract refused to pay the subcontractor the amount it claimed to have earned under that clause, arguing that such an amount was neither labor nor material covered by the Miller Act.

         The Ninth Circuit found that the plain language of the Miller Act made it clear such amounts were covered by the bond and affirmed a district's court's decision to that effect. Taylor Construction Inc. v. ABT Service Corp.(1)

         Change order that was consented to by surety's agent was not material alteration sufficient to discharge surety's obligation.

         In Am-Haul Carting Inc. v. Contractors Casualty and Surety Co.,(2) a surety argued that its obligation under a performance bond was so materially altered by a change order for blasting work, which added $250,000 to the contract, that the surety was discharged. A New York federal district court acknowledged that a surety could be discharged under its bond where the undertaking was materially altered without its consent. However, in this case, the surety's bonding agent had been notified of the change order, consented to it and confirmed his consent in writing.

      2. Procedural

         General contractor's declaration of subcontractor's default was not prohibited by stay order entered in subcontractor's bankruptcy proceeding.

         In Am-Haul Carting, the court also had to deal with the effect of an automatic stay entered by a bankruptcy court in connection with the subcontractor's bankruptcy.

         Shortly before trial, the parties settled the Miller Act claim, leaving only certain state law claims between the defendants. The court chose, in view of the extensive time already invested by it and the parties, to retain jurisdiction over the remaining claims. The surety argued that its obligations had not been triggered under the bond because of the declaration of default that occurred after an automatic stay order had been entered in connection with the bond obligee's bankruptcy.

         The court concluded, however, that the bonding company's obligations were triggered by default notification, that the surety had breached its obligations under the bond, and that it was liable for the consequences thereof.

         Ninety-day notice under Miller Act must be received by contractor and not merely mailed by subcontractor within period required by act.

         The rather straightforward decision in B & R Inc. v. Donald Lane Construction(3) was complicated somewhat by some procedural irregularities.

         The claimant filed suit in federal court under the Miller Act and sued the prime contractor, its surety, and a subcontractor for whom the claimant's work was actually performed. That subcontractor defaulted, and a judgment was entered against it. The plaintiff then filed a motion for summary judgment against the prime contractor and its surety. At that point, almost a year after the action had been filed, the prime and its surety moved to amend their answers in order to assert inadequacy of notice under the Miller Act.

         A fairly extensive discussion of the default situation resulted in a finding that the prime contractor and its surety were entitled to amend. The question then came down to whether the 90-day notice was sufficient. The notice was mailed on the 89th day and received on the 92nd day after the last day on which labor had been performed by the plaintiff.

         The Delaware district court found that the weight of authority favored the surety in this instance and required that the notice be received within 90 days.

         Claimant that proceeds under Federal Contracts Disputes Act cannot bring action under Miller Act for amounts in excess of those awarded under administrative law.

         In D'Ambra Construction Co. vs. St. Paul Mercury Insurance Co.(4) the district court for Rhode Island also had to cope with some rather complicated procedural problems.

         The U.S. Navy awarded the contract to build new buildings at a research facility in Rhode Island. Before the project was completed, however, the Navy notified the prime contractor that it was terminating the contract under its termination for convenience provision. The prime then terminated the subcontract and sponsored a class to explain the administrative procedures involved in making claims for payment following such a termination for convenience.

         The subcontractor chose to pursue its claim through the settlement process outlined in the Contract Disputes Act.(5) In doing so, the subcontractor was obligated to assert that the federal government was liable for the full amount of the claim and that it accurately reflected the contract adjustment for which the contractor believed the government to be liable. In the meantime, the subcontractor had filed suit under the Miller Act for a considerably increased amount it claimed was due under the contract and the bond.

         The federal court acknowledged that the dispute took place in the context of a complex administrative system in the federal government. But it further stated that the resolution of the conflict lay with the application of contract law fundamentals. It went on to note that the provisions of the subcontract created the process for resolution of disputes, and the claimant had utilized those provision to settle its claims against the government. In those circumstances, the court found the claimant to have agreed to accept such sums as were awarded in full settlement of its claims and that it would be held to its bargain.

   2. State and Local Bonds

      1. Substantive

         Surety for agreement by developer with city to build public improvements cannot escape liability by claiming "frustration of purpose" where project was later abandoned by developer.

         In City of Los Angeles v. Amwest Surety Co.,(6) a developer wishing to subdivide a parcel of real estate was required to obtain approval from the City of Los Angeles. In a written agreement, the city granted approval for the subdivision but did so in exchange for the subdivider's promise to build certain improvements, consisting of street lights and sidewalks. The agreement also required the developer to post a surety bond covering its obligations under the agreement.

         The bond was rather loose in its terminology and simply required the obligee to perform its agreement, and if it did so, the bonding company's obligation would become null and void, otherwise to remain in full force and effect. It did not condition the surety's obligation on proof that the development took place. As a matter of fact, the original developer chose not to go forward with his plans and eventually sold the property to another owner.

         The surety argued, relying on Section 265 of the Restatement (Second) of Contracts, that where, after a contract is made, a party's principal purpose is substantially frustrated without his fault by the occurrence of an event, the non-occurrence of which was a basic assumption on which the contract was made, that party's obligations under the contract would be discharged.

         The California Court of Appeal held, however, that the relevant contract was the bond, not the agreement with the city. It went on to conclude that there was no evidence the surety's obligation itself was frustrated by the default. Therefore, there was liability under its bond.

      2. Procedural

         Claimant not barred by failure to qualify as a foreign corporation, and its notices were adequate and timely.

         In Trestle & Tower Engineering Inc. v. Star Insurance Co.,(7) the supplier of materials to a bridge project in Topeka, Kansas, had failed to qualify as a foreign corporation. When it filed suit under the project's bond, the surety argued that it was precluded from maintaining the action by the terms of the Kansas qualification statutory authority. The claimant asserted, however, that it did not do business in Kansas and was not obligated to so qualify.

         The federal district court upheld the claimant and went on to hold that its notices under the statutory scheme were sufficient and that the bond covered equipment rentals.

         Time for bringing suit extended by parties' participation in arbitration.

         In a rather significant decision by the New York Appellate Division, the claimant initiated arbitration proceedings against the general contractor for whom the claimant had erected structural steel on a health care facility. The surety's attorneys appeared and participated in nine separate arbitration hearings. By the time the arbitration award had been confirmed by a New York court, however, the prime contractor had become insolvent. When the claimant demanded payment from the surety, its demands were rejected on the ground that it had not commenced an action on the bond within one year from the date that final payment became due under the contract, as required by state law.

         The court held, however, that the statute of limitations was measured form the date on which final payment under the subcontract became due, and that this did not occur until after the arbitration had been concluded. Windsor Metal Fabrications Ltd. v. General Accident Insurance Co.(8)

         Surety bond held to be statutory bond, not common law bond, despite additional obligations assumed by surety.

         The New York statute referred to in the preceding case allows one year after final payment for claimants to bring an action on the bonds. In A.C. Legnetto Construction Inc. v. Hartford Fire Insurance Co.,(9) the action under the bond was not brought until 20...