Contractor Loses Bad Faith Argument Against Surety

Posted by: Hilger Hammond On: 18th January 2017 | no responses.

By Aileen Leipprandt

The Sixth Circuit Court of Appeals recently affirmed that a surety did not act in bad faith when it settled the claim of its principal contractor against the State of Michigan related to disputes on a prison construction project. Great American Ins. Co. v E.L. Bailey & Co., et. al. (November 2016).

In this case, the State hired E.L. Bailey & Company to construct a kitchen in a prison in Ypsilanti. Great American Insurance Company (GAIC) provided performance and payment bonds ensuring Bailey’s performance and payment to subcontractors. In turn, Bailey agreed to indemnify GAIC for payments or expenses GAIC incurred under the bonds and to post sufficient collateral to protect GAIC from claims. The indemnity agreement between Bailey and GAIC also gave GAIC the right to settle on Bailey’s behalf any claim concerning the prison contract.

Disputes arose on the project and Bailey never finished the work. The State and GAIC agreed to have another contractor complete the project. The State withheld payment to Bailey asserting liquidated damages (“LDs”) for Bailey’s failure to timely perform. Bailey disputed the LDs, blaming delays on the State and its architect. The parties sued each other in the Michigan Court of Claims (Lawsuit #1). On the eve of facilitation, GAIC informed Bailey that it had settled Bailey’s claims against the State, with the State agreeing to pay GAIC $358,000 as final payment under the construction contract.

At about the same time, some of Bailey’s subcontractors sued Bailey and GAIC in state court under the payment bonds for amounts due for work (Lawsuit #2). GAIC demanded that Bailey provide collateral for those claims, but Bailey refused. GAIC ultimately settled the subcontractor claims for $645,287.

In another separate proceeding (Lawsuit #3), GAIC sued Bailey in federal court seeking indemnity for Bailey’s failure to provide collateral for the subcontractor claims and requesting a declaratory judgment that GAIC had the right to settle Bailey’s claims against the State. Bailey raised a “bad faith” defense, arguing that GAIC’s settlement with the State was in bad faith because GAIC concealed its negotiations with the State until the eve of facilitation.

While the federal court generally agreed that GAIC’s undisclosed settlement negotiations raised concerns because it might deprive Bailey of the opportunity to consider its options appropriately, that fact alone did not establish bad faith. Rather, Bailey had to prove that GAIC was motivated by a selfish purpose or a desire to protect its own interest at the expense of Bailey. Bailey offered no evidence as to GAIC’s state of mind. The Court sided with the surety concluding that GAIC had a right to settle Bailey’s claims under the parties’ indemnity agreement and that GAIC had not acted in bad faith in doing so, particularly where communications between GAIC and the State established that GAIC pushed the State for a higher settlement amount.

Lesson learned – a surety’s rights under the general indemnity agreement with its principal contractor are expansive. A contractor should carefully evaluate its course of action on project disputes in the face of its broad reaching indemnity obligations.

Supplier Who Does Everything Right Wins Big on Payment Bond Claim

Posted by: Hilger Hammond On: 13th May 2016 | no responses.

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By Aileen Leipprandt

On May 3, 2016, in the case of Wyandotte Electric Supply Company v Electrical Technology Systems, Inc., the Michigan Supreme Court issued an important opinion regarding “notice” requirements under the Michigan Public Works Act (PWA). The case involved renovation of the Detroit Public Library. KEO & Associates was the general contractor and Westfield Insurance Company supplied KEO with a $1.3 million payment bond as required under PWA. KEO subcontracted with Electrical Technology Systems (ETS) who in turn subcontracted with Wyandotte Electrical Supply for material and supplies.

ETS and Wyandotte had agreed to an open account arrangement, pursuant to which ETS would be liable for attorney fees and time-price differential charges of 1.5% on past due amounts. A time-price differential charge is “the difference between the current cash price of an item and the cost of purchasing the item with credit. A payment made with cash is immediate; a payment made with credit is not. Thus, when a payment is made with credit, the seller [such as Wyandotte] is burdened by a cash-flow interruption. A time-price differential compensates for the increased cost to a seller for credit. It reflects the difference between the credit price and the cash price.”

When Wyandotte began working, Wyandotte sent letters to KEO and Westfield asking for a copy of the payment bond for the project. In accordance with the Public Works Act, Wyandotte then sent a timely 30-day “Notice of Furnishing” via certified mail to KEO, Westfield, ETS and the Library. All but KEO received the notice. The United Postal Service tracking indicated KEO’s certified letter was at the post office, however, the notice never reached its destination. Again, in accordance with the PWA, Wyandotte sent a timely 90-day furnishing after it completed its work.

ETS failed to pay Wyandotte so Wyandotte eventually sued KEO, Westfield and ETS. Apparently, by this time, ETS had gone out of business and the president of ETS had declared personal bankruptcy. KEO challenged Wyandotte’s bond claim, arguing that the claim was invalid because KEO did not receive the 30-day notice of furnishing. In essence, defendants asked the court to read an actual notice requirement into the Public Works Act. The trial court refused, and ruled the bond claim was valid. KEO also argued that Wyandotte could not recover the time-price differential charges and attorney fees. The trial court disagreed and awarded Wyandotte the balance claimed, plus time price differential charges, plus attorney fees, plus post judgment interest. The Court of Appeals affirmed.

KEO and Westfield appealed to the Supreme Court. The Supreme Court affirmed the lower courts’ rulings in nearly all respects. Importantly, the Supreme Court held that the Public Works Act did not contain an “actual” notice requirement. Instead, the Act only required that the claimant serve a copy of its bond claim in the manner required by the Act. In this case, there was no dispute that Wyandotte sent notice via certified mail, thus Wyandotte complied with the PWA, regardless of whether KEO actually received the notice. Furthermore, because Wyandotte’s contract with ETS allowed Wyandotte to recover attorney fees and time-price differential charges, those charges were “justly due” under the Public Works Act and recoverable against the Payment Bond.

Lessons learned – Timely and properly filing and serving bond claims is crucial to recovering under a Public Works payment bond. Equally important, fees incurred to enforce payment on past due accounts will be enforceable against the payment bond, provided the underlying contract contains such provisions.

A Potential Pothole in the Paving – Proposed Changes to Paving Warranty Obligations

Posted by: Hilger Hammond On: 16th September 2015 | no responses.

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By: Mark A. Rysberg

Over the last year, the state government and advocacy groups have attempted to find solutions for funding road construction and maintenance that had enough support to be enacted into law. Those efforts are continuing and the Legislature has approved various bills relating to funding improvements and maintenance to Michigan’s roads. Part of those discussions and legislature deserves some additional attention as it would implement changes to warranty requirements for public paving projects.

In that respect, House Bill 4613 would require MDOT, county road commissions, cities, and villages to obtain warranties from contractors for the full replacement or appropriate repair of paving projects that exceed $1.0 million. The scope of such warranties is not clear based on the language of the bill itself. As a result, warranty obligations may be defined by project specifications based on the estimated lifespan of the paving to be installed. While warranties are nothing new in the construction industry, this proposed legislation may impact the aggregate bonding capacity of contractors engaged in public transportation projects.

In public contracting, bonding capacity arises in the context of capacity per project and aggregate capacity. The bonding necessary for a specific project is largely dictated by the contract amount, which is a measure of the financial obligations owed by the bond principal to the owner or higher-tier contractor. To the extent warranty bonds are required, those obligations would compound existing payment and performance bond requirements increasing the amount of bonding necessary for a particular project. It would also decrease aggregate bonding capacity as warranty bonds would survive the completion of a project, which means that aggregate bonding capacity would be reduced by warranty bonds from projects completed years earlier.

Those issues could pose serious problems for contractors who are already at the upper limit of their bonding capacity. Although the future of House Bill 4613 is still uncertain, the issues of bonding and bonding capacity should be regularly evaluated. To that end, contractors performing bonded work should consider their bonding capacity and how impacts to bonding capacity can effect business operations. In that respect, bonding agents, accountants, and attorneys can provide insight to assist with maximizing and evaluating bonding capacity.

Surety’s Liability Limited to Amount of Performance Bond

Posted by: Hilger Hammond On: 28th October 2013 | one response.

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By Aileen Leipprandt

Michigan courts have consistently recognized that a surety issuing performance bonds for a construction project is only liable for the amount (“penal sum”) of the performance bond. This longstanding principle was recently affirmed by the Michigan Court of Appeals in Northline Excavating v County of Livingston, et al (October, 2013).

In Northline, Livingston County hired Northline Excavating to complete a sanitary sewer project. The parties’ contract included a liquidated damages provision. Northline and its surety, Hanover, executed a performance bond as required by the Michigan Public Works Act. Shortly after Northline began work, it encountered difficulty with construction. Northline and the County disputed whether the County disclosed the problematic conditions in the plans and specifications for the project. The parties could not agree as to how to proceed and the County eventually declared a contractor default and pursued a claim under Northline’s performance bond.

Hanover denied the claim and the County then sued Northline and Hanover. The principle issue as to the surety was whether its liability could exceed the penal sum of the bond. The County argued that because the bond allowed it to proceed with “any remedy available,” the bond could be interpreted to impose liability on Hanover for liquidated damages, actual damages and reasonable attorney fees beyond the bond amount. The trial court disagreed and limited the County’s recovery to the penal sum of the bond. The County appealed.

The Court of Appeals agreed with the trial court and declined to impose liability on Hanover in excess of the bond amount (and contrary to the general interpretation and understanding of performance bonds). Because the performance bond did not plainly express the parties’ intent to expand Hanover’s liability, the appellate court refused to presume such intent. Instead, the County’s right to pursue “any remedy” merely gave the County the right to pursue any type of cause of action, not unlimited damages.

What’s New in the New AIA A312 Payment and Performance Bonds?

Posted by: Hilger Hammond On: 19th May 2011 | no responses.

Performance Bonds

By Aileen Leipprandt
While historically construction professionals may have paid little attention to the fine print on AIA payment bonds, lean times in construction have triggered more payment bond claims than ever.  New in 2010, the American Institute of Architects (AIA) has issued revised bond forms, including revised Payment and Performance Bond, A312™-2010 and revised Bid Bond A310™-2010 (Bond Forms).  The AIA process of revising the A312™-1984 Performance and Payment Bonds and the A310™-1970 Bid Bond began in 2009 and included solicitation of input from various industry groups and consideration of court opinions interpreting the language of the bonds.  While the Bond Forms retain much of their original terms, there are several changes that clarify language and attempt to address the concerns of various stakeholders.  Of particular interest are the following noteworthy changes to the A312™-2010 Payment Bond.

Claimant.  The definition of “Claimant” has been expanded to include anyone who can file a construction lien.  Under A312™-1984, claimants were more narrowly defined to include only first and second tier subcontractors to the bond principal.

Surety Response.  A312™-1984 provided that the surety had 45 days to respond to a claim and state the basis for challenging any amounts that were in dispute.  The A312™-2010 now gives the surety 60 days to respond to a bond claim.

Surety Waiver of Defenses.  Some courts found that the surety’s failure to strictly comply with its reply obligations resulted in a waiver of the surety’s defenses under the bond.  A312™-2010 now provides that if the surety fails to respond within the 60-day time frame, such failure does not waive any defenses the surety may have.  If, however, the claimant has to bring a claim under the bond, and the claimant is successful on that claim, the surety must pay the claimant’s attorney fees, even if those attorney fees exceed the penal sum of the bond.

Detailed Claim.  Under A-312™-1984, a claimant initiated a claim against the bond by sending notice to the surety. That notice only had to state the amount of the claim, and in some circumstances, the name of the party to whom the claimant furnished labor and materials.  A-312™-2010, how defines “claim” and requires that the claim  contain certain specific information such as a copy of the contract or purchase order, the total amount claimant earned, and the total amount of previous payments the claimant received.  A letter to the surety generally describing claims and demands will not be sufficient to state a claim and to start the clock running on the surety’s 60-day time to respond.

The AIA also revised language in the performance bond to provide a more stream-lined process for making a claim under the bond and for defaulting the surety.  Likewise, the AIA modified the standard bid bond, A310™-2010, to include language that allows for up to a 60-day extension of time for acceptance of the bid specified in the bid documents.  The surety, however, must be notified and consent to any extension of the date for acceptance of the bid by more than 60 days in the aggregate.