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Fidelity & Surety Law Committee · Ivette Gualdron Zurich 236 Rue Landry Rd Saint Rose, LA...
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Uniting Plaintiff, Defense, Insurance, and Corporate Counsel to Advance the Civil Justice System THE REQUIREMENT OF ACTUAL PREJUDICE IN THE 2010 EDITION OF THE A312 PERFORMANCE BOND AND ITS EFFECT ON THE SURETY By: Alec M. Taylor and Burke Stough I. Introduction The American Institute of Architects (“AIA”) produces a variety of bond forms widely used throughout the construction industry. Owners, contractors, and sureties use these forms to establish the specific rights and obligations each party has with regard to payment and/or performance bonds. In 2010, the AIA updated one of its most popular performance bonds, the 1984 edition of the A312 bond (“A312-1984 Bond”). Among other revisions, the update modified the condition precedent to the surety’s obligation under Section 3.1 of the A312-1984 Bond, which requires the obligee to (a) notify the surety that the obligee is considering declaring the principal in default, and (b) attempt to arrange a conference with the surety “to discuss methods of performing the Construction Contract.” 1 Under the A312-1984 Bond, if the obligee failed to comply with the notice required in Section 3.1, sureties often were able to successfully argue that the bond obligations had not been triggered. The 2010 edition of the A312 bond (“A312-2010 Bond”), however, only releases a surety from liability for such failure to Continued on page 11 IN THIS ISSUE: Fidelity & Surety Law Committee The Requirement of Actual Prejudice in the 2010 Edition of the A312 Performance Bond and its Effect on the Surety .............. 1 Letter From The Chair ................. 5 New Bern Riverfront Development, LLC v. Weaver Cooke Construction, LLC: Can the Surety Really Be Liable When the Principal Is Not? ............................... 6 The Arizona Court Of Appeals Rejects Bad Faith Claim Against Little Miller Act Sureties .............................. 8 The Logistics of Payroll Tax Recovery..... 9 2017 TIPS Calendar ................... 18 Winter 2017 1 Am. Inst. of Architects, AIA Document A312, Performance Bond (1984).
Transcript of Fidelity & Surety Law Committee · Ivette Gualdron Zurich 236 Rue Landry Rd Saint Rose, LA...
Uniting Plaintiff, Defense, Insurance, and Corporate Counsel to Advance the Civil Justice System
THE REQUIREMENT OF ACTUAL PREJUDICE IN THE 2010 EDITION OF THE A312 PERFORMANCE BOND AND ITS EFFECT ON THE SURETYBy: Alec M. Taylor and Burke Stough
I. IntroductionThe American Institute of Architects (“AIA”)
produces a variety of bond forms widely used throughout the construction industry. Owners, contractors, and sureties use these forms to establish the specific rights and obligations each party has with regard to payment and/or performance bonds. In 2010, the AIA updated one of its most popular performance bonds, the 1984 edition of the A312 bond (“A312-1984 Bond”). Among other revisions, the update modified the condition precedent to the surety’s obligation under Section 3.1 of the A312-1984 Bond, which requires the obligee to (a) notify the surety that the obligee is considering declaring the principal in default, and (b) attempt to arrange a conference with the surety “to discuss methods of performing the Construction Contract.”1 Under the A312-1984 Bond, if the obligee failed to comply with the notice required in Section 3.1, sureties often were able to successfully argue that
the bond obligations had not been triggered. The 2010 edition of the A312 bond (“A312-2010 Bond”), however, only releases a surety from liability for such failure to
Continued on page 11
IN THIS ISSUE:
Fidelity & Surety Law Committee
The Requirement of Actual Prejudice in the 2010 Edition of the A312 Performance Bond and its Effect on the Surety . . . . . . . . . . . . . . 1Letter From The Chair . . . . . . . . . . . . . . . . . 5New Bern Riverfront Development, LLC v. Weaver Cooke Construction, LLC: Can the Surety Really Be Liable When the Principal Is Not? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6The Arizona Court Of Appeals Rejects Bad Faith Claim Against Little Miller Act Sureties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8The Logistics of Payroll Tax Recovery. . . . . 92017 TIPS Calendar . . . . . . . . . . . . . . . . . . . 18
Winter 2017
1 Am. Inst. of Architects, AIA Document A312, Performance Bond (1984).
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Fidelity & Surety Law Committee Newsletter Winter 2017
ChairAdam Friedman
Chiesa Shahinian & Giantomasi PCOne Boland Drive
West Orange, NJ 07052(973) 530-2029
Fax: (973) [email protected]
Chair-ElectToni Reed
Strasburger & Price LLP901 Main St, Ste 4400Dallas, TX 75202-3729
(214) 651-4345Fax: (214) 659-4091
Council RepresentativeSam PoteetManier & Herod
150 4th Ave N, Ste 2200Nashville, TN 37219
(615) 742-9321Fax: (615) 242-4203
Diversity Vice-ChairIvette Gualdron
Zurich236 Rue Landry Rd
Saint Rose, LA 70087-3666(504) 471-2676
Fax: (504) [email protected]
Immediate Past ChairGary Valeriano
Anderson McPharlin & Conners LLP
707 Wilshire Boulevard, Ste 4000Los Angeles, CA 90017-3623
(213) 688-0080Fax: (213) 622-7594
NewsletterEditors-in-Chief
Omar HarbAlber Frank, PC
2301 W. Big Beaver Rd., Ste 300Troy, MI 48084-6190
(248) 282-8111Fax: (248) 822-6191
Todd BragginsErnstrom & Dreste LLP
925 Clinton SqRochester, NY 14604-1708
(585) 473-3100Fax: (585) 473-3113
John SebastianWatt Tieder Hoffar & Fitzgerald LLP
10 S Wacker Dr, Ste 2935Chicago, IL 60606-7411
(312) 219-6900Fax: (312) 559-2758
NewsletterExecutive EditorChristopher Ward
Strasburger & Price LLP2600 Dallas Parkway, Ste 600
Frisco, TX 75034-1872(214) 651-4722
Fax: (214) [email protected]
Membership Vice-ChairScott Olson
SureTec Insurance Co9737 Great Hills Trl, Ste 320
Austin, TX 78759-6418(512) 732-0099
Fax: (512) [email protected]
Scope LiaisonDavid Olson
Frost Brown Todd LLC301 E 4th St, Ste 3300
Cincinnati, OH 45202-4257(513) 651-6905
Fax: (513) [email protected]
Technology Vice-ChairMark Krone
Anderson McPharlin & Conners LLP
707 Wilshire Blvd, Ste 4000Los Angeles, CA 90017-3623
(213) 688-0080Fax: (213) 622-7594
Vice-ChairsTheodore Baum
McElroy Deutsch et al920 Bausch & Lomb Place
Rochester, NY 14604(585) 623-4286
Fax: (585) [email protected]
Ashley BelleauLugenbuhl, Wheaton, Peck, Rankin
& Hubbard601 Poydras St, Ste 2775New Orleans, LA 70130
(504) 568-1990Fax: (504) [email protected]
Robert BerensSalamirad Morrow Timpane & Dunn
2001 E Campbell Ave, Ste 203Phoenix, AZ 85016-5574
(602) [email protected]
Amy BernadasKrebs Farley, PLLC
400 Poydras St, Ste 2500New Orleans, LA 70130-3224
(504) 299-3570Fax: (504) 299-3582
Lisa BlockAxis Insurance
1211 Avenue of The Americas 24th Fl
New York, NY 10036(212) 500-7689
JoAnne BonacciDreifuss Bonacci & Parker PC
26 Columbia Tpke, Ste 101Florham Park, NJ 07932
(973) 514-1414Fax: (973) 514-5959
Virginia BoyleLiberty Mutual Group1425 Kershaw DriveRaleigh, NC 27609
(610) 858-2433Fax: (610) 828-4684
Todd BragginsErnstrom & Dreste LLP
925 Clinton SqRochester, NY 14604-1708
(585) 473-3100Fax: (585) 473-3113
Lee BrewerBryan & Brewer LLC
355 E Campus View Blvd, Ste 100Columbus, OH 43235-5616(614) 228-6131 EXT 203
Fax: (614) [email protected]
Shannon BrigliaBrigliaMcLaughlin PLLC
1950 Old Gallows Rd, Ste 750Vienna, VA 22182-4014
(703) 506-1990Fax: (703) 506-1140
Elizabeth CarleyCincinnati Insurance Company
PO Box 145496Cincinnati, OH 45250-5496
(513) 870-2173Fax: (513) 371-7252
[email protected] Carozza
Selective Ins Co of Amer40 Wantage Ave
Branchville, NJ 07890(973) 948-1823
Fax: (866) [email protected]
Paula-Lee ChambersHinshaw & Culbertson LLP
28 State St, Fl 24Boston, MA 02109-5709
(617) 213-7000Fax: (617) 213-7001
Andy ChambersJennings Strouss & Salmon PLC
1 E Washington St, Ste 1900Phoenix, AZ 85004-2554
(602) 262-5846Fax: (602) 495-2728
Bogda ClarkeNationwide Insurance
250 Greenwich St, Fl 37New York, NY 10007-2140
(212) 329-6977Fax: (732) 805-2395
Bruce CorriveauTravelers
111 Schilling RdHunt Valley, MD 21031-1110
(443) 353-2076Fax: (410) 205-0608
James DiwikSedgwick LLP
333 Bush St, Fl 30San Francisco, CA 94104-2834
(415) 781-7900Fax: (415) 781-2635
Jennifer FioreDunlap Fiore LLC
301 Main St, Ste 1100Baton Rouge, LA 70801-1916
(225) 282-0652Fax: (225) 282-0680
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Fidelity & Surety Law Committee Newsletter Winter 2017
Robert FlowersTravelers
1 Tower Sq, Ste S202AHartford, CT 06183-0001
(860) 277-7150Fax: (860) 277-5722
Jeffrey FrankAlber Frank, PC
2301 W Big Beaver Rd, Ste 300Troy, MI 48084-3326
(248) 822-6190Fax: (248) 822-6191
Melissa GardnerWeinstein Radcliff Pipkin LLP8350 N Central Expy, # 1550
Dallas, TX 75206-1600(214) 865-7020
Fax: (469) [email protected]
Jeffrey GoldbergSWISSRE
475 N Martingale Rd, Ste 850Schaumburg, IL 60173-2276
(847) 273-1268Fax: (847) 273-1260
Manju GuptaMcDonald Hopkins LLC
600 Superior Ave E, Ste 2100Cleveland, OH 44114-2690
(216) 973-4453Fax: (216) 348-5474
Leigh HenicanGray Casualty & Surety Company
3625 N I-10 Service RdMetairie, LA 70002
(504) [email protected]
Mike HenniganCincinnati Insurance Company
6200 S Gilmore RdFairfield, OH 45014-5100
(513) 870-2736Fax: (513) 881-8913
Hilary HoffmanChubb
150 Allen Road, Ste 101Basking Ridge, NJ 07920
(908) [email protected]
Marchelle HoustonTravelers Bond & Specialty
Insurance1 Tower Sq, Ste 2S2
Hartford, CT 06183-0002(860) 277-2408
Fax: (860) [email protected]
Michael HurleyBerkley Surety Group LLC
412 Mount Kemble Ave, Ste 310NMorristown, NJ 07960-6669
(973) 775-5040Fax: (973) 775-5204
Susan KarlanICW Group - OPRS
15025 Innovation DrSan Diego, CA 92128
(858) 350-7213Fax: (858) 350-2640
Peter KarneySWISSRE
475 N Martingale Rd, Ste 850Schaumburg, IL 60173-2276
(847) 273-1259Fax: (847) 273-1260
Todd KazlowKazlow & Fields LLC
8100 Sandpiper Cir, Ste 204Baltimore, MD 21236-4999
(410) 825-9644Fax: (410) 825-6466
James KeatingAllied World Insurance Company
30 South 17th Street, 16th FlPhiladelphia, PA 19103
(267) [email protected]
Christina KockeMerchants Bonding Company
215 Savanna DriveLuling, LA 70070(504) 417-5164
Frank LanakHCC Surety Group
601 S Figueroa St, Ste 1600Los Angeles, CA 90017-5721
(310) 242-4403Fax: (310) 649-0891
Darrell LeonardZurich
11074 Inspiration CirDublin, CA 94568-5530
(800) 654-5155Fax: (800) 329-6105
Lawrence LernerLevy Craig Law Firm1301 Oak St, Ste 500
Kansas City, MO 64106-2865(816) 460-1807
Fax: (816) [email protected]
William LutzStarr Companies
1000 Wilshire Blvd, 22nd FlLos Angeles, CA 90017
(213) [email protected]
John McDevittLiberty Mutual Group
20 Riverside RdWeston, MA 02493-2206
(617) 243-7918Fax: (866) 547-4882
Mary Alice McNamaraTravelers
111 Schilling RdHunt Valley, MD 21031-1110
(443) 353-2130Fax: (443) 353-1137
Henry MinissaleACE USA
436 Walnut St, WA10Philadelphia, PA 19106
(215) 640-2641Fax: (215) 640-5474
Vincent MiseoVincent C Miseo
211 Washington Corner RdBernardsville, NJ 07924
(201) [email protected]
Caryn Mohan-MaxfieldThe Walsh Group929 W Adams St
Chicago, IL 60607-3037(312) 563-5936
Shannah Morris6645 Ashe Knoll
Liberty Township, OH 45011(513) 503-6136
Fax: (513) [email protected]
Robert O’BrienLiberty Mutual Group
9450 Seward RdFairfield, OH 45014-5412
(513) 867-3718Fax: (866) 442-4060
Derek PopeilChubb
15 Mountain View RdWarren, NJ 07059(908) 903-3182
Fax: (908) [email protected]
Stephen RaeLiberty Mutual Group
2200 Renaissance Blvd, Ste 400King Of Prussia, PA 19406-2755
(610) 832-8254Fax: (610) 940-9112
Fred RettigState Farm Insurance
One State Farm Plaza A-3Bloomington, IL 61710-0001
(309) [email protected]
John RiddleStrasburger & Price LLP901 Main St, Ste 6000Dallas, TX 75202-3729
(214) 651-4672Fax: (214) 659-4038
Kenneth RockenbachLiberty Mutual Group1001 4th Ave, 17th Fl
Seattle, WA 98154(206) 473-3350
Fax: (855) 318-4099kenneth.rockenbach@libertymu-
tual.com
Edward RubachaJennings Haug & Cunningham LLP
2800 N Central Ave, Ste 1800Phoenix, AZ 85004-1049
(602) 234-7800Fax: (602) 277-5595
[email protected] SebastianWatt Tieder Hoffar & Fitzgerald LLP
10 S Wacker Dr, Ste 2935Chicago, IL 60606-7411
(312) 219-6900Fax: (312) 559-2758
Jan SokolStewart Sokol & Larkin LLC2300 SW 1st Ave, Ste 200Portland, OR 97201-5047
(503) 221-0699Fax: (503) [email protected]
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Fidelity & Surety Law Committee Newsletter Winter 2017
Scott SpearingHermes Netburn O’Connor &
Spearing PC265 Franklin St, Fl 7
Boston, MA 02110-3113(617) 728-0050
Fax: (617) [email protected]
W SpeicherZurich
3787 Sells Mill RdTaneytown, MD 21787
(410) 840-9144Fax: (800) 329-6106
Michael SpinelliCashin Spinelli & Ferretti LLC
22 Tanwood DriveMassapequa, NY 11758
Fax: (631) [email protected]
Michael StoverWright Constable & Skeen LLP
7 St Paul St, Fl 18Baltimore, MD 21202
(410) 659-1321Fax: (410) 659-1350
Dee StudlerSDC CPAs LLC
1444 N Farnsworth Ave, Ste 500Aurora, IL 60505-1644
(630) 820-5770Fax: (630) 820-5765
Frank TanzolaInternational Fidelity Insurance Company1 Newark Ctr, Fl 20
Newark, NJ 07102-5219(973) 776-8770
Fax: (973) [email protected]
Ty ThompsonMills Paskert Divers
100 N Tampa St, Ste 3700Tampa, FL 33602-5835
(813) 229-3500Fax: (813) 229-3502
Richard TowleChubb Limited
15 Mountainview RdWarren, NJ 07059-6795
(908) 903-3423Fax: (908) [email protected]
Thomas VollbrechtFabyanske Westra Hart
& Thomson P.A.333 S 7th St, Ste 2600
Minneapolis, MN 55402-2437(612) 359-7659
Patricia WagerTorre Lentz Gamell Gary
& Rittmaster LLP100 Jericho Quadrangle, Ste 309
Jericho, NY 11753-2702(516) 240-8969
Fax: (516) [email protected]
Courtney WalkerBerkshire Hathaway Specialty Insurance4539 Laurelwood Dr
Memphis, TN 38117-3507(617) 834-8652
Justin WearManier & Herod
150 4th Ave N, Ste 2200Nashville, TN 37219-2494
(615) 244-0030Fax: (615) 242-4203
Michael WeberDinsmore & Shohl LLP
227 W Monroe St, Ste 3850Chicago, IL 60606(312) 775-1742
Fax: (312) [email protected]
Blake WilcoxLiberty Mutual Group
1001 Fourth Avenue, Fl 47Seattle, WA 98154
(206) 473-3264Fax: (425) 376-6533
Douglas WillsChubb
436 Walnut Street, WA10APhiladelphia, PA 19106
(215) 640-1835Fax: (908) [email protected]
©2017 American Bar Association, Tort Trial & Insurance Practice Section, 321 North Clark Street, Chicago, Illinois 60654; (312) 988-5607. All rights reserved.
The opinions herein are the authors’ and do not necessarily represent the views or policies of the ABA, TIPS or the Fidelity and Surety Law Committee. Articles should not be reproduced without written permission from the Copyrights & Contracts office ([email protected]).
Editorial Policy: This Newsletter publishes information of interest to members of the Fidelity and Surety Law Committee of the Tort Trial & Insurance Practice Section of the American Bar Association — including reports, personal opinions, practice news, developing law and practice tips by the membership, as well as contributions of interest by nonmembers. Neither the ABA, the Section, the Committee, nor the Editors endorse the content or accuracy of any specific legal, personal, or other opinion, proposal or authority.
Copies may be requested by contacting the ABA at the address and telephone number listed above.
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Fidelity & Surety Law Committee Newsletter Winter 2017
Dear FSLC Members:
Happy New Year! I write this “Letter from the Chair” having just returned from the 2017 Mid-Winter Meeting at the Roosevelt Hotel in New Orleans. We had a great turnout – consistent with our attendance in New York last year – and I thank everyone who made the trip and supported the program. Thank you to our program co-chairs for two days of outstanding programming: John Cullen and Melissa Gardner for the fidelity program; Stacy Hipsak-Goetz, John Gillum, and Matt Bouchard for the Thursday construction program; and Sharon Edwards, Dave Kash, and Ty Thompson for the Friday surety program. I have received nothing about positive feedback about the programs and the location.
Please allow me to take this opportunity to thank, once again, the co-chairs of the Fall Meeting, Megan Manogue and Joel Wiegert, as well as all of the presenters and the many FSLC members who attended the Fall Meeting in Chicago. The feedback that I have received regarding both the presentations and the meeting’s new location similarly has been overwhelmingly positive.
The next FSLC meeting on the schedule is the Spring Meeting, which will be at the Ritz-Carlton Golf Resort (Tiburon) in Naples, Florida, from May 10-12. The focus of the spring program will be a new FSLC publication entitled “The Annotated Standard Performance Bond”. The idea for this program and publication stems from similar publications from the fidelity side of the FSLC relating to standard fidelity bond forms, and which I have found particularly useful in my practice. The program’s co-chairs, Patrick Laverty and Cindy Rodgers-Waire, have been working hard on putting together a program that will be both substantively valuable and entertaining. Please plan on joining us in Naples – and if you have an interest in getting involved in the workings of the FSLC, please include Saturday morning’s leadership meeting in your plans.
Finally, as you may know, the FSLC’s charitable efforts for 2016-17 involve a partnership with one of our strong supporters on the company side – Liberty Mutual Surety – in furtherance of the important work of the Muscular Dystrophy Association. The MDA was with us in New Orleans to explain further what they do and how we can help – we will circulate this information for the benefit of those who could not be with us in New Orleans. I hope you will join Liberty, the FSLC, and me in supporting the MDA’s vital mission.
Thanks for reading, and I look forward to seeing you in Naples for the Spring Meeting.
Adam P. FriedmanChiesa Shahinian & Giantomasi PCChair, FSLC
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Fidelity & Surety Law Committee Newsletter Winter 2017
NEW BERN RIVERFRONT DEVELOPMENT, LLC V. WEAVER COOKE CONSTRUCTION, LLC: CAN THE SURETY REALLY BE LIABLE WHEN THE PRINCIPAL IS NOT?By: Joseph A. Brophy and John Fouhy
Because su re t ysh ip
guarantees the performance of a principal obligor’s obligation, one of suretyship’s core principles is that the liability of the surety is measured by, and is coextensive with, the liability of the principal for that underlying obligation.1 Just as with any other contract, the damages for the principal’s breach of a bonded contract should put the obligee in the same position in which it would have been had the principal performed as it was obligated to perform. The obligee should not receive anything more than what it bargained to receive from the principal.
A 2014 bankruptcy court decision provides an important example of how courts can reach the wrong result by narrowly focusing on bond language without considering or understanding the broader suretyship context in which that language must necessarily be read and understood. New Bern Riverfront Development, LLC v. Weaver Cooke Construction, LLC (In re New Bern Riverfront Development, LLC)2 involved a performance bond claim arising out of a construction project. It was undisputed that the bonded construction contract between the principal and obligee contained a mutual waiver of consequential damages. The bond (AIA A312 – 1984) contained language stating that “[i]f the Surety does not proceed as provided in Paragraph 4 with reasonable promptness . . . the Owner shall be entitled to enforce any remedy available to the Owner.” The bond further provided that the surety would be responsible for “additional legal, design professional and delay costs” resulting from a breach of the bond. After the principal defaulted, the obligee sought
consequential damages from the surety based on that language in the bond.
The court in New Bern denied the surety’s motion for summary judgment on the issue of consequential damages.3 The court accepted the obligee’s argument that, although the underlying contract contained a mutual waiver of consequential damages, the bond itself contained no such waiver.4 The court reasoned that the bond imposed obligations on the surety independent of the obligations contained in the bonded contract.5 These independent obligations included taking action upon the principal’s default by arranging for the principal to complete the work, completing the work itself, finding a completion contractor, or tendering payment to the obligee.6 The surety therefore could be liable for consequential damages from the breach of these supposedly independent obligations even though the principal would not be liable for those damages.7
After the surety filed a motion for reconsideration, the bankruptcy court overturned its prior ruling and granted summary judgment to the surety based on what one may term a “technicality” unrelated to suretyship law.8 Despite the fact that it was set aside, the original decision may prove problematic for the surety industry because the opinion is published, and therefore may be cited by other courts to support the claim that a surety’s liability may be more than the principal’s, or that the principal’s defenses are not always available to protect the surety. This problem is compounded by the fact that, although the ruling was overturned, there is no indication of that fact when reviewing the case on Westlaw or Lexis.
Continued on page 15
1 Wellington Power Corp. v. CNA Sur. Corp., 614 S.E.2d 680, 687-88 (W. Va. 2005).2 521 B.R. 718 (Bankr. E.D. N.C. 2014).3 New Bern, 521 B.R. at 725.4 Id. 5 Id. 6 Id. at 724-25.7 Id. at 725.8 In granting the surety’s motion to reconsider, the bankruptcy court did not reach the surety’s argument that the decision was incorrect on the law due to the coextensive liability principle. The bankruptcy court ruled in favor of the surety based on the fact that the claimant had not timely pled consequential damages. Therefore, the New Bern case ultimately did not result in an award of consequential damages and does not provide an example of a surety being required to pay more than what was required by the bonded contract. Order Allowing Mot. for Recons. and Allowing Travelers’ Mot. for Partial Summ. J. as to Consequential Damages, New Bern, 521 B.R. 718 (No. 10-00023-8-SWH), ECF No. 1137.
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Fidelity & Surety Law Committee Newsletter Winter 2017
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Fidelity & Surety Law Committee Newsletter Winter 2017
THE ARIZONA COURT OF APPEALS REJECTS BAD FAITH CLAIM AGAINST LITTLE MILLER ACT SURETIES.By: Chad L. Schexnayder and Robert John Lamb
In a re-cent deci-sion, S & S Paving &
Const., Inc. v. Berkley Reg’l Ins. Co., the Arizona Court of Appeals held that a surety on a Little Miller Act payment bond may never be sued for bad faith.1 While the opinion is important for this holding alone, it is also significant because it distinguished the oft-cited 1989 decision in Dodge v. Fidelity & Deposit Co. of Mary-land,2 an opinion frequently encountered by sureties in briefing outside of Arizona on bad faith issues.
The S & S Paving DecisionIn S & S Paving, the plaintiff/subcontractor
had submitted a claim to the surety for work that it purportedly performed for the bonded general contractor on a public works construction project. The surety acknowledged receipt of the claim and indicated that it would investigate the claim, while expressly stating that it was not waiving any rights, interests, or defenses. The surety thereafter contacted the general contractor, which communicated a defense to the claim. The subcontractor did not follow up with the surety until well after the one-year statute of limitations on the Little Miller Act3 claim had passed, at which point the surety denied the claim as untimely.
The subcontractor eventually filed a lawsuit against the surety, alleging breach of contract4 and bad faith. The trial court granted the surety’s motion for summary judgment on the bad faith claim, finding that there was “no material question of fact that would give rise to an inference of the type of contractual relationship or special relationship for the [bad faith] claim to survive.”5
The subcontractor appealed to the Arizona Court of Appeals. The Arizona Court of Appeals affirmed, and the subcontractor did not petition for the Arizona Supreme Court to review.
In affirming the dismissal of the bad faith claim, the Arizona Court of Appeals did not focus on the obvious absence of a special relationship between claimant and surety in the statutory bond context, as the trial court had done. Instead, the court focused on the blanket inappropriateness of any bad faith claim in this context. The court refused to “graft a common law remedy onto a statutory scheme that includes within its ambit both the availability of complete relief and specific conditions precedent to recovery.”6 The court found that both the surety’s liability and the subcontractor’s right to a recovery were limited by the statute and the conditions precedent therein.7 “But for [the subcontractor’s] failure to timely file suit, [it] had a complete and valid remedy.”8 When a statute provides a complete and valid remedy, the statute is to be considered exclusive, so the subcontractor could not have a bad faith claim.9
The Bad Faith Cause of Action Recognized in Dodge is Distinguished and Limited
In 1989, the Arizona Supreme Court, in Dodge, held that a surety on a private residential performance bond could be liable for bad faith to the homeowner obligee.10 Claimants throughout the country have been willing to ignore the unique circumstances of the case in an attempt to use the case to support a universally applicable cause of action for bad faith against a surety. Some twenty-seven years later, the Arizona Court of Appeals in S&S Paving has now confirmed the limited
Continued on page 17
1 372 P.3d 1036, 1037 (Ariz. Ct. App. 2016).2 778 P.2d 1240 (Ariz. 1989).3 Ariz. rev. StAt. (“A.R.S.”) § 34-223 (B).4 The surety successfully argued to the trial court that the breach-of-contract claim was merely a statutory Little Miller Act claim that was barred by the statute of limitations. That ruling was not appealed. 5 Minute Entry, S & S Paving & Const., Inc. v. Berkley Reg’l Ins. Co., Maricopa County Superior Court Case No. CV 2013-055438 (January 22, 2015).6 S&S Paving, 372 P.3d at 1038, 1039.7 Id.8 Id. 372 P.3d at 1039. 9 Id. 10 Dodge, 778 P.2d at 1241.
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THE LOGISTICS OF PAYROLL TAX RECOVERYBy: Amy Borbely, CPA, SDC CPAs, LLC
Employee theft or employee dishonesty claims often include not just the amount of money received by the employee (“Net Pay”), but also deductions from the employee’s gross pay, as well as payroll taxes paid by the employer. Assuming a covered loss is determined, can employers recoup from the IRS payroll taxes for employee dishonesty/employee theft claims involving unauthorized or excessive payroll? And if so, how?
1. The BasicsIn most instances, employee theft or employee
dishonesty claims involving misappropriated payroll amounts are submitted with the gross pay amount claimed including payroll taxes paid by the employer. However, the net pay amount of allegedly misappropriated paychecks represents the direct loss amount. Payroll taxes and other deductions represent indirect loss amounts, which are often recoverable by the insured from the IRS and state and local taxing entities. As such, settlements with the insured for these claims typically exclude indirect loss amounts and thus exclude payroll taxes and other deductions.
So what amounts and types of payroll taxes and deductions are included in gross pay? It varies. The following is a general illustration of typical tax deductions made to the gross payroll amount to arrive at an employee’s net pay:
Gross Pay $2,500.00 Less: Employee’s Deduction
Federal Withholding Taxes (Assume 15.00%) 375.00
FICA (Social Security Tax 6.20%) 155.00Medicare Tax (1.45%) 36.25State Tax (Assume 3.00%) 75.00
Total Deductions for Employee 641.25
Net Paycheck to Employee $1,858.75
Employer’s FICA & Medicare Portion $191.25
In this illustration, the amount claimed by the insured against the insurer will be $2,691.25 ($2,500.00 + $191.25) which is the net pay received by the employee plus:
(a) the deductions from the employee’s gross pay transmitted by the employer to a third-party;
(b) the matching OASDI (Social Security) and Medicare taxes paid by the employer; and
(c) perhaps also Federal and state unemployment taxes (FUTA for Federal and SUTA for state) paid by the employer.
It should be noted that there may be other deductions from an employee’s gross pay not addressed here, such as union dues, medical insurance, and other payments made by the employer. Assuming employee dishonesty coverage exists, the settlement amount for this illustrated claim would exclude the recoverable taxes (indirect loss) and would be equal to the net pay amount of $1,858.75. Given the inability to recover these indirect losses from the insurer, how can excluded payroll taxes be recovered by the insured from taxing authorities?
2. Who Qualifies for Recovery of Payroll Taxes?Employers are responsible for paying the payroll
taxes to the IRS when it is legitimately earned payroll. If the payments are not for legitimate payroll, the employer can have the payroll taxes returned. These payments are initially made to the IRS with a Form 941. Form 941 is filed quarterly with the IRS and shows the employer’s tax liability for each month of the quarter for all employees. Form 941 reports withholding taxes, Social Security (employee and employer), and Medicare (employee and employer) taxes. Form 940 is used to report FUTA (Federal Unemployment Taxes) and is filed annually. State income tax withholding and unemployment filings and payments vary by state.
The business itself (the insured) can file corrections. An insurance company that is subrogated or assigned to the insured’s rights cannot file corrections for a refund of overpaid payroll taxes unless they have a Power of Attorney. Taxing entities will issue refund payments or credits to be applied to future tax liabilities only to the taxpayer (insured). If the insurer pays the gross amount of the claim (including indirect losses), the carrier would have to obtain reimbursement from the insured for any such refund payments or credits issued by the taxing entities.
3. How to Apply for a Refund of Overpaid Payroll Taxes
If an employee’s gross pay was never actually earned, the payroll taxes withheld and paid related
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to the unearned gross pay are considered “overpaid” payroll tax. If payroll taxes are overpaid, an employer may obtain a refund or credit for such taxes paid within the previous three years (36 months).
• Overpaid Federal Unemployment Taxes
• One must use the Form 940 for the year being revised to amend an incorrect Form 940.
• Overpaid Federal Income Taxes, Social Security Taxes and Medicare Taxes
• Form 941-X is used to correct a prior quarterly report.
• File a separate Form 941-X for each Form 941 that is being corrected to request refunds or credits.
• Form 941-X should be filed separately, and not with Form 941.
• Beginning in 2015, employee consents are required to support a claim for a refund. Corrected W-3s (W-3Cs) and corrected W-2s (W-2Cs) should be filed with the Social Security Administration for each year affected by the Form 941-X filed with the IRS. W-2Cs require the payee’s name, address and Social Security number. (Individuals who may have filed erroneous tax returns will be responsible for their own income tax withholding liability.)
• A Form 1099 should be issued to individuals who received monies (excess payroll) from the Insured as the individuals owe income taxes.
• Overpaid State Taxes
• State forms will be different, but generally follow the IRS model for income, unemployment, etc.
4. LimitationsTypically, there is a three-year statute of limitations.
As the tax is paid quarterly, the time period for
claiming a refund is three years from the original date a quarterly return is filed (or from the date the original quarterly return was due if it was not filed on-time.) This means every three months the insured does not file the necessary amended returns, the amount of payroll taxes that could be recovered is reduced. As the claim on the insurance policy proceeds since the date of discovery, the quarterly tax periods pass and may exceed the time limit to be amended and recovered. In some cases, though, the IRS has allowed amendments up to five years.
5. Other Avenues of RecoveryThe above procedures are applicable to refunds or
credits requested through the IRS. It is possible other payroll expenses not addressed here, such as medical payments and union dues paid by the employer, can be recovered directly from the applicable entity.
6. Resources• For help in completing Form 941-X, call the IRS
Toll Free number at 1-900-829-4933.
• Additional help for completing Form 941-X may also be obtained from IRS Publication 15 (Circular E), Employer’s Tax Guide and the Instructions for Form 941-X. Both documents can be downloaded from the IRS website: http://www.irs.gov/.
• Other information and resources are also available at http://www.irs.gov.
When considering employee theft or employee dishonesty claims involving covered losses for misappropriated payroll amounts, it is important to remember the claimed amount often includes payroll taxes and other deductions, which are indirect losses recoverable by the insured. Requirements and limitations to recovering overpaid payroll taxes will vary with the different taxing agencies of the federal, state and local governments. Timely filings are critical for maximum payroll tax recovery by the insured when the covered loss spans multiple years.
Amy Borbely is a Certified Public Accountant and Independent Adjuster at SDC CPAs, LLC in Aurora, Illinois.
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comply with Section 3.1 if the surety can show actual prejudice. This article will discuss this distinction and examine instances in which courts have found that a surety/insurer suffered actual prejudice due to the failure of providing proper notice.
II. Notice as a Condition Precedent under the A312-1984 Bond
Section 3.1 of the A312-1984 Bond explicitly requires that the obligee give notice to the surety prior to defaulting the principal on the project. Specifically, the language states that a surety’s obligation under the bond does not arise until after proper notice is given. Section 3.1 reads as follows:
3. If there is no Owner Default, the Surety’s obligation under this Bond shall arise after:
3.1 The Owner has notified the Contractor and the Surety at its address described in Paragraph 10 below that that the Owner is considering declaring a Contractor Default and has requested and attempted to arrange a conference with the Contractor and the Surety to be held not later than fifteen days after receipt of such notice to discuss methods of performing the Construction Contract. If the Owner, the Contractor, and the Surety agree, the Surety shall be allowed a reasonable time to perform the Construction Contract, but such an agreement shall not waive the Owner’s right, if any subsequently to declare a Contractor Default . . . .2
Because of the prefatory language stating that “the Surety’s obligation under this Bond shall arise after” certain events take place, Section 3 of the A312-1984 Bond became the road map that an obligee had to follow in order to declare a principal in default. This
process began with the notice required in Section 3.1. As cases involving the A312-1984 Bond were litigated, many courts held that Subsections 3.1, 3.2, and 3.3 were conditions precedent to the existence of an obligation of the surety; if one of these conditions precedent was not met, the surety’s liability could be extinguished.3
One of the seminal cases for this line of jurisprudence is Bank of Brewton, Inc. v. International Fidelity Insurance Co.,4 a 2002 opinion from the Supreme Court of Alabama. In Bank of Brewton, the court held:
[t]he surety’s obligation under the bond shall arise after the occurrence of the events listed in subparagraphs 3.1, 3.2, and 3.3. The owner first must give proper notice, call a meeting, discuss the problems, and attempt to resolve them (subparagraph 3.1); then, if the problems are not resolved, the owner must declare a contractor default, formally terminating the contractor’s right to complete the contract, and must declare the default at least 20 days after giving notice (subparagraph 3.2); and finally the owner must agree to pay the balance of the contract to the surety or to a new contractor who will complete the contract as originally agreed (subparagraph 3.3).5
As these cases show, prior to the 2010 revision of the A312 bond, an obligee’s failure to notify the surety of its consideration of declaring the principal in default and calling a meeting with the surety was a violation of the bond, extinguishing the surety’s liability thereunder. However, the 2010 revision of the A312 bond severely limits this argument.
III. Actual Prejudice Required by the A312-2010 Bond
Section 3.1 of the A312-2010 Bond only slightly rewords the language of that provision in the A312-1984
THE REQUIREMENT OF...Continued from page 1
2 Id.3 See Bank of Brewton, Inc. v. Int’l Fid. Ins. Co., 827 So. 2d 747, 753 (Ala. 2002); see also C & I Entm’t, LLC v. Fid. & Deposit Co., No. 1:08CV00016-DMB-DAS, 2014 WL 3640790 at *5, 2014 U.S. Dist. LEXIS 99505, at *14 (N.D. Miss. July 22, 2014) (“[T]he Court agrees with the parties that Paragraphs 3.1, 3.2, and 3.3 of the Bond are conditions precedent to Fidelity’s obligations under the Bond.”); Stonington Water St. Assoc. v. Hodess Bldg. Co., 792 F. Supp. 2d 253, 263 (D. Conn. 2011); CC-Aventura, Inc. v. Weitz Co., No. 06-21598-CIV-HUCK, 2008 WL 2557434, 2008 U.S. Dist. LEXIS 49988 (S.D. Fla. June 20, 2008); Mid-State Sur. Corp. v. Thrasher Eng’g, Inc., 575 F. Supp. 2d 731, 741 (S.D. W. Va. 2008); Enter. Capital, Inc. v. San-Gra Corp., 284 F. Supp. 2d 166, 179-181 (D. Mass. 2003); Public Bldg. Auth. v. St. Paul Fire & Marine Ins. Co., 80 So. 3d 171, 179 (Ala. 2010).4 827 So. 2d 747 (Ala. 2002).5 Id. at 753.6 See Am. Inst. of Architects, AIA Document A312, Performance Bond (2010); see also 1-139 New ApplemAN oN iNSurANce lAw librAry editioN § 139.02 (2015) (noting the changes “merely reword” Section 3).
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Bond, incorporating the same notice and termination provisions.6 Section 3.1 of the A312-2010 Bond states:
§ 3 If there is no owner default under the Construction Contract, the Surety’s obligation under this Bond shall arise after
.1 [t]he Owner first provides notice to the Contractor and the Surety that the Owner is considering declaring a Contractor Default. Such notice shall indicate whether the Owner is requesting a conference among the Owner, Contractor and Surety to discuss the Contractor’s performance. If the Owner does not request a conference, the Surety may, within five (5) business days after receipt of the Owner’s notice, request such a conference. If the Surety timely requests a conference, the Owner shall attend. Unless the Owner agrees otherwise, any conference requested under this Section 3.1 shall be held within ten (10) business days of the Surety’s receipt of the Owner’s notice. If the Owner, the Contractor and the Surety agree, the Contractor shall be allowed a reasonable time to perform the Construction Contract, but such an agreement shall not waive the Owner’s right, if any, subsequently to declare a Contractor Default . . . . 7
While this language does not diverge greatly from that in the A312-1984 Bond, the A312-2010 Bond added Section 4, which states:
§ 4 Failure on the part of the Owner to comply with the notice requirement in Section 3.1 shall not constitute a failure to comply with a condition precedent to the
Surety’s obligations, or release the Surety from its obligations, except to the extent the Surety demonstrates actual prejudice.8
Under this provision, a surety’s obligation to perform no longer hinges on compliance with Section 3.1 unless the surety proves actual prejudice. Unfortunately, “prejudice is a difficult matter to prove affirmatively.”9 At this time, there is no case law examining the question of what constitutes actual prejudice to a surety under the A312-2010 Bond. However, there are analogous cases involving the popular A311 bond and the A312-1984 Bond that should be examined. Furthermore, insurers occasionally face the same hurdle of demonstrating actual prejudice as a defense to a claim on a policy when the insured failed to timely notify the insurer of its claim. These examples illustrate situations of actual prejudice that a surety might argue when faced with the failure of an obligee to give the notice required under Section 3.1 of the A312-2010 Bond.
A. Jurisprudence Examining Actual Prejudice against Sureties
It is the surety’s burden to demonstrate actual prejudice on account of an obligee’s failure to provide the notices set forth in Section 3.1 of the A312-2010 Bond. Courts that have examined this issue generally require the surety to show that the delay in notice increased the damages sustained on a project regardless of a change in the surety’s position.10
Various interpretations of the A311 bond have resulted in a split as to whether an obligee’s compliance with the notice provisions constituted a condition precedent. One line of cases applied a rule that considered the notice requirement a condition precedent, but would only discharge the surety to the extent that it had been prejudiced by the failure to comply.11 For example, in Blackhawk Heating & Plumbing Co., the Northern District of Illinois held that the obligee’s failure to provide notice barred recovery only for the increase in damages caused by the delay.12 There, the surety provided
7 See Am. Inst. of Architects, AIA Document A312, Performance Bond (2010).8 Id.9 Vanderoff v. Harleysville Ins. Co., 78 A.3d 1060, 1066 (Pa. 2013). 10 Liberty Mut. Ins. Co. v. City of Dearborn, No. 11-13605, 2013 WL 6241585, at *18, 2013 U.S. Dist. LEXIS 169930, at *49 (E.D. Mich. Dec. 3, 2013) (citing Kilpatrick Bros. Painting v. Chippewa Hills Sch. Dist., No. 262396, 2006 WL 664210, at *5, 2006 Mich. App. LEXIS 736, at *5 (Mich. Ct. App. Mar. 16, 2006)); Blackhawk Heating & Plumbing Co. v. Seaboard Sur. Co., 534 F. Supp. 309 (N.D. Ill. 1982); see also generally Mount Vernon City Sch. Dist. v. Nova Cas. Co., 968 N.E.2d 439 (N.Y. 2012) (noting that a compensated surety must affirmatively demonstrate actual prejudice arising from the act of the obligee before the surety would be discharged).11 Blackhawk Heating, 534 F. Supp. at 317-18; see also generally Sheet Metal Workers’ Local Union No. 100 Wash., D.C. Area Pension Fund v. W. Sur. Co., No. GJH-15-1175, 187 F. Supp.3d 569 at 581 n.10 (D. Md. May 17, 2016) (noting that “if the failure to earlier declare United in default under the CBA constituted a breach of some obligation owed by Plaintiffs, Western Surety would have the burden to prove that it suffered some harm by such failure”); 1-139 New ApplemAN oN iNSurANce lAw librAry editioN § 139.02 (2015).12 Blackhawk Heating, 534 F. Supp. at 316.
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a subcontract performance bond for the electrical subcontractor.13 After failing to notify the surety that the subcontractor waited two years for approval for an air diffuser fixture needed for the project, the obligee-general contractor made a claim on the bond.14 Before considering a discharge of the surety on account of the delay, the court requested a hearing as to “what damages could have been avoided had [the surety] been given notice.”15 The court considered “prejudice” to include those damages caused by the general contractor’s failure to give the surety notice of delays, but needed more evidence to establish such a finding.16
Moreover, some states have long required compensated sureties to prove actual prejudice in order to be relieved from a bonded obligation.17 For instance, in Liberty Mutual Insurance Co. v. City of Dearborn, the surety was required to show prejudice from the obligee’s delay in declaring a contractor in default before its obligations under an A312-1984 Bond were released.18 Although the court held that a genuine issue of fact existed as to whether the surety suffered actual prejudice, the court refused to equate the principal’s insolvency during the delay as actual prejudice to the surety.19 In that case, the City of Dearborn hired the general contractor to build a sewer overflow project.20 Seven years into the project, the bonded general contractor had made little progress.21 The City declared the general contractor in default and notified the surety.22 The surety argued that the contractor had actually defaulted three years prior to the notice and that such delay to notify the surety caused actual prejudice.23 Specifically, the surety
argued that the prejudice arose because the contractor filed for bankruptcy during the delay, leaving the surety without financial recourse against the general contractor for its losses on the project.24 The court disagreed, finding authority in Section 50, illustration 2 of the Restatement (Third) of Suretyship and Guaranty, which provides that a principal’s insolvency will not discharge a surety.25
The court did, however, find the surety may have suffered actual prejudice as a matter of law. The prejudice could have manifested if the obligee’s delay violated the timing conditions of the performance bond.26 The A312-1984 Bond includes a two-year period of limitations commencing from the date the principal stopped work on the project.27 Given that a genuine dispute of fact existed as to when the contractor stopped working, the court refused to make a finding of actual prejudice on the summary judgment motion.28
Under these cases, by demonstrating either that the surety will incur a direct increase in costs, or that it lost a contractual right, such as the enforcement of a limitations period, the surety may be able to prove that it sustained actual prejudice as a result of the obligee’s delay in notifying it of the contractor’s potential default.
B. Jurisprudence Examining Actual Prejudice against Insurers
While the practitioner usually spends a substantial amount of time educating its principal, the obligee, claimants, judges, and opposing counsel that suretyship is not insurance,29 a surety may (and should) look to
13 Id. at 310.14 Id.15 Id. at 317.16 Id. at 317-18.17 See Mount Vernon City Sch. Dist. v. Nova Cas. Co., 968 N.E.2d 439, 441 (N.Y. 2012); and Liberty Mut. Ins. Co. v. City of Dearborn, No. 11-13605, 2013 WL 6241585 at *18, 2013 U.S. Dist. LEXIS 169930, at *50 (E.D. Mich. Dec. 3, 2013).18 2013 WL 6241585, at *18, 2013 U.S. Dist. LEXIS 169930, at *50 (E.D. Mich. Dec. 3, 2013).19 Id. at *56-59.20 Id. at *1.21 Id. at *2.22 Id.23 Id. at *46-47.24 Id. at *56-59.25 Id.26 Id.27 Id.; see also Am. Inst. of Architects, AIA Document A312, Performance Bond (1984) (providing two year period of limitations from the earliest of the date that the contractor defaulted, stopped working, or the surety refused to perform its obligations). 28 City of Dearborn, 2013 WL 6241585 at *19, 2013 U.S. Dist. LEXIS 169930, at *56-59.29 One of the best descriptions of this distinction can be found in Cincinnati Insurance Co. v. Centech Building Corp., 286 F. Supp. 2d 669, 689 (M.D.N.C. 2003) (citing Henry Angelo & Sons, Inc. v. Prop. Dev. Corp., 306 S.E.2d 162, 168 (N.C. Ct. App. 1983)), wherein the court stated that “the mere fact that those cases mention similarities between suretyship and insurance ‘no more justifies the conclusion that sureties are insurers and performance bonds are contracts of insurance than does the commonly known fact that sheep are somewhat like goats justify the conclusion that sheep are goats.’”
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the insurance field for illustrations of actual prejudice in failing to notify an insurer of a claim on a policy. Drawing from disputes regarding insurance coverage, a surety may argue it suffered actual prejudice by showing an obligee’s inexcusable delay hindered the extent and success of its investigation of the claim.
The Pennsylvania Supreme Court in Vanderhoff v. Harleysville Insurance Co. defined what constitutes actual prejudice to relieve an insurance company of its obligation to pay insurance benefits to an insured.30 There, the insured rear-ended another vehicle, but neither a police report written the day of the accident nor a Workers’ Compensation Employee Statement, given twenty days after the accident, mentioned an unidentified driver as the cause of the accident.31 Eight months after the accident, however, the insured filed a claim for uninsured motorist benefits stating a phantom vehicle spurred the collision.32
The insurer denied the claim, arguing that the insured’s eight-month delay caused it prejudice.33 With timely notice, it could have obtained physical evidence, canvassed the scene, interviewed the officers who wrote the police report, tracked down potential eye witnesses, and requested 911 tapes.34 While the insurer undertook many of these tasks anyway, their effectiveness dimmed as a result of the eight-month delay.35
The Pennsylvania Supreme Court agreed and held that, on a case-by-case basis, the court must balance the extent and success of the insurer’s investigation with the insured’s reasons for the delay.36 It noted that timely notice gives the insurer an opportunity to investigate and acquire information about the case, and a delay may hinder its investigation.37 The court preferred this standard of prejudice over one that would require proof of what the insurer would have found had timely notice been provided. The court described such a burden as a “Mobius strip” – where an insurer
would have to somehow show what it was unable to find because of a delay.38
Justice Baer provided a concurring opinion to give specific guidance on how an insurer can demonstrate prejudice resulting from an insured’s failure to comply with notice requirements.39 He noted that the courts should look at what evidence is available to the insurer at the time of notice and gauge its effect on the investigation.40 He also noted that a court should also consider the length and justification of the insured’s delay.41 While a one-day delay appears forgivable, a year-long delay increases the odds that prejudice will be found.42 Likewise, the lack of a reason excusing the delay should be a red-flag; whereas extenuating circumstances, such as the insured falling into a coma, could justify a lengthy delay.43
Although certainly distinguishable from suretyship, both the majority opinion in Vanderhoff and Justice Baer’s concurrence can be analogized to a surety’s potential arguments of actual prejudice. If a surety’s investigation of the performance claim is compromised either because information is no longer available or the obligee took actions that infringe upon the surety’s rights under the bond, and these instances could have been avoided if the obligee had provided the surety with the appropriate notice, a surety could argue it sustained actual prejudice. Further, Vanderhoff may help a surety establish actual prejudice when the obligee lacks any excuse for not following the notice requirements under Section 3.1.
IV. ConclusionUnder the A312-2010 Bond, a surety cannot escape
liability for an obligee’s failure to comply with the notice requirements of Section 3.1 unless the surety can show actual prejudice. However, successful showings of actual prejudice under previous iterations of performance bonds are few and far between. Despite
30 78 A.3d 1060, 1064 (Pa. 2013).31 Id. at 1062-63 32 Id.33 Id.34 Id. at 1063-64. 35 Id.36 Id. at 1067.37 Id. at 1066 (citing Metal Bank of Am., Inc. v. Ins. Co. of N. Am., 520 A.2d 493 (Pa. Super. Ct. 1987) (holding insurance carrier prejudiced by notice of oil spill 10 years after spill and 2 years into litigation)). 38 Id. at 1067. 39 Id. at 1067-1069 (Baer, J. concurring). 40 Id.41 Id.42 Id.43 Id.
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this lack of supporting jurisprudence, under the existing case law, the surety has a good argument for actual prejudice if it can prove that a delay in notice directly increased the costs incurred on a project. Examining the body of law in the insurance context and applying it to the A312-2010 Bond, a surety may also argue that, by not timely notifying the surety as is required by Section 3.1, the surety’s investigation of the legitimacy of a claim has been hindered through the spoliation of evidence and other factors. Make no mistake, the bar
has been set high for the surety to prove actual prejudice, but if faced with a circumstance similar to the cases discussed above, a surety may be able to argue that the actual prejudice required under Section 4 of the A312-2010 Bond occurred due to the owner/obligee’s failure to comply with Section 3.1 of the Bond.
Alec M. Taylor is a partner with Krebs Farley, PLLC in the firm’s Jackson, Mississippi office. Burke Stough is an associate in the firm’s New Orleans, Louisiana office.
The reasoning of the New Bern court’s original decision
In the original decision, the court viewed the bond’s language as an independent contract between the obligee and the surety and interpreted it just as it would any other contract between two parties. The bond itself did not contain a consequential damages waiver, but it did contain language regarding the surety’s liability for delay damages.
While it might be easy to say that the New Bern court’s reasoning is justified by a plain reading of the bond’s language, such analysis is problematic because the court only considered select language within the lengthy bond form. The court’s original decision simply ignored the incorporation of the underlying contract9 and essentially read the consequential damages waiver out of the agreement. Had the court considered all of the bond language and attempted to reconcile the language, it might have led the court to understand the uniquely “secondary” nature of the surety’s liability to the obligee. This, in turn, could have led the court to an interpretation of the bond that was consistent with both the bond’s language and the fundamental concepts of suretyship.
The fallacy of “independent liability” of the surety
The New Bern court attempted to interpret the bond’s language without considering or understanding what a bond is or the surety’s role in the suretyship relationship. In fact, the original decision loses sight of what the bond actually is—a guarantee that the obligee will receive the benefit of a contractual duty owed to it by the principal obligor. If there is no underlying duty owed by the principal, then the surety cannot be responsible for that duty either.10
Contrary to the New Bern court’s reasoning, the surety’s obligation is not an original and direct one for the performance of its own act, but is collateral to the obligation undertaken by the principal.11 Because the obligation of a surety is accessory to that of a principal obligor, it follows as a corollary that the liability of the surety is measured by the liability of the principal and cannot exceed it.12 In North Carolina, where New Bern was decided, and in many other jurisdictions, the extent of the engagement entered into by the surety is to be measured by the terms of the principal’s agreement.13 The New Bern court was either unaware of this law or chose to ignore it. Moreover, it is also well settled that, subject to limited exceptions not present in New Bern, the surety may invoke all defenses available to the principal.14 A consequential damages waiver like the one in New Bern is exactly such a defense.
NEW BERN RIVERFRONT...Continued from page 6
9 The Contractor and the Surety jointly and severally, bind themselves, their heirs, executors, administrators, successors and assigns to the Owner for the performance of the Construction Contract, which is incorporated herein by reference. ¶ 1 AIA A312 – 1984 Performance Bond.10 This concept seems simple, but in reading the New Bern decision, the court evidently did not grasp it. For example, the guarantor of repayment of a loan cannot be liable on the guaranty if the loan was never made. The surety on a license bond cannot be liable if the license was never issued to the principal. Thus, a bond or guaranty is, by definition, a secondary obligation, and liability under the bond cannot exist independently of the liability under the underlying guaranteed obligation.11 Shipley v. Baillie, 547 N.W.2d 711, 714 (Neb. 1996).12 72 c.J.S. Principal & Surety § 74 (1987).13 Carolina Builders Corp. v. New Amsterdam Cas. Co., 73 S.E.2d 155, 156 (N.C. 1952).14 reStAtemeNt (third) of SuretyShip & GuAr. § 34 (Am. lAw iNSt. 1996); Hous. Auth. of City of Huntsville v. Hartford Acc. & Indem. Co., 954 So.2d 577, 578 (Ala. 2006); Board of Sup’rs of Fairfax Cty. v. S. Cross Coal Corp., 380 S.E.2d 636, 639 (Va. 1989).
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The New Bern court’s focus on the bond’s language to the exclusion of both context and the language of the bonded (and incorporated) contract also caused the court to disregard the harm its decision would do to the bond principal. A bond is not a two-party contract between the obligee and the surety, but is instead an undertaking amongst three parties. A bond is, at its essence, a guaranty of a negotiated contract between the principal and the obligee. Negotiating a contract is a voluntary undertaking. One of the primary purposes of contract law is to allow the parties to allocate the risk of future losses on terms that they negotiate, and to enforce any resulting agreement consistent with the parties’ expectations.15
Construction-related contracts are typically negotiated between the parties on a project-specific basis and contain detailed provisions allocating risks of loss and specifying or limiting remedies (waivers of consequential damages, differing site conditions provisions, liquidated damages clauses, etc.). The parties consider price, difficulty and time of performance, risk, and other factors to arrive at a legally binding exchange of promises. A good contract is one that fairly allocates risk to the party best able to protect against the risk. This allows for a fair contract price and should keep either party from building in large contingencies to cover unknown or undiscoverable risks.16
Further, the presence of a surety should not alter the allocation of risk for which the parties bargained. This is particularly true because the requirement of a bond is but one of a number of exchanged risk avoidance and allocation devices contained within a contract between the parties. It works an injustice to the bond principal if the bond is read in such manner as to obviate the parties’ agreed exchange of promises. As the Restatement puts it, “[i]t is not the purpose of the secondary obligation to assure the obligee of performance to which it is not entitled pursuant to its contract with the principal obligor.”17 If the principal may avail itself of a waiver of consequential damages in the underlying bonded contract, then the surety must be protected by that waiver as well. Otherwise, the
principal, which is obligated to indemnify the surety for liability arising under the bond,18 will be required to repay the surety for the consequential damages the surety was obligated to pay. This would materially alter and violate the agreement between the principal and the obligee, where the principal had no liability for the obligee’s consequential damages.
The New Bern court’s opinion wholly failed to consider that its decision allowed the obligee, after giving up the right to consequential damages against the principal during the negotiation of the bonded contract, to nonetheless recover such damages by proceeding against the surety. If the obligee is successful in recouping this previously foregone right, the surety will almost certainly seek indemnity (both common law and contractual) from the principal for the very same consequential damages that the obligee agreed to waive (but received anyway) and from which the principal reasonably believed it was protected. In that scenario, not only does the obligee gain something it agreed to forego, but the principal loses the benefit for which it bargained. There is nothing in surety law that contemplates such a result.19
Given that the New Bern decision is a mere bankruptcy court decision, it has no precedential value. Its persuasive value is further undermined by the bankruptcy court’s own reconsideration and reversal of the ruling denying summary judgment to the surety. If a bond claimant cites to the original decision, counsel for the surety must be vigilant to inform the court that it was reversed. Nevertheless, the New Bern decision is a very real example of how bond language, if read by the court in isolation and without the benefit of an adequate understanding of the broader suretyship context and the secondary nature of the surety obligation, can result in an anomalous outcome, an outcome that is highly prejudicial to the principal, the surety, and the concepts of contract law and suretyship.
Joseph A. Brophy is a partner at Jennings, Haug & Cunningham, LLP in the firm’s Phoenix, Arizona, office. John Fouhy is claim counsel with Travelers in the Bond & Specialty Insurance division in Seattle, Washington.
15 See, e.g., Berschauer/Phillips Constr. Co. v. Seattle Sch. Dist. No. 1, 881 P.2d 986, 993 (Wash. 1994).16 Hazel Glenn Beh, Allocating the Risk of the Unforeseen, Subsurface and Latent Conditions in Construction Contracts: Is There Room for the Common Law?, 46 u. KAN. l. rev. 115 (1997).17 reStAtemeNt (third) of SuretyShip & GuAr. § 34 cmt. a (Am. lAw iNSt. 1996). 18 reStAtemeNt (third) of SuretyShip & GuAr. §§ 18, 22 (Am. lAw iNSt. 1996).19 In fact, surety law specifically prohibits an obligee from circuitously imposing liability upon a principal through an indemnity claim by the surety after the obligee releases the principal. If the principal is released, then so is the surety (subject to certain exceptions that were not applicable in New Bern). See reStAtemeNt (third) of SuretyShip & GuAr. § 39 (Am. lAw iNSt. 1996).
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Fidelity & Surety Law Committee Newsletter Winter 2017
scope of Dodge.11 While the decision in Dodge appears to remain good law in the unique context in which it arose, the S&S Paving decision clearly suggests certain boundaries to the Dodge holding.
The Court of Appeals found that “[t]he most fundamental distinction between Dodge and this case is that the former did not involve a statute.”12 With this language, the court made clear that Dodge is inapplicable to Little Miller Act bonds and likely inapplicable to any bond issued pursuant to a statute. Since many contract and commercial surety bonds are issued pursuant to statute, this explanation severely limits the scope of the Dodge decision.
In S & S Paving the claimant subcontractor argued that the Arizona Court of Appeals should recognize and impose upon sureties a general duty to investigate and pay claims. The court immediately looked to the language of the Little Miller Act and noted it grants claimants only a right to sue, not a right to be paid before a lawsuit is filed.13 The court held that even a remedial statute, such as the Little Miller Act at issue, cannot be altered to impose a duty to investigate upon a surety where the only right spelled out in the statute is a claimant’s right to bring suit upon the
bond.14 There being no right to be paid pre-litigation, it logically follows that there can be no bad faith for failing to investigate or pay a claim pre-litigation. Arizona’s Little Miller Act, as well as the federal Miller Act, only mentions a right to sue, not a right to pre-litigation claims.15 This appears to be consistent with the vast majority of the Little Miller Act’s surveyed.16 In reaching this decision, the Arizona Court of Appeals joins an increasing number of courts throughout the country that have rejected obligees’ bad-faith claims against sureties.17
In sum, Dodge may not be dead, but its application should be limited to a small subset of situations in the surety world—private performance bonds in a non-commercial context. The Arizona Court of Appeal’s decision in S & S Paving is not only an important decision for sureties that issue bonds in Arizona, but also throughout the country. The manner by which the Court distinguished Dodge will apply to many bad faith claims whose assertion relies upon Dodge, and the specific holding in S & S Paving has elements applicable to bad faith claims sought to be asserted under most Little Miller Acts.
Chad L. Schexnayder is a partner and Robert John Lamb is an associate at Jennings, Haug & Cunningham, LLP, in Phoenix, Aizona.
THE ARIZONA COURT OF...Continued from page 8
11 S&S Paving, 372 P.3d at 1037.12 S&S Paving, 372 P.3d at 1040.13 Id. 14 Id. at 1040 (quoting O’Connor v. Star Ins. Co., 83 P.3d 1, 6 (Alaska 2003) (“The statute nowhere states or implies that licensing bond sureties have a duty to independently investigate claims made against bonded contractors. The statutory language only requires that licensing bonds be conditioned on a promise to pay amounts adjudged against the contractor.”)). 15 40 U.S.C. § 3133 (the claimant “may bring a civil action on the payment bond”); A.r.S. § 34–223(A) (the claimant “shall have the right to sue on such payment bond”).16 See, e.g., AlA. code § 39-1-1 (b); AlASKA StAt. § 36.25.020 (a); ArK. code § 18-44-503 (b); colo. rev. StAt. § 38-26-105(1); d.c. code § 2-201.02 (a); hAw. rev. StAt. § 103D-324 (d); idAho code § 54-1927; 30 ill. comp. StAt. 550/2; KAN. StAt. § 60-1111(b); me. rev. StAt. tit. 14, § 871 (4); md. code, StAte fiN. & proc. § 17-108; mASS. GeN. lAwS ch. 149, § 29A; mich. comp. lAwS § 129.207; miSS. code. § 31-5-51(2), (3); moNt. code § 18-2-204; Neb. rev. StAt. § 52-118.01; Nev. rev. StAt. § 339.035; N.m. StAt. § 13-4-19; N.y. StAte fiN. lAw § 137 (3); N.c. GeN. StAt. § 44A-27 (a); N.d. ceNt. code § 48-01.2-11; oKlA. StAt. tit. 61, § 2 (b); or. rev. StAt. § 279C.600; 8 pA. StAt. § 194; r.i. GeN. lAwS § 37-12-2; S.d. codified lAwS § 5-21-6; tex. Gov’t code § 2253.073; utAh code § 63G-6a-1103(4); vA. code § 2.2-4341(a), (b); wASh. rev. code § 39.08.030; wiS. StAt. § 779.14 (2); wyo. StAt. ANN. § 16-6-113. 17 See, e.g., U.S. Sewer & Drain, Inc. v. Earle Asphalt Co., No. 15-1461, 2015 WL 3461087 (D.N.J. June 1, 2015); Upper Pottsgrove Twp. v. Int’l Fid. Ins. Co., 976 F. Supp. 2d 598 (E.D. Penn. 2013); S. W. Va. Paving, Inc. v. Elmo Greer & Sons, LLC, 691 F. Supp. 2d 677 (S.D. Va. 2009); Boldt Co. v. Thomason Elec. & Am. Contractors Indem. Co., 820 F. Supp. 2d 703 (D.S.C. 2007); Bell BCI Co. v. HRGM Corp., 276 F. Supp. 2d 462 (D. Md. 2003); Cincinnati Ins. Co. v. Centech Bldg. Corp., 286 F. Supp. 2d 669 (M.D.N.C. 2003); Tacon Mech. Contractors, Inc. v. Aetna Cas. & Sur. Co., 860 F. Supp. 385 (S.D. Tex. 1994); Inst. of Mission Helpers of Balt. City v. Reliance Ins. Co., 812 F. Supp. 72 (D. Md. 1992); United States ex rel. Ehmcke Sheet Metal Works v. Wausau, 755 F. Supp. 906 (E.D. Cal. 1991); O’Connor v. Star Ins. Co., 83 P.3d 1 (Alaska 2003); Cates Constr., Inc. v. Talbot Partners, 980 P.2d 407, 410 (1999); Great Am. Ins. Co. v. N. Austin Mun. Util. Dist., 908 S.W.2d 415 (Tex. 1995).
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Fidelity & Surety Law Committee Newsletter Winter 2017
February 2017
23-25 Insurance Coverage Litigation Midyear Mtg Arizona Biltmore Rst Contact: Felisha Stewart – 312/988-5672 & Spa, Phoenix AZ
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