TWENTY FIRST ANNUAL NORTHEAST SURETY AND FIDELITY CLAIMS CONFERENCE

Transcription

1 TWENTY FIRST ANNUAL NORTHEAST SURETY AND FIDELITY CLAIMS CONFERENCE rd th SEPTEMBER 23-24, 2010 THE INTERPLAY BETWEEN COMMON LAW AND STATUTORY PAYMENT BONDS: WHAT'S REALLY IN YOUR BOND? PRESENTED BY: JONATHAN BONDY, ESQ. WOLFF & SAMSON PC One Boland Drive West Orange, New Jersey BRIAN C. KUHN ARCH INSURANCE COMPANY Philadelphia, Pennsylvania 19102

2 The Interplay Between Common Law And Statutory Payment Bonds: What s Really In Your Bond? Jonathan Bondy & Brian C. Kuhn Sureties are routinely requested to issue payment bonds for public improvement contracts where the form of the bond actually issued is significantly different from the statutory language of the Little Miller Act statutes that almost every state has with respect to payment bonds for such improvements. Sometimes the bond imposes conditions upon bond claimants that are greater than those imposed under the applicable state statute, sometimes the bonds are silent with respect to terms set forth in the statute, and sometimes the bond issued may contain terms that are more favorable for a claimant than those actually required by law. Many public bodies simply use the forms generated by The American Institute of Architects, regardless of whether the governing statute requires language that differs from that set forth in the AIA forms. What exposure the Surety may actually have under the bond actually issued is an increasingly convoluted question, and courts have given inconsistent decisions with respect to which terms are controlling with respect to such bonds. When Is a Bond a Statutory Bond? Bonds are contracts, and are subject to the ordinary rules of contractual interpretation. Normally, such interpretation falls within the province of the Court. The first issue in determining whether the bond issued by the Surety is a statutory or common-law bond depends on the nature of the underlying contract being bonded, as well as the identity and legal status of the obligee. Under the laws of most states, the bond principal, in order for the bond to be construed as a statutory bond, must have a contract with a public owner for a public improvement. It seems somewhat self-evident that a payment bond is a statutory bond when it is issued to satisfy a statutory requirement that such a bond be issued for a public improvement, or public works, contract. Almost all states have adopted their own versions of the Miller Act 1, the payment bond statute for Federal construction contracts, for all construction contracts (over a minimum financial threshold) between a public body and a contractor. Accordingly, construction contracts between a public body such as a state, county, city, town, or school district are usually subject to a state s own Little Miller Act. Increasingly, courts are interpreting payment bonds issued for public improvement contracts as statutory bonds, rather than common-law bonds, when the bond was issued to comply with a statutory requirement that such a bond be provided. In New York, for example, State Finance Law 137 requires contractors to provide a bond guaranteeing prompt payment of moneys due to all persons furnishing labor or materials in the prosecution of a public improvement. In A.C. Legnetto Construction, Inc. v. Hartford Fire Ins. Co. 2, New York s highest court held that because 1 40 U.S.C.A. 3131, et seq. (formerly 40 U.S.C.A. 270a, et seq.) 2 92 N.Y. 2d 275 (1998).

3 the State Finance Law made payment bonds mandatory on public projects, the traditional distinction between common-law and statutory bonds was moot. The Court found that the principal was required by law to furnish a bond for the project, and that the bond had to conform to the statutory requirements. Notwithstanding the lack of a statutory reference in the bond itself, the bond was deemed to have been furnished to comply with the statutory requirements; [S]ince this bond was required under the State Finance Law, it must be deemed ipso facto to have been furnished pursuant to the statute, and the provisions contained therein must govern... 3 The fact, however, that the underlying contract is with a public entity, or is being financed with public funds, does not always mean that the payment bond is a statutory bond. Due to the various ways private entities have structured development agreement deals with public bodies, courts have been required to define what is, and what is not, a public improvement. In Davidson Pipe Supply Co. v. Wyoming County Development Agency, 4 Indeck, a privately owned company, entered into an installment sale agreement with the Wyoming County Industrial Development Agency in order to secure tax and other benefits in conjunction with Indeck s development of an energy cogeneration plant for the production of steam and electrical energy to be sold to private companies. The arrangement was essentially a sale and leaseback, between Indeck and WCIDA, with Indeck to bear the risks and benefits associated with the project. 5 Plaintiff, a supplier, sued Indeck and WCIDA for monies due for materials delivered to the project, alleging that Indeck and WCIDA were responsible for the failure of the general contractor to obtain a payment bond as required by the State Finance Law. The Court rejected Davidson s claim, holding that the project was not a public improvement. The Court found it significant that Indeck, a private entity engaged in the cogeneration business for profit, was the ultimate beneficiary of the plant and would ultimately carry on its business. That WCIDA was a public benefit corporation which under New York law would ordinarily make mandatory the issuance of a payment bond was not a controlling factor. 6 Rather, the Court determined which party to the agreement would actually benefit from, and incur the risks of, the project, as opposed to merely relying upon who owned the property upon which the project was located: The conveyance of legal title to the agency with simultaneous lease back to the company is structured merely as a mechanism to facilitate financing and is not a genuine allocation of ownership in the agency. The economic benefits and burdens of ownership are reserved to the company and the agency serves only as a conduit for the tax benefits provided by such an arrangement... The agency's role is strictly that of an intermediary to 3 Id. at (internal citations omitted). 4 Id. N.Y.2d 281 (1995). 5 Id. at Id. at 285 (citing N.Y. Municipal Law 856[2] and N.Y. Lien Law 2(6)). 2

4 insure that private parties qualify for tax exemptions; it assumes no risk of loss and has no opportunity to gain. 7 While ownership was not the controlling factor in determining whether a statutory bond was required in Davidson, ownership has been held to be the controlling factor when a public agency has entered into a turnkey agreement whereby a contractor or developer acquires the land, completes the project, and turns over the property and improvement to the public body after it has been approved by the public agency. This type of arrangement was at issue in Murnane Associates, Inc. v. Harrison Garage Parking Corp. 8, where the Court held that the City of Syracuse was not obligated to require a payment bond when it entered into Turnkey Agreement with HGCP, a developer. There, the Court held that in order to constitute a public improvement, the land where the work specified in the contract is to be completed must be owned by the State or a public corporation at the time that the contract is executed. 9 Since, the project was not owned by the City at the time Plaintiff entered its agreement with HGCP, the City was not liable for failing to require a payment bond from HGCP in the Turnkey Agreement. The Court concluded that if plaintiff had wanted the additional protection of a payment bond, it should have placed that requirement in its contract with HGCP. 10 With the increase in redevelopment agreements, it should not be automatically assumed that what appears to be a public improvement is in fact one that requires a statutory bond. The issues in Davidson and Murnane are case specific, and there is little in the way of case law on this specific issue. However, in a New Jersey case, RAL Supply Group, Inv. v. W&J Services, Inc. 11, the court, in interpreting a prior version of New Jersey s Public Works Bond Act, 12 found the Act to be inapplicable to a turnkey agreement between a real estate developer, the Newark Housing Authority, and the U.S. Dept. of Housing and Urban Development, where the project was funded by HUD, but was to be conveyed to the Housing Authority upon completion. Similarly, in V. Petrillo & Sons, Inc. v. American Const. Co. 13, a New Jersey court held that a housing project partially financed by the New Jersey Housing Finance Agency was not a public building, or other public work or improvement, and was not subject to the Bond Act. Conflicts Between The Statute And The Bond Courts in various jurisdictions have issued conflicting decisions with respect to conflicts between the language of the bond and the language of the public works bond statute. What appears to be the case, in many instances, is that courts view the controlling statute as setting a floor, beyond which the bond cannot either (a) impose 7 Id. at 286 (quoting Erie County Indus. Dev. Agency v. Roberts, 94 A.D.2d 532 (App. Div. 1983), aff d on opinion below, 63 N.Y.2d 810 (1984)) A.D.2d 882 (App. Div. 1997). 9 Id. at 883 (quoting N.Y. Lien Law 2[7] (a public improvement is an improvement of any real property belonging to the state or a public corporation. ) (emphasis in opinion, not statute being cited therein). 10 Id. at N.J. Super. 604 (Law Div. 1997) 12 N.J.S.A. 2A:44-143, et seq N.J. Super. 1 (App. Div. 1977). 3

5 additional conditions on a claimant, or (b) give lesser protection to the claimant. To the extent, however, the bond form gives more protection or is more liberal that than the statute, courts frequently hold the Surety to the terms of its bond. The inconsistency seen in the decisions should actually be unnecessary, particularly with respect to the AIA A312 bond form, because the bond form itself addresses in two places how it should be interpreted when there are conflicts between the bond and the controlling statute. Paragraph 13 of the AIA A312 payment bond provides: When this Bond has been furnished to comply with the statutory or other legal requirement in the location where the construction was to be performed, any provision in this Bond conflicting with said statutory or legal requirement shall be deemed deleted herefrom and provisions conforming to such statutory or other legal requirement shall be deemed incorporated herein. The intent is that this Bond shall be construed as a statutory bond and not as a common law bond. This paragraph essentially allows the AIA A312 form to be used for both public and private projects, with the terms of the bond to be amended to conform with the statutory language when the bond itself is issued to satisfy a statutory requirement. Notwithstanding this apparently saving language, however, most courts have held the Surety to the express language of its bond where that language was more favorable to a claimant than the language set forth in the applicable statute. The issue more often than not arises in a statute of limitations context. Many state laws require, as does the Miller Act, that suit be filed within one year of the date on which the claimant/plaintiff last worked or supplied material. Should the Court apply the language of the statute or of the bond when the language between the two differs? In Carroll Seating Company J.J.L. Inc. v. Verdico 14, the Court addressed a conflict between the six-month limitation period imposed by Illinois law on the filing of suit under a public works bond and the language of the bond itself, which gave the claimant one year to file suit from either the date on which the claimant gave the notice required by the bond or the date on which the last labor or service was performed by anyone, whichever of the two first occurs. The bond form, in this same paragraph ( 11 of the A312 form), provided that [I]f the provisions of this Paragraph are void or prohibited by law, the minimum period of limitation available to sureties as a defense in the jurisdiction of the suit shall applicable. 15 The bond also contained the language of 13 of the AIA A312 payment bond, and the Surety contended that the language of 11 and 13 made it clear that the six-month limitation period was controlling. The Court, however, disagreed for two reasons, the first being that while the Illinois legislature required the inclusion of Illinois Bond Act into all public works bonds, Ill.App.3d 724 (App. Ct. 2006). 15 Id. at

6 the Bond Act had no similar mandate for claims-filing provisions. Secondly, the Court found that parties to a public works bonds are free to contract for protection that exceeds the [Act s] minimum. 16 The Carroll Seating Court cited to other Illinois cases which stood for the proposition that [A]lthough the express provisions of the statute are deemed to be contained in every bond for a public construction project, whether actually inserted in the bond or not, the contractor and its surety are free to contract with the public entity for additional liability which exceeds the statutory provisions. 17 The Carroll Seating holding essentially eviscerates the language set forth in 13 of the AIA A312 form, and clearly holds the Surety to the more lenient terms set forth in its bond as long as those terms do not abridge the statutory protections afforded claimants, notwithstanding the equally express language set forth in the bond which provides that any language therein which conflicts with any statutory language shall be deemed deleted herefrom. In New York, the statute of limitations applicable to public payment bonds is set forth in State Finance Law 137(4)(b), which states that suit cannot be filed after the expiration of one year from the date on which final payment under the claimant's subcontract became due. In A.C. Legnetto 18, New York s highest court, in what is arguably dicta, stated that the timeliness provisions of State Finance Law 137 must govern, to the extent that they are not superseded by more liberal provisions in the bond. 19 Construing such a liberal bond provision one where the accrual date for filing suit was the date the principal ceased work the court in American Bldg. Contractors Associates, Inc. v. Mica & Wood Creations, LLC 20, citing to Legnetto, held that the bond s more liberal language controlled, rather than the State Finance Law. Nevertheless, the dicta in Legnetto, and the subsequent holding in Mica & Wood Creations, could be challenged. The courts in both cases apparently failed to consider another New York statute, General Obligations Law , which states, in part: 1. A promise to waive, to extend, or not to plead the statute of limitation applicable to an action arising out of a contract express or implied in fact or in law, if made after the accrual of the cause of action and made, either with or without consideration, in a writing signed by the promisor or his agent is effective, according to its terms, to prevent interposition of the defense of the statute of limitation in an action or proceeding commenced within the time that would be applicable if the cause of action had arisen at the date of the promise, or within such shorter time as may be provided in the promise. * * * 16 Id. at Id. at 730 (internal citations omitted). 18 Supra, 92 N.Y. 2d 275 (1998). 19 Id. at (emphasis added) A.D.3d 322 (App. Div. 2005) 5

7 3. A promise to waive, to extend, or not to plead the statute of limitation has no effect to extend the time limited by statute for commencement of an action or proceeding for any greater time or in any other manner than that provided in this section, or unless made as provided in this section. 21 Under General Obligations Law , since all payment bonds are issued before a subcontractor s cause of action accrues (in fact, before it performs any work at all), then the extra-statutory limitation language in the bonds should have no effect to extend the time limited by statute for commencement of an action[.] 22 It should also be noted that, after its decision in Legnetto, the Court of Appeals, in Windsor Metal Fabrications Ltd. v. General Accident Ins. Co. of America 23, stressed the legislative mandate and strong public policy reasons behind the one-year limitation period applicable to payment bond claims, stating: We observe that this case yields the ironic result of a subcontractor being shut out from a timely lawsuit by the very statute meant generally to protect the rights of subcontractors. However, the Legislature has clearly made a conscious policy decision with respect to public improvement projects. It defines and delimits the remedy by requiring prompt payment, pursuant to mandatory payment bonds, in a manner that is fair to claimants, as well as consistent and reasonably definitive as to the duration of the surety's litigation exposure. There are also strong policy reasons for not reading contract clauses to interject an open durational set of events into this statute. That practice would under-mine the essential purpose of the limitations period and would effectively circumvent the intent of the Legislature in this respect. We cannot, by adroit construction of the statute that side-steps its purpose, as well as our guiding precedents, countenance a sympathetic escape hatch for a particular subcontractor's claim under these circumstances. That would unjustifiably damage the desirable definiteness fabric and principle of this statutory formulation. The adverse impact on the construction industry in forestalling prompt, fair resolution of disputes growing out of this vast, complicated commercial enterprise contraindicates the theory advanced by Windsor, and adopted by the Appellate Division. 24 It should be further noted, however, that while General Obligations Law renders unenforceable contractual commitments to extend limitations periods if made 21 Emphasis added. 22 See also John J. Kassner & Co., Inc. v. City of New York, 46 N.Y.2d 544 (1979) ( The statute, it should be noted, is exclusive... Thus extension agreements made prior to the accrual of the cause of action continue to have no effect[.] ) N.Y.2d 124 (1999). 24 Id. at (internal citation omitted). 6

8 prior to the accrual of a cause of action, the statute does not affect the power of the court to find that by reason of conduct of the party to be charged it is inequitable to permit him to interpose the defense of the statute of limitation 25, so a court may, where appropriate, find a party to be equitably estopped from asserting a limitations defense. 26 There are courts which that have looked to 13 of the AIA A312 form in resolving conflicts between the statutory language and the bond. In Santos Foundation, Inc. v. Ins. Co. of N. America 27, the Surety sought dismissal of the suit filed on a payment bond issued for a public project, contending that the claim should be dismissed due to the claimant s failure to comply with Connecticut s General Statutes, which the Surety contended were controlling. The Court found that the language of 13 of the AIA A312 bond superseded the notice provisions set forth in 4 of the bond. Since the notice provided to the Surety was provided beyond the time within which notice had to be provided under the statute, the claim was dismissed. An analogous argument can be made from the holding in the case of Gloucester City Board of Ed. v. American Arbitration Association, 28 where the Court addressed not a payment bond situation, but a performance bond case where the Surety contended the Obligee s claims where barred by virtue of the Obligee s failure to comply with conditions in the AIA A312 performance bond issued for the underlying contract, as well as the fact that the suit was untimely under the terms of the bond. The Appellate Division reversed the lower court s decision, where the Surety prevailed on these defenses, finding that the Surety s reliance upon the express terms of the A312 bond form was misplaced because the bond form differed from the statutory bond form required by New Jersey Law. New Jersey law required that the bond (a single performance/payment bond) be in substantially the... form set forth thereunder. 29 Notwithstanding the fact that the bid documents required that that the bonds be in the form furnished by the architect, or the state s statutory form, the bond (an AIA A312 form) issued by the Surety and accepted the Obligee, was neither. The Court rejected the Surety s arguments, stating: [W]hen a surety bond is issued to satisfy the requirements of its statute, the bond will be construed in conformity with the legislative mandate. Where a statute prescribes the form of bond to be given by a public contractor, any bond given by the contractor must be interpreted as though its provisions conformed to the statutory requirements, whether 25 N.Y. General Obligations Law (4)(c). 26 Conceivably, a subcontractor might argue that a Surety is estopped from asserting a limitations defense because the Surety voluntarily issued a bond with more liberal provisions. However, estoppel to plead the statute of limitations generally requires some element of reasonable reliance by a plaintiff on the defendant s challenged conduct. If, for example, a subcontractor or its counsel did not see the more generous bond form, prior to the running of the statute of limitations, the claimant presumably did not rely (reasonably or otherwise) relied on the bond s looser limitations language when waiting to file a lawsuit WL (Conn. Superior Ct., 1994) N.J.Super. 511 (App. Div. 2000). 29 Id. at

9 they in fact do so or not. Consequently whatever is included in the bond, and is not required by the law, must be read out of it...when a statute requires a bond to be given, the statutory terms and conditions will be read into the bond and conditions not required by statute will be stricken from the bond as surplusage. 30 The Court further rejected the Surety s argument that because the statute did not expressly bar the Surety from imposing additional conditions, the bond did not conflict with the statute. The Court concluded that the prohibition on containing alternative terms was implicitly prohibited by both the statute and bid documents. The Gloucester Court further cited to the provision in the bond that where the bond was issued to comply with a statutory requirement, any provision in this bond conflicting with such statutory or other legal requirement shall be deemed incorporated herein. 31 The Court found that the statutory language was language with which the Surety s bond was required to conform, and because the bond s terms differed, the statutory language took precedence over any inconsistency in the bond form. This argument should be capable of being used by Sureties to contend that the statute trumps more liberal language in the bond when there is a conflict. Other areas of conflict between statutory language and the AIA A312 relate to notice. The notice requirement under 4 of the AIA A312 with respect to direct claimants does not apply under many statutory bond forms. For example, New York s State Finance Law 137(3) requires that a second-tier claimant, not having a direct contract with the bond principal, provide notice of its claim to the bond principal within 120 days of the date on which the claimant last performed work or supplied material in connection with the bonded contract. The AIA A312 form, at 4.2.1, however, requires notice be provided to the principal, with a copy to the Obligee, within 90 days. If, therefore, a second-tier claimant gives notice within the 120 days required by the State Finance Law 137, but beyond the 90 days required by the AIA A312 bond, the Surety will almost certainly be held to the 120-day period, since the more limited period of 90 days expressly conflicts with the 120-day period afforded the claimant by the statute. Furthermore, of the AIA A312 form requires that additional notice of the second-tier claim be provided to the Surety if the claim has not been resolved or rejected by the principal within 30 days of the principal s receipt of the notice. Notice to the Surety is not even required of a second-tier claimant under New York law. The AIA A312 form requires that even claimants having a direct contract with the principal must provide notice to the Surety, and obligation that does not exist under the State Finance Law such that a first-tier claimant s failure to give notice to the Surety would almost certainly not be fatal to the claim. And under New Jersey law, a second-tier claimant must give notice to the principal, even before the second-tier claimant starts work, of the 30 Id. at 526 (internal citations omitted). 31 Id. at

10 fact that the second-tier claimant will be providing labor or material. Failure to provide notice bars any claims for labor or material provided prior to the issuance of the notice. 32 A further point of conflict is the requirement that the Surety respond to the claimant s claim within 45 days of receipt of notice of the claim. Neither the Miller Act nor most Little Miller Acts require a response from the Surety to the notice of claim. Under 6.1 of the AIA A312 bond, once a claimant gives the Surety notice as required by 4, the Surety is obligated to [s]end an answer to the claimant... within 45 days after receipt of the claim, stating the amounts that are undisputed and the basis for challenging any amounts that are disputed. Under 6.2, the Surety is also required to [p]ay or arrange for payment any undisputed amounts of the claim. As is well known, there are three significant cases all on private projects in which the Surety was found to have waived any defenses to payment bond claims where the Surety failed to provide a timely response delineating the basis for disputing the claim in accordance with 6 of the AIA A312 bond. 33 In response to these decisions, the AIA A312 is being amended this year. 34 While claims are still pending under the 1984 version of the AIA A312 bond, it needs to be emphasized that the mandatory response to a claim should not be binding on the Surety, pursuant to 13, unless the controlling statute requires a response. It remains to be seen if courts will follow the Bramble line of cases where an AIA A312 Bond was furnished to comply with a statutory requirement for a public improvement contract. 32 N.J.S.A. 2A: See National Union Fire Ins. Co. of Pittsburgh v. David A. Bramble, Inc., 388 Md. 195 (2005); Casey Indus., Inc. v. Seaboard Surety Co., WL (E.D. Va.), clarified by 2006 WL , at *4 (E.D. Va. 2006) (relying on Bramble), and J.C. Gibson Plastering Co. v. XL Specialty Ins. Co., 521 F.Supp. 2d 1326, 1338 (M.D. Fl. 2007) vacated, 2009 WL (M.D. Fl., August 26, 2009). But see Methuen Constr. Co., Inc. v. The Austin Company, C.A. No G (Mass. Super. Ct. 2006) where the Court held the Surety was not required to pay the full amount of the claim when it failed to dispute the claim in 45 days because Massachusetts does not construe surety bonds as insurance contracts (which was the basis for the court's holding in Bramble), and because, given the nature of large construction projects, the Surety s timely letter requesting an Affidavit of Claim from the subcontractor demonstrated that the Surety was, in fact, disputing the claim until its investigation was complete. 34 The Surety will have 60 days to respond, and the Surety s failure to respond or otherwise discharge its obligations shall not be deemed to constitute a waiver of the Surety defenses; rather the Surety shall be liable to the claimant for the attorney s fees the Claimant incurs to recover any sums found to be due and owing to the Claimant. See for the proposed amendments. 9

11 Conclusion Given the inconsistent decisions being issued by courts around the country, it is very important to be familiar with the law of the state in which a specific claim is being made. Assuming that the Surety s bond is in fact for a public improvement contract, there are solid, well-reasoned arguments to be made that the Surety s payment bond obligations, regardless of the bond form used, are to be construed solely and strictly in accordance with the applicable public works payment bond statute The authors gratefully thank Darren Grzyb and Beth Rotenberg of Wolff & Samson PC for their invaluable assistance in the preparation of this paper. 10

12 JONATHAN BONDY Jonathan Bondy is a member with Wolff & Samson PC, which maintains offices in West Orange, New Jersey and New York City. He received his Bachelor of Science in Economics from the Wharton School of Business of the University of Pennsylvania in 1988, and a Juris Doctor degree in 1991 from the Benjamin N. Cardozo School of Law, Yeshiva University, where he was a member of the Moot Court Honor Society. Prior to joining Wolff & Samson, Mr. Bondy served as an Assistant District Attorney in Kings County (Brooklyn), New York. He concentrates his practice in surety and fidelity law, and commercial and construction litigation. He is a member of the New York and New Jersey State Bar Associations and the Fidelity and Surety Law Committee of the Tort and Insurance Practice Section of the American Bar Association. He is admitted to practice in the States of New York and New Jersey, the United States Courts of Appeals for the Second Circuit, and the United States District Courts for the Southern, Eastern and Northern Districts of New York and the District of New Jersey. He has previously presented papers at the Northeast Surety & Fidelity Claims Conference, as well as the Surety & Fidelity Claims Institute and the Commercial Finance Association. BRIAN C. KUHN Brian C. Kuhn has been employed as a Surety Loss Control Attorney with Arch Insurance Company since Prior to joining Arch, he was in private practice handling civil litigation with an emphasis on construction disputes. Brian received his Juris Doctor degree in 1999 from the University of Pittsburgh School of Law and his Bachelor of Science degree in Psychology and Philosophy from the University of Pittsburgh in He is admitted to practice in both Pennsylvania and New Jersey and recently earned the Associate in Fidelity and Surety Bonding designation. 11