TWENTIETH ANNUAL SOUTHERN SURETY AND FIDELITY CLAIMS

Transcription

1 TWENTIETH ANNUAL SOUTHERN SURETY AND FIDELITY CLAIMS CONFERENCE Clearwater, Florida th st APRIL 30 & MAY 1, 2009 BACK TO THE FUTURE: HAS BRAMBLE REVIVED THE A311 BONDS AND DO WE REALLY WANT TO GO THERE? PRESENTED BY: JARROD W. STONE, ESQ. JEFFREY S. PRICE, ESQ. MANIER & HEROD th Avenue N. - Ste Nashville, TN KIMBERLY B. CZAP TRAVELERS BOND AND FINANCIAL PRODUCTS

2 TABLE OF CONTENTS I. Introduction 1 II. Does the proposed amendment to the AIA A312 payment bond adequately solve the Bramble problem?...2 III. Brief Summary of Bramble and its Progeny 4 IV. A311 Payment Bond v. A312 Payment Bond..5 A) Who is a claimant?..6 1) A311 Payment Bond.6 2) A312 Payment Bond.8 B) What is covered?.8 1) A311 Payment Bond.8 2) A312 Payment Bond...10 C) Notice Requirements.11 1) A311 Payment Bond ) A312 Payment Bond...13 D) What is the limitations period? 16 1) A311 Payment Bond ) A312 Payment Bond...16 E) What are the surety s obligations upon receipt of claim? 17 1) A311 Payment Bond..17 2) A312 Payment Bond..18 F) Summary of Pros v. Cons of using A311 Payment Bond in lieu of A312 Payment Bond.21 1) Pros of Reverting to the AIA A311 Payment Bond.21 2) Cons of Reverting to the AIA A311 Payment Bond 22 V. A311 Performance Bond v. A312 Performance Bond.24 A) Who is protected by the Performance Bond? 24 1) A311 Performance Bond 24 2) A312 Performance Bond 24 B) Does the surety have any pre-declaration of default rights? 25 1) A311 Performance Bond 25 2) A312 Performance Bond i

3 C) Is the obligee obligated to declare the principal to be in default in order to trigger the surety s potential liability and/or duty to perform? 27 1) A311 Performance Bond 27 2) A312 Performance Bond 32 D) What is a default?.33 1) A311 Performance Bond 33 2) A312 Performance Bond 36 E) If declaration of default is required, how must the declaration be conveyed?..37 1) A311 Performance Bond 37 2) A312 Performance Bond 38 F) What are surety s performance options? 39 1) A311 Performance Bond 39 2) A312 Performance Bond 40 G) Does the obligee have to declare the surety to be in default? 43 1) A311 Performance Bond 43 2) A312 Performance Bond 43 H) Does the bond list or limit the types of damages that may be covered?.44 1) A311 Performance Bond 44 2) A312 Payment Bond..47 I) What is the limitation period?.48 1) A311 Performance Bond 48 2) A312 Performance Bond 49 J) Summary of Pros v. Cons of using A311 Performance Bond in lieu of A312 Performance Bond.51 1) Pros of Reverting to the AIA A311 Performance Bond ) Cons of Reverting to the AIA A311 Performance Bond.51 V. Conclusion ii

4 I. Introduction BACK TO THE FUTURE: HAS BRAMBLE REVIVED THE A311 BONDS AND DO WE REALLY WANT TO GO THERE? In light of the now infamous Bramble decision, many sureties have considered reverting back to the AIA A311 payment bond and the AIA A311 performance bond instead of issuing the AIA A312 payment bond. 1 This publication addresses several potential pitfalls that may arise if a surety reverts back to the AIA A311 bond forms so that the surety can make an informed decision as to whether the benefits of reverting to the AIA A311 bond forms outweigh the risk of utilizing these prior generation forms. Though reverting to the AIA A311 bond forms would eliminate the Bramble issue and therefore potentially reduce a surety s exposure to payment bond claimants, a surety s total exposure may be increased in some jurisdictions under the AIA A311 bonds forms in light of the additional pre-declaration of default protections incorporated into the AIA A312 performance bond. In other words, the potential loss of pre-declaration of default rights under the AIA A311 performance bond may essentially negate the benefit the surety would receive from reverting to the AIA A311 payment bond. Of course, there are a number of ways a surety can attempt to avoid the Bramble pitfalls, and this publication makes no attempt to catalog or critique all of the various alternatives. 2 Manuscripted bond forms, non-aia forms, and riders to the A312 form can be utilized to resolve some of these issues. However, obligees and owners often prefer standard AIA contracts and bond forms, which has led to the use the forms existing prior to the introduction of the A312 forms in This publication briefly summarizes the potential Bramble pitfalls associated with the AIA A312 payment bond, briefly discusses the impact of the recent amendment to the AIA A312 payment bond, and then focuses on the substantive distinctions between the AIA A311 bond forms and the AIA A312 bond forms. In addition to comparing and contrasting the bond forms, this publication also identifies and briefly discusses some of the issues that have arisen under each bond form. 1 2 The now infamous Bramble decision is reported as Nat l Union Fire Ins. Co. of Pittsburgh v. David A. Bramble, Inc., 879 A.2d 101 (Md. 2005). Some of the alternatives are discussed in Section IV(E)(2) of this publication

5 II. Brief Summary of Bramble and its Progeny As most surety claim professionals are aware, Maryland s highest court sent shockwaves through the surety industry when it held in Bramble that a surety may be barred from disputing any portion of a payment bond claims if the surety does not strictly comply with Paragraph 6 of the AIA A312 payment bond, which provides: 6. When the Claimant has satisfied the conditions of [Paragraph] 4, the Surety shall promptly and at the Surety s expense take the following actions: 6.1 Send an answer to the Claimant, with a copy to the Owner, within 45 days after receipt of the claim, stating the amounts that are undisputed and the basis for challenging any amounts that are disputed. 6.2 Pay or arrange for payment of any undisputed amounts. 3 The Bramble court concluded that Paragraph 6.1 of the AIA A312 payment bond requires a surety to do three things if it intends to dispute any portion of payment bond claim: (1) answer the claim within 45 days of receiving it, (2) state what amounts of the claim is undisputed within 45 days of receiving it, and (3) state the bases for challenging the disputed portions of the payment bond claim within 45 days of receiving it. 4 The Bramble court further warned: Paragraph 6 does not... simply require that the sureties state which portions of the claim are disputed and which are not; [sureties] must also specifically delineate the grounds underlying the dispute. This places a greater burden on the sureties with respect to those amounts they wish to challenge as compared to those parts of the claim that are undisputed, the latter of which the sureties must only list Though the surety in Bramble had corresponded with the claimants at issue, requested those claimants to document their claims, and expressly reserved its rights relative to those payment bond claims, the Bramble court held that the surety s failure to strictly comply with Paragraph 6.1 effectively rendered those payment bond claims to be undisputed in their entirety as a matter of law, which obligated the surety to promptly pay those claims. 6 In other words, because the surety did not attempt to delineate the disputed portion of the payment bond claims from any undisputed portion of the payment bond claims, those payment bond claims were deemed to be undisputed and immediately AIA Document A , Standard Payment Bond. Bramble, 879 A.2d at Id. Id

6 owing as a matter of law, even though the surety may have otherwise possessed valid defenses to those claims. 7 Federal courts have applied Bramble s logic in Virginia and Florida. The United States District Court for the Eastern District of Virginia held that a surety was barred from asserting any factual defense that it failed to assert in writing within 45 days of receiving the underlying payment bond claim in Casey Industrial, Inc. v. Seaboard Sur. Co. 8 In Casey, the surety rejected the underlying payment bond claim in writing within 45 days of receiving it. 9 The surety s rejection letter listed a number of potential defenses, and the rejection letter explained that the surety continued to reserve all rights and defenses that it or [its principal] may have at law, equity, or under the bond. 10 Despite this express reservation language, the Casey court concluded that the surety was precluded from developing any new bases for disputing the payment bond claim that were not articulated in the surety s rejection letter. 11 The United States District Court for the Middle District of Florida also followed Bramble and concluded that the surety s failure to strictly comply with Paragraph 6.1 of the AIA A312 payment bond barred the surety from disputing the underlying payment bond claim in J.C. Gibson Plastering Co. v. XL Specialty Ins. Co. 12 Accordingly, at a minimum, sureties now potentially face waiver and estoppel issues under the AIA A312 payment bond in Maryland, Virginia, and Florida. As anyone who routinely handles payment bond claims will attest, Bramble and its progeny have created a minefield for sureties. In jurisdictions adhering to Bramble, claims professionals now face the difficult, and sometimes impossible, task of independently investigating the underlying payment bond claim, consulting with the principal and obligee regarding the payment bond claim, requesting and/or reviewing documentation and other information relating to the payment bond claim, determining whether any portion of the payment bond claim will be disputed, and articulating all potential bases for disputing the claim all within 45 days of the date upon which the claim was received by the surety. Despite the burden this places upon claims professionals, the surety faces the following pitfalls when a claim is asserted under an AIA A312 payment bond: If the surety is unable to answer the payment bond claim within 45 days of receipt, the surety may be barred from disputing any portion of the claim even if the surety otherwise possesses valid defenses to the claim See id WL (E.D. Va. Oct. 2, 2006). Id. at *1. Id. at *4. Id WL (M.D. Fla. Oct. 8, 2007)

7 If the surety fails to delineate the disputed portion of the claim and the undisputed portion of the claim, the surety may be barred from disputing any portion of the claim even if the surety otherwise possesses valid defenses to the claim. If the surety fails to articulate the bases upon which it disputes a particular portion of the underlying payment bond claim, the surety may be barred from disputing that portion of the claim even if the surety otherwise possesses valid defenses as to that portion of the claim. If the surety properly disputes a portion of the claim but only articulates some of the its potential bases for disputing the claim, the surety may be barred from asserting any new bases for disputing the claim that are discovered after the 45 day answer period expires. In light of these potential pitfalls, some sureties have instructed their agents to cease issuing AIA A312 payment bonds without modifications, and some sureties have also considered reverting back to the AIA A311 bond forms. III. Does the proposed amendment to the AIA A312 payment bond adequately solve the Bramble problem? Soon after the Bramble decision was issued, both the National Association of Surety Bond Producers ( NASBP ) and the Surety & Fidelity Association of America ( SFAA ) pressed the American Institute of Architects ( AIA ) to amend Paragraph 6 of the AIA A312 payment bond as a stopgap measure until the AIA can draft an entirely new payment bond form. In May of 2008, the AIA issued an amendment to Paragraph 6 of the AIA A312 payment bond, the text of which reads as follows: 6. When the Claimant has satisfied the conditions of Section 4, the Surety shall promptly and at the Surety s expense take the following actions: 6.1 Send an answer to the Claimant, with a copy to the Owner, within days after receipt of the claim, stating the amounts that are undisputed and the basis for challenging any amounts that are disputed. 6.2 Pay or arrange for payment of any undisputed amounts. 6.3 The Surety s failure to discharge its obligations under this Section 6 shall not be deemed to constitute a waiver of defenses the Surety or Contractor may have or acquire as to a claim. However, if the Surety fails to discharge its obligations under this Section 6, the Surety shall indemnify the Claimant for the reasonable attorney s fees the Claimant incurs to recover any sums found to be due and owing to the Claimant

8 Though this amendment to Paragraph 6 certainly solves the main problem associated with Bramble and its progeny, some in the industry question whether the amendment could open an entirely new Pandora s Box. On the one hand, the amendment increases the surety s response time from 45 days to 60 days, which gives claims professionals and their consultants 15 additional days to investigate and formally answer the claim. More importantly, the amendment expressly states that the surety s failure to strictly comply with Paragraph 6 of the AIA A312 payment bond shall not be deemed to constitute a waiver of defenses the Surety or Contractor may have or acquire as to the claim. This language seemingly eliminates the waiver issues that could otherwise potentially result from (1) the surety s failure to answer a payment bond claim within 60 days of receipt, (2) the surety s failure to delineate the disputed portion of the claim from any undisputed portion of the claim, (3) the surety s failure to articulate the bases for its dispute of the claim, or (4) the surety s discovery of a basis for disputing the claim after the expiration of the 60 day answer period. On the other hand, the amendment to Paragraph 6 of the AIA A312 payment bond may have created new issues for sureties. For example, the amendment clarifies that a surety s failure to comply with Paragraph 6 of the payment bond shall not be deemed to constitute a waiver of defenses the Surety or Contractor may have or acquire as to the claim. Nonetheless, the AIA should have clarified that no failure on the surety s party to comply with any provision of the payment bond should be considered a waiver of the surety s potential defenses. The amendment also exposes the surety to claims for attorneys fees if the surety fails to comply with Paragraph 6. The amendment does not clarify whether the claimant would be entitled to recover all of its attorneys fees relating to the claim, whether the claimant would only be able to recover its attorneys fees relating to the disputed portion of the claim if it is eventually deemed to be due and owing, or whether the claimant would only be entitled to recover the attorneys fees resulting directly from the surety s failure to comply with Paragraph 6. The amendment also does not impose any obligation upon the claimant to cooperate with the surety or to otherwise provide documentation to substantiate its claim. For these and other reasons, some sureties remain reluctant to issue the AIA A312 payment bond as amended. IV. A311 Payment Bond v. A312 Payment Bond This section of the publication compares and contrasts the AIA A311 payment bond and the AIA A312 payment bond. At its conclusion, this section of the publication also discusses the pros and cons of reverting back to the AIA A311 payment bond as a method of avoiding the pitfalls associated with Bramble and its progeny

9 A) Who is a claimant? 1) A311 Payment Bond Paragraph 1 of the AIA A311 payment bond defines the term claimant as follows: A claimant is defined as one having a direct contract with the Principal or with a Subcontractor of the Principal for labor, material or both, used or reasonably required for use in the performance of the Contract, labor and material being construed to include that part of water, gas, power, light, heat, oil, gasoline, telephone service or rental of equipment directly applicable to the Contract. 13 Accordingly, under the express terms of Paragraph 1 of the AIA A311 payment bond, claimants fall into the following two categories: (1) subcontractors and suppliers/materialmen having a direct contract with the principal for labor, material, or both, used or reasonably required for use in the performance of the contract; and (2) subcontractors and suppliers/materialmen having a direct contract with a subcontractor of the principal for labor, material, or both, used or reasonably required for use in the performance of the contract. To qualify as a claimant, the subcontractor or supplier/materialman must have a direct contract with the principal or a subcontractor of the principal, but the AIA A311 payment bond does not define the term subcontractor or the phrase subcontractor of the principal. Nonetheless, the AIA A311 does not use terms such as subsubcontractor or second-tier subcontractor, which indicates that a subcontractor or a supplier/materialman must have direct contract with the principal or a first-tier subcontractor (i.e. a subcontractor with a direct contractual relationship with the principal) before it may qualify as a claimant. Furthermore, because only those with a direct contract with the principal or a subcontractor of the principal may qualify as a claimant, subcontractors or suppliers/materialmen that have a direct contract with a supplier/materialman (as opposed to a subcontractor) will not qualify as a claimant under the AIA A311 payment bond. A second-tier supplier will not qualify as a claimant even if the first-tier supplier has a direct contract with the principal, and a supplier can only qualify as a claimant if it has a direct contractual relationship with the principal or a first-tier subcontractor. Like the term subcontractor, the AIA A311 payment bond does not define the terms supplier or materialman. Accordingly, courts often look to the state law to distinguish 13 AIA Document A , Labor and Material Payment Bond

10 subcontractors from suppliers/materialmen, and state law should always be consulted on the issue of whether the party with whom the potential claimant has a direct contractual relationship qualifies as a subcontractor or a supplier/materialman. With that said, a party that merely supplies materials for the project and performs no physical labor or special fabrication will generally be deemed a supplier/materialman. 14 A party that undertakes to physically perform a portion of the work called for by the prime contract will generally be deemed a subcontractor. 15 Of course, there is a gray area between these two positions. Some courts have held that a party remains a supplier/materialman even if that party specially fabricates components used for the prime contract. This view is summarized as follows: [A] subcontractor is a worker who actually participates in the building or erection of the edifice. A materialman is one who supplies material either manufactured or fabricated for use in that building. If the fabricator of material does not engage in any process that incorporates the item furnished into the immovable under construction, he is a materialman. It matters not whether his product is procured from another manufacturer and delivered unchanged to the building site or if it is shaped by him from other materials before it is delivered to the job site. 16 Other courts have held that special fabrication of components pursuant to the underlying drawings and/or specifications merits subcontractor status. This view is summarized as follows: [T]he essential feature which constitutes one a subcontractor rather than a materialman is that in the course of performance of the prime contract he constructs a definite, substantial part of the work of improvement in accord with the plans and specifications of such contract, not that he enters upon the job site and does the construction there.... We do not accept the view of some other jurisdictions that to be a subcontractor one must install work at the site of the improvement. Rather, we conclude that one who agrees with the prime contractor to perform a substantial specified portion of the work of construction which is the subject of the general contract in accord with the plans and specifications by which the prime contractor is bound has charge of the construction of that part of the work of improvement and is a subcontractor although he does not undertake to himself incorporate such portion of the projected structure into the building See 17 Am. Jur. 2d Contractors Bonds 48 (2008). See id. Leonard B. Herbert., Jr. & Co. v. Kinler, 336 So. 2d 922, 924 (La. Ct. App. 1976). Piping Specialties Co. v. Kentile, Inc., 229 Cal. App. 2d 586, 589 (Cal. Ct. App. 1964) (internal citations omitted)

11 Again, state law should be consulted if claimant status depends upon whether the party to whom the potential claimant has a direct contractual relationship qualifies as a subcontractor or a supplier/materialman. 2) A312 Payment Bond Paragraph 15.1 of the AIA A312 payment bond defines a Claimant as [a]n individual or entity having a direct contract with the Contractor or with a subcontractor of the Contractor to furnish labor, materials or equipment for use in the performance of the Contract. 18 Similar to claimants under the AIA A311 payment bond, Claimants under the AIA A312 payment bond fall into the following two categories: (1) individuals or entities having a direct contract with the principal to furnish labor, materials, or equipment for use in the performance of the bonded contract; and (2) individuals or entities having a direct contract with a subcontractor of the principal to furnish labor, materials, or equipment for use in the performance of the bonded contract. Like the AIA A311 payment bond, the AIA A312 payment bond does not define the term subcontractor or the phrase subcontractor of the Contractor. Nonetheless, the use of the phrase subcontractor of the Contractor (as opposed to more generally using the term subcontractor ) indicates that an individual or entity must have a direct contractual relationship with the principal or a first-tier subcontractor before it may qualify as a Claimant. However, because the AIA A312 payment bond does not expressly distinguish subcontractors from suppliers/materialmen, state law must again be consulted if an issue arises as to whether an individual or entity qualifies as a subcontractor or a supplier/materialman for purposes of Paragraph 15.1 of the AIA A312 payment bond. Though it seems obvious from the definition of claimant, at least one court has expressly held that the obligee does not qualify as a claimant under an AIA A312 payment bond. 19 B) What is covered? 1) A311 Payment Bond Pursuant to Paragraph 1 of the AIA A311 payment bond, the bond form covers labor, material or both, used or reasonably required for use in the performance of the contract. 20 Paragraph 1 clarifies that the phrase labor and material includes that part of water, gas, power, light, heat, gasoline, telephone service or rental equipment AIA Document A , Standard Payment Bond. Sherman Constr. Corp. v. Spotsylvania County Sch. Bd. of Spotsylvania, 1989 WL , *2-*3 (Va. Cir. Ct. Aug. 21, 1989). AIA Document A , Labor and Material Payment Bond (emphasis added)

12 applicable to the Contract. Of course, this list really relates more to the types of material that may be covered than it relates to types of labor that may be covered. For example, the AIA A311 payment bond does not explain whether architectural or supervisory services would qualify as labor that is covered by the payment bond. Accordingly, a surety should consult state law to determine whether a particular service would fall within the ambit of labor under an AIA A311 payment bond. Materials that are specifically incorporated into the bonded project fall within the scope of labor and material covered by the AIA A311 payment bond. However, the use of the phrase reasonably required for use in the performance of the contract has spawned litigation on numerous occasions as to whether certain categories of materials or construction costs are covered. For example, courts interpreting the reasonably required phrase have held that the bond would not cover the costs associated with idle equipment and/or idle equipment operators because the equipment and/or operators were not reasonably required to complete the bonded project. 21 In other words, even if certain rental equipment is undisputedly used to complete the bonded project, a claimant can only recover the rental value of the time the rental equipment was reasonably required to be on the bonded project. Courts have also held that finance/service charges do not fall within the ambit of material costs that are reasonably required on the bonded project. 22 Other courts have determined that delay and/or acceleration costs are not covered by such payment bonds because those costs are not reasonably required for the completion of the project. 23 These courts reason that delay and/or acceleration costs are not indispensable projects costs. 24 Some courts have reached the opposite conclusion and have held that labor and material costs resulting from delay are covered by the payment bond as they are reasonably required for the completion of the bonded project. 25 While interpreting similar bond language, courts have also held that materials could theoretically be reasonably required for use in the performance of the contract, even though the materials were not actually used in the performance of the project, if the supplier furnished the materials with the good faith belief or reasonable expectation that the materials would be used on the bonded project. 26 A leading treatise has described this issue as follows: See, e.g., Larson v. Granite Re, Inc., 532 F.3d 724 (8th Cir. 2008). See, e.g., J.C. Snavely & Sons, Inc. v. Web M&E, Inc., 594 A.2d 333 (Sup. Ct. Pa. 1991). See, e.g., Samuel Grossi & Sons, Inc. v. U.S. Fid. & Guar. Co., 2006 WL (Pa. Comm. Pl. Nov. 10, 2006). See, C. Arena & Co. v. White Horse Village, Inc., 1993 WL , *5 (E.D. Pa. Nov. 3, 1993) (stating that [c]ourts have repeatedly held that delay damages are not an indispensable project cost in the same sense as labor or materials for purposes of construing a surety obligation ). See, e.g., Lexicon, Inc. v. Safeco Ins. Co. of Am., 436 F.3d 662 (6th Cir. 2006). See, e.g., Bethlehem Steel Corp. v. U.S. Fid. & Guar. Co., 598 N.Y.S.2d 873 (N.Y. App. Div. 1993) (holding that steel supplier could recover cost of steel under Miller Act payment bond, even though steel was not used in the bonded project, was reasonably required to complete the bonded project)

13 Traceability of covered materials to the bonded project remains an important evidentiary requirement. Although coverage is provided for materials furnished by covered claimants and proven to have been incorporated into, used or consumed in completion of the bonded work, controversy has continued to surround claims of suppliers unable to trace their materials to specific bonded work. Even more difficult are the claims of suppliers who prove that materials were furnished directly to a particular bonded project but who can not prove that their materials actually were incorporated, used or consumed in the performance of a bonded contract. Recognizing that material suppliers control proof of delivery to a bonded site but not necessarily the proof of whether the materials were properly used or consumed by contractors for the benefit of the bonded work, courts generally have required suppliers to prove good faith [delivery] to the bonded job site. Acknowledging the beneficent objectives of the Miller Act, the Little Miller Acts and mechanics lien statutes, courts require claimants to prove simply that they furnished material in the good faith belief or reasonable expectation that the materials were intended for and would be substantially used or consumed on the bonded work. The same evidentiary requirements apply even where materials are earmarked for the bonded project but stored offsite. 27 2) A312 Payment Bond Paragraph 1 of the AIA A312 payment bond expressly references labor, materials and equipment furnished for use in the performance of the Construction Contract Paragraph 15.1 of the AIA A312 payment bond further states: The intent of this Bond shall be to include without limitation in the terms labor, materials or equipment that part of water, gas, power, light, heat, oil, gasoline, telephone service or rental equipment used in the Construction Contract, architectural and engineering services required for performance of the work of the Contractor and the Contractor s subcontractors, and all other items for which a mechanic s lien may be asserted in the jurisdiction where the labor, materials or equipment were furnished. 29 Unlike the AIA A311 payment bond, the AIA A312 payment bond expressly covers architectural and engineering services required for the performance of the principal s work and the work of the principal s subcontractors. The catch-all provision at the end of Paragraph 15.1 requires claims professionals to be familiar with the applicable jurisdiction s mechanic liens laws. If the BRUNER & O CONNOR CONSTRUCTION LAW 8:166 (2008) (internal citations omitted). AIA Document A , Standard Payment Bond (emphasis added). Id

14 claimant could assert a mechanic s lien on the bonded project for a particular item of labor, material, or equipment, then that particular item of labor, material, or equipment will be covered under the AIA A312 payment bond so long as that item of labor or material was furnished for use in the performance of the bonded project. As a general rule, public projects are immune from mechanic s liens. Though the AIA A312 payment bond does not contain the reasonably required language used in the AIA A311 payment bond, the underlying labor, materials, or equipment will be covered by the AIA A312 payment bond if they are furnished for use in the performance of the Construction Contract.... Generally speaking, [m]aterials usually are deemed to be furnished to a project when they are physically delivered to the site or when they are fabricated pursuant to contract plans and specifications and stored offsite for future delivery. 30 The AIA A312 payment bond does not expressly require that the underlying labor, materials, or equipment actually be used in the performance of the Construction Contract, which could expose the surety to the same good faith belief and reasonable expectation arguments it has faced under the AIA A311 payment bond. C) Notice Requirements 1) A311 Payment Bond The notice requirements under an AIA A311 payment bond are governed by Paragraph 3(a), which provides: No suit or action shall be commenced hereunder by any claimant: a) Unless claimant, other than one having a direct contract with the Principal, shall have given written notice to any two of the following: the Principal, the Owner, or the Surety above named, within ninety (90) days after such claimant did or performed the last of the work or labor, or furnished the last of the materials for which said the claim is made, stating with substantial accuracy the amount claimed and the name of the party to whom the materials were furnished, or for whom the work or labor was done or performed. Such notice shall be served by mailing the same by registered mail or certified mail, postage prepaid, in an envelope addressed to the Principal, Owner or Surety, at any place where an office is regularly maintained for the transaction of business, or served in any manner in which legal process may be served in the state in which the aforesaid project is located, save that such service need not be made by a public officer. On its face, Paragraph 3(a) of the AIA A311 payment bond does not require subcontractors or suppliers/materialmen having a direct contractual relationship with the 30 3 BRUNER & O CONNOR CONSTRUCTION LAW 8:166 (2008)

15 principal to provide notice of their potential payment bond claim, but Paragraph 3(a) of the AIA A311 payment bond imposes special notice requirements upon claimants who do not have a direct contractual relationship with the principal. In order to comply with the notice requirements contained in Paragraph 3(a) of the AIA A311 payment bond, a subcontractor or supplier/materialman who does not have a direct contractual relationship with the principal must do each of the following: 1. Give written notice to either (a) the principal and the owner, (b) the principal and the surety, or (c) the owner and the surety; 2. Provide the written notice to one of the above combinations within 90 days after that subcontractor or supplier/materialman did or performed the last of its work or furnished the last of the material for which that claim is being asserted; 3. The written notice must state with substantial accuracy the amount claimed; and 4. The written notice must list the name of the party to whom the claimant furnished materials or for whom the claim performed work. Interestingly, claimants are not required to provide notice of their claims to the surety before initiating suit against the surety because Paragraph 3(a) of the AIA A311 payment bond allows claimants to provide notice of their claims to the owner and the principal. The claimant s written notice must be delivered by registered mail or certified mail, postage prepaid, and must be addressed to a place where the addressee regularly maintains an office for the transaction of business. As an alternative, the claimant may serve its written notice in any manner in which legal process may be served upon those parties in the state in which the bonded project is located. Most states allow service of legal process upon a corporation via hand delivery upon an officer or managing agent of the corporation, or the chief agent of the corporation in the county wherein the action is brought, or any other agent authorized by appointment or by law to receive service on the corporation s behalf. A full discussion of the enforceability of these notice provisions is beyond the scope of this publication. 31 In short, the use of the word unless in Paragraph 3(a) of the AIA A311 payment bond implies that proper notice is a condition precedent to commencing an action against the surety under an AIA A311 payment bond. Some courts have required strict compliance with similar notice provisions, while other courts engage in an analysis of whether the lack of proper notice prejudiced the surety s rights For a more detailed discussion of the enforceability of such notice requirements, a surety can refer to 3 BRUNER & O CONNOR CONSTRUCTION LAW 8:175 (2008). See 3 BRUNER & O CONNOR CONSTRUCTION LAW 8:175 (2008)

16 Accordingly, sureties should consult state law on the enforceability of such notice provisions to determine whether the jurisdiction at issue will treat the notice provisions as conditions precedent that must be strictly satisfied or whether the claimant s substantial compliance with the notice provisions will be deemed sufficient. 2) A312 Payment Bond The notice requirements under an AIA A312 payment bond are governed by Paragraph 4, which provides: 4. The Surety shall have no obligation to Claimants under this Bond until: 4.1 Claimants who are employed by or have a direct contract with the Contractor have given notice to the Surety (at the address described in Paragraph 12) and sent a copy, or notice thereof, to the Owner, stating that a claim is being made under this Bond and, with substantial accuracy, the amount of the claim. 4.2 Claimants who do not have a direct contract with the Contractor:.1 Have furnished written notice to the Contractor and sent a copy, or notice thereof, to the Owner, within 90 days after having last performed labor or last furnished materials or equipment included in the claim stating, with substantial accuracy, the amount of the claim and the name of the party to whom the materials were furnished or supplied or for whom the labor was done or performed; and.2 Have either received a rejection in whole or in part from the Contractor, or not received within 30 days of furnishing the above notice any communication from the Contractor by which the Contractor has indicated the claim will be paid directly or indirectly; and.3 Not having been paid within the above 30 days, have sent a written notice to the Surety (at the address described in Paragraph 12) and sent a copy, or notice thereof, to the Owner, stating that a claim is being made under this Bond and enclosing a copy of the previous written notice furnished to the Contractor. 33 Paragraph 12 of the AIA A312 payment bond further states: 33 AIA Document A , Standard Payment Bond

17 Notice to the Surety, the Owner or the Contractor shall be mailed or delivered to the address shown on the signature page. Actual receipt of notice by Surety, the Owner or Contractor, however accomplished, shall be sufficient compliance as of the date received at the address shown on the signature page. 34 Like the AIA A311 payment bond, the AIA A312 payment bond imposes different notice requirements upon individuals and/or entities having a direct contractual relationship with the principal than it imposes upon individuals and/or entities not having a direct contractual relationship with the principal. Individuals and/or entities that have a direct contract with the principal must take the following steps to satisfy the notice requirements imposed by Paragraph 4.1 of the AIA A312 payment bond: 5. Furnish notice of the claim to the surety at the address listed on the signature page of the AIA A312 payment bond via mail or any other method that effectuates actual receipt of the written notice by the surety; 6. The notice must expressly state that a claim is being made against the payment bond; and 7. The notice must state the amount of the claim with substantial accuracy. Paragraph 4 of the AIA A312 payment bond does not expressly require individuals and/or entities having a direct contractual relationship with the principal to provide their written notice to the surety within a certain number of days after they perform work or furnish materials on the bonded project. Paragraph 4 of the AIA A312 payment bond imposes more stringent notice requirements upon individuals and/or entities that do not have a direct contractual relationship with the principal. Those individuals and/or entitles must take the following steps to comply with the notice requirements imposed by Paragraph of the AIA A312 payment bond: 1. Furnish notice to the principal via mail or any other method that effectuates actual receipt of the written notice by the principal; 2. Send a copy of the notice, or notice of the notice, to the owner via mail or any other method that effectuates actual receipt of the notice by the owner; 34 Id

18 3. Furnish the above referenced notices to the principal and owner within 90 days after that claimant last performed labor or last furnished materials or equipment included in the claim; 4. The notice to the principal must state the name of the party to whom the materials were furnished or supplied or for whom the labor was done or performed; and 5. The notice to the principal must state the amount of the claim with substantial accuracy. Assuming that the claimant complies with Paragraph 4.2.1, Paragraph of the AIA A312 payment bond allows a claimant to proceed with providing notice of its claim to the surety if the claimant: 1. Receives a rejection of its claim in whole or in part from the principal; or 2. Does not receive any communication from the principal within 30 days of furnishing notice under Paragraph in which the principal indicates that the claim will be paid directly or indirectly. If the claimant receives a total or partial rejection from the principal or does not receive an indication from the principal that payment will be forthcoming directly or indirectly, the claimant must take the following steps to comply with the notice requirements contained in Paragraph of the AIA A312 payment bond: 1. Furnish notice of the claim to the surety by mail via mail or any other method that effectuates actual receipt of the written notice by the surety; 2. Furnish a copy of that notice, or notice of that notice, to the owner via mail or any other method that effectuates actual receipt of the notice by the owner; 3. The notice to the surety must state that a claim is being asserted against the payment bond; 4. The notice to the surety must enclose a copy of the written notice that the claimant previously furnished to the principal. As noted above, a full discussion of the enforceability of these notice provisions is beyond the scope of this publication. The authors of this publication reiterate that the terms of Paragraph 4 of the AIA A312 payment bond imply that proper notice is a condition precedent the surety s obligations to claimants. Nonetheless, sureties should consult state law on the enforceability of such notice provisions to determine whether the jurisdiction at issue will treat the notice provisions as conditions precedent that must be

19 strictly satisfied or whether the claimant s substantial compliance with the notice provisions will be deemed sufficient. D) What is the limitations period? 1) A311 Payment Bond The limitation period for commencing an action against a surety under an AIA A311 payment bond is governed by Paragraph 4 of the bond form, which provides, in pertinent part: No suit or action shall be commenced hereunder by any claimant:.... b) After the expiration of one (1) year following the date on which Principal ceased Work on said Contract, it being understood, however, that if any limitation embodied in this bond is prohibited by law controlling the construction hereof such limitation shall be deemed to be amended so as to be equal to the minimum period of limitation permitted by such law. 35 By its terms, Paragraph 4 of the AIA A311 payment bond contemplates that some jurisdictions will not enforce a contractual limitations period as short as 1 year, and a full discussion of the enforceability of such limitations provisions is beyond the scope of this publication. 36 However, in jurisdictions in which a 1 year contractual limitation period is enforceable, the claimant must commence its action against the surety within 1 year following the date upon which the principal ceased Work on said Contract. 2) A312 Payment Bond The limitations period for commencing an action against a surety under an AIA A312 payment bond is governed by Paragraph 11 of the bond form, which provides, in pertinent part: No suit or action shall be commenced by a Claimant under this Bond... after the expiration of one year from the date (1) on which the Claimant gave the notice required by Subparagraph 4.1 or Clause 4.2.3, or (2) on which the last labor or service was performed by anyone or the last materials or equipment were furnished by anyone under the Construction Contract, whichever of (1) or (2) first occurs. If the provisions of this AIA Document A , Labor and Material Payment Bond. For a detailed discussion of the enforceability of a contractual limitations provision that shortens the period for initiating litigation, see A.M. Swarthout, Annotation, Validity of Contractual Limitation of Time for Bringing Action, 121 A.L.R. 758 (1939); B.H. Glenn, Annotation, Validity of Contractual Time Period, Shorter than Statute of Limitations, for Bringing Action, 6 A.L.R.3d 1197 (1966)

20 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 be applicable. 37 Like Paragraph 4 of the AIA A311 payment bond, Paragraph 11 of the AIA A312 payment bond contemplates that some jurisdictions will not enforce a contractual limitations period as short as 1 year. Nonetheless, in jurisdictions where such contractual limitations periods are valid and enforceable, the claimant must commence its action against the surety under an AIA A312 payment bond within the earlier of the following dates: 1. One year from the date upon which the individual or entity having a direct contractual relationship with the principal gave written notice to the surety as required by Paragraph One year from the date upon which the individual or entity not having a direct contractual relationship with the principal gave written notice to the surety and the owner as required by Paragraph 4.2.3; or 3. One year from the date upon which anyone performed labor or service the last labor or service was performed by anyone or the last materials or equipment were furnished by anyone under the Construction Contract. The surety can sometimes easily determine the date upon which a claimant provided notice to the surety as required by Paragraph 4.1 or of the AIA A312 payment bond. However, the surety often finds it more difficult to determine the last date upon which anyone performed labor or service or furnished material or equipment on the bonded project. E) What are the surety s obligations upon receipt of claim? 1) A311 Payment Bond The AIA A311 Payment bond does not expressly impose any duties upon the surety in terms of responding to a payment bond claim. Instead, Paragraph 2 of the AIA 311 payment bond states: The above named Principal and Surety hereby jointly and severally agree with the Owner that every claimant as herein defined, who has not been paid in full before the expiration of a period of ninety (90) days after the date on which the last of such claimant s work or labor was done or performed, or materials were furnished by such claimant, may sue on this bond for the use of such claimant, prosecute the suit to final judgment for 37 AIA Document A , Standard Payment Bond

21 such sum or sums as may be justly due claimant, and have execution thereon. The Owner shall not be liable for the payment of any costs or expenses of any such suit. 38 The authors reiterate that there exists the possibility that a claimant may commence an action against the surety without first giving notice of its payment bond claim to the surety because Paragraph 3(a) of the AIA A311 payment bond allows claimants to provide notice of the their claims to the owner and principal instead of the surety. As claims professionals are aware, some courts have imposed extra-contractual duties upon sureties in the context of responding to payment bond claims, even though the underlying payment bond does not expressly impose any such obligations. Again, a full discussion of those extra-contractual duties and the potential for bad-faith penalties is beyond the scope of this publication. 39 With that said, claims professionals should consult state law when faced with a claim under an AIA A311 payment bond to determine whether the jurisdiction at issue imposes any such extra-contractual obligations. 2) A312 Payment Bond As explained in more detail above, courts in Maryland, Virginia, and Florida have held that Paragraph 6 of the AIA A312 payment bond imposes specific obligations upon sureties upon receipt of a payment bond claim. Again, Paragraph 6 of the AIA A312 payment bond provides: 6. When the Claimant has satisfied the conditions of [Paragraph] 4, the Surety shall promptly and at the Surety s expense take the following actions: 6.1 Send an answer to the Claimant, with a copy to the Owner, within 45 days after receipt of the claim, stating the amounts that are undisputed and the basis for challenging any amounts that are disputed. 6.2 Pay or arrange for payment of any undisputed amounts. 40 By its express terms, Paragraph 6 of the AIA A312 payment bond requires the surety to take the following steps once the claimant has satisfied the notice requirements contained in Paragraph 4: AIA Document A , Labor and Material Payment Bond. For a more detailed discussion of a surety s exposure for bad faith penalties, a surety can refer to 4 Bruner & O Connor Construction Law 12:7 (2008). These issues are also briefly discussed in Section IV(F)(1) of this publication. AIA Document A , Standard Payment Bond

22 1. Send an answer to the claimant within 45 days of the date upon which the surety received notice of the claim at the surety s address listed on the signature page of the payment bond; 2. Send a copy of the answer to the owner within 45 days of the date upon which the surety received notice of the claim at the surety s address listed on the signature page of the payment bond; 3. The surety s answer must state the undisputed portion of the claim, if any; 4. The surety s answer must state the surety s bases for challenging any disputed portion of the claim; and 5. The surety must either pay or arrange for payment of any undisputed amounts of the payment bond claim. The authors must reiterate that Paragraph 12 of the AIA A312 payment bond requires a Claimant to mail, or otherwise deliver, notice of its potential payment bond claim to the owner, the principal, and/or the surety at the address shown on the signature page of the AIA A312 payment bond. The AIA A312 payment bond form provides a space for the surety to list its mailing address on the first page of the payment bond, and the second page of the bond form contains additional spaces for the names and addresses of any co-sureties. Therefore, the surety should insure that the address listed on the signature page of the AIA A312 payment bond form is the address to which payment bond claims should be sent. Unfortunately, the first page of the AIA A312 payment bond form also contains a space for the name and address of the surety s agent/broker, and claimants may erroneously send their claims to the agent/broker instead of sending the claim to the surety s address listed on the signature page. If a claims professional ever receives such a claim that has been forwarded by the agent/broker, the claims professional may consider immediately notifying the claimant, in writing, of the date upon which the surety actually received written notice of the claim at the address shown on the signature page of the AIA A312 payment bond. The initial letter to the claimant could also explain that Paragraph 12 of the AIA A312 payment bond does not allow claimants to submit notices of their claims to the surety s agent/broker but the surety nonetheless acknowledges actual receipt of the claimant s notice as of the date of the letter. Though the authors have been unable to find any case considering the issue of whether notice received by the agent/broker should be deemed notice to the surety under an AIA A312 payment bond, the surety may benefit from documenting the date upon which it actually received notice as contemplated by Paragraph 12. Such a letter would also demonstrate the speed with which the surety responded to the claim upon actual receipt of notice as contemplated by Paragraph 12. By now, many sureties have already taken steps to modify their claim handling procedures as a result of Bramble and its progeny, and a full discussion of those procedures is beyond the scope of this publication. With that said, below are a few steps