TWENTY SIXTH ANNUAL SOUTHERN SURETY AND FIDELITY CLAIMS

TWENTY SIXTH ANNUAL SOUTHERN SURETY AND FIDELITY CLAIMS CONFERENCE Clearwater Beach, Florida RD TH APRIL 23 & 24, 2015 HANOVER V. ATLANTIS DRYWALL & FRAMING, et al: ARE INDEMNITY CLAIMS SUBJECT TO ARBITRATION? PRESENTED BY: Alec M. Taylor Krebs, Farley & Pelleteri, LLC 188 East Capitol Street, Suite 900 Jackson, Mississippi 39201 (601) 968-6708 Stephanie Geer Merchants Bonding Company 2100 Fleur Drive Des Moines, IA 50321 (515) 558-8737

Hanover v. Atlantis Drywall & Framing, et al: Are Indemnity Claims Subject to Arbitration? PRESENTED BY: Alec M. Taylor Krebs, Farley & Pelleteri, LLC 188 East Capitol Street, Suite 900 Jackson, Mississippi 39201 (601) 968-6708 Stephanie Geer Merchants Bonding Company 2100 Fleur Drive Des Moines, IA 50321 (515) 558-8737 I. Introduction Most payment and performance bonds do not contain an arbitration provision. Instead, a surety s duty to arbitrate often arises from language in an underlying contract between an owner and a contractor or from a subcontract between the principal and the obligee. In these situations, the payment and performance bonds typically contain language incorporating by reference the contract between the obligee and the principal, which contains an arbitration provision. The First, Second, Fifth, Sixth and Eleventh Circuits and several district courts have found that a surety must arbitrate disputes related to a performance bond where the performance bond specifically incorporates by reference a contract containing an arbitration clause. 1 The Eighth Circuit is the only federal circuit to diverge from this view. 2 There have been numerous papers authored on the effect of these arbitration provisions on performance bond claims between 1 Commercial Union Ins. Co. v. Gilbane Bldg. Co., 992 F.2d 386, 388 (1st Cir. 1993); Exchange Mut. Ins. Co. v. Haskell Co., 742 F. 2d 274, 276 (6th Cir. 1984), United States Fidelity & Guar. Co. v. West Point Constr. Co., 837 F.2d 1507, 1508 (11th Cir. 1988); Compania Espanola de Petroleos v. Nereus Shipping, 527 F.2d 966, 973 (2d Cir.1975), overruled on other grounds by United Kingdom of Great Britain and Northern Ireland v. Boeing Co., 998 F.2d 68, 71 (2d Cir.1993); J.S. & H. Const. Co. v. Richmond County Hospital Authority, 473 F.2d 212 (5th Cir. 1973); Jewish Fed'n of Greater New Orleans v. Fid. & Deposit Co. of Md., No. 01-30371, 2001 WL 1085096, at *2 (5th Cir. Aug. 29, 2001); see Hoffman v. Fidelity and Deposit Co. of Maryland, 734 F. Supp. 192 (D.N.J. 1990); Cianbro Corp. v. Empresa Nacional de Ingenieria, 697 F.Supp. 15 (D.Me.1988); O'Connor and Co. v. Insurance Co. of North America, 697 F. Supp. 563 (D. Mass. 1988). 2 Mandaree Public School Dist. #36, 503 F.3d 709 (8th Cir. 2007). AgGrow Oils, LLC v. National Union Fire Ins. Co. of Pittsburgh, Pa., 242 F.3d 777, 781 (8th Cir. 2001).

the surety, principal and/or obligee. This paper does not discuss these decisions. The purpose of this paper is to discuss the effect of these arbitration provisions on a surety s claim for indemnity, an issue that has not been before any courts until recently. In Hanover Ins. Co. v. Atlantis Drywall & Framing LLC, 579 Fed. Appx. 742 (11th Cir. Ala. 2014), the Eleventh Circuit Court of Appeals vacated and remanded the United States District Court for the Northern District of Alabama s ruling denying the Indemnitors motion to compel arbitration of Hanover s indemnity claims against them. This paper discusses this decision and its potential effect on the surety industry. Facts of the Hanover/Atlantis In 2009, Atlantis Drywall & Framing, LLC ( Atlantis ) and The Hanover Insurance Company ( Hanover ) entered into a relationship where Hanover agreed to issue payment and performance bonds to Atlantis on various projects. Hanover was not willing to assume the sole risk that any failure or default by Atlantis might result in a loss to it, so at the inception of Hanover s relationship with Atlantis, Hanover required the Indemnitors to execute an Indemnity Agreement before it would issue any bonds. During the course of Atlantis relationship with Hanover, Atlantis and the Indemnitors executed two indemnity agreements, neither of which was married to a specific project. On April 27, 2009, Atlantis and several other indemnitors (Bay Meadows Consulting, LLC; Marilourdes Deyo; Laurence Lamphere; and Christin M. Lamphere) executed the Indemnity Agreement (Bay Meadows Consulting, LLC; Marilourdes Deyo; Laurence Lamphere; and Christin M. Lamphere are collectively referred to as the Indemnitors ). This Indemnity Agreement covered all future bonds that Hanover would issue to Atlantis. On or about May 19, 2011, the Indemnitors executed a nearly identical Indemnity Agreement with Hanover, the only difference being that where Mr. Deyo had signed previously, the words divorce pending were now written. The opening paragraph of the Indemnity Agreement states [t]he Hanover Insurance Company... has executed, or may in its discretion hereafter execute certain surety contracts, undertakings, and/or other instruments of guarantee of indemnity... for which the Indemnity Agreement applies. The Indemnitors expressly promised and agreed to perform the following obligations in favor of Hanover: 2. The Indemnitors shall exonerate, indemnify, and save harmless the Surety from and against every claim, demand, liability, cost, charge, suit, judgment and expense which the Surety may pay

or incur including, but not limited to, loss, interest, court costs and consultant and attorney fees: (a) (b) (c) (d) by having executed or procured the execution of the bonds; or in making an independent investigation of any claim, demand or suit; or in defending any suit, action, mediation, arbitration or any other proceeding to obtain release from liability whether the Surety, in its sole discretion, elects to employ its own attorney or permits or requires Indemnitors to defend the Surety; or in enforcing any of the covenants, terms and conditions of this Agreement. 3. Payment shall be made to the Surety by the Indemnitors as soon as liability exists or is asserted against the Surety, whether or not the Surety shall have made any payment therefor. Such payment to the Surety shall be: (a) if the amount asserted as a claim, demand or suit is an ascertainable or liquidated amount, the amount of the claim, demand or suit asserted against the bond or bonds by any claimant or obligee, plus the amount the Surety deems sufficient, in its sole discretion, to indemnify and hold harmless from and against any loss, cost, interest, and expense necessary to defend, investigate or adjust the claim, demand or suit; or (b) if the amount asserted as a claim, demand or suit is an unascertainable or unliquidated amount, the amount the Surety deems sufficient, in its sole discretion, to indemnify and hold it harmless from and against any loss, cost, interest, and expense necessary to defend, investigate or adjust the claim, demand or suit. The Surety shall have the right to hold such funds as collateral (without any obligation to earn interest on the collateral for the Indemnitors) until the Indemnitors serve evidence satisfactory to the Surety of its discharge from all bonds and all liability by reason thereof, and to use such funds or any part thereof, at any time, in payment or settlement of any judgment, claim, liability, loss, damage, fees, or any other expense. The Surety shall have the exclusive right to adjust, settle or compromise any claim, demand, suit, or any other proceeding arising out of any bond against the Surety and/or the Indemnitors, take whatever action it deems appropriate in response thereto, and its determination of whether to defend or settle the same shall be

binding and conclusive upon the Indemnitors. In the event of any payment or disbursement by the Surety, the Indemnitors agree to immediately reimburse the Surety for any and all payments and disbursements made (including, but not limited to, interest from the date of the Surety s payments at the maximum rate allowable) under the Surety s belief that liability for the payments existed or that payment was necessary or expedient, whether or not such liability, necessity or expediency existed. Vouchers or other evidence of payment by the Surety shall be conclusive evidence of the fact and amount of such liability, necessity or expediency existed. Vouchers or other evidence of payment by the Surety shall be conclusive evidence of the fact and amount of such liability, necessity or expediency and of the Indemnitors liability to the Surety therefor. 8. The Surety, or its designated agents, shall have full and free access to the Indemnitors books and records at any and all reasonable times until the liability of the Surety under any bond is completely terminated and the claims of the Surety against any Indemnitors are fully satisfied. The Indemnity Agreement does not incorporate the specific bonds issued to Atlantis by Hanover. The reasoning for this is simple. At the time of the execution of the Indemnity Agreement, no bonds had been issued by Hanover to Atlantis. On or around March 8, 2011, Atlantis entered into a subcontract with Brice Building Company, LLC ( Brice ) for work to be performed in Alabama on the University of Alabama North Bluff Residential Community Project (the Subcontract ). The Indemnitors were not parties to the Subcontract. At the request of Atlantis and in reliance on the Indemnity Agreement, on June 30, 2011, Hanover issued payment and performance bonds naming Atlantis as Principal and Brice as Obligee (the Bonds ). The Indemnitors were not parties to the Bonds. The Subcontract contained the following arbitration provision: Paragraph CC. The parties agree and acknowledge that this Subcontract and the subject matter hereof is substantially connected with and involved with interstate commerce. In the event of a dispute(s), claim(s) or other matter(s) in question of any kind whatsoever between the parties (i) arising out of or related or collateral to the provision and/or subject matter of this Subcontract or the breach thereof, or independent from the Subcontract or (ii) relating to any transaction or occurrence of any kind between the parties to this Subcontract or their officers,

directors, agents and/or employees, it is agreed that the parties in this Subcontract will attempt to resolve such dispute(s), claim(s), or other matters(s) in question amicably by informal discussions and negotiations within a seven (7) day period. Notwithstanding any conflicting or contrary provisions contained within the General Contract nor any provisions in this Subcontract that incorporates herein the terms and conditions of the General Contract by reference, all dispute(s), claim(s), and other matter(s) in question which cannot be settled by negotiation among the parties within such time shall at the election of, the Contractor (but not otherwise), be submitted by the parties to arbitration under the Construction Industry Arbitration Rules of the American Arbitration Association except as such rules may be modified or restricted by any provision of this Subcontract. The parties intend that the scope of this arbitration clause shall be construed as broadly as possible so as to include, but not be limited to, the enforceability of this arbitration provision, the arbitrability of a particular claim or dispute, as well as any claims of misrepresentation, concealment of material facts, or fraud among the parties whether occurring before or after the execution of this agreement. Notice of demand by Contractor for arbitration shall be filed in writing with the other party or parties to this Subcontract and with the American Arbitration Association.... The Bonds incorporate the Subcontract by reference, which makes sense because the Bonds were issued after the Subcontract (and therefore could incorporate it by reference) and specifically referred to the Subcontract as the document the Bonds were incorporating by reference. Hanover incurred losses on the payment and performance bond, and as a result, filed suit against Atlantis and the Individual indemnitors in the United States District Court for the Northern District of Alabama. The Indemnitors filed a motion to compel arbitration, which was denied by the District Court. 3 The District Court Opinion. The issue of whether or not the Individual Indemnitors could compel arbitration of Hanover s claims for indemnity was first briefed for the United States District Court for the Northern District of Alabama, which denied the Indemnitors motion to compel. In its Memorandum Opinion and Order (the Opinion ), the District Court analyzed pertinent Alabama law in determining that 3 Atlantis also filed a motion to compel arbitration, which was granted by the Court, due to the broad scope of the arbitration provision in the Subcontract.

the Indemnity obligations of the Indemnitors were not subject to the arbitration provision contained in the Subcontract. The District Court determined that in order to compel arbitration, it must first find that the parties have agreed to arbitrate the issue, 4 because, as the United States Supreme Court held in a case originating from Alabama, a party cannot be required to submit to arbitration any dispute which he has not agreed to submit. 5 In the Opinion, the District Court explained the numerous ways that arbitration can be compelled. 6 The Court noted that no arbitration agreement was contained in the Indemnity Agreement and found that Hanover did not directly assent, either in writing or through its conduct, to arbitrate any dispute with the Lampheres. 7 The District Court then analyzed Alabama law regarding incorporation by reference, as this was the only viable method for compelling arbitration between the Indemnitors and Hanover. The District Court found that absent express language in the Indemnity Agreement, the Bonds and the Subcontract could still be incorporated into the Indemnity Agreement if it expressly refers to and sufficiently describes that document. 8 Applying Alabama law the language of the Indemnity Agreement to, the District Court held here, the Indemnity Agreement contains only general references to other contracts and bonds, with no description whatsoever. Therefore, it does not incorporate the Subcontract by reference or otherwise. 9 Despite the fact that the Indemnity Agreement did not explicitly incorporate into it any document by reference and did not expressly refer to and sufficiently describe the Subcontract or the Bonds, the District Court continued its analysis under Alabama law. The District Court analyzed whether or not the Subcontract, the Bonds, and the Indemnity Agreement should be read together as part of a single transaction, thus allowing incorporation by reference under Alabama law. 10 In determining whether or not the three documents could be viewed as a part of the same transaction, the District Court examined and applied factors that 4 The Opinion (Doc. 26), p. 3 (citing Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614, 626-28.; Ex parte Bill Heard Chevrolet, Inc., 927 So. 2d 792, 798 (Ala. 2005)); see also Shores of Pan., Inc. v. Safeco Ins. Co. of Am., 2008 U.S. Dist. LEXIS 75956, *10-11 (S.D. Ala. Sept. 29, 2008); Patriot Manufacturing, Inc. v. Dixon, 399 F. Supp 2d 1298, 1300 (S.D. Al. 2005); 5 Id. at 3 (quoting United Steelworkers v. Warrior & Gulf Nav. Co., 363 U.S. 574, 582 (1960)). 6 A written arbitration agreement signed by all parties exists, the parties assent to arbitration, or an arbitration agreement can be incorporated by reference into the contract between the parties. 7 Id. at 3-5 (the Lampheres are two of the five Indemnitors, other than Atlantis, who signed the Indemnity Agreement). 8 Id. at 5 (quoting Fid. & Deposit Co. v. Jefferson County Comm'n, 756 F. Supp. 2d 1329 (N.D. Al 2010) 9 Id. at 5-6. 10 The Opinion, at 6.

allow the incorporation by reference of non-contemporaneously executed documents, if they can be viewed as a single transaction. 11 One such factor is the congruity of parties in the non-contemporaneously executed documents (the Indemnity Agreement, Bonds, and Subcontract). The District Court acknowledged that under Alabama law two or more instruments executed contemporaneously by the same parties in reference to the same subject matter constitute one contract. 12 Since the contracts at issue were created by four different parties (the Indemnitors, Hanover, Atlantis, and Brice), the District Court held that the different documents executed by different parties, even involving a central theme, could not be merged together. 13 However, even if these non-contemporaneously executed documents by four parties could be read together, the District Court acknowledged that they must be part of a single, continuous transaction. 14 The Court analyzed the facts before them, applying Alabama law, and found that the three contracts could not be read as part of a single transaction. 15 Lastly, the District Court recognized that a non-signatory s claims can be compelled to arbitration where those claims arise out of the agreement containing the arbitration clause. 16 The District Court found that Hanover s claims against the Indemnitors did not arise out of the agreement containing the arbitration clause because Hanover was not claiming a direct right or benefit under the Subcontract, but sought to enforce explicit terms of the Indemnity Agreement. 17 In its decision, the District Court analyzed at least five ways under Alabama law that a party can be compelled to arbitrate its claims against another party. Applying Alabama law to the facts before it, the District Court denied the Indemnitors motion to compel arbitration as none of the methods for incorporation by reference under Alabama law were applicable to the facts before the District Court. The Appeal of the District Court s Ruling The Indemnitors appealed the District Court s denial of its Motion to Compel. On appeal, the Indemnitors argued that the District court erred by 11 Id. 12 Id. (quoting Pacific Ents. Oil Co. (USA) v. Howell Petroleum Corp., 614 So. 2d 409 (Ala. 1993). 13 Id. at 6-7 (citing Cavalier Mfg., Inc. v. Clarke, 862 So. 2d 634, 639 (Ala. 2003). 14 Id. at 7 (quoting Smith v. Smith, 43 So. 3d 1249, 1254 (Ala. Civ. App. 2009). 15 Id. at 7-8. 16 Id. at 8. (citing Ex parte Dyess, 709 So. 2d 447, 448-49 (Ala. 1997). 17 Id.

failing to compel arbitration of all claims asserted by Hanover against the Indemnitors, and further erred by failing to dismiss the action (or at least stay judicial proceedings pending completion of arbitration). The Indemnitors argued that the District Court ignored or obfuscated well established jurisprudence on contract construction and enforcement of arbitration agreements under the Federal Arbitration Act. According to the Indemnitors, a written agreement with a nexus to interstate commerce existed between Hanover and the Indemnitors to arbitrate claims: (a) arising out of or related to the provisions or subject matter of the Subcontract or a breach thereof; (b) collateral to the provisions or subject matter of the Subcontract or a breach thereof; (c) independent from the provisions or subject matter of the Subcontract or a breach thereof; or (d) related to any transaction or occurrence of any kind between Hanover and Indemnitors. 18 The Indemnitors argued that Hanover's indemnity claims related to, arose out of, were collateral to or were independent from the provisions or subject matter of the Subcontract or a breach thereof. Alternatively, the Indemnitors argued that the Indemnity Agreement and Hanover's claims in this action relate to a single transaction or occurrence between Hanover and Indemnitors. Thus, Hanover's efforts to avoid arbitration were futile because Hanover bound itself to the arbitration clause contained in the Subcontract through its own actions and the application of traditional principles of law, including traditional principles of contract law, contract construction, and arbitrability. As such, Hanover's claims against the Indemnitors were due to be arbitrated. While the Indemnitors arguments centered around the validity of the arbitration provision contained in the Subcontract, Hanover argued that this issue was a red herring. Hanover argued that before the validity of the arbitration provision in the Subcontract becomes relevant, the Indemnitors must prove that the Indemnity Agreement contains an arbitration provision or incorporates by reference the arbitration provision found in the Subcontract. Hanover argued that a simple reading of the Indemnity Agreement showed that it does not contain an arbitration provision or incorporate any other document by reference. Further, Hanover argued that the District Court correctly analyzed Alabama law and did not err in denying the Indemnitors Motion to Compel. The Eleventh Circuit Opinion On August 29, 2014, the Eleventh Circuit Court of Appeals issued its opinion vacating the District Court s ruling and remanding the case to the District 18 This language was taken from the arbitration provision contained in the Subcontract.

Court with instructions to compel arbitration. In so deciding, the Court recognized that the Indemnitors were not signatories to the Brice/Atlantis Subcontract, which contained the arbitration provision that was incorporated into the payment and performance bonds. Since the Indemnitors weren t signatories, the Court examined the limited instances when non-signatories can be compelled to arbitration. First, the Court pointed out that the Indemnitors can compel arbitration if the Indemnity Agreement incorporated the Subcontract, in which case it must expressly refer to and sufficiently describe the document. 19 Alternatively, the Subcontract may be incorporated by reference if it is part of the same transaction, that is, if the bonds, Indemnification Agreement, and subcontract are all part of a single transaction. 20 The Court recognized that Generally, this involves documents signed by the same parties at or near the same time. 21 However, the Court noted that Alabama law has never held that the parties must be the same. Lastly, the Court found that a non-signatory can seek arbitration if (1) the non-signatory is a third-party beneficiary of the contract containing an arbitration provision, and (2) the non-signatory s claims are intertwined with and related to the contract. 22 In vacating the District Court s decision, the Eleventh Circuit held that the Indemnity Agreement, bonds, and subcontract should be viewed as a single transaction since they relate to the same subject matter. 23 In so deciding the Court stated the parties were aware that Hanover required the Indemnification Agreement before it would issue the bonds, and thus the issuance of the bonds depended on the indemnification. And Atlantis could not perform its work under the subcontract without the bonds. 24 The Court further found that the Indemnity Agreement refers to the bonds that Hanover may enter into, even though it does not specifically identify the bonds at issue, and even though the Indemnity Agreement is not limited to the Brice/Atlantis subcontract there is no dispute that the parties entered into the Indemnification Agreement with the Brice-Atlantis subcontract and the specific payment and performance bonds in mind. 25 Finally, the Court stated that the District Court's conclusion that the documents were not related because at any stage the parties could have contracted with someone else without destroying the contract misses the 19 Hanover Ins. Co. v. Atlantis Drywall & Framing LLC, 579 Fed. Appx. 742, 745 (11th Cir. Ala. 2014). 20 Id. 21 Id. 22 Id. at 746. 23 Id. 24 Id. 25 Id.

point. 26 The parties were interconnected and the documents concerned the same subject matter. Thus, we cannot conclude that the Indemnification Agreement pertains to a different subject matter than the subcontract and bonds, and the district court erred when it declined to read the three documents as a single transaction. 27 Thus, the Court vacated the District Court s ruling and remanded the case to the District Court with instructions to compel arbitration. Hanover v. Atlantis Potential Effect on the Surety Industry Subsequent to the issuance of the Eleventh Circuit s opinion, Hanover filed a petition for rehearing and the Surety and Fidelity Association of America filed an Amicus Brief in support of Hanover s petition. On October 29, 2014, the 11 th Circuit granted the petition for rehearing. 28 Should the ruling be upheld, the effect of Hanover v. Atlantis could be far reaching. Although this is an unpublished opinion, it gives Indemnitors ammunition to argue that indemnity matters must be arbitrated. Many cases will differ factually from Hanover v. Atlantis, especially in the number of bonds associated with an indemnity agreement and the wording of the applicable arbitration agreement. Practitioners must be prepared to distinguish the facts before them from those in Hanover v. Atlantis. Further, as many indemnity matters are currently decided summarily, and since it is becoming increasingly more difficult to obtain summary judgment in arbitration, solvent indemnitors may seek to compel arbitration in an attempt to effectuate a more favorable settlement. Finally, as arbitration is generally more costly than litigation, a surety claims professional s analysis on whether to pursue an indemnity claim must be adjusted accordingly. Going forward, should this case gain traction in other venues, sureties should consider amending their indemnity agreements to account for this decision. A provision explicitly prohibiting indemnity claims from being arbitrated would give more assurance to the surety that indemnity claims would be adjudicated in court, a more favorable locale than arbitration. 26 Id. 27 Id. 28 Oral Arguments were originally scheduled for March 20, 2015, but the Court recently cancelled oral arguments and stated that the Court would rehear the arguments based solely on the briefs.

About the Authors Alec Taylor is an associate at Krebs, Farley & Pelleteri and resides in the firm s Jackson, Mississippi Office. Alec represents surety companies in connection with payment, performance, fiduciary and commercial bond disputes through the Southern United States. Alec is licensed to practice law in Mississippi and Alabama. He can be contacted at ataylor@kfplaw.com or (601) 968-6710. Stephanie Geer is a claims attorney at Merchants Bonding Company. She works out of the company s headquarters in Des Moines, Iowa. Stephanie received her Bachelor of Arts from the University of Iowa in 2005 and her Juris Doctor from the University of Iowa Law School in 2008.