SEVENTEENTH ANNUAL SOUTHERN SURETY AND FIDELITY CLAIMS

SEVENTEENTH ANNUAL SOUTHERN SURETY AND FIDELITY CLAIMS CONFERENCE St. Pete Beach, Florida th th MAY 4-5, 2006 PURSUIT AND PRESERVATION OF PRE AND POST DEFAULT CLAIMS AGAINST THE UNITED STATES GOVERNMENT PRESENTED BY: CHRISTINA A. CRADDOCK, ESQ. BOVIS, KYLE & BURCH, LLC 53 Perimeter Center East Third Floor Atlanta, Georgia 30346-2298 770.391.9100 678.338.3912 Direct Line 770.668.0878 Facsimile cac@boviskyle.net

PURSUIT AND PRESERVATION OF PRE AND POST DEFAULT CLAIMS AGAINST THE UNITED STATES GOVERNMENT INTRODUCTION A surety on a federal project may be faced with a defaulting or defaulted principal who, at the time of default, has or had viable claims against the Government. Unless the surety can preserve those claims, it stands to lose a great deal. A surety, upon default, acquires valuable rights, including the right of equitable subrogation and all of the rights detailed in any indemnity agreement executed by the principal, among others. Despite the long standing recognition of a surety s equitable subrogation rights in courts around the country dating back to the Prairie State National Bank v. United States, 164 U.S. 227, 32 Ct. Cl. 614, 17 S.Ct. 142, 41 L. Ed. 412 (1896) decision, they continue to be assailed by private and governmental entities alike, and courts continue to misconstrue the nature, breadth and depth of these valuable rights. A surety s pursuit of its pre and post default claims against the United States government are further aggravated by the fact that all federal courts are courts of limited jurisdiction and the United States is shielded by the armor of sovereign immunity. Unless a surety can prove that both the government has waived that sovereign immunity and the court has jurisdiction to hear the claim, the surety s claim against the government will fail, regardless of its merits. Federal Government attorneys are asserting jurisdictional defenses whenever possible. They would prefer to have a case dismissed on jurisdictional grounds rather than have to address the merits of a claim. If they succeed in getting the case dismissed for lack of jurisdiction, regardless of the merits of the claim, the Government pays nothing. One judge just recently described federal suretyship law, particularly when it comes to the issue of a court s jurisdiction to hear a claim, as a tangled web of law woven in overlapping cocoons of contradictory doctrine and unpredictable application. Liberty Mutual Ins. Co. v. United States, 2006 WL 465845 (Fed. Cl.) While none of us can accurately predict the twists and turns that the courts may take, a road map of what the courts have done to date and the tolls required to get through certain jurisdictional gates may be instructive in determining just what actions should be taken by sureties upon learning of a default and in responding to a declaration of default to enable them to preserve and pursue their pre and post default claims against the United States government. TWO FEDERAL ROADS CONVERGED IN A WOOD A surety has two avenues available to it when pursuing its pre and post default claims against the United States Government and both have their own unique tolls to be satisfied before the claim may be pursued. The surety can elect to pursue its claims against the government in the Armed Services Boards of Contract Appeals under the 2

Contract Disputes Act, 41 USC 601, et. seq. or in the Court of Federal Claims under the Tucker Act, 28 USC 1491. The starting point of this, or any surety analysis, however, must be the bond and the underlying construction contract which has been incorporated into the bond by reference. The construction contract may declare that all disputes must be resolved either by arbitration or by a cause of action filed in either the Armed Services Board of Contract Appeals or the Court of Federal Claims. The directive of the contract is going to control the forum. A. Pursuit of Claims Before the Boards of Contract Appeals Certain construction contracts may provide that any and all claims arising under the contract must first be addressed by the contracting officer and in the event that a party disagrees with the ruling of the contracting officer, appeals must be filed with the Board of Contract Appeals. This road, if at all possible, should be the road less traveled by sureties. Appeals to the Board of Contract Appeals are limited by the Contract Disputes Act, 41 USC 601, et. seq. (CDA) to contractors with claims on contracts entered into by a Government agency: [Each] agency board shall have jurisdiction to decide any appeal from a decision of a contracting officer (1) relative to a contract made by its agency. 41 USC 607 (d). The Courts have enforced these strict limits of the CDA as jurisdictional prerequisites to any appeal of a contracting officer s decision. Sharman Co., Inc. v. United States, 2 F.3d 1564, 1569, n. 6 (Fed.Cir. 1993). Only 2 types of claims are acknowledged under the CDA those claims brought by a contractor against the government and those claims asserted by the government against a contractor. 41 USC 605(a). A contractor is defined by the CDA as a party to a Government contract other than the Government. 601(4). Over the years, sureties attempts to qualify as a contractor under the CDA in order to pursue their pre and post default claims against the Government have met with dismal results. The Boards have refused to recognize that a completing surety, equitably subrogated to the rights of its principal, qualifies as a contractor. The Boards have held that unless the surety has a direct contract with the Government, the surety cannot qualify as a contractor for purposes of the CDA. Ransom v. United States, 900 F.2d 242 (Fed.Cir. 1990); Admiralty Constr., Inc. v. Dalton, 156 F.3d 1217 (Fed.Cir. 1998). Once a surety enters into a Takeover Agreement with the Government, the surety is in a direct contractual relationship with the Government and the surety does qualify as a contractor for purposes of the CDA and pursuit of any claims it might have against the Government. 3

Even with the execution of a Takeover Agreement, completing sureties continue to encounter problems pursuing the recovery of claims that arose prior to the default and prior to the execution of that Takeover Agreement. The Government has sought and obtained the dismissal of a completing surety s pre-default claims on the basis that the claims arose prior to the execution of the Takeover Agreement, that prior to the Takeover Agreement, the surety did not have a direct contract with the Government and that thus, the surety could not pursue the claims because it was not a contractor for purposes of the CDA with respect to those pre-default claims. Sureties attempts to pursue those pre-default claims against the Government pursuant to the assignment and Power of Attorney in the indemnity agreement have also failed. The Boards have ruled that since the Government was not a party to the indemnity agreement, the assignment contained therein violates the Anti-Assignment Act. The Boards have denied the surety s right to pursue those claims on that basis. What is commonly referred to as the Anti-Assignment Act consists of two statutory provisions, 31 USCA 3727 (a) (1), (b) and 41 USCA 15(a). Under 31 USCA 3727 (a)(1), (b), an assignment of any part of a claim against the United States or any interest in that claim may be made only after a claim has been allowed, the amount of the claim has been finally determined and a warrant for payment of the claim has been issued. In addition, 41 USCA 15(a) prohibits the transfer of any contract involving the Government or any interest in such a contract. Together, these statutes prohibit the assignment of claims against the United States or transfer of contracts involving the United States except under particular limited circumstances. Claims may be assigned but only after they have been allowed in a specific amount and authorization for the payment of the claim has been issued. Thus, even though a completing surety executes a Takeover Agreement and thereby qualifies as a contractor for purposes of pursuit of claims against the Government arising out of the contract, the surety must then find a way to convince the Boards that its entitlement to pursue the pre-default claims does not violate the Anti-Assignment Act. Only then may the surety actually pursue the merits of its claims against the Government. 1. Recent Developments Regarding Pursuit of Claims Under the CDA Two relatively recent decisions from the Boards of Contract Appeals illustrate that creative drafting of the Takeover Agreement and thorough and detailed claims handling may provide the sureties just the ammunition they need to defeat the Government s jurisdictional arguments and force the Government to address the merits of their claims. A recent ruling by the Department of Labor Board of Contract Appeals provides completing sureties a ray of light under which to argue that upon execution of a Takeover Agreement with the Government, the surety is in direct contractual privity with the Government and may pursue any and all claims arising out of and relating to the construction contract, including pre-default claims. In the Matter of: Maharaj Construction, Inc., 2005 WL 166351 (L.B.C.A.), LBCA No. 2001-BCA-3 (January 25, 2005). 4

In that case, the contractor, Maharaj Construction, Inc. ( Maharaj ), had been terminated for default and the Owner had called upon the surety, Lumbermens Mutual Casualty Co. to complete the Project. Maharaj filed an appeal of the Contracting Officer s decision to declare a default. The Contracting Officer filed a Motion to Stay the appeal on the basis that Lumbermens had asserted its rights under the Indemnity Agreement and its equitable subrogation rights and sought to enter into negotiations with the Contracting Officer for completion of the Project. During the interim, Lumbermens entered into a Takeover Agreement with the Government in which both parties acknowledged the surety s right to exercise the assigned rights under the Indemnity Agreement and specifically, the surety s rights to exercise all of the affirmative claims of its principal dating back to the inception of the contract. Lumbermens then filed a Motion to Intervene and Withdraw the Appeal of its principal, Maharaj. Maharaj opposed the Motion and argued that the Board did not have jurisdiction to address Lumbermens request because Lumbermens did not qualify as a contractor under the CDA and the assignment of the rights under the Indemnity Agreement violated the Anti-Assignment Act. The Board rejected Maharaj s defenses and ruled that it had jurisdiction to address Lumbermens Motion. The Board held that Lumbermens had satisfied its burden of establishing that it had standing to pursue its claim. Upon the Department of Labor s termination of Maharaj for default, Lumbermens executed a Takeover Agreement with the Department of Labor, hired a completion contractor and financed completion of the Project. The Board stated that it is settled law that the Surety, in effect as a contractor, can exercise all of the assigned rights of the defaulted contractor, provided that it is not barred by the Anti-Assignment Act. In support of its ruling it also cited the decision in In the Matter of: Insurance Company of the West, 1988 WL 83978, 88-3 BCA 21,056 (July 20, 1988) for the proposition that the surety s execution of a takeover agreement and performance of the contract accord the surety standing as a contractor. This was only the first hurdle that Lumbermens had to get over. In order to prevail, the Board had to agree that the assignment of the rights and claims by Maharaj to Lumbermens under the General Agreement of Indemnity was not barred by the Anti Assignment Act. Lumbermens pursuit of claims that occurred pre-default was dependent upon its right to enforce the assignment under the General Agreement of Indemnity. In addressing this second prong of the case, the Board reiterated that the Anti- Assignment Act was intended for the protection of the Government and that it did not allow a party to enter into a consensual agreement and then avoid the consequences of the agreement by relying on the Anti-Assignment Act. More importantly, however, the Board pointed out that the Government is in privity with Lumbermens by virtue of the Takeover Agreement and the Takeover Agreement specifically incorporated by reference the totality of the assignment and Power of Attorney granted in the General Indemnity Agreement. The Board held that the Government had waived the Application of the Anti- Assignment Act by executing the Takeover Agreement which incorporated the terms of the General Indemnity Agreement. It is well recognized that the Government can waive the 5

protection of the Anti-Assignment Act by its conduct or by any other recognition, acknowledgment or consent to the assignment. Tuftco Corp. v. United States, 614 F.2d 740 (Ct. Cl. 1980); Insurance Company of the West, ASBCA No. 35253. As a result of the Government s waiver of the protections provided it under the statute, the Anti-Assignment Act did not bar Lumbermens assumption of Maharaj s rights under the Indemnity Agreement, including particularly the right to settle all of Maharaj s affirmative claims, Lumbermens standing to prosecute and settle those claims and Lumbermens right to withdraw Maharaj s appeal. The Appeal was thereafter dismissed as withdrawn. The execution of the Takeover Agreement gave the surety standing as a contractor, one in direct contractual privity with the Government, to pursue claims against the Government arising out of the construction contract. The Board s decision in the Maharaj Construction case makes clear, however, that in order to fully preserve its rights, including its rights under the Indemnity Agreement, the Takeover Agreement needs to include an acknowledgement of those rights and incorporate the terms of the Indemnity Agreement by reference, if possible. Just such an acknowledgement of the general contractor s assignment of its rights to its surety in a Takeover Agreement allowed Safeco Insurance Company to prevail on its claims for pre-takeover damages against the Government in the Appeal of Safeco Insurance Company of America, 2003 WL 21783795 (A.S.B.C.A.), 03-2 BCA P 32341, ASBCA No. 52107 (July 30, 2003). Safeco Insurance Company of America ( Safeco ) had issued performance and payment bonds for Manning Electric & Repair Co., Inc. ( Manning ) for its contract with the Air Force to perform electrical work on the Patrick Air Force Base, Florida, Project. Prior to the issuance of the bonds, Manning had executed an Indemnity Agreement in favor of Safeco. The Project had been plagued by significant delays, most of which were not the fault of Manning. Manning voluntarily defaulted on the Project, advising Safeco that it could not pay its subcontractors and suppliers. Safeco had a construction consultant review the Project and it determined that there was a significant delay claim to be asserted against the Owner, that there were sufficient funds remaining in the contract to cover the cost to complete, so long as time extensions were granted by the Government for the delays. Safeco had Manning execute several agreements, one of which was an agreement assigning to Safeco all of its contracts, including its rights to the remaining contract balances. Manning also executed a Power of Attorney appointing Safeco its attorney-in-fact. Manning and Safeco advised the Government of the assignments and Manning s relinquishment of all rights in the contract to Safeco and demanded that all contract balances be paid to Safeco. Safeco thereafter entered into a Takeover Agreement with the Government. The Takeover Agreement recited that Manning had executed the Power of Attorney in favor of Safeco and that Manning had relinquished all of its rights, title and interest in the contract, 6

including its right to receive contract balances, retainages or any other sums or payments from the Air Force, to Safeco. Safeco hired a completion contractor and financed the completion of the Project. Safeco filed an Appeal to prosecute Manning s pre-default claims, including, among others, a significant delay claim against the Government. The Government filed a Motion in Limine to exclude all evidence of costs incurred during Manning s tenure on the Project prior to default on the basis that Safeco had no standing to pursue any claims prior to the execution of the Takeover Agreement. The Board rejected the Government s arguments. The Takeover Agreement had included an acknowledgment of Manning s assignment of its contracts, including the right to pursue claims and to receive contract balances thereunder, and Manning s execution of the irrevocable power of attorney in favor of Safeco. Both Safeco and Manning had notified the Government of the assignment and the execution of the irrevocable power of attorney and the Government stood mute. During settlement negotiations regarding the merits of Safeco s claim prior to the filing of the claim with the Contracting Officer and prior to Safeco s filing of the appeal, the Government had conducted numerous audits of Safeco s claims and never once challenged Safeco s claim to costs incurred by Manning prior to the default. The Board found that the Government knew about and consented to the assignment in its execution of the Takeover Agreement and that the Government moreover by its conduct had waived any claim to protection under the Anti-Assignment Act. The Maharaj Construction, Inc. and Safeco Insurance Company of America decisions are instructive as to how sureties may defeat jurisdictional claims of the Government through creative drafting of Takeover Agreements and through thorough and detailed claims handling and force the Government to address the merits of their claims before the Boards of Contract Appeals. 2. Troublesome News on the State Level with Government Contracts The rulings of the various Boards and the Federal Courts of Appeals as to whether equitable subrogation qualifies a surety as a contractor under the Contract Disputes Act are having a much more far reaching effect in that they have now been relied upon to defeat a surety s pursuit of claims against a State Agency. The rulings were recently relied upon by the Supreme Court of Virginia in the case of XL Specialty Ins. Co. v. Commonwealth of Virginia Dept. of Transportation, 269 Va. 362, 611 S.E.2d 356 (2005) to adopt a similarly strict construction of a state statute relating to parties allowed to pursue causes of action against the Virginia Department of Transportation (VDOT). Bravos Concrete, Inc. ( Bravos ) contracted with VDOT to perform 2 construction contracts. XL Specialty Insurance Company ( XL ) provided performance and payment bonds on behalf of Bravos. Bravos defaulted on the contracts and VDOT called upon XL to complete. XL and VDOT executed Takeover Agreements for both projects and XL completed both projects. 7

XL filed a demand for payment for costs it incurred in repairing work not completed or defectively completed by Bravos but for which Bravos had been paid by VDOT. XL followed the provisions of Code 33.1-386 in pursuing its claims. The claims were denied by the Deputy Commissioner and XL filed 2 motions for judgment based upon the original construction contracts, not the Takeover Agreements, in the Circuit Court. VDOT defended on the basis of sovereign immunity and filed motions to dismiss in which it asserted that there was no express contract between VDOT and XL and that there was no waiver of sovereign immunity which would allow the causes of action to proceed. The trial court granted the motions to dismiss and XL appealed. On appeal, XL argued that it was a contractor with VDOT by virtue of the performance bond it issued for the construction contract, a tripartite agreement of which VDOT was a party. The Court disagreed, pointing out that while the surety, contractor and owner all have recognized rights and duties under the construction contract and performance bond, none of the cases addressing those rights and duties ever found that a direct contractual relationship was established between parties that did not sign a contract by virtue of related rights and duties that arose from some other related but separate contract. The Supreme Court cited the decisions in both Ransom v. United States, 900 F.2d 242 (Fed.Cir. 1990) and Admiralty Const. Inc. v. Dalton, 156 F.3d 1217, 1220-21 (Fed.Cir. 1998) for the proposition that the performance bond and the construction contract, regardless of the rights and duties arising thereunder, do not create an express contract between the owner and the surety. XL, undaunted, argued that it qualified as a contractor under the right of action clause based upon the doctrine of equitable subrogation. As a completing surety, XL stepped into the shoes of its principal and thus, assumed the posture of contractor vis a vis VDOT. The Court rejected this argument pointing out that the surety does not actually step into the shoes of the contractor because the surety has rights that the contractor doesn t have upon default. For example, the completing surety can ultimately recover retainage although the contractor lost that right as a result of its default. The surety is discharged from its obligation to perform under its bond if the owner and contractor execute a cardinal change to the contract. The surety has the right to demand repayment of amounts overpaid to the contractor during the course of construction. The Supreme Court then looked at the decisions of the federal courts with respect to whether a surety, by virtue of its equitable subrogation rights, qualifies as a contractor and on the basis of the decisions in Transamerica Ins. Co. v. United States, 31 Fed. Cl. 602 (1994) and Fireman s Fund Ins. Co. v. Secretary of the Navy, 313 F.3d 1344, 1351 (Fed.Cir. 2002), the Court ruled that a claim based upon equitable subrogation did not make the surety a contractor for purposes of the Virginia statute. Id. at p. 372. The appeal was then transferred to the Court of Appeals for a decision on the merits and the Court of Appeals abided by the conclusions reached by the Supreme Court in ruling that XL s claims were barred by sovereign immunity. XL Specialty Ins. Co. v. Commonwealth of Virginia Dept. of Transportation, 47 Va. App. 424, 624 S.E.2d 658 (2006). The Court of Appeals did, however, rule that the trial court erred in denying XL s 8

Motion to Amend its Motions for Judgment to include a claim under the Takeover Agreement. The Court ruled that the Takeover Agreement was an integral part of the relationship between XL and VDOT, which specifically referred to the bonds and contracts and provided that both XL would complete the construction and VDOT would pay XL in accordance with the terms and conditions of the original contracts. The case was remanded for further proceedings. Once again, this decision illustrates how important a Takeover Agreement can be in preserving a surety s rights to pursue claims once the dust has settled, the Project is complete and the money has yet to be paid. B. Pursuit of Claims Before the Court of Federal Claims The Court of Federal Claims is definitely a friendlier forum in which sureties may pursue both pre and post default claims against the Government. Federal case law has long recognized a surety s right to sue the Government in the Court of Federal Claims under the doctrine of equitable subrogation. Great American Ins. Co. v. United States, 202 Ct. Cl. 532, 481 F.2d 1298, 1308 (1973). All federal courts are courts of limited jurisdiction. RHI Holdings, Inc. v. United States, 142 F.3d 1459, 1461 (Fed. Cir. 1998). The U.S. Court of Federal Claims has jurisdiction over a claim brought against the United States only if Congress has consented through a waiver of sovereign immunity. United States v. Mitchell, 463 U.S. 206, 212 (1983). The waiver must be expressed in statute and may not be implied and the scope of the waiver will be strictly construed in favor of the government. Lane v. Pena, 518 U.S. 187, 192 (1996); Library of Congress v. Shaw, 478 U.S. 310, 318 (1986). Claims may be brought in the Court of Federal Claims under the Contract Disputes Act but just as in the cases before the Boards, the surety is required to prove that it qualifies as a contractor under the terms of the Act in order to pursue those claims. In the case of Carchia v. United States, 202 Ct. Cl. 723, 735, 485 F.2d 622, 628 (1973), a completing surety which has executed a Takeover Agreement to complete performance of the original construction contract upon the original contractor s default was found to have standing to sue the government on the takeover agreement for extra work that it had performed in excess of that contemplated in the original contract price. With the existence of the takeover agreement, the surety, in effect, [became] the contractor, subject to the terms of the new agreement. Universal Surety Co. v. United States, 10 Ct. Cl. 794, 800 (1986). In the Court of Federal Claims, sureties may also pursue pre-default claims against the United States pursuant to the Tucker Act, 28 USC 1491. Under the Act, the Court of Federal Claims has jurisdiction to render a judgment on any claim against the United States founded upon the Constitution or any Act of Congress or any regulation of an executive department, or upon any express or implied contract with the United States or for liquidated or unliquidated damages in any non-tort case. The Act creates jurisdiction in the Court of Federal Claims, however, it does not create subject matter jurisdiction. The 9

plaintiff must identify a substantive right that is enforceable against the United States for money damages. Mitchell at p. 216-17. Even though the Court of Federal Claims has recognized Tucker Act jurisdiction over contract based claims brought by sureties under the doctrine of equitable subrogation, sureties have received mixed results from the Court in recent cases. Lumbermens Mutual Casualty Co. had the Court recognize that as a completing surety, it was equitably subrogated to the rights of its defaulting principal only to lose the case on its merits because it failed to give the government required notice. Lumbermens Mutual Casualty Co. v. United States, 67 Fed. Cl. 253 (2005), The Navy had awarded a contract to Landmark Construction Company for the repair and renovation of a number of family housing units and Lumbermens provided the payment and performance bonds for Landmark for the Project. Landmark ultimately advised the Navy that it was unable to complete the Project and the Navy terminated the contract for default and called upon Lumbermens to complete the Project. Lumbermens executed a Takeover Agreement with the Navy, hired a completion contractor and financed the completion of the Project. The Navy withheld approximately $1,000,000.00 in liquidated damages from Lumbermens due to the delayed completion of the Project. Lumbermens filed suit against the United States in the Court of Federal Claims under theories of equitable subrogation, impairment of suretyship and breach of the Takeover Agreement. Lumbermens asserted that the Navy had overpaid Landmark and had paid for materials that had never been delivered. At the time of the takeover, the Navy had paid Landmark 40% of the contract balance but only 15% of the units had been completed. In addition, under the terms of the contract, the Navy was not supposed to pay for materials until Landmark had proven that it had paid for and obtained title to those materials. The Court recognized the surety s equitable subrogation rights but noted that if the surety expected the Government to withhold funds from the contractor or divert funds to the surety prior to default, the surety had to notify the Government that the contractor could not complete. Any equitable duty on the part of the Government to retain funds for the surety is triggered only by notice from the surety that the contractor is in default or that payment should be made to the surety. Ransom v. United States, 17 Ct. Cl. 263, 272 (1989), aff d 900 F.2d 242 (Fed. Cir. 1990); Fireman s Fund Ins. Co. v. United States, 909 F.2d 495, 499 (Fed. Cir. 1990). Lumbermens had not notified the Government that Landmark was likely to default and had not advised the Government to withhold funds or make payments to the surety. Failure to notify the Government to withhold payments from Landmark or make payments to Lumbermens cost Lumbermens its claims. Lumbermens also raised claims for damages resulting from the Government s actions which impaired the surety s rights. Specifically, Lumbermens complained of a bilateral modification of the contract between the Navy and Landmark that added a significant number of additional housing units to the contract but did not include an 10

extension of the contract completion date to accommodate the extra work required. Lumbermens argued that the additional work materially increased its risk. The Court ruled that factual questions precluded its ruling on the Motion for Summary Judgment and remanded the matter for further factual development. The Court cited the case of National Surety v. United States, 118 F.3d 1542 (Fed. Cir. 1997) in which it had been held that contract terms that provide security for the bonded performance cannot be ignored, waived or modified without the consideration of the surety s interests. The Court pointed out that Lumbermens would have to prove that the Government departed from the terms of its contract with Landmark and that that departure impaired its rights in order to prevail on these claims. One final note on the Lumbermens decision. The Court, in addressing Lumbermens breach of the Takeover Agreement claims under the CDA, purports to draw a distinction between a completing surety and a paying surety. The Court does not elaborate however as to how such a distinction would affect its ruling on the claims under the CDA. This distinction between completing sureties and paying sureties has been the basis for the Government s attacks on sureties claims in at least 2 recent cases. In both the case of Liberty Mutual Ins. Co. v. United States, 2006 WL 465845 (Fed. Cl. 2/27/2006) and the case of Nova Casualty Co. v. United States, 69 Fed. Cl. 284 (2006), the Government latched onto some dicta from the Insurance Company of the West, 243 F.3d 1367 (2001) to argue that since that decision, only a performance bond surety can be subrogated to the rights of the prime contractor and that a surety which pays only under the payment bond cannot avail itself of the Tucker Act waiver of sovereign immunity. In both the Liberty Mutual and Nova Casualty cases, the principals defaulted on their obligations under the construction contracts. The sureties did not make any payments under the performance bonds but did satisfy and pay claims under the payment bonds. The sureties then filed suit in the Court of Federal Claims. Both sureties invoked their equitable subrogation rights to assert their claims to recover from the Government either amounts improperly paid by the Government to the principal or contract funds still retained by the Government. In the Nova Casualty case, the Coast Guard had awarded a contract to prepare and paint the Coney Island Light Tower to Eagle Management Enterprises, Inc. (Eagle ). Nova issued the performance and payment bonds on the Project. Prior to obtaining the bonds, Eagle had executed an Indemnity Agreement in favor of Nova. The work on the Project had been substantially completed when the Government discovered deficiencies in the work. The Government sent out a cure notice to Eagle, with a copy to Nova. Eagle failed to respond to the cure notice. The Contracting Officer issued a final decision advising that it was going to have the corrective work performed by another contractor and charge the costs for the corrective work to Eagle and Nova. Neither Eagle nor Nova appealed this decision. The Coast Guard entered into a completion contract for the corrective work and sent notice to Eagle and Nova that once the work was completed, the Government would seek 11

reimbursement from Eagle and Nova. Once the corrective work was completed, the Contracting Officer issued a second final decision, which included a claim against Eagle and its surety, Nova, for the completion costs. Only upon receipt of this second final decision did Nova reply to the Contracting Officer, objecting to the final decision and asserting a claim that the Government had improperly released a progress payment to Eagle after the defective work had been discovered. Nova did not make a payment under the performance bond but it paid the claims asserted by 2 of Eagle s subcontractors under the payment bond, obtaining full and final releases from both subcontractors. Nova filed a complaint in the Court of Federal Claims appealing the Contracting Officer s final decision and the Government moved to dismiss the complaint on jurisdictional grounds, arguing that Nova did not qualify as a contractor under the CDA and alternatively, that its payments under the payment bond were not sufficient to establish a claim for equitable subrogation against the Government that was cognizable by the Court. The Court granted the Government s Motion to Dismiss on the ground that Nova did not qualify as a contractor under the CDA. Nova was not a signatory of the original construction contract and did not execute a Takeover Agreement with the Government for completion. Nova had no contractual privity with the Government and as such, Nova was prohibited from asserting any rights under the CDA with respect to the final decision. Nova s attempt to salvage its position by arguing that it had standing to appeal the Final Decision pursuant to the assignment of rights by Eagle in the Indemnity Agreement failed. The Court rejected the argument and held that the assignment violated the Anti- Assignment Act and noted further that Eagle could not have assigned its right to appeal the Final Decision to Nova as the claim against the Government had not even arisen when the Indemnity Agreement was executed. Nova was not out of Court yet, though. The Court noted that Nova still had the right to invoke the doctrine of equitable subrogation and assert a claim under the Tucker Act. The Court favorably cited and discussed the long line of Supreme Court cases holding that a surety can establish its right of subrogation either by completing the construction contract under the performance bond or by paying materialmens claims under the payment bond. The Government argued that the surety s claims were barred by sovereign immunity. The Government seized upon the statement of the Court in the Insurance Company of the West case, Id., to the effect that [It] is well established that a surety who discharges a contractor s obligations to pay subcontractors is subrogated only to the rights of the subcontractor. Such a surety does not step into the shoes of the contractor and has no enforceable rights against the government. and argued that that language barred a surety who has only satisfied claims under a payment bond from seeking relief directly from the government. The Court rejected this argument, refusing to take the quoted statement out of context and looked at the intent of the Insurance Company of the West decision as a whole for its ruling. The Insurance Company of the West Court had also held that the Court in the 12

case of Balboa Ins. Co. v. United States, 775 F.2d 1158 (Fed. Cir. 1985) had correctly stated the law of equitable subrogation and that the case of Pearlman v. Reliance Ins. Co., 371 U.S. 132 (1962) stood for the proposition that the subrogee steps into the shoes both of the contractor and the government. Ins. Co. of West, at p. 1375, n.3. The Nova Court reasoned that in making these statements, the Insurance Company of the West Court acknowledged that these cases, and the long of cases preceding them, continued to be binding upon the courts as to the manner in which the rights of sureties under the doctrine of equitable subrogation are applied vis a vis government contracts. The Court concluded that the Tucker Act supplies a waiver of sovereign immunity for a surety making a claim of equitable subrogation after having satisfied its obligations under a payment bond, just as the Tucker Act also serves that purpose for a surety who has satisfied a performance bond. Nova Casualty, Id. The Court in the case of Liberty Mutual Ins. Co. v. United States, 2006 WL 465845 (Fed. Cl. 2/27/2006) arrives at an almost identical conclusion. In addressing the Government s arguments, the Court goes through an exhaustive analysis of the major Supreme Court opinions on the issue of equitable subrogation, beginning with Prairie State National Bank v. United States, 164 U.S. 227, 32 Ct. Cl. 614, 17 S. Ct. 142, 41 L.Ed. 412 (1896). CONCLUSION As a general rule, a completing surety is equitably subrogated to the rights, claims and defenses of its principal. Furthermore, upon a declaration of default, the assignment by the principal to the surety of all of its rights, title and interest to its contracts, including, but not limited to, the right to collect any and all retained contract balances is invoked. It would be a mistake to assume, however, that each and every surety may exercise those rights and obtain a successful recovery. Government attorneys, both State and Federal, are asserting jurisdictional defenses to sureties claims on an ever increasing basis. The selection of the forum in which the surety s claims will be heard is a significant factor and it may very well be dictated by the original construction contract. Sureties must be vigilant from the first inkling that the principal might be in distress, notifying the government to withhold payments from the principal, investigating the alleged default and being creative in drafting Takeover Agreements that include, among other things, acknowledgments by the Government of the assignment and power of attorney granted by the principal to the surety under the Indemnity Agreement, etc. so as to preserve those claims in the event that litigation must be filed in order to obtain recovery. 13