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Fall 2015
Uniting Plaintiff, Defense, Insurance, and Corporate Counsel to Advance the Civil Justice System
Carbon nanotubes (CNTs) holdpromise for many beneficialapplications. However, there havebeen concerns and calls for amoratorium raised over “mountingevidence” that CNT may be the“new asbestos,”1 or at leastdeserving of “special toxicologicalattention” due to prior experienceswith asbestos.2 The shape and sizeof some agglomerated CNTs aresimilar to asbestos—the most“desirable.” And because CNTs forstructural utility are long andthin—characteristics thought toimpart increased potency to
asbestos fibers—discussions ofparallels between these twosubstances are natural. Thus, giventhe legacy of asbestos-relatedinjury and the thousands of caseslitigated each year, consideration ofpossible implications of the use ofCNTs in research and in consumerproducts is prudent.
First reported in 19913, CNTsepitomize the emerging field ofnanotechnology, defined by someas the “ability to measure, see,manipulate, and manufacturethings usually between 1 and100 nanometers.”4 CNTs are a typeof carbon-based engineerednanoparticle generally formed by
Uniting Plaintiff, Defense, Insurance, and Corporate Counsel toAdvance the Civil Justice System
Fall 2009
Toxic Torts and EnvironmentalLaw Committee
IN THIS ISSUECarbon Nanotubes: The Next Asbestos . . . . . . . . . . . . . . . . . . . . . . . 1
Editor’s Message . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Tatera v. FMC Corporation: When Is A Product No A Product? . . . 3
Mexico’s National Wastes Management Program. . . . . . . . . . . . . . . 4
Environmental Risk During Restructuring And Bankruptcy . . . . . 5
Upcoming TTEL Programs And Meetings . . . . . . . . . . . . . . . . . . . . 6
Limitations Of Toxicogenomic Studies To Assess Toxic ExposuresAnd Injury From Benzene . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Burlington Northern: The Requisite Intent For Arranger LiabilityUnder Cercla . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
2009-2010 TIPS Calendar . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Continued on page 18
CommitteeNewsCommitteeNews
CARBON NANOTUBES: THE NEXT ASBESTOS?Fionna Mowat, Exponent, [email protected] Tsuji, Exponent, [email protected]
1 Miller, G. 2008. Mounting evidence that carbonnanotubes may be the new asbestos. Friends of theEarth Australia. Available at http://nano.foe.org.au.2 The Royal Society and Royal Academy ofEngineering (RS/RAE). 2004. Nanoscience andnanotechnologies. Royal Society and Royal Associationof Engineers. London: The Royal Society. Available athttp://www.royalsoc.ac.uk/.3 Iijima, S. 1991. Helical microtubules of graphiticcarbon. Nature (London) 354:56–58.4 National Science and Technology Council (NSTC).2007. The National Nanotechnology Initiative. StrategicPlan. Washington DC: NSTC, Committee onTechnology, Subcommittee on Nanoscale Science,Engineering, and Technology. December. Available athttp://www.nano.gov/ NNI_Strategic_Plan_2004.pdf.
F i d e l i t y and surety practitioners know all too
well how difficult it can be to collect on amounts owed under an indemnity agreement. And few things are more frustrating than negotiating a settlement, only later to have the indemnitee back out. So what does a savvy practitioner do to increase the chance of successful and timely collection, while still saving the client money?
One method that has been employed with varying success outside of the indemnity context is to include a confession of judgment clause within the contract. With these clauses, the indemnitee consents to giving power of attorney to an individual designated by the indemnitor to appear for and obtain a judgment against indemnitee without notice or hearing.
Essentially, the indemnitee waives her due process rights to notice and hearing. As such, confession of judgment clauses raise state and federal due process concerns, which have led more than a dozen states to refuse to recognize them. Many other courts, however, will enforce them when the clauses are properly bargained for and utilized.
This article provides basic background on confession of judgment clauses, explores the current legal landscape across the states, and offers practice pointers for those considering including confession of judgment clauses in indemnity agreements.
Fidelity & Surety Law Committee
THE USE OF CONFESSION OF JUDGMENT CLAUSES WITHIN INDEMNITY AGREEMENTSBy: Drew J. Gentsch and Danya M. Keller
IN THIS ISSUE:The Use Of Confession Of Judgment Clauses Within Indemnity Agreements . . . . . . . . . . . . . . . . . . . . . . . . . 1Letter From The Chair . . . . . . . . . . . . . . . . . . . . . . . . . . 6The Enemy Is Within: What Happens When The Defaulter Completes The Application For Fidelity Coverage? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9Contractor vs . Surety: Is Termination Always Required Under An A312 Performance Bond–A Point/Counterpoint . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11Ohio Court Of Appeals Supports Suretyship Rights . 13Potential Exposure For Homebuilders/Contractors For Installing/Supplying Lumber Liquidators’ Laminate Flooring Products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142015 - 2016 TIPS Calendar . . . . . . . . . . . . . . . . . . . . . . 30
Continued on page 17
Fidelity & Surety Law Committee Newsletter Fall 2015
2 2
ChairGary Valeriano
Anderson McPharlin & Conners LLP
707 Wilshire Boulevard, Ste 4000Los Angeles, CA 90017-3623
(213) 688-0080Fax: (213) 622-7594
Chair-ElectAdam FriedmanChiesa Shahinian &
Giantomasi PCOne Boland Drive
West Orange, NJ 07052(973) 530-2029
Fax: (973) [email protected]
Council RepresentativeSam Poteet
Manier & Herod150 4th Ave N, Ste 2200
Nashville, TN 37219(615) 742-9321
Fax: (615) [email protected]
Immediate Past ChairMike Pipkin
Weinstein Radcliff Pipkin LLP6688 N Central Exprsswy, Ste 675
Dallas, TX 75206(214) 865-7012
Fax: (469) [email protected]
NewsletterEditors-in-Chief
Todd BragginsErnstrom & Dreste LLP
180 Canal View Blvd, Ste 600Rochester, NY 14623-2849
(585) 473-3100Fax: (585) 473-3113
Scope LiaisonDavid Olson
Frost Brown Todd LLC301 E 4th St, Ste 3300
Cincinnati, OH 45202-4257(513) 651-6905
Fax: (513) [email protected]
Vice-ChairsShannon Briglia
BrigliaMcLaughlin PLLC1950 Old Gallows Rd, Ste 750
Vienna, VA 22182-4014(703) 506-1990
Fax: (703) [email protected]
Elizabeth CarleyCincinnati Insurance Company
PO Box 145496Cincinnati, OH 45250-5496
(513) 870-2173Fax: (513) 371-7252
Jennifer FioreDunlap Fiore LLC
301 Main St, Ste 1100Baton Rouge, LA 70801-1916
(225) 282-0652Fax: (225) 282-0680
Jeffrey FrankAlber Crafton PSC
2301 W Big Beaver Rd, Ste 300Troy, MI 48084-3326
(248) 822-6190Fax: (248) 822-6191
Peter KarneySWISSRE
475 N Martingale Rd, Ste 850Schaumburg, IL 60173
(847) 273-1259Fax: (847) 273-1260
James KeatingAllied World Insurance Company30 South 17th Street, 16th Floor
Philadelphia, PA 19103(267) 800-1819
Edward RubachaJennings Haug & Cunningham LLP
2800 N Central Ave, Ste 1800Phoenix, AZ 85004-1049
(602) 234-7800Fax: (602) 277-5595
Michelle Smith Cotto225 Converse Street
Longmeadow, MA 01106-1701(860) 697-4361
Fax: (508) 635-0448
Michael StoverWright Constable & Skeen LLP
100 N Charles St, Fl 16Baltimore, MD 21201-3805
(410) 659-1321Fax: (410) 659-1350
Thomas VollbrechtFabyanske Westra Et Al333 S 7th St, Ste 2600
Minneapolis, MN 55402-2437(612) 359-7659
Patricia WagerTorre Lentz Gamell Gary &
Rittmaster LLP100 Jericho Quadrangle, Ste 309
Jericho, NY 11753-2702(516) 240-8969
Fax: (516) [email protected]
Justin Wear150 4th Avenue N, Suite 2200
Nashville, TN 37219(615) 244-0030
Fax: (615) [email protected]
Theodore BaumMcElroy, Deutsch, Mulvaney &
Carpenter, LLP920 Bausch & Lomb Place,
Rochester, NY 14604(585) 623-4286
Fax: (585) [email protected]
Ashley BelleauMontgomery Barnett LLP
1100 Poydras St, Ste 3300New Orleans, LA 70163-3300
(504) 585-7932Fax: (504) 200-8932
Robert BerensLangley LLP
2001 E Campbell Ave, Ste 203Phoenix, AZ 85016
(602) [email protected]
Lisa BlockAxis Insurance
1211 Ave of The Americas, 24th FlNew York, NY 10036
(212) 500-7689
Virginia BoyleLiberty Mutual Group
450 Plymouth Rd, Ste 400Plymouth Meeting, PA 19462-1644
(610) 832-8246Fax: (610) 828-4684
Gerald CarozzaSelective Ins Co of Amer
40 Wantage Ave, Attention Bond ClaimsBranchville, NJ 07890
(973) 948-1823Fax: (866) 324-3786
Paula-Lee ChambersHinshaw & Culbertson LLP
28 State St, Fl 24Boston, MA 02109-5709
(617) 213-7000Fax: (617) 213-7001
Andy ChambersJennings Strouss & Salmon PLC
1 E Washington St, Ste 1900Phoenix, AZ 85004-2554
(602) 262-5846Fax: (602) 495-2728
Bogda ClarkeThe Hanover Insurance Group
400 Atrium Dr, Suite 500Somerset, NJ 08873-4170
(732) 805-2378Fax: (732) 805-2395
Bruce CorriveauTravelers
111 Schilling RdHunt Valley, MD 21031-1110
(443) 353-2076Fax: (410) 205-0608
James DiwikSedgwick LLP
333 Bush St, Fl 30San Francisco, CA 94104-2834
(415) 781-7900Fax: (415) 781-2635
Marc DomresKrebs Farley & Pelleteri PLLC
400 Poydras St, Ste 2500New Orleans, LA 70130-3224
(504) 299-3570Fax: (504) 299-3582
Robert FlowersTravelers
1 Tower Sq, Ste S104Hartford, CT 06183-0001
(860) 277-7150Fax: (860) 277-5722
Fidelity & Surety Law Committee Newsletter Fall 2015
3 3
Jeffrey GoldbergSWISSRE
475 N Martingale Rd, Ste 850Schaumburg, IL 60173-2276
(847) 273-1268Fax: (847) 273-1260
Ivette GualdronZurich
236 Rue Landry Rd, Saint Rose, LA 70087-3666
(504) 471-2676Fax: (504) 712-3507
Mike HenniganCincinnati Insurance Company
6200 S Gilmore RdFairfield, OH 45014-5100
(513) 870-2736Fax: (513) 881-8913
Hilary HoffmanChubb
15 Mountain View RdWarren, NJ 07059-6795
(908) [email protected]
Marchelle HoustonTravelers Bond & Specialty
Insurance1 Tower Sq, Ste 2S2
Hartford, CT 06183-0002(860) 277-2408
Fax: (860) [email protected]
Michael HurleyBerkley Surety Group LLC
412 Mount Kemble Ave, Ste 310NMorristown, NJ 07960-6669
(973) 775-5040Fax: (973) 775-5204
Patrick HusteadThe Hustead Law Firm
4643 S Ulster St, Ste 1250Denver, CO 80237-4307
(303) 721-5000Fax: (303) 721-5001
Susan KarlanICW Group - OPRS
11455 El Camino RealSan Diego, CA 92130-2088
(858) 350-7213Fax: (858) 350-2640
Christina KockeMerchants Bonding Company
215 Savanna DriveLuling, LA 70070(504) 417-5164
Mark KroneAnderson McPharlin &
Conners LLP444 S Flower St, Fl 31
Los Angeles, CA 90071-2932(213) 688-0080
Fax: (213) [email protected]
Frank LanakHCC Surety Group
601 S Figueroa St, Ste 1600Los Angeles, CA 90017-5721
(310) 242-4403Fax: (310) 649-0891
Darrell LeonardZurich
11074 Inspiration Cir, Dublin, CA 94568-5530
(800) 654-5155Fax: (800) 329-6105
Lawrence LernerLevy Craig Law Firm1301 Oak St, Ste 500
Kansas City, MO 64106-2865(816) 460-1807
Fax: (816) [email protected]
John McDevittLiberty Mutual Group
20 Riverside RdWeston, MA 02493-2206
(617) 243-7918Fax: (866) 547-4882
Mary McNamaraTravelers
111 Schilling RdHunt Valley, MD 21031-1110
(443) 353-2130Fax: (443) 353-1137
Henry MinissaleACE USA
436 Walnut St, WA10Philadelphia, PA 19106
(215) 640-2641Fax: (215) 640-5474
Vincent MiseoVincent C Miseo
211 Washington Corner RdBernardsville, NJ 07924
(973) [email protected]
Louis ModugnoMcElroy Deutsch et al
1300 Mount Kemble Ave, Morristown, NJ 07960-8009
(973) 425-8660Fax: (973) 425-0161
Caryn Mohan-MaxfieldThe Walsh Group929 W Adams St
Chicago, IL 60607-3037(312) 563-5936
Thomas MosesCNA
333 S Wabash Ave, Floor 41Chicago, IL 60604(312) 822-4528
Robert NiesleyWatt Tieder Hoffar & Fitzgerald
LLP2040 Main St, Ste 300Irvine, CA 92614-7291
(949) 852-6700Fax: (949) 261-0771
Robert O’BrienLiberty Mutual Group
9450 Seward RdFairfield, OH 45014-5412
(513) 867-3718Fax: (866) 442-4060
Scott OlsonSureTec Insurance Co
9737 Great Hills Trl, Ste 320Austin, TX 78759-6418
(512) 314-3650Fax: (512) [email protected]
Thomas PenningtonFrost Brown Todd LLC
150 3rd Ave S, Ste 1900Nashville, TN 37201-2011
(615) 251-5550Fax: (615) 251-5551
Martha PerkinsNational Association of Surety
Bond Producers1140 19th St NW, Ste 800
Washington, DC 20036-6607(202) 686-3700
Fax: (202) [email protected]
Derek PopeilChubb & Son, A Division of
Federal Ins. Co.15 Mountain View Road
Warren, NJ 07059(908) 903-3182
Fax: (908) [email protected]
Stephen RaeLiberty Mutual Group
450 Plymouth Rd, Ste 400Plymouth Meeting, PA 19462-1644
(610) 832-8254Fax: (610) 940-9112
Toni ReedStrasburger & Price LLP901 Main St, Ste 4400Dallas, TX 75202-3729
(214) 651-4345Fax: (214) 659-4091
Edward Reilly20 Overhill Rd
Summit, NJ 07901-4127(212) 441-2575
Frederick RettigState Farm Insurance
One State Farm Plaza A-3Bloomington, IL 61710-0001
(309) [email protected]
Jan SokolStewart Sokol & Larkin LLC2300 SW 1st Ave, Ste 200Portland, OR 97201-5047
(503) 221-0699Fax: (503) [email protected]
W SpeicherZurich
3787 Sells Mill RdTaneytown, MD 21787
(410) 840-9144Fax: (800) 329-6106
Michael SpinelliCashin Spinelli & Ferretti LLC
801 Motor Pkwy, Ste 103Hauppauge, NY 11788-5256
(631) 680-3100Fax: (631) 737-9171
Dee StudlerSDC CPAs LLC
1444 N Farnsworth Ave, Ste 500Aurora, IL 60505-1644
(630) 820-5770Fax: (630) 820-5765
Fidelity & Surety Law Committee Newsletter Fall 2015
4 4
Frank TanzolaInternational Fidelity Insurance
Company1 Newark Ctr, Fl 20
Newark, NJ 07102-5219(973) 624-7200
Fax: (973) [email protected]
Ty ThompsonMills Paskert Divers
100 N Tampa St, Ste 3700Tampa, FL 33602-5835
(813) 229-3500Fax: (813) 229-3502
Richard TowleChubb Group of Insurance
Companies15 Mountainview Rd
Warren, NJ 07059-6795(908) 903-3423
Fax: (908) [email protected]
Courtney WalkerBerkshire Hathaway Specialty
Insurance4539 Laurelwood Dr
Memphis, TN 38117-3507(617) 834-8652
Blake WilcoxLiberty Mutual Group
1001 Fourth Avenue, Floor 47Seattle, WA 98154
(206) 473-3264Fax: (425) 376-6533
Douglas WillsChubb & Son Inc
15 Mountainview RdWarren, NJ 07059-6795
(908) 903-5339Fax: (908) [email protected]
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©2015 American Bar Association, Tort Trial & Insurance Practice Section, 321 North Clark Street, Chicago, Illinois 60654; (312) 988-5607. All rights reserved.
The opinions herein are the authors’ and do not necessarily represent the views or policies of the ABA, TIPS or the Fidelity and Surety Law Committee. Articles should not be reproduced without written permission from the Copyrights & Contracts office ([email protected]).
Editorial Policy: This Newsletter publishes information of interest to members of the Fidelity and Surety Law Committee of the Tort Trial & Insurance Practice Section of the American Bar Association — including reports, personal opinions, practice news, developing law and practice tips by the membership, as well as contributions of interest by nonmembers. Neither the ABA, the Section, the Committee, nor the Editors endorse the content or accuracy of any specific legal, personal, or other opinion, proposal or authority.
Copies may be requested by contacting the ABA at the address and telephone number listed above.
STAY CONNECTED Follow @ABATIPSFSLC on Twitter
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Fidelity & Surety Law Committee Newsletter Fall 2015
5 5
Volunteers Needed!Augustus H. Shaw Jr. Montessori School
Education Awareness Project
*October 15, 2015* 10:00 AM – 11:00 AM
*Phoenix, AZ
Join the ABA TIPS Diversity Committee, Staff Counsel Committee and Law in PublicService Committee for a youth outreach program with Augustus H. Shaw Jr. Montessori School students during the ABA TIPS Fall Leadership Meeting.
Volunteers will meet with students for the Committee’s “A Day in the Life of anAttorney” program. Attorneys will discuss their professional experience in the legalindustry and encourage students to explore the possibility of a law-related career.
Participants should meet in the lobby of the Westin on Thursday, October 15, 2015 at9:15 AM for transportation to the school. Also, please contact Staff Liaison Norma
Campos at (312) 988-5574 or [email protected] to sign-up for the projectprior to the Fall Leadership Meeting.
Augustus H. Shaw Jr. Montessori School is located at123 N. 13th St., Phoenix, AZ 85034
Fidelity & Surety Law Committee Newsletter Fall 2015
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Goodness, it’s already Fall as I can tell by the leaves changing here in Los Angeles, California – not really. It is Fall, however, and you can set your calendar because you are currently looking at the Fall 2015 edition of the Fidelity and Surety Law Committee’s newsletter which has been edited under the capable hands of Omar Harb, Todd Braggins, and Adam Friedman. We all know how much work this takes and we all appreciate the effort that they put into making certain that the FSLC continues to turn out timely, topical, and entertaining articles. This edition is no different and in fact raises the bar.
Let me start with a rundown of the upcoming CLE programs for our Committee. First up will be the Fall meeting in Washington, D.C., a venue which the FSLC has not visited for about ten years. The program is headed up by Toni Scott Reed of Strasburger
and Price LLP and Carleton Burch of Anderson, McPharlin & Conners LLP. The program is scheduled for November 4 through November 6 at the Liaison Capitol Hill hotel, located at 415 New Jersey Avenue N.W., Washington, D.C., right behind the Capitol building. The program is entitled The Annotated Commercial Crime Insurance Policy, 3d Edition, and subtitled An Up To Date Look at Crime, Loss and Technology. We are very excited about the program, which includes a combination of distinguished speakers addressing the most important substantive areas of commercial and mercantile crime protection policies, as well as several panels that will encompass participants outside of our normal presenter pool. This year, the program will feature presentations and panels with underwriters, claims handlers, law enforcement personnel, criminal defense attorneys, and prosecutors, and we will explore some of the criminal aspects of what we normally see in a commercial setting. In addition, we have a speaker lined up from Homeland Security who will be explaining and highlighting the most recent trends in cyber crimes, which of course implicate all of our businesses.
Each attendee of the Fall program will receive a copy of the Annotated Commercial Crime Insurance Policy, 3d Edition, which is the “go to” resource for industry professionals when it comes to discerning what the law is in our various jurisdictions. An update has been ten years in the waiting and this publication itself will be worth the price of attendance. The program and the social events make attendance a must.
I would personally like to thank Carleton and Toni for their hard work in editing this new publication, and to thank all of the authors who devoted their time, skill, and expertise. It goes without saying that the Annotated Commercial Crime Insurance Policy, 3d Edition, will be an essential part of any law library for fidelity attorneys, claims handlers, and outside consultants for many years to come. Please remember that, if you are not able to attend the Fall program, you can purchase your copy of the Annotated Commercial Crime Insurance Policy, 3d Edition, from TIPS, both in paperback and e-book format.
Let me also remind you that our program in Washington will be held right after the annual Fidelity Law Association meeting, which is taking place at the same venue on Wednesday, November 3, 2015. I encourage you to attend the FLA program, which is always a great complement to our program, and the joint cocktail party planned at the Liaison Capitol Hill on Wednesday night, November 3, 2015.
Needless to say, Washington is a wonderful place to visit and you really should take your family if the opportunity allows. Our program will take advantage of this beautiful and historic city and Thursday night, November 4, 2015, especially promises to be a fun event as we are having a cocktail reception and dinner at the Newseum, whose mission is “to champion the five freedoms of the First Amendment through exhibits, public programs and education.” The dynamic, engaging, and interactive Newseum allows visitors to experience the stories of yesterday and today through the eyes of the media while celebrating the freedoms guaranteed to all Americans by the First Amendment. From the modern building located on historic Pennsylvania Avenue, not far from our venue, to the state of the art theaters, exhibits, and hands-on activities located inside, the Newseum quickly demonstrates why TripAdvisor users rate it as a “travelers choice top ten museums in the U.S.” For more information, please go to www.newseum.org.
LETTER FROM THE CHAIR
Fidelity & Surety Law Committee Newsletter Fall 2015
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We also currently are planning a December Webinar on virtual currencies. While we may be skeptical of the eventual takeover of cryptocurrencies, the topic seems to generate a lot of interest and I know that everyone is not only inquisitive, but entertained by the idea of a future with virtual money. The Webinar, which will be scheduled in mid-December, is certainly one to look for. It will deal with what virtual currencies are and how they work; what types of losses we can expect from virtual currency; the insurance products and coverage issues that may apply to virtual currency; and some coverages which are actually in place. Please stay tuned for more information.
I also want you to please go ahead and make your plans to join the FSLC for its annual Mid-Winter CLE and Leadership meetings at the Waldorf Astoria Hotel in New York City on January 20-22, 2016. The brochures for that meeting should be available at our Fall program, but let me set out what promises to be another really excellent mid-winter event. The Mid-Winter Meeting will kick off with the construction program headed up by Larry Lerner of the Levy Craig law firm and Shannon Briglia of Briglia McLaughlin, PLLC. The program is entitled “Subcontractor Nuts and Bolts: The Essential and Practical Details for the Surety and Construction Practitioner.” This program will address commonly encountered construction disputes involving subcontractor trades, and each session will be presented by an outside attorney, a consultant, and a company representative, each having direct experience with the trade subject and related legal issues.
The fidelity program will be a full day on Thursday, January 21, and a half day on Friday, January 22, and is co-chaired by Matt Horowitz of Wolf, Horowitz & Etlinger, LLC, and Dominque Sena-DiDonato of Chubb Insurance. This ambitious program will deal with a complicated broker/dealer claim, involving multiple insurers, and will attempt to follow that claim from initiation to potential resolution through mediation. I am particularly delighted that the mediation aspects of the program will be a main focus, as this is a subject that has not received a lot of attention in our field of endeavor in recent years. Matt and Dominque are planning a panel discussion with several mediators who will inform attendees as to what they want to hear, what they like to hear, and what they expect to hear. This program will also have an ethics element, which is an added bonus for everyone who has CLE requirements.
On Friday, January 22, we also will present our surety program headed up by Jarrod Stone of Manier & Herod and Eric Mausolf of Travelers Insurance. Jarrod and Eric have assembled a breathtaking group of presenters who will be focusing on payment bonds and attendant issues. This program will also feature what will be a supplement to the Law of Payment Bonds, 2d Edition, updating that FSLC publication to now. Again, the supplement will be something everyone working in this area will want and, along with the presentation, the Surety program is essential attendance.
The brochure for the Mid-Winter Meeting for 2016 also will list the Committee’s business meetings, including meetings of many of the Committee’s active divisions including Law, Communications, and Membership Inclusion. These start as early as 9:00 a.m. on Wednesday, January 20, and while many of these groups meet via teleconference throughout the year, the in-person meetings are obviously beneficial in that they allow for personal interaction and opportunities for creative mischief. Please remember that all business meetings of the FSLC are open to all members unless otherwise noted. Because of this, it is always best to plan on early attendance and to get to the Waldorf by Tuesday evening or early Wednesday morning.
The Young Professionals Sub-Committee (“YPS”) of the Membership/Inclusion Division also will be putting on its events, and committee members 40 and younger are invited to attend not only the annual business meeting for YPS on Wednesday afternoon, January 20, but also the “dutch treat” dinner which follows. I suspect, but do not yet know, that there will be a 2016 version of the annual poker tournament, which I have had the pleasure of attending in the past and I can assure all that it is a fun way to meet some people that you might never have known in our Committee. In addition, YPS members are invited to a reception with new members, program speakers, and Committee leadership on Thursday afternoon, January 21. The YPS also has a hospitality suite and will no doubt be hosting other interesting and way too late in the evening events for me. For more information on the YPS, please contact co-chairs Shannah Morris, Carlos Garcia, Rodney Thompkins, Jr., and Melissa Gardner.
Fidelity & Surety Law Committee Newsletter Fall 2015
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And finally, for those making Spring plans with respect to Committee programming, please make sure you have calendared May 4-6, 2016 at the La Quinta Resort in Palm Springs, California. This venue will host the 2016 FSLC Spring CLE program and Leadership meetings. Our program chairs are Brett Divers of Mills Paskert Divers and Blake Wilcox of Liberty Mutual. The program will be focused on surety takeover, and it is an event that you will not want to miss in a beautiful and warm location. As usual, plenty of golf opportunities will be included. Of course, the meeting of FSLC Leadership will take place as usual on Saturday morning, May 7.
We also want to continue the committee’s efforts on the community service outreach program for 2015- 16. Having had a son who served time overseas, it is my belief that among the worthiest and most necessary charitable programs available to us are those involving our wounded war veterans. With that in mind, the FSLC focus for 2015-16 will be on the organization Homes For Our Troops (HFOT). The mission of HFOT is to build specifically adapted homes for severely injured veterans across the nation, to enable them to rebuild their lives, lives that were drastically affected by their service to our country. Most of these veterans have sustained catastrophic injuries, which may include multiple limb amputations, partial or full paralysis, or severe traumatic brain injury. The homes provided to these veterans restore some of the freedom and independence they sacrificed while defending our country, and enable them to focus on their family, recovery, and rebuilding their lives. Since its inception in 2004, nearly 90 cents of every dollar donated to HFOT has gone directly to program services for veterans. HFOT builds these homes where the veteran chooses to live, and continues its relationship with the veteran after home delivery to assist them with getting their lives back. Despite their life altering injuries, many of the HFOT veterans have embarked on new careers, completed their college degrees, or started families. Empowered by the freedom of a mortgage-free and specially adapted home, these veterans can focus on living the rest of their full and productive lives. More can be learned about HFOT at https://hfotusa.org/. Please visit their website and please contribute generously to this truly admirable organization.
I do want to take a moment to thank Mike Pipkin, the immediate past chair, for all the hard work and effort he put into providing the FSLC with what had to be one of its high points in programming and book publication. Finally, thanks so much for your support and participation in the upcoming year. The FSLC continues to be a shining example of what Committees in the ABA should be. Please be sure to join our group on LinkedIn, follow us on Twitter (at abatipsfslc), and “like us” on Facebook.
I look forward to seeing you all in Washington (and bring the family!).
Gary J. Valeriano Chair – ABA TIPS Fidelity and Surety Law Committee
VISIT US ON THE WEB AT:
www.ambar.org/tipsfslc
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C o u r t s , i n s u r e r s ,
and policyholders continue to deal with the challenges that arise in situations where the application for fidelity coverage has been completed by the very employee who is perpetrating the fraud. Recent decisions illustrate the tensions inherent in this scenario, and the challenge of finding the appropriate boundary between the
necessity of truthfulness in the underwriting process and the perceived unfairness to insureds when claims are denied, or policies are voided, on the basis of a misrepresentation made by the defaulter.
The legal framework governing misrepresentations in fidelity bond applications is well-established; generally speaking, a material misrepresentation renders the contract voidable by the insurer. The principles governing the imputation of knowledge to an insured are also reasonably clear. The knowledge of an agent is imputed to his or her principal, subject to an exception where the agent acts adverse to the interest of his or her principal. The adverse interest exception is, in turn, subject to an exception, where the agent is the sole representative or alter ego of his or her principal.1
United Kentucky Bank
Several recent decisions illustrate the tension between these two concepts. In Bancinsure, Inc. v. U.K. Bancorporation Inc./United Kentucky Bank of Pendleton
County., Inc.,2 a decision from the Eastern District of Kentucky, the insured bank asserted a claim under its financial institution bond in respect of a fraud in excess of $2 million perpetrated by its former CEO, Donna Wood.3 The bank’s Board of Directors had given Wood exclusive authority to complete the bank’s application to renew its financial institution bond.4 The application asked for knowledge of any act that might give rise to a bond claim, and stated that “[i]t is agreed that if such knowledge or information exists, any resulting claims are excluded from coverage.”5 In the application, Wood represented that she did not have any such knowledge.6
The bond provided that “[a]ny intentional misrepresentation . . . of a material fact, in the application or otherwise, shall be grounds for the rescission of this Bond.”7 The insurer rescinded the bond based on Wood’s misrepresentations. The bank argued that Wood’s misrepresentation could not be imputed to it, as her conduct fell within the adverse interest exclusion.8
The court observed that this case presented a “unique factual scenario”,9 and held that Wood’s interest in concealing the fraud was adverse to the Bank; accordingly, the adverse interest exception applied.10 The court questioned how an insured could conceivably protect itself in such circumstances and, as a result, concluded that, as a matter of public policy, it would be “unfair” to now permit the insurer to rescind the bond.11
Viewed from the perspective of an insured, United Kentucky Bank has a superficial appeal to it. After all, since the insured can submit a bond application only
THE ENEMY IS WITHIN: WHAT HAPPENS WHEN THE DEFAULTER COMPLETES THE APPLICATION FOR FIDELITY COVERAGE?By: David S. Wilson, Chris McKibbin, and Stuart Woody
Continued on page 22
1 See, e.g., Karen Wildau & Marlo Orlin Leach, “What Did They Know and When Did They Know It, Who Are “They” Anyway, and What Difference Does It Make – Imputation Under the Financial Institution Bond and Its Implications for Coverage” 3 Fidelity. l. Ass’n J. 1 (1997).2 830 F. Supp. 2d 294 (E.D. Ky. 2011). 3 Id. at 296.4 Id. at 298.5 Id.6 Id.7 Id. at 298-99.8 Id. at 301.9 Id.10 Id. at 302.11 Id. at 305.
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Sponsored by the Tort Trial & Insurance Practice Section’s Law in Public Service Committee
Help us give back to Phoenix! Public Service Project Friday, October 16th
Volunteer with the ABA Tort Trial & Insurance Practice Section to give back to the local Phoenix community! Join us for the Fall 2015 TIPS public service project with the HonorHealth Desert Mission Food Bank on Friday, October 16th. Volunteers should plan to meet in the lobby of the Westin on the day-of at 8:45 AM for transportation to the project and are encouraged to dress casually.
The HonorHealth Desert Mission was founded by the local Presbyterian Church’s Desert Mission in 1927 providing food and medical supplies to families who migrated to the Phoenix area to find relief from their respiratory ailments in the desert climate. Today, Desert Mission continues to work to meet the health and social needs of the community by offering a wide range of resources, including a Food Bank, Children’s Dental Clinic, medical and behavioral health centers, Adult Day Center for seniors, early childhood education and programs to help create stronger neighborhoods.
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Fidelity & Surety Law Committee Newsletter Fall 2015
CONTRACTOR VS. SURETY: IS TERMINATION ALWAYS REQUIRED UNDER AN A312 PERFORMANCE BOND– A POINT/COUNTERPOINTBy: Theodore K. Stream and Shashauna Szczechowicz
One of the most widely
used performance bonds in the construction industry is the AIA A312 Performance Bond (the “Bond”). The Bond was developed to include clear language to define: (1) the scope and extent of the surety’s liability; (2) the conditions necessary to trigger the surety’s obligations; (3) the surety’s options to satisfy its bond obligations; (4) the limits on the surety’s liability; (5) the damages recoverable; and (6) the duration of the surety’s obligations.1
Sections 1 and 2 of the Bond create the scope of the surety’s obligation. The surety and the contractor are jointly and severally liable under the Bond for the performance of a construction contract, and the construction contract is incorporated by reference.2 If the contractor performs the contract, the surety and contractor have no obligation under the Bond.3
Section 3 of the Bond provides that the surety’s obligation arises if there is no Owner Default,4 and after three events occur: notice to surety of possible default;5 default of the contractor and termination of the construction contract;6 and an agreement to pay the contract balance to the surety.7
On some projects, for one reason or another, the contractor defaults during the critical stage of construction and is terminated. In such a situation, the owner will look to the surety to complete the project.
However, what happens when the work is substantially complete, but the project is not finally complete and damages continue to accrue? Does the
owner/general contractor declare a default, terminate the contract, and notify the surety? Can the surety’s obligations be triggered without a termination?
We were recently involved in a similar situation with an A312 Bond, where Ted represented the general contractor and Shauna represented the subcontractor’s surety. The subcontractor substantially completed its work, but then delayed completing the punchlist. This, coupled with other delays, resulted in the job exceeding the scheduled final completion date, and damages continued to accrue.
Because the owner had issued a certificate of substantial completion on the project (and the subcontractor had substantially performed its scope of the work), the general contractor felt that it did not have grounds under the subcontract to terminate the subcontractor. When the general contractor made a claim against the Bond for the delay damages, the surety denied the claim because the general contractor did not terminate the subcontract. The general contractor contended that it was not required to terminate the subcontract to recover delay damages from the surety.
Ultimately, the general contractor, subcontractor, and surety participated in several 3.1 conferences and were able to resolve the dispute. If we had to litigate these issues, we each believed that there were persuasive legal arguments in favor of our respective clients. In a point/counter-point argument, we try to highlight the perspectives of both the surety and the general contractor in working through the issue of whether the contract must be terminated for the surety to be liable for delay damages.
1 See AIA Bond Form Commentary and Comparison, AIA Documents 310-2010 and 312-2010 (2010); 4A Bruner & O’COnnOr On COnstruCtiOn lAw § 12:16 (2015) (hereinafter “Bruner & O’COnnOr”).2 Id., ¶ 1.3 Id., ¶ 2.4 Id., ¶¶ 3 and 14.3 (defining “Owner Default” as: Failure of the Owner, which has not been remedied or waived, to pay the Contractor as required under the Construction Contract or to perform and complete or comply with the other material terms of the Construction Contract).5 Id., ¶ 3.1. Paragraph 3.1 of the AIA Document A312-2010 Performance Bond does not require that the obligee request a conference, only that the obligee attend a conference if requested by the surety. In addition, section 4 of the Bond provides that, if the obligee fails to comply with pre-default notice requirements of paragraph 3.1, that failure shall not constitute a failure to comply with a condition precedent to the surety’s obligations, or release the surety, unless the surety can show actual prejudice. Research did not locate any reported decisions analyzing section 4.6 Id., ¶ 3.2.7 Id., ¶ 3.3.
Continued on page 25
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The American Bar Association Tort Trial & Insurance Practice Section will kick off the 2015 bar year with it’s Section Fall Leadership Meeting, held October 14-18, 2015 at the Westin Kierland Resort & Spa in beautiful Scottsdale, Arizona. The meeting will feature a number of must-attend events including:
Complimentary CLE Program featuring Corporate Counsel Executives: Lessons Learned in the Trenches of Litigation Management
Important Business Meetings and Valuable Networking Events
Friday Afternoon Golf Tournament
Saturday Evening Dinner featuring Music, Dancing and “Glow-Putt” Mini-Golf
The Kirsten Christophe Memorial Award for Excellence in Trial and Insurance Law Presentation
The Opportunity to Enjoy the Stunning and Relaxing Surroundings of Scottsdale
ABA TIPS 2015 Fall Leadership Meeting October 14-18, 2015
The Westin Kierland Resort & Spa Scottsdale, AZ
Register Today! Register Today!
Fidelity & Surety Law Committee Newsletter Fall 2015
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Sureties forced to battle with owners about the protection of contract balances recently received strong reinforcement from a unanimous decision of the Court
of Appeals of Ohio Tenth Appellate District.
The case, Selective Insurance Company of America v. Ohio Department of Rehabilitation & Correction,1 arose out of a generator upgrade project for the Ohio Department of Rehabilitation and Correction (ODRC). A major supplier on the project filed a mechanics’ lien in accordance with state law. Because payment was not forthcoming, the supplier filed a lawsuit against the ODRC, the surety, and the principal. The surety then learned that, although the supplier filed a lien against the contract funds, ODRC failed to comply with its contractual and statutory obligation to detain funds in an amount equal to the lien. When it received the $359,059.00 lien, ODRC was holding $400,242.84 in contract balance. Had ODRC complied with its statutory obligations, there would have been sufficient funds to satisfy the supplier’s lien and resulting payment bond claim. Instead, as of the date the supplier filed suit, ODRC was holding only $24,111.85 in contract funds. The supplier’s claims ultimately were settled. The surety paid $207,466.00 and ODRC paid the $24,111.85 contract balance it was holding. The settlement agreement allowed Selective to retain its rights against ODRC, including rights as the supplier’s assignee.
Selective filed suit against ODRC in the Court of Claims of Ohio, asserting that ODRC’s failure to comply with the express provisions of the contract and the mechanics lien statutes that required it to set aside sufficient money to satisfy the lien impaired the surety’s collateral and led to its loss. Selective also sought to recover its loss by asserting its rights as assignee of the lienor.2 ODRC asserted a counterclaim against Selective, wherein it asserted a claim on the Bid Guaranty & Contract Bond executed by Selective,
and third-party claims against the general contractor/principal for breach of contract and fraud.
After extended litigation about the proper forum for the case, Selective and ODRC filed competing motions for summary judgment. The trial court entered summary judgment in favor of Selective and denied ODRC’s claim against the Bond. The trial court’s decision awarding Selective summary judgment rested on the theory of equitable subrogation, which it explained saying:
Based upon the undisputed evidence, the court concludes that Selective’s claim for money damages is premised upon the common law theory of equitable subrogation. Under this theory, a surety of a government contractor may recover progress payments made to a defaulting contractor where such payments were made after the government entity received notice of the contractor’s default.3
The trial court also cited to § 37 of the Restatement of the Law (Third), Suretyship and Guarantee and to an earlier ruling of the Ohio Court of Appeals that recognized that one basis for Selective’s claim was “the common-law duty an obligee owes a surety to protect the collateral.”4
The general contractor sought summary judgment on ODRC’s claims against it. The general contractor argued, in part, that “ODRC’s claims of breach of contract, fraud, and indemnity and contribution fail as a matter of law inasmuch as ODRC cannot prove that any conduct of [the general contractor] damaged ODRC.”5 Citing to § 2305.31 of the Ohio Revised Code, the trial court held that ODRC was not entitled to indemnification or contribution from the general contractor, as ODRC’s damages were “the result of its own failure to escrow funds.”6 ODRC appealed both decisions.
OHIO COURT OF APPEALS SUPPORTS SURETYSHIP RIGHTSBy: Lee M. Brewer
1 Case No. 14AP-588, 2015 WL 872972 (Ohio Ct. App. Mar. 3, 2015).2 Neither the trial court nor the appellate court decisions addressed the surety’s assignment claim.3 Selective Ins. Co. of Am. v. Ohio Dep’t of Rehabilitation & Correction, No. 2009-07407, 2012 WL 7808338 (Ohio Ct. Cl. Nov. 16, 2012), aff’d, Case No. 14AP-588, 2015 WL 872972 (Ohio Ct. App. Mar. 3, 2015).4 Selective Ins. Co. of Am. v. Ohio Dep’t of Rehabilitation & Correction, No. 11AP-597, 2012 WL 1059666, ¶ 31 (Mar. 27, 2012).5 Selective Ins. Co. of Am. v. Ohio Dep’t of Rehabilitation & Correction, No. 2009-07407, 2014 WL 2991616, *2 (June 23, 2014).6 Id. at *4.
Continued on page 29
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In the wake of a 60 Minutes expose that aired on March 1, 2015,1 class action lawsuits
have been filed in more than twenty states across the country against Lumber Liquidators, Inc. The retailer is accused of selling Chinese-manufactured wood flooring products containing high levels of toxic formaldehyde gas in excess of the emission standards promulgated by the California Air Resources Board (CARB). Although Lumber Liquidators has been the target defendant in lawsuits filed to date, homebuilders, contractors, and others in the supply chain face potential exposure for installing and/or supplying the affected flooring.
The genesis of the litigation against Lumber Liquidators is that the retailer allegedly falsely labeled the flooring as compliant with the CARB standards for formaldehyde.2 “CARB standards provide that medium-density fiberboard products manufactured in 2001 or later may not emit more than 0.11 parts per million of formaldehyde. Thin density fiberboards can emit up 0.13 parts per million of formaldehyde.”3 According to OSHA, formaldehyde exposure can increase the risk of cancer, allergic reactions, long-term respiratory problems, and irritation of the eyes, nose, and throat.4 The complaints allege that independent testing of products revealed formaldehyde levels substantially exceeding the CARB standard. During its undercover investigation, 60 Minutes tested 31 flooring samples purchased at stores across the country. The report alleged that only one sample was found to be compliant with CARB, and others tested more than 13 times the permissible level. Many of the class actions are now proceeding as multidistrict litigation pursuant to 28 U.S.C. § 1407.5 Due to the timing of this article, the reader should update the citations identified herein to confirm whether the court has made any rulings.
Although there are no comparable standards in other states, classes of consumers across the country are seeking damages under a variety of consumer laws. Moreover, the Consumer Product Safety Commission (CPSC) is now investigating the claims against Lumber Liquidators.6 Elliot F. Kaye, CPSC Chairman, reported that the CPSC’s investigation will involve testing of samples and consider “real world” risks by evaluating home-based exposure scenarios. The investigation with commence with Chinese-based laminate products.
Amidst the heightened scrutiny and increased consumer awareness, homebuilders and contractors who installed or supplied Lumber Liquidators’ laminate flooring products should be cognizant of possibly having to defend against future claims. As with building-product cases involving asbestos and Chinese drywall, possible damages may include property damage or repair expenses, bodily injury, and diminished value. The following theories of liability are commonly asserted in building-product related disputes: (1) breach of contract; (2) breach of warranty; (3) contractual or common law indemnification; (4) equitable/injunctive relief claims and medical monitoring; (5) negligence; (6) rescission; (7) statutory consumer protection violations; (8) strict liability; and (9) unjust enrichment. The success of several of these claims will depend on the terms of agreements with homeowners. Homebuilders may also reduce their exposure by pursuing others in the supply chain such as manufacturers, distributors, suppliers, sellers, and retailers of the affected flooring. Similar theories of liability as those stated above are oftentimes asserted in those circumstances.
One particular area of concern is whether insurance coverage will be available for claims directly or tangentially related to Lumber Liquidators’ laminate
POTENTIAL EXPOSURE FOR HOMEBUILDERS/CONTRACTORS FOR INSTALLING/SUPPLYING LUMBER LIQUIDATORS’ LAMINATE FLOORING PRODUCTSBy: Heather M. Jonczak
1 60 Minutes: Lumber Liquidators Linked to Health and Safety Violations (CBS television broadcast Mar. 1, 2015), available at http://www.cbsnews.com/news/lumber-liquidators-linked-to-health-and-safety-violations/. 2 See Plaintiffs Request MDL for Formaldehyde Suits Against Lumber Liquidators, 33 No. 3 westlAw J. tOxiC tOrts 2 (2015). 3 Id. 4 OsHA, OsHA FACt sHeet: FOrmAldeHyde (2011) available at https://www.osha.gov/OshDoc/data_General_Facts/formaldehyde-factsheet.pdf.5 See In re Lumber Liquidators Chinese-Manufactured Flooring Prods. Mktg., Sales Practices & Prods. Liab. Litig., 1:15-md-026279-AJT-TRJ.6 See Transcript: CPSC Chairman Elliot F. Kaye’s Media Call on Lumber Liquidators, http://www.cpsc.gov/global/newsroom/cpscpresscall03262015_final.pdf.
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flooring products. Insurers have had varying degrees of success raising exclusions to coverage in building-product cases. The availability of coverage likely will depend on the types and terms of insurance policies involved, the underlying nature of claims asserted, and the specific allegations made. For example, Commercial General Liability (“CGL”) policies may provide coverage for bodily injury and property damage claims, but CGL policies typically contain exclusions for pollutants, latent defects, and faulty materials, among others. In addition to CGL policies, other types of insurance that may provide coverage include homeowners, builders’ risk, contractors’ pollution liability, umbrella, and excess policies. While policies will vary and provide different types of coverages, most insurance policies will contain at least some exclusions that could affect coverage. Regardless of the type of policy at issue, the insured has the duty to establish coverage, i.e., that there is a legal obligation to pay.7 If coverage is established, the insurer has the burden of proof on all coverage-related exclusions.8
Below are examples of the primary exclusions that insurers could raise in defense of claims arising from Lumber Liquidators’ flooring materials. The decisional law regarding insurance coverage for these types of claims remains to be seen and should be closely monitored. Coverage decisions related to Chinese drywall and other building-product claims provide some guidance.
Pollution Exclusion
The total pollution exclusion is commonly raised by insurance carriers to avoid coverage for product-related claims.9 In American Home Assurance Company v. Arrow Terminals,10 the issue was whether the exclusion barred coverage for property damage resulting from defective drywall which was
confined to the interior of the underlying plaintiffs’ residences. The exclusion read:
Such coverage as is afforded by this policy shall not apply to any claim arising out of the discharge, dispersal, release or escape of smoke, vapors, soot, fumes, acids, alkalis, toxic chemicals, liquids or gases, waste materials, oil or other petroleum substance or derivative (including any oil refuse or oil mixed wastes) or other irritants, contaminants or pollutants into or upon land, the atmosphere, or any watercourse or body of water.11
In holding that the exclusion did not apply, the court agreed “with cases from other jurisdictions that hold that the ‘into or upon land, the atmosphere, or any water course or body of water’ language limits the pollution exclusion to outdoor environmental contamination.”12
As formaldehyde contamination emanating from Lumber Liquidators’ flooring products takes place within the confines of the home, pollution exclusions with similar language should not be implicated. However, whether the pollution exclusion applies will depend on the language of the exclusion and how it is interpreted by the controlling jurisdiction.
“Your Work” Exclusion
After navigating around the pollution exclusion, insureds may have to overcome additional exclusionary hurdles such as the faulty workmanship exclusion or the your work exclusion.
Numerous jurisdictions have denied coverage under a CGL policy for property damage to the insured’s own work or products supplied, reasoning that a CGL policy is not a guaranty or warranty of the insured’s work, nor is it a performance bond.13 Thus, insurers frequently argue that a CGL policy excludes coverage for a claim
7 See N. Am. Bldg. Maintenance, Inc. v. Fireman’s Fund Ins. Co., 40 Cal. Rptr. 3d 468 (Ct. App. 2006) (when an insurer’s “duty to defend is the subject of an action for declaratory relief, the parties have differing burdens; to prevail, the insured must prove the existence of a potential for coverage, while the insurer must establish the absence of any such potential”); see also Regency Title Co. v. Westchester Fire Ins. Co., 5 F. Supp. 3d 836 (E.D. Tex. 2013) (the insured carries the burden of demonstrating to the court that a claim is potentially within the scope of policy coverage). 8 See, e.g., Regent Ins. Co. v. Strausser Enters., Inc., 902 F. Supp. 2d 628 (E.D. Pa. 2012) (under Pennsylvania law, if a complaint avers facts that might support recovery under a liability insurance policy, coverage is triggered and the insurer has a duty to defend; the burden then shifts to the insurer to demonstrate that an exclusion places the particular harm outside of the policys reach).9 See Granite State Ins. Co. v. Am. Bldg. Materials, Inc., 504 F. App’x. 815 (11th Cir. 2013) (insurers that had issued CGL policies and umbrella policies sought a declaratory judgment that – based on exclusions – they had no duty to defend or indemnify the supplier or builders for homeowners’ claims for allegedly defective drywall); see also Builders Mut. Ins. Co. v. Parallel Design & Dev. LLC, 785 F. Supp. 2d 535 (E.D. Va. 2011) (insurer sued its policyholder (a real estate developer) seeking a declaration that it had no obligation to either defend or indemnify the developer in an underlying action arising from the developer’s use of defective drywall in building a house).10 No. 8:11-cv-1278-T-30AEP, 2013 WL 1909597 (M.D. Fla. May 8, 2013).11 Id. at *3 (emphasis added).12 Id. at *513 See Colo. Cas. Ins. Co. v. Brock USA LLC, No. 11-cv-02527-DME-KMT, 2013 WL 4550416, at *5 (D. Colo. Aug. 28, 2013) (applying “your work” exclusion because defect in product existed before the product was installed and became real property).
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against a drywall contractor for the cost of tearing out and replacing drywall.14 However, the exclusion may not apply to work performed by an insured’s subcontractors.15
Coverage likely will depend on the nature of the homebuilder’s and/or contractor’s agreement with homeowners and its subcontractors. However, if the homebuilder or contractor directly installed and/or supplied the defective flooring, the “your work” exclusion may preclude coverage for the costs associated with removing and replacing the flooring.
Health Hazard Exclusion
Insurers may also rely on the subject policies’ health hazard exclusion. Insureds may counter that the health hazard exclusion has no application to property damage claims and is therefore inapplicable.16
The applicability of the health hazard exclusion, like all exclusions, will depend on several factors, including the types and terms of insurance policies involved and the underlying nature of claims asserted. The result of investigations by the CPSC will also be instructive on the health risks associated with formaldehyde exposure in home-based scenarios.
As consumer class action lawsuits against Lumber Liquidators are still in their infancy, the direction of these cases as well as the extent of exposure for homebuilders, contractors, and others in the supply chain for supplying and/or installing the affected flooring products remains to be seen. In the near future, construction practitioners will learn whether Chinese-manufactured flooring related claims will be more commonplace in construction defect litigation.
Heather M. Jonczak is associated with Carlton Fields Jorden Burt of Miami, Florida.
14 See SUA Ins. Co. v. Tikal Construction Co., No. 2:10CV00406, 2010 WL 2748693 (M.D. Fla. June 25, 2010) (insurer argued had no duty to defend or indemnify insured for damages associated with Chinese drywall claims because such damages are encompassed by the “your work” exclusion contained in the policies); see also Builders Mut. Ins. Co. v. Futura Grp., L.L.C., 779 F. Supp. 2d 529, 532 (E.D. Va. 2011) (insurer argued damages associated with Chinese drywall claims excluded from coverage under the “your work” exclusion).15 See Great Am. Fid. Ins. Co. v. JWR Constr. Servs., Inc., 882 F. Supp. 2d 1340 (S.D. Fla. 2012) (interpreting New York law) (faulty workmanship exclusion did not bar coverage of an underlying action against insured general contractor related to its use of defective Chinese drywall in a condominium unit when work performed by insured’s subcontractors); see also Lamar Homes, Inc. v. Mid-Continent Cas. Co., 242 S.W.3d 1 (Tex. 2007).16 See, e.g., Arrow Terminals, 2013 WL 1909597 at *6 (in holding that the exclusion did not apply to property damage claims, the court explained “[t]he plain language of the health hazard exclusion makes it clear that it has potential application only to claims arising out of the human ingestion of hazardous substances”); see also Rickie A. Cobb v. Sipco Servs. & Marine, Inc., No. CIV. A. 95–2131, 1997 WL 369633 (E.D. La. June 27, 1997) (concluding that the health hazard exclusion precluded coverage for respiratory injuries allegedly resulting from a worker’s inhalation of toxic paint fumes); Monticello Ins. Co. v. Baecher, 477 S.E.2d 490 (Va. 1996) (enforcing health hazard exclusion and finding insurer had no obligation to defend or indemnify insured in suit brought on behalf of child who ingested lead-based paint).
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I. Introduction to Confession of Judgment Clauses
Clauses providing for confession of judgment have a long history in American law.1 Perhaps the most recognizable use of them is the cognovit note, in which the note contains a clause authorizing an attorney designated by the holder to confess judgment on behalf of the maker and obtain a judgment, without notice or hearing, for any sums remaining when the note comes due.2 The cognovit note has been described as “the loosest way of binding a man’s property that ever was devised in any civilized country.”3
Because a confession of judgment clause permits entry of judgment without notice to the debtor and without a pre-judgment hearing, courts heavily scrutinize such clauses—and the circumstances leading to their execution—to ensure a debtor’s Fourteenth Amendment due process rights have not been violated. As the Pennsylvania Supreme Court explained:
[a] warrant of attorney authorizing judgment is perhaps the most powerful and drastic document known to civil law. The signer deprives himself of every defense and every delay of execution, he waives exemption of personal property from levy and sale under the exemption laws, he places his cause in the hands of a hostile defender. The signing of a warrant of attorney is equivalent to a warrior of old entering a combat by discarding his shield and breaking his sword. For that reason the law jealously insists on proof that this helplessness and impoverishment was voluntarily accepted and consciously assumed.4
Although state courts had long struggled with the due process concerns raised by confession of judgment clauses, the Supreme Court did not weigh in on the subject until its decision in D.H. Overmyer v. Frick Co. in 1972.5 In that case, D.H. Overmyer challenged
the constitutionality of a confessed judgment entered against it in Ohio after it defaulted under a cognovit note. The Court held that cognovit provisions are not per se violative of the Fourteenth Amendment because due process rights are subject to waiver.
Thus, the facts of each case must be examined to determine whether a defendant effectuated a valid waiver of constitutional rights. The Court did not specify what standard must be applied in analyzing whether a waiver is valid. Instead, the Court noted Overmyer waived its rights under even the strictest standard, which requires that a defendant in a criminal proceeding voluntarily, intelligently, and knowingly make the waiver.6
In reaching this conclusion, the Court stressed the importance of the particular set of facts before it. Both Overmyer and its creditor were large, sophisticated corporations that had equal bargaining power. The cognovit clause was specifically bargained for and Overmyer received consideration for it. Overmyer also was not left entirely defenseless as a result of the confessed judgment, because Ohio law provided for a post-judgment hearing at which Overmyer could present defenses. The Court went on to caution that “where the contract is one of adhesion, where there is great disparity in bargaining power, and where the debtor receives nothing for the cognovit provision, other legal consequences may ensue.”7
Although Overmyer does not require courts to apply the criminal standard governing waiver of constitutional rights, the criminal standard is what most courts have adopted for reviewing the enforceability of a confession of judgment clause. As such, practitioners desiring to utilize a confession of judgment clause in an indemnity agreement should take steps to ensure that the indemnitee’s waiver is knowing, intelligent, and voluntary.
II. Use of Confession of Judgment Clauses in Indemnity Agreements Across the States
Overmyer made clear that confession of judgment clauses are not per se violative of due process and are enforceable, at least in certain circumstances. Nonetheless, states have taken drastically different
1 D.H. Overmyer Co. Inc., of Ohio v. Frick Co., 405 U.S. 174, 176 (1972) (noting that a cognovit clause is an “ancient legal device”).2 Id. 3 Diament v. Alderman, 7 N.J.L. 197, 198 (1824).4 Cutler Corp. v. Latshaw, 97 A.2d 234, 236 (Pa. 1953).5 405 U.S. 174 (1972).6 Overmyer, 405 U.S. at 186.7 Id. at 187-88.
THE USE OF CONFESSION...Continued from page 1
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approaches to the clauses. Many states prohibit them in all circumstances, while others prohibit them only in certain transactions. Unfortunately, there is sparse case law dealing specifically with confession of judgment clauses in indemnity agreements. Thus, practitioners wishing to utilize a confession of judgment clause in an indemnity agreement must be familiar with the forum state’s general law regarding confession of judgment clauses. A discussion of the various approaches and the jurisdictions that employ them follows.
A . Jurisdictions Explicitly Permitting Confession of Judgment Clauses in Indemnity Agreements
• New York: In addition to a clause within the contract, the debtor should contemporaneously execute an affidavit “stating the sum for which judgment may be entered, authorizing entry of judgment, and stating the county where the defendant resides.”8 The Advisory Committee Notes to Rule 3218 of the Civil Practice Law and Rules, which authorizes judgments by confession, states that New York’s procedure is designed, in part, to provide a security device to “creditors and persons, such as sureties . . . who assume contingent liability.” The affidavit may be filed, even before the debt is due, as security any time within three years of its making.
• Ohio: Confession of judgment clauses are valid if the instrument evidencing the indebtedness contains specific warning language, the warning is located near the signature spaces, and the clause appears “more clearly and conspicuously than anything else on the document.”9
• Pennsylvania: Confession of judgment clauses will be given effect if the contract “indicate[s] conscious assent” to the clause.10 Thus, the clause should stand out from the rest of the contract and be clearly written.11
Courts are more likely to enforce the clause when it is part of an arms-length negotiation between sophisticated business persons.12
B. Jurisdictions That Have Not Specifically Addressed the Use of Confession of Judgment Clauses in Indemnity Agreements but Would Likely Permit Them.
• Alaska: State law permits confessed judgments on warrant of attorney; notice must be given to the defendant before judgment is entered.13
• Colorado: Colorado courts have cited Overmyer approvingly for the proposition that due process rights to notice and hearing may be contractually waived as long as the waiver is made voluntarily, knowingly, and intelligently.14
• Connecticut: Connecticut’s sparse case law on the use of confession of judgment clauses suggests that such clauses are generally acceptable as long as there is sufficient evidence that the defendant knowingly, intelligently, and voluntarily waived his or her due process rights.15
• Delaware: Confession of judgment clauses are generally valid upon a showing that the defendant validly waived her due process rights.16 The clause should be clearly written and stand out from the rest of the contract so as to ensure that the defendant is aware of the importance of the provision.17 A clause is more likely to be enforced against a defendant who is a sophisticated businessperson, has experience with similar documents, was represented by counsel, and had opportunity to read and understand the clause.18 Before judgment is entered, the defendant must receive written notice and an opportunity for a judicial determination of whether the defendant “understandingly waived his or her right to notice and an opportunity to be heard.”19
8 N.Y. C.P.L.R. 3218.9 OHiO rev. COde. Ann. § 2323.13(D).10 Westinghouse Elec. Co. v. Murphy, Inc., 228 A.2d 656, 660-61 (Pa. 1967) (noting that courts have refused to give effect to warrants of attorney to confess judgment that appeared in fine print, on the reverse side of written agreements); see also Frantz Tractor Co. v. Wyo. Valley Nursery, 120 A.2d 303, 306 (Pa. 1956). 11 Commonwealth Ins. v. Int’l Transp., Inc., No. 003302, 2006 WL 3696619 (Pa. Ct. Com. Pl. July 19, 2006).12 Id. (upholding confessed judgment entered pursuant a warrant of attorney provision in indemnity agreement).13 AlAskA stAt. Ann. § 09.30.050; Douglas v. Beneficial Fin. Co., 334 F. Supp. 1166, 1171 (D. Alaska 1971) (requiring pre-judgment notice).14 Columbine Valley Constr. Co. v. Bd. of Dirs., Roaring Fork Sch. Dist., 626 P.2d 686, 693 (Colo. 1981) (upholding validity of state law that allowed contracting parties to agree in advance to submit a claim to arbitration “and to waive any further notice and hearing incident to the entry of the judgment on the award”); see also Dewey v. Hardy, 917 P.2d 305, 309 (Colo. App. 1995) (holding that state’s solatium statute did not violate due process because a party may waive due process rights).15 See Bank of Boston Conn. v. Barbieri, No. CV-91-0388963-S, 1991 WL 107979, at *2 (Conn. Super. Ct. June 10, 1991) (noting that due process rights can be waived and finding cognovit notes enforceable because defendants were represented by counsel at the time of signing and the notes involved financing for a commercial building).16 See Architectural Cabinets, Inc. v. Gaster, 291 A.2d 298, 300-01 (Del. Super. 1971).17 Id. at 301.18 RBS Citizens, N.A. v. Caldera Mgmt., Inc., Civil Action No. 08–0242, 2009 WL 3011209, at *3 (D. Del. Sept. 16, 2009).19 del. COde Ann. Tit 10, § 2306.
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• Illinois: Confessed judgments on warrant of attorney are permitted.20 However, there should be evidence that the defendant intelligently and knowingly waived her due process rights. The clause should stand out from the rest of the contract, be part of an arms-length negotiation, and the defendant should have an opportunity to read and understand the clause.21
• Maryland: Maryland Rule of Civil Procedure 2-611 permits confessed judgment upon warrant of attorney. The rule also requires that, after judgment is entered, the defendant must receive written notice and be given an opportunity to present defenses. “Judgments by confession are not favored in Maryland . . . . Thus, [they] are freely stricken on motion to let in defenses.”22
• Michigan: An individual may confess judgment on behalf of another as long as the “authority for confessing such judgment [is] in some proper instrument distinct from that containing . . . the . . . contract”).23 Thus, Michigan law indicates that a confession of judgment agreement could be used in conjunction with an indemnity agreement; however, a confession of judgment clause within an indemnity agreement might not be recognized.24
• Minnesota: Confessed judgments upon warrant of attorney are authorized under Minnesota law.25 However, the instrument authorizing the confession “must be distinct from that containing the bond, contract, or other evidence of the demand for which judgment is confessed”26 such that the authorizing instrument contains “sufficient information to allow a court to give it effect without reference to the debt instrument.”27 Actions based upon confession of judgment provisions must be brought within one year of the action’s accrual.28
• Nebraska: Nebraska law explicitly allows for confessions of judgment upon warrant of attorney as long as the warrant is produced at the time judgment is
confessed.29 Unfortunately, there is insufficient case law to determine how Nebraska courts would treat a warrant of attorney contained as a clause within in an indemnity agreement.
• Nevada: Case law indicates that the debtor should execute a confession of judgment containing the information required by Nevada Revised Statutes § 17.100 and that the instrument evidencing the debt should contain a clause authorizing the creditor to file the confessed judgment when the debt becomes due.30
• New Jersey: Confession of judgment clauses are disfavored in New Jersey; however, they will be enforced upon strict compliance with the statute authorizing confessed judgments.31 Rule 4:45-1 of the New Jersey Rules of Court prohibits confession of judgment clauses from being “included in the body of a bond or other instrument for the payment of money.” This rule, however, does not require the authorization to confess judgment to be a separate document. Rather it is sufficient, for instance, if the clause is set apart from the rest of the agreement and requires an additional signature such that it is “clearly an undertaking separate from the promises contained in the [instrument] itself.”32 New Jersey Court Rule 4:45-2 sets out the requirements for entering a confessed judgment, which include providing the defendant with notice prior to entry.
• North Dakota: A confession of judgment clause, or separate agreement, must contain a statement signed by the defendant and verified by oath that states “the amount for which judgment may be entered and authorizing the entry of judgment” and “the facts constituting the liability”.33
• Utah: Although there is sparse case law on confession of judgment clauses, they appear to be enforceable as long as the statutes authorizing confession of judgment are strictly complied with.34 Utah Rule of
20 735 ill. COmp. stAt. 5/2-1301; see also Herget Nat’l Bank v. Theede, 537 N.E.2d 1109, 1111 (Ill. App. Ct. 1989) (upholding validity of cognovit note).21 Star Fin. Corp. v. McGee, 326 N.E.2d 518 (Ill. App. Ct. 1975).22 Garliss v. Key Fed. Sav. Bank, 627 A.2d 64, 68 (Md. Ct. Spec. App. 1992). 23 miCH. COmp. lAws § 600.2906.24 See Jones v. Turner, 228 N.W. 796 (Mich. 1930).25 minn. stAt. § 548.23.26 Id. 27 Majestic, Inc. v. Berry, 593 N.W.2d 251, 255 (Minn. Ct. App. 1999) (also providing thorough overview of statutory procedure required for confession of judgment agreements). 28 minn. stAt. § 541.09(1).29 neB. rev. stAt. § 25-1312.30 See generally Coast to Coast Demolition & Crushing, Inc. v. Real Equity Pursuit, LLC, 226 P.3d 605 (Nev. 2010) (describing procedure used to obtain a confessed judgment that the court ultimately upheld as a valid judgment).31 Choi v. Kim, 50 F.3d 244, 250 (3d Cir. 1995).32 First Mut. Corp. v. Grammercy & Maine, Inc., 423 A.2d 680, 686 (N.J. Super. Ct. Law Div. 1980).33 N.D. R. Civ. P. 68(c). See also 1st Summit Bank v. Samuelson, 580 N.W.2d 132 (N.D. 1998).34 Utah Nat’l Bank v. Sears, 44 P. 832, 832 (Utah 1896).
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Civil Procedure 58A(f) and Utah Code § 78B-5-205 detail this required procedure.
• Virginia: Confession of judgment clauses generally have been held to be enforceable.35 However, confessed judgments will be set aside where a defendant raises “any ground which would have been an adequate defense.”36 Additionally, although Virginia law expressly authorizes a party to confess judgment on behalf of another, the statute requires strict compliance.37 Virginia law also requires the confession of judgment clause to contain specific language, which is set out in Virginia Code § 8.01-433.1.
• Wyoming: Generally, contractual confession of judgment clauses are valid and not against public policy.38 However, confessed judgments, like default judgments, are not favored and will be set aside upon a “sufficient showing of a meritorious defense.”39 Judgment by confession is specifically authorized by law,40 as is confession upon warrant of attorney.41
C . Jurisdictions Prohibiting Confession of Judgment Clauses in Indemnity Agreements
Numerous states have prohibited confession of judgment clauses either by statute or court ruling. Alabama, Massachusetts, and Montana have declared all confession of judgment clauses void.42 Some states,
including Florida, Georgia, and Texas, recognize agreements to confess judgment but only if they are executed after commencement of an action.43 In a few jurisdictions, pre-action agreements to confess judgment are not expressly prohibited, but the procedure for confessing judgment does not allow for judgment to be confessed upon warrant of attorney.44
Despite these states’ aversion to confession of judgment clauses, courts in most of these states have held that foreign judgments entered pursuant these clauses will be given full faith and credit, as long as the judgment is valid under the rendering state’s confession of judgment rules.45
D . Jurisdictions in Which Case Law and/or Statutes Are Unclear
Several states have statutes authorizing confessed judgments, but it is unclear whether the defendant may authorize an attorney to confess judgment on the defendant’s behalf.46 In other states, it is unclear whether the procedure required by the statute would permit the use of confession of judgment clauses.47 Finally, a handful of states have no statutes specifically authorizing confessed judgments, or have insufficient case law to determine whether cognovit clauses are recognized at common law.48
35 See, e.g., Kalsi v. Patel, 53 Va. Cir. 302 (2000) (clause in promissory note valid); FWB Bank v. R.S.Q., 31 Va. Cir. 74 (1993) (clause in forbearance agreement valid). 36 vA. COde Ann. § 8.01-433.37 Id. § 8.01-432; Boothe v. First Va. Cmty. Bank, 82 Va. Cir. 477 (2011).38 Gifford v. Casper Neon Sign Co., 618 P.2d 547, 552 (Wyo. 1980); Westring v. Cheyenne Nat’l Bank, 393 P.2d 119, 121 (Wyo. 1964).39 Westring, 393 P.2d at 122.40 wyO. stAt. Ann. § 1-16-201.41 Id. at § 1-16-202.42 AlA. COde § 8-9-11; Wright v. Robinson, 468 So. 2d 94, 97 (Ala. 1985) (“agreements to confess judgment are void as against public policy”); mAss. Ann. lAws ch. 231, § 13A; mOnt. COde. Ann. § 28-2-709.43 FlA. stAt. § 55.05; GA. COde Ann. § 9-12-18; ind. COde §§ 34-54-3-2�3; ky. rev. stAt. § 372.140; miss. COde Ann. § 11-7-187; n.m. stAt. Ann. § 39-1-16; tenn. COde Ann. § 25-2-101; tex. Civ. prAC. & rem. COde Ann. § 30.001; Buying Co. v. Miller, 161 S.E. 617, 619 (Ga. 1931); Ashland Armco Emps. Credit Union v. Cantrell, 685 S.W.2d 559, 560 (Ky. Ct. App. 1984).44 Ariz. rev. stAt. § 44-143; OklA. stAt. tit. 12, § 689 (authorizing confession of judgment when defendant personally appears); OklA. stAt. tit. 12, § 690 (repealed statute that permitted confessed judgment upon warrant of attorney); Cuykendall v. Doe, 105 N.W. 698, 701 (Iowa 1906) (noting that Iowa’s “rules governing confessions of judgment . . . do not include confessions upon warrant of attorney”); A.I.C. Fin. Corp. v. Commercial Units, Inc., 245 N.W.2d 923, 926 (Wis. 1976) (noting the statute permitting confessed judgments on warrant of attorney in limited circumstances had been amended to prohibit them). West Virginia also likely would not allow confession of judgment clauses because the exact amount to be confessed is unknown at the time the agreement is made. See Edward F. Gerber Co. v. Thompson, 100 S.E. 733 (W. Va. 1919). 45 See, e.g., Trauger v. A.J. Spagnol Lumber Co., 442 So.2d 182, 184 (Fla. 1983) (declaring Florida’s statute prohibiting pre-action agreements to confess judgment unconstitutional to the extent that it prohibited enforcement of a valid foreign confessed judgment); Cox v. First Nat’l Bank of Woodlawn, 426 N.E.2d 426, 430 (Ind. Ct. App. 1981) (“in spite of Indiana’s aversion to cognovits provisions, a valid foreign judgment based on a cognovits note will be given full faith and credit in Indiana.”); but see ind. COde §§ 34-54-3-2�3 (prohibiting Indiana courts from enforcing foreign judgments that do not comply with its statutes regarding confession of judgment under power of attorney).46 Ark. COde Ann. § 16-65-301; Ore. r. Civ. p. 73; s.C. COde Ann. §§ 15-35-350, 15-35-360; s.d. COdiFied lAws §§ 21-26-1�5; vt. stAt. Ann. tit. 12, § 4671.47 CAl. Civ. prO. COde § 1132(b) (permitting confessed judgments only when an attorney representing the defendant certifies that “the attorney has examined the proposed judgment and has advised the defendant with respect to the waiver of rights and defenses under the confession of judgment procedure and has advised the defendant to utilize the confession of judgment procedure”). d.C. sCr-Civil rule 68-I (seemingly limiting confessed judgments to situations in which judgment is confessed in a pending case and the confession by judgment is either approved by the defendant’s attorney or the plaintiff’s attorney certifies that he or she “explained to the defendant the nature and consequences” of the confessed judgment); lA. COde Civ. prO. Ann. art. 2631-2644 (provides for an executory procedure by which confession of judgment clauses can be used to foreclose on debts secured by mortgages); mO. rev. stAt. § 511.100 (seemingly limiting confessed judgments upon warrant of attorney to debts arising from a note, bond, or bill of exchange); N.C. Gen. stAt. § 1A-1, R. 68.1, cmt. (noting that provision in former rule allowing judgment to be confessed to secure any person against contingent liability had been omitted); wAsH. rev. COde 4.60.050 (permits pre-action confession of judgment by statute but case law has yet to address whether agreement to confess can be contained within a contract); but see Stambler v. Holt, No. 92-0582, 1992 WL 165985, at *1 (D.D.C. July 6, 1992) (clause enforceable where the parties were sophisticated businesspersons and the defendants raised no valid defense). 48 Hawaii, Idaho, Kansas, Maine, New Hampshire, Rhode Island, and Washington.
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III. Best Practices
If you are in a jurisdiction that does or may allow the use of confession of judgment clauses, there are a few practices that may increase the likelihood of the clause being found enforceable.
First, the clause should be the result of an arms-length negotiation. Unequal bargaining power or a party’s lack of business sophistication will cause many courts to apply extra scrutiny to the clause, often setting aside the judgment and requiring the case to proceed on the merits. Second, the circumstances surrounding execution of the agreement should adequately indicate that the other party executed a knowing, intelligent, and voluntary waiver of due process rights. The clause should be clear and set apart from the rest of the agreement in some way—such as through large, bold font near the party’s signature. Some states require—and it is probably a best practice—a signature next to the clause, in addition to a signature on the overall agreement. Make sure the party has legal representation and adequate time to consult counsel before signing the agreement.
If you are in a jurisdiction that requires the clause to contain specific language, such as Ohio or Virginia, follow the language provided in the statute verbatim. When a confession of judgment clause is meant to secure a party against a contingent liability, as would be the case in an indemnity agreement, most of the statutes would require the clause to clearly state the circumstances that will give rise to the liability. Because many states still require the confessed judgment to be for a specified sum, the clause also should state the maximum amount for which judgment may be confessed.
Most importantly, review your jurisdiction’s confession of judgment statutes carefully. Many statutes have detailed requirements regarding timing, notice, and what documents must be provided when seeking entry of judgment. Many courts have held that strict compliance with the state’s confession of judgment rules is required. Even minor, technical errors can result in a refusal to enter judgment or in a confessed judgment being vacated.
Drew J. Gentsch is a member of, and Danya M. Keller is associated with, Whitfield & Eddy, PLC, of Des Moines, Iowa.
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through a human agent, what more could it have done to protect itself in the event of a fraud perpetrated by its CEO? However, two more recent decisions illustrate the limits of this logic.
Martinez
In Scottsdale Indemnity Company v. Martinez, Inc.12, from the Northern District of Alabama, the insured building maintenance company, MBS, submitted a claim under its fidelity insurance policy in respect of a fraud in excess of $2.2 million perpetrated by Brenda Walters, its former CEO/CFO.13 Walters had completed the policy application on behalf of MBS. In that application, she made misrepresentations concerning MBS’s audit and accounting controls.14
The policy provided that:
In the event the Application . . . contains any misrepresentation or omission made with the intent to deceive, or contains any misrepresentation or omission which materially affects either the acceptance of the risk or the hazard assumed by Insurer under this Policy, this Policy . . . shall not afford coverage to the following Insureds for any Claim alleging, based upon, arising out of, attributable to, directly or indirectly resulting from, in consequence of, or in any way involving, any untruthful or inaccurate statements, representations or information: . . .
any . . . Insured, if any past or present chief executive officer [or] chief financial officer . . . knew the facts misrepresented or the omissions, whether or not such individual knew
of the Application, such materials, or this Policy.15
The insurer defended on the basis of, inter alia, Walters’ material misrepresentations in the application, whereas MBS relied on the adverse interest exception. The court characterized MBS’s attempt to take the benefit of the policy application, without the burden of Walters’ misrepresentations therein, as an “I want to have my cake and to eat it, too” argument.16 Applying the strict language of the policy, the court concluded that Walters’ misrepresentations were material and, as a result, the insurer was entitled to deny the claim.17
On June 22, 2015, the Eleventh Circuit dismissed MBS’s appeal, holding that the undisputed evidence established that the misrepresentations were material to the issuance of the policy. The Eleventh Circuit’s decision is based only upon the policy wording, and does not mention the sorts of public policy or “unfairness” arguments advanced by the insured in United Kentucky Bank.
Middleburg Volunteer Fire Department
In Middleburg Volunteer Fire Department, Inc. v. McNeil & Company, Inc.,18 from the Eastern District of Virginia, the insured claimed under its commercial crime policy in respect of a fraud totalling nearly $500,000 perpetrated by Paul Draisey, its former treasurer.19 In the midst of his fraud, Draisey signed a policy renewal application on behalf of the insured and increased the policy’s coverage limits from $50,000 to $250,000.20 One of the questions in the renewal application asked “whether there were any changes in the operations or exposures of the organization.”21 Draisey answered “yes” and wrote that the insured was seeking an increased coverage limit. However, he did not disclose his own embezzlement. Draisey later committed suicide. Shortly before doing so, he advised the insured that he had increased the coverage limits to provide coverage for the fraud that he had perpetrated.22
THE ENEMY IS WITHIN:...Continued from page 9
12 No. CV-12-BE-2146-S, 2014 WL 4792986 (N.D. Ala. Sept. 25, 2014), aff’d, No. 14-14958, 2015 WL 3823728 (11th Cir. 2015). 13 Id. at *1-4.14 Id. at *3.15 Id. at *5.16 Id. at *7.17 Id. at *12.18 60 F. Supp. 3d 640 (E.D. Va. 2014). 19 Id. at 644.20 Id.21 Id. at 642.22 Id.
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The court held that, given the phrasing of the question in the application, Draisey had made no positive misrepresentation in the application itself, with the result that the insurer was unsuccessful in contending that the policy should be voided on that basis. The policy contained two provisions of significance. The “Concealment, Misrepresentation or Fraud” provision stated:
[t]his insurance is void in any case of fraud by you as it relates to this insurance at any time. It is also void if you or any other insured, at any time, intentionally conceal or misrepresent a material fact concerning:
(1) This insurance;
(2) The property covered under this insurance;
(3) Your interest in this insurance; or
(4) A claim under this insurance.23
The policy also contained a “Joint Insured” provision, which stated “[if] any insured, or partner, ‘member’ or officer of that insured has knowledge of any information relevant to this insurance, that knowledge is considered knowledge of every insured.”24
The court held that the combination of these two provisions permitted the insurer to void the policy: 25
it is undisputed that Draisey, in addition to being an insurance broker, was also Middleburg’s treasurer when he filled out the Renewal Survey and intentionally concealed his embezzling activities. Draisey’s intentional concealment of this clearly material fact is significant because, by the terms of the Policy, any intentional concealment by Middleburg’s officers or members is imputed to Middleburg, thereby allowing defendants to void the Policy. . . . [T]he principal cases on which Middleburg relies . . . explicitly acknowledge that the [adverse interest exception] does not operate where
the insured has knowledge of a misrepresentation made with respect to the policy. Here, the “you” in the “Concealment, Misrepresentation Or Fraud” provision extends to Middleburg via the “Joint Insured” or imputation clause . . . thereby imputing to Middleburg actual knowledge of Draisey’s embezzling activities and allowing defendants to void the Policy. . . .
This result comports with the common sense principle that no one should be able to obtain insurance coverage to cover losses for embezzling activities they are engaging in or planning to engage in.26
The court specifically declined to give effect to the adverse interest exception, given the express policy language to the contrary.27
Conclusions
United Kentucky Bank is in tension with Middleburg and Martinez. Moreover, while Martinez and Middleburg are ad idem regarding the consequences of a defaulter’s signature on the policy application, each case adopts different reasoning in arriving at that conclusion. While the court applied a strict reading of the policy wording in Martinez, the court in Middleburg permitted the insurer to rely on an imputation clause largely on the principled basis that the court ought not to give effect to the defaulter’s act of increasing the policy limits to provide greater coverage for his own defalcations from the insured.
The essential questions posed by United Kentucky Bank, Martinez, and Middleburg appear to be as follows:
1 . Can an insured take the benefit of an insurance policy application and simultaneously avoid the consequences of any misrepresentations therein? This was the outcome of United Kentucky Bank, as the insured was able to take advantage of the defaulter’s policy application without incurring the burden of her misrepresentation therein.
23 Id. at 647.24 Id. at 642.25 Id. at 648-49.26 Id. at 648-49.27 Id. at 649.
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2 . Can express policy language regarding the imputation of an agent’s knowledge to his or her principal oust the general principles of agency law? In Martinez and Middleburg, the language of the policy was applied in preference to general common-law principles governing the imputation of an agent’s knowledge to his or her principal. As the insurer in Middleburg was unable to rely on its misrepresentation clause, underwriters can be expected to place greater emphasis on the precise wording of such clauses in future.
3 . How will courts resolve the inherent tension between the inability of a corporation to obtain insurance other than through its agents and the imperative of limiting insurance coverage to fortuitous losses? This is the essential dilemma posed by United Kentucky Bank and Middleburg. In United Kentucky Bank, there was no evidence that the defaulter had procured the bond with the intent of obtaining coverage for her own defalcations; as such, the “unfairness” argument carried the day. In Middleburg, the evidence made it clear that the defaulter increased
the policy limits with intent to obtain coverage for his own defalcations, with the result that the lack-of-fortuity argument was persuasive. In this regard, should the nature of the defaulter’s intent in obtaining coverage determine whether the insured is ultimately entitled to coverage?
This area of fidelity insurance law is difficult, and encompasses numerous competing considerations, such as underwriting accuracy, the reasonable expectations of both insureds and insurers, the principle that only fortuitous losses should be covered, and general notions of fairness. Middleburg illustrates one approach that insurers might consider taking in these types of fact scenarios. However, the nature of the problem is such that insureds and insurers can be expected to continue to contest coverage in circumstances where the signatory to the fidelity bond application is the very defaulter in respect of which a bond claim is later made.
David S. Wilson and Chris McKibbin are partners, and Stuart Woody is an associate, with Blaney McMurtry LLP in Toronto, Canada.
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25 25
From the surety’s perspective, the answer is simple: the general contractor must declare a default, terminate the contract, and give notice to the surety before the surety’s obligations under the Bond are triggered. If the contract is not terminated, the conditions of the Bond are not met, and the surety is not liable.
From the general contractor’s perspective, the answer similarly is simple: the Bond guarantees full and faithful performance of the contract. The contract was not faithfully performed, resulting in delay damages. The surety is liable for those delay damages, even if the contract is not terminated.
Assume that all other conditions of the Bond have been met. Further assume that the general contractor, subcontractor, and surety are at a 3.1 conference to discuss the subcontractor’s default, but there does not appear to be a workable resolution. The general contractor advises the surety that it intends to make a claim against the Bond for the delay damages. The surety responds that it has no obligation because the subcontract has not been terminated, as required by paragraph 3.2 of the Bond. The following discussion occurs:
Contractor: No doubt that the wording of the Bond appears to state clearly that the surety’s obligation arises only after termination. That is a problem in this case: damages for delay can be assessed whenever the delay causes damage to the owner, not only when the contractor’s performance has been so unsatisfactory that a full declaration of default and termination is necessary.8
Do you believe that the provisions of the Bond – specifically paragraph 3.2 – requires the general contractor to formally terminate the subcontractor for the surety to be obligated for these damages?
Surety: Yes. The contractor and surety entered into a contractual relationship under the Bond. The Bond is subject to the general rules of contract interpretation and construction.9 The provisions of the Bond balance the rights of the contractor and the surety.10
When the contractor and surety entered into the Bond, they agreed to certain conditions. Mainly, they agreed that the surety’s obligations would be triggered only after all of the conditions of Paragraph 3 are met. The terms of Paragraph 3 are clear and unambiguous.11 Courts have consistently held that these requirements of Paragraph 3 are conditions precedent to the surety’s obligation to perform. 12 If these conditions are not met, the surety has no liability under the Bond.13
Here, the general contractor declared a default, but did not terminate the subcontract. The surety’s obligations under the Bond have not been triggered. Why should the contractor not be required to strictly comply with the conditions precedent of the Bond, irrespective of whether the subcontract has been substantially completed?
Contractor: Well, first of all, I am not sure that paragraph 3.2 is a condition. But regardless, in most states, terminating a subcontractor after the subcontractor has substantially performed is itself a breach of the construction contract.14
So you have to acknowledge that there are many situations where a subcontractor will be liable for liquidated damages, delay damages, warranty work, or other damages after substantial completion, but termination is not warranted.
8 Int’l Fid. Ins. v. Cnty. of Rockland, 98 F.Supp.2d 400, 436-37 (S.D.N.Y. 2000), citing steven m. stein, COnstruCtiOn lAw, ¶ 11.02[3][e][i] (1st ed. 1997). 9 United States Fid. & Guar. Co. v. Braspetro Oil Servs. Co., 369 F.3d 34, 51 (2d Cir. 2004) (courts “look to the standard principles of contract interpretation to determine the rights and obligations of a surety under a bond”); Cates Constr., Inc. v. Talbot Partners, 980 P.2d 407, 412 (Cal. 1999) (holding A312-1984 Performance Bond would be interpreted according to general contract principles); see also Stonington Water St. Assoc., LLC v. Hodess Bldg. Co., 792 F. Supp. 2d 253, 262 (D. Conn. 2011) (same).10 See Solai & Cameron, Inc. v. Plainfield Cmty. Consol. Sch. Dist. No. 202, 871 N.E.2d 944, 954 (Ill. App. Ct. 2007). 11 Mid-State Sur. Corp. v. Thrasher Eng’g, Inc., 575 F. Supp. 2d 731, 741 (S.D. W. Va. 2008) (“Leading commentators in the area of construction law consider the A312 Performance Bond to be ‘one of the clearest, most definitive, and widely used type of traditional common law ‘performance bonds’ in private construction.’”) 12 Braspetro, 369 F.3d at 51 (“Paragraph 3 of the [AIA A312-1984] Bonds contained a number of conditions precedent to the Sureties’ obligations under the Bond”); Developers Sur. & Indem. Co. v. Dismal River Club, No. 4:07CV3148, 2008 WL 2223872 (D. Neb. May 22, 2008) (“courts in other jurisdictions have consistently held that the notice requirement and other provisions of paragraph 3 are conditions precedent to the surety’s obligation to perform” and citing cases); Breath of Life Christian Church v. Travelers Ins. Co., No. W2009-00284-COA-R3-CV, 2010 WL 1172080 (Tenn. Ct. App. Mar. 26, 2010) (stating that Paragraph 3 “unambiguously sets-forth the conditions” under which surety’s obligations would arise).13 See, e.g., Stonington, 792 F. Supp. 2d at 263 (holding that the obligee’s failure to terminate the principal’s contract constituted a material breach of the A312 Performance Bond and discharged surety from obligations under bond); Town of Plainfield v. Paden Eng’g Co., 943 N.E.2d 904 (Ind. Ct. App. 2011) (denying obligee’s claim against surety under performance bond based on failure of obligee to terminate contractor according to terms of contract).14 See, e.g., Michael G. Buck & Son Constr. Corp. v. Poncell Constr. Co., 629 N.Y.S.2d 584, 584-85 (App. Div. 1995); Cleveland Neighborhood Health Servs., Inc. v. St. Clair Builders, Inc., 582 N.E.2d 640, 644-45 (Ohio Ct. App. 1989). For example, an appellate court in Louisiana stated: “The law is clear that a building contract may not be dissolved after substantial performance has been rendered.” Huguet v. Musso P’ship, 509 So.2d 91, 93 (La. Ct. App. 1987); see also AgGrow Oils, LLC v. Nat’l Union Fire Ins. Co. of Pittsburgh, Pa., 276 F. Supp. 2d 999, 1016 (D.N.D. 2003) (“It is now a well-established rule that substantial performance of a contract will be sufficient to support recovery by the performing party, substantial performance being considered as a performance in good faith and in compliance with the contract, except for minor and relatively unimportant deviations”).
CONTRACTOR VS. SURETY...Continued from page 11
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Surety: Perhaps, but a surety cannot act under the Bond if the subcontract is not terminated.15 A surety does not have unilateral power to determine how and when to perform the subcontract; that right rests solely with the subcontractor.16 If the surety undertakes performance of the subcontract before there is a termination, the surety risks losing its rights to indemnification from subcontractor, and might be subject to a suit for tortious interference with the subcontract.17
Why would the surety waive the termination requirement of the Bond, when doing so would be ignoring the preconditions of the Bond, and could subject the surety to liability from the subcontractor for interfering with the subcontract?
Contractor: First, the contractor would not be asking you to “act” – unless you call paying for delay damages “action”. In other words, we are not talking about taking over the project in this scenario. The job is substantially complete. We are not talking about the remedies that the surety has under paragraph 4 of the Bond to mitigate its damages and complete the project itself. We are talking about payment of damages after the job is completed under paragraph 6. The general contractor should not be forced to terminate the subcontract, which is substantially complete, just so the surety can protect its rights vis-à-vis the subcontractor.
And if the contractor terminates the subcontract in order to recover under paragraph 3.2, doesn’t that give the surety the argument that the contractor violated the first sentence of Paragraph 3 of the Bond by being in “Owner Default”? 18
This seems to place the contractor in a catch-22: (1) either terminate the subcontractor after substantial completion and risk being in “Owner Default”, in which case there is no surety obligation; or (2) do not terminate, in which case the surety will argue that the contractor has not met the termination requirement of paragraph 3.2.
Surety: There is no catch-22. The basic condition of the Bond is that if the subcontractor performs the subcontract, the surety shall have no obligation.19
The surety is not liable for partial breaches of the subcontract, only material breaches. This is clear by the terms of the Bond, which requires a declaration of “Contractor Default”. “Contractor Default” is defined as the failure of the contractor, which has not been remedied or waived, to perform or otherwise comply with a material term of the contract.20
If the breach is not a material breach, the surety has no obligation under the Bond, and the contractor’s recourse is against the subcontractor. If the breach is material, the contractor is required to comply with the conditions precedent of the Bond: declare a default, terminate, provide notice to the surety, and agree to pay the contract balance to the surety.
Here, the contractor claims that the subcontractor failed to complete its obligations under the subcontract after substantial completion. Substantial performance means that the contractor has completed its work and is not in material breach. 21
How can the contractor claim on the one hand that it cannot terminate the subcontract because the project is substantially complete, but yet on the other hand claim that subcontractor materially breached the subcontract?
Contractor: But the Bond incorporates the subcontract by reference. In most subcontracts, the subcontractor’s obligations do not end at substantial completion. Further, the surety’s obligations do not end even though an owner has issued a substantial completion certificate.22
Is the surety arguing that it is not obligated under the Bond for damages after substantial completion?
Surety: No, there are some instances where the surety may have some obligations after substantial completion,
15 4A Bruner & O’COnnOr § 12:36 n.3 (citing Morris, Jr., A Surety’s Lawyer’s Viewpoint, 2 puB. COnt. l.J. 79, 82 (1968)).16 See Colo. Structures, Inc. v. Ins. Co. of the W., 167 P.3d 1125, 1143 (Wash. 2007) (citing 2 ROBert F. CusHmAn & JAmes J. myers, COnstruCtiOn lAw HAndBOOk § 35.04[B] at 1279-80 n.5 (1999)).17 See L & A Contracting Co. v. S. Concrete Servs., Inc., 17 F.3d 106, 111 and n.15 (5th Cir. 1994) (“Before a declaration of default, sureties face possible tort liability for meddling in the affairs of their principals”) (citing restAtement (seCOnd) OF tOrts §§ 766, 766A).18 See AIA Document 312-2010, ¶ 14.4, defining “Owner Defaul” as “Failure of the Owner, which has not been remedied or waived, to pay the Contractor as required under the Construction Contract or to perform and complete or comply with the other material terms of the Construction Contract.”19 Id., ¶ 2.20 Id., ¶ 14.3.21 See 5 Bruner & O’COnnOr § 18.12 n.6. 22 AgGrow Oils, 276 F. Supp. 2d at 1016; Hunters Pointe Partners Ltd. P’ship v. United States Fid. & Guar. Co., 486 N.W.2d 136, 138 (Mich. Ct. App. 1992); Sch. Bd. of Pinellas Cnty. v. St. Paul Fire & Marine Ins. Co., 449 So.2d 872, 874 (Fla. Dist. Ct. App. 1984); but see Bank of Brewton, Inc. v. Int’l Fid. Ins. Co., 827 So.2d 747, 753 (Ala. 2002) (entering summary judgment in favor of surety on the grounds that contractor’s delays did not entitle payment from the surety unless all conditions of Paragraph 3 were met and stating that the intent of the A312 Bond, taken as a whole, is for the surety to ensure completion of the project; when the project is certified as substantially complete, the surety’s obligations under the performance bond cease.)
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but those obligations are limited to performance. The purpose of a performance bond is to guarantee the completion of the contract upon default by the contractor.23 The Bond incorporates the contract by reference to clearly define the scope of work the surety guarantees will be performed if the contractor defaults, and to ensure that the Bond and contract will be read together. It does not follow that a performance bond necessarily guarantees the performance of all covenants and agreements contained in the contract.24 A performance bond is not an insurance policy that insures against all damages.25
Even if the surety’s obligations extend beyond substantial completion, the surety’s obligations are still conditioned on the subcontractor’s material breach of the subcontract, and the preconditions of 3.2: a declaration of default, termination, and notice.
Contractor: I agree that the wording of paragraph 3.2 seems clear, although I still am not sure it is a “precondition.” In most states, the bond issued by a compensated surety is to be construed liberally in the interest of the beneficiary, and ambiguities are to be resolved in the beneficiary’s favor.26
There is at least one case that applied these rules of construction to the Bond and held that paragraph 3.2 does not constitute a condition precedent to the surety’s obligation to indemnify the general contractor for delay damages: International Fidelity Insurance Company v. County of Rockland.27 In the County of Rockland, the court concluded that “damages for delay in a contractor’s performance can be assessed whenever the delay causes damage to the owner, not only when the contractor’s performance has
been so unsatisfactory that a full declaration of default and termination is necessary or justified.”28
A West Virginia court examined the County of Rockland decision and came to the same conclusion in Mid-State Surety Corp. v. Thrasher Engineering, Inc.29 In that case, the court held that the parties intended for the Performance Bond to insure the performance of the construction contract. In order to effectuate this intent, the court found, as did the New York federal court, that paragraph 3 was not intended as a condition precedent to the surety’s obligation to indemnify the obligee for the contractor’s breach of the construction contract.30
Courts in other states – including New Jersey and Georgia – have reached similar conclusions.31
Surety: Admittedly, County of Rockland and Thrasher Engineering support your argument. However, these cases are the perfect example of bad facts making bad law. County of Rockland and Thrasher Engineering deal with the very limited circumstance of surety versus surety claims, arising out of completion contracts. In both cases, the original contractor defaulted and the surety arranged for the projects to be completed under a completion agreement, which was bonded by another surety.
The decision of County of Rockland is in direct contradiction to subsequent decisions of the Second Circuit and New York State appellate courts, all of which held or stated that the provisions of paragraph 3 of the Bond are conditions precedent to the surety’s obligations, and require “strict” compliance.32 Further,
23 Am. Home Assurance Co. v. Larkin Gen. Hosp., Ltd., 593 So.2d 195, 198 (Fla. 1992) (recognizing that “[t]he purpose of a performance bond is to guarantee the completion of the contract upon default by the contractor” and that “[o]rdinarily a performance bond only ensures the completion of the contract”).24 See 17 Am. Jur. 2d Contractors’ Bonds § 34 (2015) (citing P. Emp’rs Ins. Co. v. City of Berkeley, 158 Cal. App. 3d 145, 150 (Cal. Ct. App. 1984)).25 Cates, 980 P.2d at 427.26 See, e.g., McClare v. Mass. Bonding & Ins. Co., 195 N.E. 15, 17 (N.Y. 1935); City of Mullens v. Davidson, 57 S.E.2d 1, 7 (W. Va. 1949) (“a bond executed by a surety for compensation is usually expressed in terms prescribed by the surety, it will for that reason be strictly construed in favor of the obligee”); see also United States Fid. & Guar. Co. v. Christoffel, 566 P.2d 308, 310 (Ariz. Ct. App. 1971) (“Whatever is included in the bond, and is not required by the law, must be read out of it”); Ill. State Toll Highway Comm’n v. M.J. Boyle & Co., 186 N.E.2d 390, 397 (Ill. Ct. App. 1962) (“the bond shall inure to the benefit of the person, firm, company or corporation to whom any money may be due from the principals, any subcontractors or other person for any such machinery so furnished, and that suit may be maintained on such bond by any such person, firm, company or corporation for the recovery of any such money”); Wichita Sheet Metal Supply, Inc. v. Dahlstrom & Ferrell Constr. Co., 792 P.2d 1043, 1046 (Kan. 1990) (If a statute requires a bond to be granted, then the conditions not required by the statute will be considered surplusage and striken); Cruz-Mendez v. ISU/Ins. Servs., 722 A.2d 515 (N.J. 1999) (a surety bond issued to satisfy statutory requirements is construed in conformity with the legislative mandate).27 98 F. Supp. 2d 400 (S.D.N.Y. 2000).28 Id. at 436-437. 29 575 F. Supp. 2d 731 (S.D. W. Va. 2008). 30 Id. at 746. 31 See Gloucester City Bd. of Educ. v. Am. Arbitration Ass’n, 755 A.2d 1256 (N.J. Super. Ct. App. Div. 2000) (paragraph 3.2 did not require termination of the construction contract as a condition for the surety to be obligated because it conflicted with a New Jersey statute requiring the faithful performance of the subcontract); Commercial Cas. Ins. Co. of Ga. v. Mar. Trade Ctr. Builders, 572 S.E.2d 319 (Ga. Ct. App. 2002) (in construing the bond and the construction contract together, the court found that the language of the construction contract that was specifically negotiated between the parties took precedence over the language in paragraph 3 of the bond).32 See Braspetro, 369 F.3d at 51 (holding that paragraph 3 of the A312 Performance Bond contained a number of conditions precedent to the sureties’ obligations under the bonds); 150 Nassau Assocs. LLC v. Liberty Mut. Ins. Co., 826 N.Y.S.2d 567 (App. Div. 2007) (holding that “owner failed to comply strictly with the conditions of the [A312] performance bond which went directly to the surety’s liability); Tishman Westwide Constr. LLC v. ASF Glass, Inc., 823 N.Y.S.2d 71 (App. Div. 2006) (“The conditions of the [A312 Performance] bond with which plaintiff owner failed to comply went directly to the surety’s liability, and required strict compliance” [emphasis added]); 153 Hudson Dev. LLC v. DiNunno, 778 N.Y.S.2d 482 (App. Div. 2004) (same).
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County of Rockland was wholly discredited by the later decision of 120 Greenwich Development Associates, LLC v. Reliance Insurance Co.33
As for Thrasher Engineering, the contract was terminated and the court found that all conditions precedent were satisfied. This was the primary basis for the court to grant summary judgment in favor of the original surety against the completion contractor’s surety. The court’s discussion of whether the surety also could be held liable for delay damages under the completion contract incorporated by reference was only an alternate theory based on County of Rockland.
The logical interpretation of the Bond is that the conditions precedent contained in paragraph 3 pertain to all of “the Surety’s obligation(s) under this Bond”, not merely the provisions relating to the surety’s completion options under Paragraph 5. The Bond obligations include, but are not limited to, claims against the surety under paragraph 7. Paragraph 7 (unlike paragraphs 1 and 2) defines the scope of the surety’s obligations to the owner for damages if the surety elects to act under paragraphs 5.1, 5.2 or 5.3 of the Bond. Paragraph 7 does not create a separate obligation of the surety, and must be read in conjunction with the remainder of the Bond, including specifically paragraph 3.
Conclusion
One thing upon which we both can agree is that most states have not tackled this issue, let alone decided it. And when a project is substantially complete, a claim is made against a bond, and the owner has not formally terminated the construction contract, both the contractor and the surety are in murky waters.
Even assuming that the three subparagraphs in paragraph 3 are conditions precedent that pertain to all of the surety’s obligations under the Bond, there still may be some unanswered questions regarding how the surety’s obligations under the Bond arise.
Consider this: the Bond does not provide for a specific method of termination, instead incorporating the construction contract by reference. What happens when the construction contract does not require termination for recovery of post-substantial completion damages (i.e., delay damages, warranty items, punch list)? Or, what happens when a construction contract itself includes language that the contractor and the surety are liabile for certain damages?
Do the provisions of the Bond or the provisions of the contract control? How should ambiguities between the contract and the Bond regarding the surety’s obligations be resolved?
From the contractor’s perspective, the logical conclusion seems to be that the subcontract should control since (a) the Bond guarantees performance of the subcontract, and (b) the Bond incorporates the subcontract by reference.
From the surety’s perspective, the logical conclusion seems to be that the Bond should control, as (a) the Bond is executed after the subcontract and (b) the converse would render the involved provisions of the Bond without effect, which violates a cardinal rule of contract interpretation. But at least two courts have reached the opposite conclusion.34
Theodore K. Stream is a shareholder of Gresham Savage Nolan & Tilden, PC, in Riverside, California. Shashauna Szczechowicz is associated with Wolkin Curran, LLP, in San Diego, California.
33 No. 01 Civ. 8219 (PKL), 2004 WL 1277998, at *12 (S.D.N.Y. June 8, 2004) (holding that paragraph 3 “creates unambiguous preconditions for triggering [the surety’s] obligations under the Bond that apply not just to the completion options in Paragraph 4, but also to its obligations for delay costs and other damages under Paragraph 6.”)34 Mar. Trade Center Builders, 572 S.E.2d at 321-22 (holding that contractor was not required to give the surety notice before supplementing the subcontractor’s labor or materials in order to collect under the performance bond because the terms of the subcontract regarding notice controlled over the terms of the bond); Raito, Inc. v. Cardi Corp., Case No. PB 07-3235, 2010 WL 1422002, at *4 (R.I. Apr. 5, 2010) (finding that notice was required under the terms of the performance bond and the subcontract and thus contractor who failed to fulfill this condition was not entitled to damages from the surety); Carnell Constr. Corp. v. Danville Redevelopment & Hous. Auth., No. 4:10CV00007, 2011 WL 320574, at *7 (W.D. Va. Jan. 27, 2011) (holding that because bond incorporated sections of contract that created ambiguities regarding the surety’s obligations under bond, court denied summary judgment and stated that in the event the jury found the contractor’s right to proceed was terminated under prime contract that surety was liable under bond for damages).
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Earlier this year, the Ohio Court of Appeals affirmed both summary judgments, rejecting all four of ODRC’s assignments of error. The Surety and Fidelity Association of America filed an amicus curiae brief.
ODRC’s first argument relied upon a statute that provides that any recovery against the State “be reduced by the aggregate of insurance proceeds, disability award, or other collateral recovery received by the claimant.”7 ODRC argued that the subcontractor received collateral recovery that reduced its claim, almost entirely, but the court pointed out that Selective was asserting its own claim – impairment of its collateral – against ODRC. Because ODRC continued to make progress payments to the general contractor after receiving notice of the subcontractor’s lien, it “impaired Selective’s interest in the collateral securing its secondary obligation” (to pay the subcontractor if the general contractor did not).8 According to the court, “Selective was exercising its right of equitable subrogation after it had paid out under the bond”, and Selective had received no collateral recovery.9
ODRC’s second and third arguments attacked the validity of the subcontractor’s lien. The problem alleged by ODRC was that the generator required corrective work at the time the lien was filed. ODRC argued that because the generator provided by the supplier did not comply with the project plans and specifications, it had no obligation to detain the funds upon its receipt of the mechanics’ lien. ODRC further contended that, although the generator eventually was brought into compliance with the project plans and specifications, it still had no obligation to detain funds because the general contractor signed a zero dollar change order, and the supplier did not re-file its mechanics lien. There were two problems with this argument, as the court saw it. First, according to the statute, “[i]t is not up to the public authority to take it upon itself to decide the work was defective
and then fail to detain the funds.”10 Second, the statute authorized the filing of a lien for work in progress by a subcontractor “who is performing or . . . is furnishing . . . material for any public improvement”.11 Successful completion of the work is not a prerequisite for filing.
ODRC also argued that its participation in the settlement of the supplier litigation did not waive any defenses or admit to the validity of the lien. Recognizing the language of the settlement agreement, the court noted that “nothing in the settlement agreement affects Selective’s right of equitable subrogation, which is the theory of the case pursued in the Court of Claims and upon which the trial court granted summary judgment.”12
ODRC’s final argument was that Selective was obligated to indemnify ODRC for the general contractor’s defective work and failure to pay its subcontractors and suppliers. By paying the subcontractor for work that was corrected only after the lien was filed, Selective acted as a volunteer, according to ODRC, and thus had no standing to bring its claims. Again, the Court of Appeals was unconvinced:
Once again, the validity of [the subcontractor’s] claim is not the issue. Rather, the damages in this case were created by ODRC’s failure to detain funds thereby impairing Selective’s suretyship rights. ODRC is not entitled to recover damages from Selective for its own negligence in failing to detain funds.13
The Court of Appeals of Ohio has determined that an obligee that impairs suretyship rights is liable for the resulting damages. In this case, the consequence of the state agency’s failure to protect the surety’s collateral is that it had to compensate the surety for its resulting loss.
Lee M. Brewer is a partner with Bryan & Brewer, LLC, of Columbus, Ohio.
OHIO COURT OF APPEALS...Continued from page 13
7 OHiO rev. COde Ann. § 2743.02(D).8 Selective, 2015 WL 872972, *4.9 Id. at *3.10 Id. at *4.11 Id.12 Id. at *5.13 Id.
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