The Law of Payment Bonds Second Edition

KEVIN L. LYBECK, W A Y N E D. L A M B E R T , A N D

J O H N E. S E B A S T I A N , E D I T O R S

Defending Liberty

Pursuing Justice

The Law of Payment Bonds, 2d Ed.

Contents

Chapter 1 - Introduction to Payment Bonds

en D. Podwill, M. Lanak

Introduction 1

I. Payment Bonds and the Contract of Suretyship 1

II. History and Purpose 3

III. Types of Payment Bonds 5 A. Public Bonds 5

Federal Public Works Projects 5 2. State Public Works Projects 6

B. Private Bonds 7 Statutory Private Bonds 7

2. Common Law Bonds 8 C. Alternative Products

IV. Rules of Construction and Interpretation 12 A. Public or Private Project? 12

1. The Miller Act 12 2. Little Miller Acts 15

B. Construing Payment Bonds 16 Statutory Bonds 16

2. Common Law Bonds 19 C. Statutory Bond or Common Law Bond? 19

1. Bond Terms 19 2. Statutory Terms 24

V. Who is Entitled to Recover? 26 A. Tiers 26 B. Other Potential Claimants 26

VI. What Is Covered 27 A. Labor and Materials 27 B. Nature of Services Provided 29

Contents

VII. Extent of Coverage 30 A. Multiple Prime Contractors 30 B. Replacement Contractors 31

New Form 2. New Contractor 33

C. Employee Benefits Claims 35 D. Bonds 36

VIII. Period of Coverage 38 A. Retroactive Coverage 38 B. Multiple-Year Coverage 39 C. When Sureties Can Terminate Bonds 40

IX. Notice and Proof Requirements 41

X. Defenses 41

Conclusion 42

Bibliography 42

Chapter 2 - Who Is Entitled to Recover?

Brett D. Divers, P. Keith Lichtman, Ira

Introduction 45

I. The Miller Act 45 A. Language of Miller Act 45 B. "Remoteness" 46 C. Prime Contractor 48 D. Subcontractor Versus Materialman 48 E. Suppliers 50

1. Materials Supplier 50 2. Labor Supplier

F. Second-Tier Claimants or Sub-Subcontractors G. Sham 53

Contents

H. Other Potential Claimants 55 1. Obligee 55 2. Assignees 56 3. Design and Other Professionals 56 4. Accountants 57 5. Subcontractors, Suppliers, and Laborers of

Replacement Contractors 58 6. Employment Agencies 58 7. Parties to Joint Checks 59 8. Factors 60 9. Onsite/Offsite Office Maintenance 60

State Public Works Miller Acts" 61 A. Statutory Language and Remoteness 61 B. Prime Contractor 63 C. Subcontractors 63 D. Second-Tier Claimants or Sub-Subcontractors 64 E. Suppliers 64

1. Materials Suppliers 65 2. Labor Suppliers 66

F. Direct 67 G. Sham Claimants 67 H. Other Potential Claimants 68

1. Obligees 68 2. Assignees 69 3. Design and Other Professionals 69 4. Accountants 70 5. Subcontractors, Suppliers, and Laborers of

Replacement Contractors 70 6. Employment Agencies 71 7. Factors 71 8. Parties to Joint Checks 71

III. Common Law Bonds 72 A. Examples of Common Law Bond Language 73

1. Bond Forms 73 2. Other Typical Bonds 73

B. Concept of "Remoteness" 74 C. The "Contractor" or "Prime Contractor" 74 D. "Subcontractors" 75

Contents

E. "Second-Tier Subcontractors" or "Sub-Subcontractors" 75 F. "Suppliers" 76

1. Materials Suppliers 76 2. Labor 77

G. Other Potential Claimants 77 1. Owners 77 2. Co-Obligee Lenders 78 3. Design and Other Professionals 78 4. Subcontractors, Suppliers, and Laborers of

Replacement Contractors 79 5. Factors 79

Conclusion 79

Chapter 3 — Types of Claims Covered

Mike F. Pipkin, Nina S. McDonald, Jason Stonefeld

Introduction 81

I. Miller Act 82 A. Labor 83

1. Withholding Taxes 85 2. Employee Benefit Plan Contributions 86

B. Materials 87 1. In General 87 2. Specially Fabricated Materials 89

C. Equipment 91 1. Capital Purchase 91 2. Rental 92 3. Damage to or Loss of Equipment 93 4. Repairs 94

D. Services 96 E. Premiums 98 F. Loans 98 G. Contract Damages 99

1. Delay Damages 100 2. Overhead 102

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3. Lost Profits 102 4. Termination Damages 103

H. Extra Contractual Damages 104 1. Quantum 104 2. Damages 106 3. Negligence 107

I. Attorneys' Fees 107 J. Interest 110 K. Retainage

Little Act and Common Law Payment Bonds 112 A. Labor

1. Withholding Taxes 113 2. Union Contributions

B. Materials 116 1. In General 116 2. Specially Fabricated Materials

C. Equipment 1. Capital Purchase 118 2. Rental 118 3. Repairs 119

D. Services 120 E. Insurance Premiums and Bond Premiums 121 F. Loans 122 G. Contract Damages 123

Delay Damages 123 2. Lost Profits 123

H. Extra Contractual Damages 124 Quantum 124

2. Punitive Damages 125 3. Negligence 125

I. Attorneys' Fees 125 J. Interest 126 K. Retainage 127

Conclusion 128

Chapter 4 - Proof Requirements

Contents

Keith Langley, J. Blake Wilcox

Introduction 129

I. Payment Bond Claims and Evidentiary Issues 129 A. Statutory Bond Claims: The Miller Act and

Little Miller Acts 131 Materials and Labor Were Supplied for Use

in the Project 132 2. Payment Has Not Been Made 141 3. Jurisdictional Requirements 145

B. Common Law Bond Claims 155 1. Understanding the Terms the Bond 156 2. Movement Towards a New Form 157

II. The Surety's Pretrial Discovery and Practical Considerations... 158 A. Requests for Documents 158 B. Requests for Information 160 C. Practical Considerations 160

1. Alternative Means for Acquiring Proof. 161 2. Admissibility of Evidence 161

Conclusion 162

Chapter 5 - Notice Requirements For Bond Claims

Michael I. Less, J. Wallace John A. McDevitt

Introduction 163

I. Public Works Notice Requirements 163 A. Miller Act 163

The Purpose of the Notice Requirement 164 2. Who Must Give Notice 164 3. To Whom Notice Must Be Given 166 4. The Contents and Form of Notice 167 5. Time Period for Giving Notice 173

B. Little Miller Acts 177

Contents

1. Types of Notice Requirements 177 2. Who Must Give Notice 180 3. To Whom Notice Must Be Given 181 4. The Contents and Form Notice 182 5. The Time Period for Giving Notice 186

C. State By State Notice Requirements 187 1. Alabama 187 2. Alaska 188 3. Arizona 188 4. Arkansas 189 5. California 190 6. Colorado 191 7. Connecticut 191 8. Delaware 192 9. District of Columbia 192 10. Florida 193

Georgia 193 12. Hawaii 194 13. Idaho 195 14. Illinois 195 15. Indiana 196 16. Iowa 197 17. Kansas 198 18. Kentucky 198 19. Louisiana 198 20. Maine 199 21. Maryland 199 22. Massachusetts 200 23. Michigan 200 24. Minnesota 201 25. Mississippi 202 26. Missouri 202 27. Montana 203 28. Nebraska 203 29. Nevada 204 30. New Hampshire 204 31. New Jersey 205 32. New Mexico 205 33. New York 206 34. North 206

Contents

35. North Dakota 206 36. Ohio 207 37. Oklahoma 207 38. Oregon 208 39. Pennsylvania 208 40. Island 209 41. South Carolina 210 42. South Dakota 210 43. Tennessee 210 44. Texas 45. Utah 212 46. Vermont 213 47. Virginia 213 48. Washington 214 49. West Virginia 214 50. Wisconsin 215 51. Wyoming 215

D. Miscellaneous 215

Private Works Notice Requirements 216

III. Typical Payment Bond Notice Provisions 217 A. Bond 217 B. ConsensusDOCS Payment Bond Subcontractor

Payment Bond 218 C. Miller Act Payment Bond 218

Conclusion 218

Chapter 6 - Suit Limitations Courtney Turnage Walker, Eric H. Bradford R Carver

Introduction 221

I. Suit Limitations under the Miller Act 222 A. The 90 Day Waiting Period 222

B. The One Year Suit Limitation Period 224

Contents

Computation and Commencement of the Miller Act Suit Limitation 226

2. Claimant's Actions Affecting the Commencement of the Limitations Period 228

3. Summary 235

II. Suit Limitations in the Little Miller Acts 235 A. The Little Miller Acts 235 B. Interpretation and Application of Suit Limitation

Periods in the Little Miller Acts 245 C. Effect of a Different Suit Limitation Period in

the Payment Bond from That Set Forth in the Little Miller Act 252

D. Summary 255

III. Suit Limitations Applicable to Common Law Payment Bonds 256 A. Contractual Limitation Periods in Payment Bonds 256

The Parties to a Payment Bond Can Generally Establish a Contractual Limitation Period 257

2. Statutory Prohibitions or Mínimums 261 3. Application of the Contractual Suit Limitation

Period 268 B. Statutes of Limitations as Applied to Common

Law Payment Bonds 270

IV. Estoppel, Waiver, and Relation Back 275 A. Tolling the Suit Limitation Period 275 B. Estoppel 279 C. Waiver 284

Conclusion 285

Chapter 7 - Jurisdiction, Venue and Forum Selection Clauses

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Contents

Denise C. Puente, Marcha Durcan

Introduction 287

I. Miller Act Bonds 287 A. Subject Matter Jurisdiction 287 B. Venue 294

Little Miller Act Statutes 297 A. Jurisdiction 297 B. Venue 299

III. Common Law Bonds 301 A. Jurisdiction 301 B. Venue 302

IV. Bankruptcy Venue 302 A. Change of Venue in Bankruptcy Cases 306 B. Actions Removable Generally under U.S.C. § 1441 308 C. Removal to Bankruptcy Court under 28 U.S.C. § 1452 D. Exceptions to Removal 313

E. Remand 314

V. Forum Selection Clauses 315

Conclusion 319

Chapter 8 - Effect of An Arbitration Provision in The Principal's Contract With the Claimant

James D. Ferrucci

Introduction 321

I. Arbitration in Brief Overview 323 A. Statutory Framework 323 B. Limited Judicial Review of Arbitration Awards 330 C. The Consensual Nature of Arbitration 338

II. The Surety's Obligation to Arbitrate 343

Contents

A. Direct Compulsion 345 1. Incorporation by Reference 345 2. Equitable Estoppel 355

B. Indirect 358 C. Statutory Compulsion 359

The Claimant's Obligation to Arbitrate with the Principal and Submit to a Stay of Related Court Action against the Surety 362 A. The Nullification Argument 363 B. When the Claimant's Agreement to Arbitrate

is Undisputed or Found to Exist 368 C. When the Claimant's Agreement to Arbitrate

is Disputed 376

IV. Consolidation of Related Arbitrations 383 A. Under the Federal Arbitration Act 384

1. Before Green Tree 384 2. After Green Tree 389

B. Under State Statutes 394 Statutes Which Do Not Address Consolidation 95

2. The Revised Uniform Arbitration Act 397

Conclusion 400

Chapter 9 - Preclusive Effect on the Surety of Prior Judgment or Arbitration Award Against the Principal

James D. Ferrucci

Introduction 403

I. Basic Principles of Preclusion 406 A. Res Collateral Estoppel and Privity 408 B. Due Process Limitations on Nonparty Preclusion 410

II. Preclusion in the Suretyship Context 421

Contents

A. Extent of Preclusive Effects 429 1. No Preclusive Effect 430 2. Conclusively Binding 434 3. Rebuttable Presumption and Prima Facie Evidence 439

B. Conditions Affecting the Imposition of Preclusive Effects ..446 Default Judgments or Awards 446

2. Notice and Opportunity to Defend 453

III. Prescription, the Incorporation

Doctrine and Other Issues 472

TV. The Miller Act Jurisdictional Issue 486

V. Suretyship Defenses 492

Conclusion 500

Appendix 501

Selected Suretyship and Guaranty Cases on Preclusion 501

Federal Common Law 501 Alabama 502 Alaska 502 Arkansas 503 Arizona 503 California 503 Colorado 503 Connecticut 503 Delaware 504 District of Columbia 504 Florida 504 Georgia 504 Hawaii 505 Illinois 505 Indiana 505 Kansas 505 Kentucky 505 Louisiana 506 Maryland 506

Contents

Massachusetts 507 Michigan 507 Minnesota 507 Mississippi 507 Missouri 507 Nebraska 507 Nevada 508 New Hampshire 508 New Jersey 508 New Mexico 508

York 509 North Carolina 510 North Dakota 510 Ohio 510 Oklahoma 510 Oregon 510 Pennsylvania Puerto Rico 511 Rhode Island 511 South Carolina Texas Virginia 512 Washington 512 West Virginia 512

Chapter 10 - Entitlement to Contract Proceeds

Edward G. Gallagher

Introduction 513

I. The Rights of Persons Who Furnish Labor and Material to Payment Out of Contract Proceeds 514 A. Equitable Rights 514 B. Trust Fund Statutes 517 C. Barriers to Claims by Subcontractors and Suppliers 518

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II. Theoretical Bases for the Payment Bond Surety's Rights to Contract Funds 520 A. Subrogation 520

1. Subrogation to the Rights of Claimants 522 2. Subrogation to the Rights of the Obligee 522 3. Subrogation to the Rights of the Principal 526

B. Assignment from the Principal or Claimants

III. Alleged Conditions Precedent to Exercise of the Payment Bond Surety's Rights 533

rv. The Payment Bond Surety Versus Other Claimants to Contract Funds 537 A. The Principal 537 B. An Assignee of the Principal with a Perfected

Security Interest 538 C. The Principal's Trustee in Bankruptcy 538 D. The Internal Revenue Service 539 E. The Surety Versus the Obligee's Setoff. 546 F. The Surety Versus Claims of Unpaid Subcontractors

and Suppliers 548

V. The Payment Bond Surety's Claim to Contract Funds on Other Jobs 549 A. The Payment Bond Surety Is Subrogated to the

Owner's Rights 550 B. The Extent of the Surety's Subrogation Rights C. The Obligee Could Use Contract Funds from One Job

to Pay Subcontractors and Suppliers on Another Job 552

Conclusion 554

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Contents

Chapter 11 - Defenses James A. Knox, Jr., Stacy Hipsak Goetz

Introduction 555

I. The Payment Bond Surety's Right to Assert its Principal's Defenses 556 A. In General 556 B. The Effect of Bond Language 559 C. Second-Tier Claims 560

II. The Payment Bond s Right to Assert its Principal's Counterclaims 561 A. Setoff and Recoupment 561 B. First-Tier Claims 562 C. Second-Tier Claims 564 D. Restrictions 566

III. The Claimant's Material Breach as a Defense 568

IV. Payment as a Defense 569 A. Actual Payment 569 B. Misapplication of Payment 571

In General 571 2. The Minority Rule 572 3. The Majority Rule 573 4. Restrictions 575

C. Joint Check Arrangements 576 Introduction 576

2. The "California Rule" 576 3. The "Federal Rule" 579

V. Particular Subcontract Conditions 580 A. The Defense 581

Introduction 581 2. Construed as a Timing Provision 582 3. Construed as a Condition Precedent 585 4. Prevention of the Condition 586 5. Availability of the Defense to the Surety 587 6. Public Policy 590

Contents

B. The "Disputes" Clause and Pass-Through Defenses 594 C. The Clause 596 D. Procedures for Extras and Change Orders 597 E. Shop Drawing Responsibilities 599

Waiver, Estoppel and Related Defenses 599 A. Waiver 600 B. Estoppel 603 C. Release 608 D. Compromise and Settlement 610 E. Accord and Satisfaction 612 F. Novation 613

VII. The Defense Comply with Licensing Requirements 614 A. In General 614 B. Lack of License as a Defense to the Surety 616 C. Who Must be Licensed 617 D. The Unjust Enrichment Argument 618 E. The Doctrine of Substantial Compliance 619 F. Federal Projects 621

VIII. The Claimant's Duty of Mitigation 621

IX. The Payment Bond Surety's Impairment Defenses 624 A. Owner Default 624 B. Material Alteration 625 C. Extension of Time 627 D. Overpayment 631

X. The Penal Sum as a Limitation of the Payment Bond Surety's Liability 632 A. In General 632 B. Exhaustion and Proration 633 C. Attorneys' Fees 634 D. Prejudgment Interest 635 E. of the Performance Bond 636

Conclusion 637

Contents

Chapter 12 - Bankruptcy

Chad L. Schexnayder

Introduction 639

I. Fundamental Purposes and Principles of Bankruptcy Law 639

A. Forgiveness of Indebtedness 640 B. Sharing 640 C. Breathing Space 641 D. An Important of the Estate" 642

II. The Impact of Bankruptcy on the Liability of the Payment Bond Surety 643 A. Does the Bankruptcy Stay the Assertion of a

Payment Bond Claim? 643 1. Expansion of the Automatic Stay 644 2. Stay Pursuant to the Bankruptcy Court's

Equitable Powers 645 B. Can Bankruptcy Extend the Time for a Claimant

to Make Claims against the Bond? 647 Bankruptcy Filing by the Bond Principal 648

2. Bankruptcy Filing by the Claimant 648 C. The Doctrine of "Preference" and its Potential to

Increase the Surety's Payment Bond Losses 650 The Law of Preference 650

2. The Preference Complaint against a Project Supplier or for Concern to the Surety 651

3. The Preference Complaint Brought Directly against the Payment Bond Surety 654

4. Defenses Available to the Payment Bond Surety 655 D. Setoff-Recoupment Rights as a Defense to the Surety 673

1. Setoff and Recoupment in Bankruptcy 674 2. Recoupment 676 3. Setoff 677

E. Aid in Investigation of Claims; Schedules and Rule 2004 Examinations 681

Contents

III. The Impact of Bankruptcy on the Indemnity and Subrogation Rights of the Payment Bond Surety 683 A. Does the Bankruptcy Stay the Lawsuit by the

Surety against Non-debtor Indemnitors? 683 Application of Section 362(A) to Non-debtor

Indemnitors 684 2. Equitable Authority of Bankruptcy Court to

Stay Surety Actions 686 B. The Surety's Rights to Contract Proceeds 688

The Surety's Rights Are Superior to Debtor's Interest in Contract Funds 688

2. Debtor's Limited Use of Bonded Contract Proceeds 696 C. The Actions to Protect Surety's Rights in Bonded

Contract Proceeds 698 Surety Notice to the Obligee 698

2. Investigate First Day Motions and Orders 702 3. Motion to Sequester Cash Collateral and,

Alternatively, for Adequate Protection 704 4. Motion for Relief from the Automatic Stay

Regarding Bonded Contract Proceeds 707 D. Asserting the Surety's Right to Distributions from

the Debtor's Bankruptcy Estate 710 1. The Surety's Proof of Claim 710

Conclusion 716

EXHIBIT 717

Chapter 13 - The Surety's Common Law and Contractual Rights of Indemnity

J. Michael Hennigan, Jeffrey S. Price, Jarrod W. Stone

Introduction 719

I. The Surety's Common Law Rights 721 A. Exoneration 721 B. Quia Timet 723 C. 726

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Contents

D. Contribution 729 Two or More Sureties for the Same Principal 730

2. Two Different Sureties Providing Bonds for Different Principals 731

II. The Surety's Rights under the Indemnity Agreement 732 A. Indemnity Provision 734 B. Collateral Deposit Provision 739 C. Right-to-Settle Provision 745

1. Absence of Right-to-Settle Provision 747 2. Balancing the Surety's Discretion and

Standards of Reasonableness and Good Faith 747 3. Deposit of Collateral 752 4. Prima Facie or Conclusive Evidence Provision 754 5. Failure to Mitigate Damages 755 6. The Bond Versus the Indemnity Agreement 756 7. Notice to Indemnitors 758 8. Right to Settle the Principal's Affirmative Claims 759

D. Evidence of Payment Provision 763 E. Recovery of Attorneys' Fees Provision 766 F. Assignment Provisions 770

1. Bonded Contract Balances 772 2. The Principal's Claims against Third Parties 774 3. Assignment of Material and Equipment

on Bonded Projects 775 G. Filing Provision 779 H. Provision 781 I. Right to Finance Provision 783 J. Trust Fund Provision 786

1. Local Law Must Be Observed 787 2. Courts Finding That a Trust Was Formed 788 3. Courts Finding That a Trust Was Not Formed 790

K. Duty to Cooperate Provision 793

III. Defenses to the Surety's Rights of Indemnity 794 A. Defenses Based upon the Surety's Action or Inaction 794

Assertion That Surety Paid an Payment Bond Claim 794

2. Assertion That Surety Made a Payment in Bad Faith 796

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3. Assertion That Surety Acted Unreasonably 801 4. Assertion That Surety Failed to Mitigate

Its Damages 803 5. Assertion That Surety Not Entitled to Recover

Damages Arising from Surety's Conduct 804 B. Technical Defenses Asserted by Principals

and Indemnitors 809 Lack of Notice to the Principal and 809

2. Improper Signature on Indemnity Agreement C. "Indemnitor Only" Defenses 812

1. Failure to Adequately Pursue Principal 812 2. Sale of Business to Another Principal 813

D. Defenses Based upon Wrongful Interference, Dominion, or Abuse of Rights 813 1. Wrongful Interference 813 2. Domination 817 3. Abuse of Rights 817

E. Defenses Based upon the Surety's Underwriting Procedures 818

Conclusion 820

Chapter 14 - Payment Bond Claims Handling and the Law of Bad Faith

Charles W. Bennett J. Lee, Robert C. Niesley

Introduction 821

I. Follow the Statutory Claims Settlement Regulations in Effect in the Jurisdiction Where the Claim Arose 822

II. The Law of Bad Faith and the Payment Bond Surety 846 A. The Development of Bad Faith Law 846 B. The Application of Bad Faith Law to a

Payment Bond Surety 852 C. Bad Faith and the Miller Act 865

Contents

D. Bad Faith Damages 868 1. Punitive Damages 869 2. Statutory Damages 873 3. Consequential Damages 875 4. Effect upon the Penal Sum 876

III. Payment Bond Claims Handling: Four Practical Suggestions ....877 A. Step 1: Document Everything of Significance 878 B. Step 2: Independently Investigate 879 C. Step 3: Utilize a Diary System and Communicate 881 D. Step 4: Carefully Assess Whether to Tender

the Surety's Defense 882

Conclusion 885

Chapter 15 - Miscellaneous Issues Catherine Squillace, Susan Evans Jones, Michelle

Matthew M. Horowitz

Introduction 887

I. Apportionment of Liability between Sureties 887 A. Co-Suretyship 888

When There Are Two Sureties on the Same Without a Written Agreement 888

2. When There Are Two Sureties on the Same With a Written Agreement 889

B. Sub-Suretyship 891 Apportionment Between the Subcontractor's

Bond the Prime Contractor's Bond 892 C. Priority among Different Bond Types 893

n. Obligation to Sue Both the Surety and Principal 894

Assignment of Payment Bond Claims 897

IV. Claims in Excess of the Penal Sum and Pro Rata Distributions 900

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V. Will the Surety be Precluded from Later Asserting Any Defense Not Raised in Its Denial of a Payment Bond Claim? 904

VI. Criminal Liability of the Principal for Diverting

Contract Proceeds 909

VII. Joint and Several Liability of the Principal and the Surety

VUL Delivery 912

Unauthorized Bonds 914

X. Insurance Policies and the Payment Bond Surety 918