March 16, 2008
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A recent series of court decisions has prompted several major sureties to require modifications to the American Institute of Architect’s A312 Payment Bond before issuing new payment bonds using the form. Courts in Maryland, Virginia and Florida have held that a surety’s failure to deny a claim within 45 days as required by ¶6.1 of the bond form constituted a waiver of the surety’s defenses to the claim.
These rulings could impact projects for which A312 payment bonds are currently in place and have caused at least three major sureties to instruct their agents not to issue payment bonds on the A312 form without first modifying ¶6.1. It provides:
6 When the claimant has satisfied the conditions of paragraph 4, the surety shall promptly and at the surety’s expense take the following actions:
6.1 Send an answer to the claimant, with a copy to the owner, within 45 days after receipt of the claim, stating the amounts that are undisputed and the basis for challenging any amounts that are disputed.
6.2 Pay or arrange for payment of any undisputed amounts.
The first reported case on the issue was in Maryland. National Union Fire Insurance Co. of Pittsburg v. Wadsworth Golf Construction Co. of the Midwest, 863 A.2d 347 (Md. Ct. of Spec. App. 2004), aff’d sub nom. National Union Fire Insurance Co. of Pittsburgh v. David A. Bramble, Inc., 879 A.2d 101 (Md. 2005).
There, the subcontract contained a pay if paid clause, and the prime contractor withheld payment because of the owner’s failure to make payment. After receiving the claim, the surety requested a proof of claim from the subcontractor. After receiving the proof of claim, the surety stated that it would be in contact with the claimant in due course but never contacted the claimant again. Six months after receiving the proof of claim, the subcontractor filed suit on the bond, and the trial court held that the surety had waived all defenses to the action by not denying the claim within the 45 days as required by ¶6.1 of the bond.
On appeal, the surety argued that it was not liable to the subcontractor because payment was not yet due from the contractor under the pay if paid clause. Because the bond is to be construed in connection with the underlying subcontract, the surety argued that the claim was premature and the 45-day answer period was never triggered. The appeals court rejected the argument and held:
The problem the sureties have in making this argument is that it could have been, but was not, asserted in the answer to [claimant’s] proof of claim.... [u]pon the filing of what the surety believes is a premature claim, it is incumbent upon the surety to dispute the claim on the ground that payment is not yet due. If the surety does not do so, the terms of the payment bond require it to proceed promptly with payment of the undisputed claim.
The next case was decided in Virginia after the surety denied a claim in a timely letter that identified certain specific bases for the denial and expressly reserved all rights. Casey Industrial, Inc. v. Seaboard Surety Co., 2006 WL 2850652 (E.D. Va. Oct. 2, 2006). After suit was filed on the bond, the surety raised new defenses that were not included in its original letter. The U.S. District Court held that the surety’s failure to identify factual defenses within the 45-day period acted as a waiver of new factual defenses. The court, however, allowed the surety to raise legal defenses not asserted in the letter based on the reservation of rights.
The battle then moved to Florida in J.C. Gibson Plastering Co., Inc. v. XL Specialty Insurance Co., 2007 WL 2916399 (M.D.Fla. Oct. 8, 2007). There, the claimant subcontractor gave notice of the claim to the surety and the owner stating the amount of its claim. The surety responded by requesting copies of the claimant’s cost records and stating that it was contacting the prime contractor to get its position on the claim. The subcontractor provided the cost records 32 days after the surety received the initial notice. Two weeks later (46 days after the date of the initial notice), the subcontractor wrote the surety and explained its position that the surety had breached its obligations by failing to make an appropriate response to the claim within the 45-day period. The surety responded the next day and asserted the 45-day period did not begin to run until after receipt of the cost data. On the 48th day after receipt of the claim, the surety denied the claim.
In response the claimant’s motion for summary judgment, the surety raised two significant arguments. First, it argued that the 45-day period did not begin to run until after the claimant had submitted a Proof of Loss and/or other documents which provide sufficient details to substantiate the claim. The court examined the notice requirements in ¶4 of the bond, which simply required the claimant to state (a) that a claim is being made under the bond and (b) the amount of the claim with substantial accuracy. Based on the plain language of this paragraph, the court rejected the surety’s argument and held: “That the notice did not contain enough information for [the surety] to verify the claim is immaterial because paragraph 4 did not require notices to contain such information.”
Second, the surety argued that its rejection on day 48 substantially complied with the bond requirements. The court also rejected this argument and held: “In this case forty-eight days may as well have been a hundred days. Under Florida law, bond language must ‘be strictly construed against the surety and in favor of the obligee.’ Under such a construction, the forty-five day period set forth in paragraph 6 means forty-five days. [The surety] could not comply with paragraph 6 by answering within forty-eight days.”
These decisions already have affected the surety industry. Several major sureties are now requiring modifications to ¶6 before writing payment bonds using the A312 form. If sureties already have issued bid bonds on contracts requiring use of the A312, they still may be obligated to issue unmodified bonds. Absent that situation, it is likely to be much harder to procure unmodified A312 payment bonds.
These decisions also will affect other project participants. Owners and architects should recognize that it will be difficult for contractors to obtain bonds using an unmodified A312 form and should account for that fact when putting contracts out to bid. If bid requests require use of the A312 form, contractors and subcontractors should qualify their bids to provide for modification of the form or use of an alternative form.
The decisions are even more important with respect to ongoing projects using the A312 form. Bond principals – the contractors and subcontractors who have bonded a job using A312 forms – will need to work with their sureties and counsel on an expedited basis so that the surety can respond by stating the amounts that are undisputed and the basis for challenging any amounts that are disputed within the 45-day answer period. Moreover, in many states, sureties are subject to fines and penalties for unfair or bad faith claims-handling practices. If the surety does not have the information necessary to support a denial, a denial may exposed it to liability under those laws.
Failure to provide this information to the surety also may expose bond principals and their individual owners to liability. Sureties universally require bond principals to sign indemnity agreements under which the principals agree to reimburse the surety for all costs incurred in responding to a claim. Sureties often require the corporate owners and their spouses to sign similar indemnity agreements. If the surety is not able to raise a defense because the bond principal has not provided information in a timely manner, the surety may be able to recover its losses from the bond principal and its individual owners. Thus, even though a contractor may have had a good defense to the underlying claim (such as the pay if paid defense in Wadsworth), both it and its individual owners could become liable to its surety on the claim.
Bond claimants also should keep these decisions in mind. It may not be practical for sureties to identify all defenses in response to a claim within 45 days. This provides claimants with a huge advantage if they properly present their claim.
Finally, it should be noted that there is one unpublished decision from a Massachusetts trial court in which the court held that the surety’s request that the contractor complete an Affidavit of Claim qualified as a rejection of the claim. Methuen Construction Co. v. Austin Co., Superior Ct. C.A. No. 04-1207-G (Sept. 1, 2006). Accordingly, while the Maryland, Virginia and Florida decisions represent a majority view at this point, the issue is not fully settled, and anyone with an issue relating to the A312 payment bond should retain counsel.
For more information about the issues covered in this report, please contact William DeVan in our Washington, D.C. office at 202-508-4054 or at [email protected] or contact your Thelen attorney. For more information about Thelen’s Construction and Government Contracts Department, click here.