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The Wrong Bond at the
Wrong Time
A general contractor
comes out on the short end of a dispute over its rights to make a claim against
a payment bond
When a general contractor
to finish a job that its subcontractor started, the general is not automatically
entitled to make a claim against the subcontractor’s payment bond for the extra
costs incurred. So ruled the Arizona Court of Appeals in March 2003 in
American Casualty Company v. D.L. Withers Construction, L.C.
Background. After
being awarded the contract for the construction of Pinnacle High School, D.L.
Withers Construction subcontracted with 1st Mechanical of Arizona for HVAC
installation. In its contract with Withers, 1st Mechanical agreed to furnish all
labor, materials and equipment necessary to complete the job.
Withers required 1st
Mechanical to furnish a payment bond. The bond provided payment claim rights to
parties “having a direct contract with [1st Mechanical] for labor, material, or
both …”
As the project went
forward, 1st Mechanical fell behind schedule. At a jobsite meeting to discuss
the delays, the two companies agreed that Withers would provide 1st Mechanical
with additional manpower. Withers contracted with Midstate Mechanical to finish
the job, resulting in extra costs incurred by Withers. Seeking reimbursement for
those costs, Withers filed a claim against 1st Mechanical’s payment bond.
The issuer of the bond,
American Casualty, rejected Withers’ claim, arguing that Withers was not a
proper claimant since it did not have the required “direct contract” with 1st
Mechanical for labor, material, etc.
Predictably, a flurry of
claims and counterclaims ensued. Withers argued that it was entitled to
reimbursement because of the agreement it reached with 1st Mechanical to bring
in more labor. That agreement, Withers contended, constituted a direct contract
sufficient to satisfy the bond requirement.
The Superior Court judge
disagreed and ruled for American Casualty, and Withers appealed.
Ineligible claimant.
The Court of Appeals upheld the trial court’s decision, based in part on a
distinction between a payment bond and a performance bond.
A performance bond, wrote
the court, “indemnifies the obligee [Withers] for the principal’s [1st
Mechanical] failure to fully perform the contracted work.” Unfortunately for
Withers, what 1st Mechanical had was a payment bond, which “protects the obligee
from claims by the principal’s unpaid laborers or suppliers.” In this case, 1st
Mechanical had paid everyone, so there were no unpaid laborers or suppliers to
go after Withers.
The court ruled that the
payment bond’s definition of “claimant” could not be reasonably interpreted to
include Withers, since, according to the court, Withers did not have a direct
contract with 1st Mechanical to provide labor, material, etc. Withers’
subcontract agreement with 1st Mechanical provided that, if the subcontractor
failed to perform, Withers had several remedies, one of which was to “assist”
the subcontractor by “securing any labor” necessary to complete the work.
Withers argued that
because the payment bond incorporated the subcontract agreement, Withers had a
direct contract with the subcontractor. The court disagreed, and Withers had to
eat the extra costs of bringing in Midstate to finish the job.
Dual purpose. The
court did agree with one of Withers’ arguments: that the classification of a
bond as either a “performance” or “payment” bond does not, per se, determine who
gets to make a claim against it. Unfortunately for Withers, the court found that
argument to be inapplicable to this case.
However, the court’s
discussion on that point is instructive and could provide valuable guidance to
contractors hoping to avoid Withers’ predicament. The court cited Davis
Wallbridge, Inc. v. Aetna Cas. & Sur. Co., which provided that “[I]n all
events, it is the language employed in the bond which determines the
beneficiaries.”
Thus, the court noted, a
performance bond “containing language purporting to benefit laborers and
materialmen” serves the dual purpose that would have legitimized Withers’ claim.
Our recommendation.
If you require a subcontractor to furnish a bond — performance or payment — be
sure that its language (a) provides you with your desired remedies for
subcontractor non-performance and (b) protects you from claims by the
subcontractor’s unpaid laborers and suppliers.
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