|
 | |
|
Surety Can Recover from Principal for Reasonable, Good Faith Payment Even Though Claim Was Not Covered by Bond
|
|
April 14, 2008
|
|
|
|
Howrey LLP
A subcontractor agreed to provide concrete paving work on a highway repair project in North Carolina. A surety issued a performance and payment bond on behalf of the subcontractor for the project. During the project, a heavy equipment repair company filed a claim with the surety to collect past due amounts for repairs the company made to equipment the subcontractor was using on the project.
After receiving the repair company's claim, the surety sent a claim form to the repair company and requested return of the form with supporting documentation. The repair company returned the completed claim form with copies of the unpaid bills. The surety then wrote a letter to the subcontractor, informing the subcontractor of the claim and asking for the reasons for the subcontractor's delay in payment. Included with the letter were copies of the claim form and unpaid bills. The subcontractor responded that a partial payment had been made and stated that the remaining balance was "being disputed and must be resolved prior to completion of payment."
The surety then sent another letter to the subcontractor, requesting further information and documentation regarding the dispute and a copy of the partial payment. After more than a month passed with no response from the subcontractor, the surety again sent a letter to the subcontractor requesting documentation supporting the subcontractor's dispute of the claim by the repair company. A month later, the surety sent the subcontractor another letter demanding that it pay the repair company within five days. When the subcontractor did not pay, the surety did - in all, more than six months after the claim first had been made. After the final deadline had passed and payment had been made, the subcontractor responded to the surety's letter, disputing entitlement.
The surety sued the subcontractor for reimbursement under the indemnity agreement supporting the payment and performance issued by the surety. The Circuit Court allowed recovery by the surety only for the portion of the claim involving labor by the repair company incidental to carrying on the project for which the bond was issued. The Court of Special Appeals and then the Court of Appeals of Maryland held that the surety could recover the entire payment the surety made to the repair company. Atlantic Contracting and Material Co., Inc. v. Ulico Casualty Co., 844 A.2d 460 (2004).
The Court of Appeals approved and adopted the rule followed by federal courts: repair parts, appliances and accessories that add materially to the value of the equipment and render it available for other work are not "labor and material" within the coverage of the payment bond. They are general costs of doing business. However, repairs to equipment that are incidental to carrying on the project, that are merely the result of wear and tear, and that do not add to the value of the equipment are covered by the bond.
Based on the facts as known at the time of the trial, the claims by the repair company appeared to be outside the coverage of the bond. However, the Court of Appeals continued its analysis by looking at the facts known by the surety at the time of the claim as well as the process used by the surety to investigate.
The Court of Appeals announced that payments by a surety would be examined under a good faith standard, limited by the bounds of reasonableness. The court declined to allow the surety to recover for any payments except when the surety engaged in fraud, noting that to do so would leave the principal and indemnitor at the mercy of the surety's unreasonable conduct.
The Court of Appeals decided that the following factors should be used in determining whether payments were reasonable and in good faith: 1) the obligations of the surety as provided by the terms and coverage of the bond; 2) whether the principal has made more than generalized demands that the surety deny the claim; 3) the cooperation, or lack thereof, by the principal in dealing with the surety; and 4) the thoroughness of the investigation performed by the surety.
The court also held that the principal is bound to the surety by a reciprocal duty of good faith and fair dealing.
In the case before it, the court held that the surety reasonably paid the equipment repair company in good faith and, therefore, was entitled to recover the entire amount of the payment made to the repair company. The subcontractor did not provide facts in a timely fashion supporting the subcontractor's contention that the bond did not cover the work performed by the repair company, even after repeated requests by the surety. Had the subcontractor timely provided the surety with the details of why the claim was not covered by the bond and provided documentation supporting such a defense, the court held, a reasonable and diligent surety might not have made payment.
If you would like to receive legal reports and updates more quickly, by e-mail, click here and fill out the mailing list form. If you would like to subscribe to our RSS feeds or learn more about RSS, click here.
For more information about the issues covered in this report, please contact Paul Berning in our San Francisco office at 415-848-4996 or at paulberning@howrey.com or contact your Howrey attorney. For more information about Howrey's Construction Practice Group, click here.
©2008 Howrey LLP
|
|
