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By
Scott S. Shepardson
Thelen Reid Brown Raysman & Steiner LLP
A
company that settles a claim with a contractor, thereby
releasing the contractor from any claims, also releases
the surety company that wrote the contractor's performance
bond. So held the U.S. Court of Appeals for the 4th Circuit
in Food Lion, Inc. v. S.L. Nusbaum Insurance Agency,
Inc., 202 F.3d 223 (4th Cir. 2000).
The
company in question, Food Lion, had contracted with John
R. Kurfees ("Kurfees") to construct four stores.
As part of the contract, Kurfees was required to obtain
performance bonds to ensure its performance. Kurfees contracted
with a broker, Nusbaum, to locate and obtain the bonds.
Unable
to obtain the bonds on the regular market, Nusbaum contacted
a surplus lines broker and subsequently obtained the bonds
from American Diversified Insurance Co. ("American"),
a California company. Construction began, but before completion,
Kurfees filed for bankruptcy. Food Lion then demanded that
American provide the funds necessary to complete construction,
but American defaulted on the bonds and subsequently entered
receivership.
While
its bankruptcy petition was pending, Kurfees filed suit
against Food Lion seeking to recover amounts owed under
the construction contracts. Food Lion countersued, claiming
setoff for the anticipated costs of completion. The parties
settled the lawsuit, and the Court entered their stipulated
order, which stated: "Food Lion shall not have claim
(sic) against Debtor for its alleged costs to complete and
credits due of $121,860.69 regarding the Tidewater Stores
referenced in the Motion."
Shortly
afterward, Food Lion filed suit against American and Nusbaum,
alleging among other things professional negligence, breach
of contract and violations of Virginia laws regarding out-of-state
insurance companies selling insurance in Virginia without
being licensed in the state. American did not respond to
the complaint, and broker Nusbaum filed a motion for summary
judgment. The District Court granted summary judgment, holding
that Food Lion's release of Kurfees operated as a release
of American and, therefore, Nusbaum. The court cited Virginia
cases holding that a release of a principal debtor by the
creditor, by an absolute release of the debt or by an obligatory
extension of the time of the payment, without the consent
of the surety, releases the surety.
The
court explained that Food Lion could not press a claim for
violation of the unlicensed insurer statute when it had
no claim against that insurer. Accordingly, Food Lion also
could not pursue a claim against broker Nusbaum, who had
obtained the bond. Food Lion argued that Nusbaum should
be equitably estopped from raising the release as a defense,
but the court noted that estoppel requires that the injured
party rely on a misrepresentation of the opposing party
and that no such reliance with regards to the settlement
could be shown.
Food
Lion next argued that Section 524 (e) of the Bankruptcy
Code should operate to preserve its claim against American
and Nusbaum because, under that statute, discharge of a
debt does not extinguish the related liability of other
entities. The court, however, noted that voluntary settlement
of a claim differs from discharge under the bankruptcy provisions
and, consequently, Food Lion's claims were properly extinguished.
Finally,
Food Lion argued that it had a proper claim for breach of
contract because Food Lion was a third-party beneficiary
of the contract between Kurfees and Nusbaum. The court did
not agree. It stated that under Virginia law, the third
party must show that the parties to the contract clearly
and definitely intended to confer a benefit upon that party.
Mere incidental beneficiaries have no right to enforce a
contract. The court reasoned that Kurfees had no intention
of benefiting Food Lion in its contract with Nusbaum and
instead contracted with Nusbaum solely to comply with the
conditions imposed by Food Lion in order obtain the construction
contract. Although Food Lion stood to benefit from the contract,
that benefit was not the intention of either of the parties
to the bond contract. Consequently, Food Lion had no standing
to enforce the terms of the contract, and its claims against
Nusbaum were denied.
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For more information about the issues covered in this report, please contact Scott S. Shepardson in our San Francisco office at 415-369-7184 or at sshepardson@thelen.com or contact your Thelen attorney. For more information about Thelen's Construction and Government Contracts Department, click here.
©2000 Thelen Reid Brown Raysman & Steiner LLP
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