Construction Bonds Come With Strings Attached. Make Sure You Know What They Are.

When serious trouble befalls a bonded contractor, its surety might be called upon to shoulder significant risk both downstream (i.e., payment obligations to subs & suppliers) and upstream (i.e., performance obligations to the owner, if the bonded contractor is prime, or to the prime, if the bonded contractor is a sub).

Yet even when adversity strikes, sureties don’t expect to suffer a loss, as counter-intuitive as that might sound.  That’s a feature of suretyship distinguishing it from insurance (for a handy, 1-page chart summarizing other distinctions, see page 6 of this 18-page surety primer by CNA Surety).

How do bonding companies seek to avoid losses on troubled construction projects?  One of the most significant weapons in the surety’s loss-avoidance arsenal is the “general indemnity agreement” or GIA, an instrument that virtually every surety requires each bonded contractor, the contractor’s owners and the owners’ spouses to sign as a condition of surety credit extension.  The GIA vests in the surety numerous rights and remedies against the corporate and individual indemnitors, which are typically triggered once trouble starts brewing.

Here are some of the key rights enjoyed by sureties under a typical GIA:

1.  The Right to be Reimbursed.  Most GIAs contain a broad indemnification provision requiring the indemnitors to exonerate, hold harmless and indemnify the surety from and against all liability and all loss, including expenses and attorneys’ fees incurred.  That means, for example, if a surety pays a subcontractor’s payment bond claim, it can then demand contractual indemnification from the bonded contractor, not just for what was paid to the sub, but also for all expenses and costs incurred by the surety in so doing.

2.  The Right to Settle Claims.  Most GIAs allow the surety not only to resolve claims brought against the bonds themselves, but also the affirmative claims of the bonded contractor.  That means, for example, if a surety pays a subcontractor’s payment bond claim, and the bonded contractor has claims for extras against the project owner, the surety has a contractual right to resolve those claims on the contractor’s behalf.

3.  Assignment Rights.  Typical GIAs provide the surety with a contingent assignment of its bonded principal’s interest in contract funds on both bonded and unbonded contracts, with the assignment triggered upon the happening of an “Event of Default,” as defined in the instrument.  Most GIAs I’ve come across define “Events of Default” quite broadly, such that the surety is assigned the bonded contractor’s interest in contract proceeds upon the mere receipt of a payment bond claim.

4.  Right to Act as Attorney-in-Fact.  To give full effect to the other provisions mentioned above, most GIAs give the surety the power to execute all documents required to effectuate its rights on behalf of the bonded contractor.  That means, for example, if a bonded contractor obtains a lien judgment against the project owner, the surety can assign that judgment to itself by executing an Assignment of Judgment instrument on behalf of its principal.

Monday MemoCourts will typically enforce these such provisions in the absence of bad faith by the surety, including North Carolina courts.  In that regard, I commend to your reading the N.C. Court of Appeals’ decision in John Wm. Brown Co., Inc. v. State Employees’ Credit Union.  In that case, the bonded contractor, a GC on a bank branch office building, ran into early trouble arising from a significantly delayed notice to proceed and changed work.  Its performance costs increased, but it waited until the end of the project to seek additional compensation from the owner.  In the interim, subs and suppliers asserted claims against the payment bond that were investigated and satisfied by the surety.

Before litigation commenced, the owner offered the GC $100,000 on its claims.  The GC rejected the offer and filed its complaint.  After a year of discovery, the owner renewed its $100,000 offer.  At that point, the surety, relying upon its GIA with the GC and its owners, exercised its rights and accepted the settlement.  The trial court granted the owner’s motion to approve and enforce the settlement agreement, and the GC appealed.  The Court of Appeals held that the owner was entitled to enforcement of the settlement agreement, citing various provisions of the applicable GIA.  It also ruled that if the GC believed the surety acted in bad faith in resolving the claim, the place to raise that issue was in the indemnity action the surety had asserted against the GC and its owners, not in the action asserted against the owner.

Here’s the takeaway:

  • When presented with a GIA for signature, make sure you spend the time to familiarize yourself thoroughly with its provisions.  Each of those terms is likely to be enforced by the courts in the absence of bad faith by the surety.
  • When you acquire claims arising from the acts or omissions of the project owner, assert your time extension and/or change order requests timely.  Otherwise, you might run into cash flow problems and require the surety’s assistance later in the project to bail you out, either by paying subs or financing completion.  That, in turn, is likely to result in a complete loss of control over the claims process against the owner.
  • Make sure to document your claims well throughout the course of a troubled construction project.  Even if your claim rights get assigned to the surety by virtue of the provisions of your GIA, the surety is less likely to settle upstream claims for pennies-on-the-dollar if those claims are well-supported.

As always, be sure to contact an experienced construction attorney to enhance your understanding of the obligations contained in a GIA.

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Filed under Indemnity Rights, Surety Law

Custom-Build Your Next Arbitration Clause

Image by Tingeling via Pixabay.com

Image by Tingeling via Pixabay.com

Of all the great AEC content in the Twitterverse this week, the following chirp from Kansas City construction attorney Rob Pitkin (@KCconstrlawyer) really piqued my interest:

Rob’s tweet links to this article from Gary Rubin, a New York construction lawyer, about how to make arbitration more cost-effective.  Gary discusses how parties can use the contract negotiation phase of their relationship to craft a better arbitration provision.  He even suggests helpful language aimed at curtailing the duration of the hearings and the arbitrators’ authority to award certain types of damages.

All of which crystallized something I’ve been thinking about in recent years: arbitration is not a “one-size fits all” deal.  While in theory arbitration presents construction industry stakeholders with an attractive alternative to the very public, very long and very expensive litigation process, in practice, arbitration procedures and costs often elude the parties’ control. These are by no means novel thoughts on my part; a number of other observers have raised similar concerns (see here and here for a couple examples).

Now for the good news.

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Paying Twice For the Same Work is Horrendous. What Can You Do About It in North Carolina?

If you’re a prime contractor on a private, commercial construction project, your contract with the owner likely includes a provision requiring you to bond off or otherwise dispose of real property liens filed by your subs & suppliers.  And if you’re a prime contractor on a bonded public project, the agreement of indemnity between you and your bonding company makes you ultimately responsible for any bond claim the surety might pay.

Either way, you’re exposed to financial loss arising from the lien & bond claims of second-tier and more remote subs & suppliers, even if you faithfully pay your first-tier subs each and every time payment is due.

So what can you do about the risk of double payment in North Carolina?

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Filed under Lien Law, Payment Bonds, Subcontractors

Courts Generally Will Enforce North Carolina’s Anti-Indemnity Statute, But How Far?

Back in March, I wrote about the role of North Carolina’s anti-indemnity statute in the construction industry.  The statute, codified at N.C. Gen Stat. § 22B-1, appears below (you can click the image for a larger version):

Anti-Indemnity Statute

As my previous blog post indicated, the statute prevents “one party from shifting the entire risk of its own negligence to another.”  A recent case from the U.S. Bankruptcy Court for the Eastern District of North Carolina demonstrates how courts utilize the so-called “blue pencil” doctrine to accomplish that goal.

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Filed under Federal case law, Indemnity Claims, State law, policy & news, Subcontractors

A Few Simple Words That Make a World of Difference for Lower-Tier Miller Act Claimants

If you’re a lower-tier subcontractor or supplier on a public construction project, it might be tempting to calendar your notice-of-claim deadline 90 days (in the case of federal Miller Act projects) or 120 days (in the case of North Carolina “Little Miller Act” projects) from your last furnishing of labor and materials, regardless the nature of that last furnishing.

Resist that temptation.

It overlooks a few simple but critical words recited in the federal Miller Act, as well as similar language contained in North Carolina’s Little Miller Act.

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Filed under Federal case law, Payment Bonds

Have a Lien Claim Arising from an Improvement to Leased Property? Aim for the Right Target.

In most cases, the “owner” of a tenant improvement project is NOT the record owner of the real property, but rather the tenant who entered into the contract for the improvement.

That distinction can be critical when perfecting and enforcing mechanics liens in North Carolina.

Take, for example, the fireproofing contractor who asserted a mechanics’ lien enforcement action against both the landlord and the tenant of a leased premises in yesterday’s unpublished Court of Appeals decision in Century Fire Protection, LLC v. Heirs.

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Filed under Lien Law, NC case law

Subcontract Negotiation Is a Question of Leverage. Leverage Is a Function Of . . .

Two tweets touching upon subcontract negotiation dynamics jumped out at me this week.  The first was from zlien founder Scott Wolfe, Jr., who linked to his recent blog post about general contractors who demand that their subcontractors sign away their lien rights:

Money quote from the post:

General contractors scream that relationships are important, but really, it’s relationships on their terms.  …  In reality, however, the subcontractor is likely feeling a bit abused.  They accommodate because of the general contractor’s influence and contracting power.

The second tweet was from good friend and Virginia construction attorney Chris Hill, who linked to fellow Virginia attorney Juanita F. Ferguson’s piece discussing (among other things) forum selection clauses in subcontracts between out-of-state prime contractors and local subs:

Money quote from the post: “local contractors must be savvy in negotiating contracts with out-of-state companies.”

Which, in turn, begs the Friday Forum money question:

What factors impact the relative bargaining power of primes and subs when it’s time to make a deal?

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Filed under Construction Risk Management, Contract Review & Negotiation, Forum Selection Clauses, Subcontractors

N.C. Construction Industry First Fractures, Then Coalesces, Around Prequalification Legislation

By a whopping 116-0 margin, the N.C. House of Representatives yesterday passed House Bill 1043 (“HB 1043″), aimed at bringing objectivity and uniformity to the prequalification of contractors on public construction projects in the Tar Heel State.

Don’t let yesterday’s vote tally deceive you, however; the legislation was not without its share of controversy.

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Filed under Construction Management, Project Delivery Systems, State law, policy & news, Subcontractors

Bound, But Determined: How Subs Might Evade Terms Binding Them to Decisions of Architects

It’s typical for subcontracts to include a clause binding the subcontractor to the decisions of the project architect.  Such terms help general contractors and construction managers at-risk avoid obligations to subs below that can’t be passed through to owners above.  That’s a sensible and enforceable risk allocation most of the time.

But not all of the time.

Sometimes, the architect doesn’t play fairly.  Sometimes, the prime contractor fights hard for itself, but not hard enough for its subs.  And sometimes, a statute might provide a remedy when the subcontract does not.

On such occasions, as discussed below, subcontractors might avail themselves of an escape hatch:

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Filed under Change Orders, Delay Claims, NC case law, Subcontractors

Why Yesterday’s 4th Circuit Lien Law Decision Is a Mammoth Victory for Contractors & Suppliers

Image by Shirley v. Pixabay.com

Image by Shirley via Pixabay.com

I was out-scooped yesterday by good friend and fellow Raleigh construction lawyer Brian Schoolman, who announced via Twitter that the Fourth Circuit Court of Appeals has approved the filing of North Carolina mechanics’ liens even after a party higher up in the contractual chain seeks bankruptcy protection:

I highly recommend clicking the link and reading Brian’s blog post.  It does a terrific job summarizing the Court’s rationale and discussing how CSSI puts the last nails in the coffins of the 2009 Shearin, Mammoth Grading and Harrelson Utilities decisions of a lower court that had reached the opposite result, before subsequently reversing itself a few years later in CSSI, which the 4th Circuit has now affirmed.  (For additional legal context, check out my previous blog post on the Mammoth Grading and Harrelson Utilities cases.).

I write today to emphasize how important the 4th Circuit’s CSSI decision is to your construction business.  Specifically, I write to answer this question: Why does having the right to file a mechanics’ lien, after the party immediately above you in the contractual chain seeks bankruptcy protection, matter?

Here’s why:

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Filed under Federal case law, Federal law, policy & news, Lien Law, State law, policy & news, Subcontractors