ACI National Advanced Forum on Lit igat ing Contract Surety Bond & Fidel ity Insurance Claims

Phi ladelphia, PA

Oct. 17-18, 2012

The Interplay Between Equitable

Subrogation and The GIA’s Assignment

RightsMatthew Bouchard Lewis & Roberts, PLLC

Mark OertelLewis Brisbois Bisgaard & Smith LLP

A surety who discharges or performs the obligations of its principal is entitled to step into the shoes and assert the rights of those persons to whom or on whose behalf the surety has performed or made payment. Pearlman v. Reliance Ins. Co., 371 U.S. 132 (1962).

Types of rights to which surety becomes equitably subrogated:

Obligee’s right to apply earned but unpaid progress payments and retainage in Obligee’s hands to cost of completion

Principal’s rights against subs and suppliers whose work was delayed, defective or otherwise deficient

Subcontractors’ rights against contract balances, trust funds, other sureties, mechanic’s lien rights

Powerful stuff !

EVERYONE’S FAVORITE SOURCE OF SALVAGE: EQUITABLE

SUBROGATION

Assignment right “seems to add nothing to the [equitable subrogation] rights here asserted.” Nat’l Sur. Corp. v. Allen-

Codell Co., 70 F. Supp. 189, 191 (E.D. Ky. 1947)

WHAT ABOUTASSIGNMENT RIGHTS?

Some hypotheticals

DOESN’T THE ASSIGNMENT CLAUSEDESERVE OUR RESPECT?

Timing is everything! Rights arise upon principal’s “default,” as defined in GIA;

bond performance not a condition precedent to exercise of right Fid. & Deposit Co. of Md. v. U.S. , 31 Fed. Cl. 540, 542-43 (1994)

(equitable subrogation rights do not vest until surety has performed principal’s obligation)

Supports notice to owner not to pay contract funds to principal

ADVANTAGES OF ASSIGNMENT

Broader protection than equitable subrogation

Rights against job supplies, tools, equipment, plant, material

Salvage from other bonded contracts not in default

Salvage from non-bonded contracts not in default

ADVANTAGES OF ASSIGNMENT

“Some assembly required” -- fi ling Agreement of Indemnity as UCC Financing Statement to perfect interest in supplies, tools, plant, equipment and materials on job site and establish priority over completing claims Downside of fi ling – drying up potential sources of financing Industry practice – don’t fi le until signs of distress Could be too late vis-à-vis principal’s lender

Late fi ling of UCC = inferior priority v. other secured creditors

Applicability to contract funds on federal projects limited

DISADVANTAGES OF ASSIGNMENT

“No assembly required” – rights arise automatically as matter of equity In most jurisdictions, UCC action not necessary to perfect

surety’s priority interest over proceeds of bonded contracts. Nat’l Shawmut Bank of Boston v. New Amsterdam Cas. Co ., 411

F.2d 843 (1st Cir. 1969)

Relation back to date of issuance of bonds

Avoiding privity/non-assignability problems

ADVANTAGES OF EQUITABLE SUBROGATION

Performance of bonded obligation is a condition precedent to eff ectiveness – no performance, no right Although some jurisdictions recognize “contingent equitable

subrogation”

Right may not reach principal’s equipment or personal property Potential argument for job-related material and equipment based on

prime contract language Virtually no argument for principal’s material and equipment not

dedicated to bonded contract in default

May be limited to bonded contract in default Split in authority re: whether right reaches proceeds of other

contracts

Right likely does not include claim expense recovery

DISADVANTAGES OF EQUITABLE SUBROGATION

Contract proceeds either due or to become due Includes progress payment, retainage, compensation for

extras, proceeds from damages claims Depending on language utilized, may include other bonded

contracts not in default or even non-bonded contracts not in default

Right, title and interest in job-related supplies, tools, plant, equipment and materials Includes stored materials and components in process of

manufacture Permits sale of property not utilized for completion without

risk of liability with respect to commercial reasonableness of the sale

RIGHTS TYPICALLY ASSIGNED

Subcontracts / Bonds covering subcontracts Useful in compelling subcontractors to ratify subcontracts

upon takeover Also useful in negotiating with subcontractors to return to

the project when surety takes over and uses its principal as completion contractor

Claims of the principal Includes right to settle claims on terms surety considers

reasonable under the circumstances

RIGHTS TYPICALLY ASSIGNED

Event of default as defined in GIA

Typically defined broadly Receipt of claims Failure or inability of principal to perform Failure to fulfill an obligation under GIA Declaration of default by obligee

NOT synonymous with default under bonded contract

TRIGGER

Attorney-in-fact provision providing surety full authority to: Handle claims and causes of action Execute documents necessary to facilitate assignment

rights Proceed without putting Indemnitors on notice of its actions

Right to settle affi rmative claims

Indemnity and collateral security provisions

COMPLEMENTARY PROVISIONS OF GIA

Hutton Constr. Co., Inc. v. County of Rockland , 52 F.3d 1191 (2d Cir. 1995)

Obligee disputed principal’s unanticipated subsurface conditions claim and terminated principal

Obligee sued principal and surety for completion and correction costs

Principal brought Spearin claims arising from defective plans and specs, unanticipated subsurface conditions and alleged wrongful termination

Surety compromised claims between and among obligee, principal and surety over principal’s objections, then moved to dismiss the action and for an order enforcing settlement agreement

PUTTING IT ALL TOGETHER:THE HUTTON DECISION

Hutton Constr. Co., Inc. v. County of Rockland , 52 F.3d 1191 (2d Cir. 1995)

Right-to-settle clause did not expressly grant surety right to settle affi rmative claims

Indemnitors failed and refused to make indemnity payments demanded by surety, triggering assignment clause

Assignment clause, which unambiguously assigned all rights “growing in any manner out of” bonded contracts, coupled with attorney-in-fact provision, allowed surety to settle affi rmative claims against the obligee

PUTTING IT ALL TOGETHER:THE HUTTON DECISION

What aff ect might UCC fi ling have on principal’s operations and financing?

Often times the Bank or Other Lenders have already filed.

STRATEGIC CONSIDERATIONS

What aff ect might UCC fi ling have on principal’s operations and financing?

STRATEGIC CONSIDERATIONS

Alternatives:

Demand that owner mitigate its damages by exercising contract clause giving owner dominion over materials purchased for the job

Cooperate with principal on filing a separate, voluntary financing statement on job-related property only

Negotiate with lender to allow materials and equipment to remain for project completion per the assignment clause of GIA

STRATEGIC CONSIDERATIONS

Does the exercise of the assignment clause prejudice subsequent exercise of equitable subrogation rights?

Majority rule: no Old Kent Bank v. City of Detroit , 444 N.W.2d 162 (Mich. Ct. App.

1989); Canter v. Schlager, 267 N.E.2d 492 (Mass. 1971)

Some jurisdictions have struggled with the question Transamerica Ins. Co. v. Barnett Bank of Marion County, N.A. ,

524 So.2d 439 (Fla. Dist. Ct. App. 1988), rev’d, 540 So.2d 113 (Fla. 1989) Trial court initially held that after failing to file assignment under UCC

Article 9, surety could not rely on remedy of equitable subrogation to “ambush a financing bank”

The Supreme Court of Florida disagreed

STRATEGIC CONSIDERATIONS

How should the right be exercised?

Enlisting the Cooperation of the Principal

Compelling reason for Principal to cooperate is “hold harmless and indemnify” Clause of GIA

Right to Compel Collateral

Power of Attorney coupled with Right to Collateral

STRATEGIC CONSIDERATIONS

Seeking Judicial Assistance in Compelling Cooperation

Quia Timet / Injunctive Relief

Specific Performance

Declaratory judgment action

Power-of–Attorney Clause

STRATEGIC CONSIDERATIONS

QUESTIONS?