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Inside This Issue:

*  Sureties Walk Fine Line Between Contractor Default and Claim Investigation

*  Equitable Adjustment Allowed for Deductive Change

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ARTICLE # 1
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Sureties Walk a Fine Line Between Contractor Default
and Claim Investigation

By:  Robert J. MacPherson, Esq.

Surety bonds are contracts and the rights and obligations of the parties will be determined in accordance with basic principles of contract law.  The size of the claims and complexity of the project will not impact the result.  That is proven by a recent court decision of the New York Court of Appeals decision in Walter Concrete Constr. Corp. v. Lederle Laboratories, 2003 WL 367460, and by a decision of the U.S. District Court for the Southern District of New York decision in  United States Fidelity and Guaranty Company, et al. v. Braspetro Oil Services Company, et al., 219 F.Supp. 2d. 403 (2002).

Walter Concrete involved a claim by a general contractor (“GC “) against its subcontractor’s performance bond surety.  The GC had problems with its subcontractor’s performance, but never terminated the subcontract.  When the subcontractor abandoned the project, the GC did not ask the surety to complete the work.  Instead, it completed the subcontractor’s work.  The GC in turn demanded payment for those costs from the surety.  The surety denied the claim, contending that the GC had never notified the surety of its subcontractor’s default.  The Court of Appeals affirmed a decision granting summary judgment against the surety, finding that the performance bond contained no provision requiring a notice of default as a condition precedent to any legal action against the surety.  The only condition imposed on the GC in order to make a valid claim was that it commence its action within the bond’s time limits.

In contrast to Walter Concrete which involved a commercial building with claims of a little over a half-million dollars, the case in USF&G v. Braspetro involved claims by the owner against its contractor’s sureties on two related, but distinct projects.  One involved a $165 million design-build contract to convert an oil and natural gas platform into a semi-submersible oil and natural gas production platform and was reported to be the largest of its kind ever undertaken.  The second project was a $163 million design-build contract to convert an oil tanker into a floating production, storage and offloading vessel.

The bonds at issue in USF&G required that the sureties and the contractor be given a pre-default notice and that the sureties’ obligations under the bonds would not arise until after the contractor had been declared in default and its contract formally terminated.  The owner provided the pre-default notice and eventually formally terminated the contractor’s right to proceed with the work, but the sureties disclaimed any liability.  They contended that they were prejudiced by the owner’s delay in declaring a default.

The court rejected the sureties’ claims, finding that after the owner had sent the pre-default notice, the sureties actively discouraged the owner from formally declaring a default.  They did so by emphasizing that once a default was declared all work on the projects would stop while the sureties conducted an investigation to determine the propriety of the default.  The sureties also told the owner that such an investigation could not begin until a default was declared.  According to the Court, this did not stop the sureties from beginning the preparation of their defense to any claims under the bonds.  The Court found that when the default was formally declared the sureties made only a token effort to explore the possibility of taking over the contracts and did not conduct a good faith investigation.  Rather, they continued their efforts to prepare for litigation while characterizing these activities as an “investigation.”

While the Court held that the sureties had no legal obligation to take any specific action prior to a formal declaration of default, once a default was declared they had an obligation to make a good faith investigation into the claims.  The court found that the owner was entitled to recover damages of $90 million, plus attorneys’ fees on the tanker conversion project.  The damage award, plus attorneys’ fees, could not exceed the amount of the bond for each project, but the owner was also awarded pre-judgment interest, which is not limited by the amount of the bonds.  The sureties have appealed.

Author’s Note:  The decision to terminate a contractor and call upon its surety is always difficult.  It will invariably cause delay and disruption to the project and involve the expenditure of costs that may never be recovered.  Default declarations should never be made lightly and should only be made after exploring all avenues for having the contractor complete the project.  This may include a request to the surety that it actively take steps to prevent an impending default.  Sureties, however, have no legal obligation to take any affirmative action prior to a declaration of default and will not do so absent compelling reasons.  This does not mean that a party faced with a non-performing contractor should refrain from contacting the surety when warning signs appear.  The late submittal of a shop drawing is probably not such a sign, but claims by subcontractors that they have not been paid for work for which the general contractor has been paid most surely is.  A bond claimant who has provided complete and accurate information to a surety will be in a better position to insist that the surety act promptly once the default is declared.  Claimants must also comply strictly with the notice provisions and any time limitations contained in the bond.  Sureties, who under the guise of conducting an investigation into a claimed default, spend their time and resources building a defense, may find their delay in responding exposes them to a greater liability.

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About the Author:  Robert MacPherson is an attorney with the nationally recognized law firm of Postner & Rubin, with a practice emphasizing construction law.  The firm represents all parties who participate in the many phases of the construction process – from owners, contractors, construction managers, subcontractors and suppliers to architects, engineers, sureties and insurers.   He may be reached at 17 Battery Place, Suite 210 , New York , NY 10004 (21) 269-2510. E-mail: rmacpherson@postner.com.

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ARTICLE # 2
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Equitable Adjustment Allowed for Deductive Change Despite Contractor’s Unbalanced Bid

By:  Philip R. White, Esq.

Where a public owner issued a deductive change order, it was required to equitably adjust a contract despite the absence of an equitable adjustment clause in the contract, despite the absence of specifications or applicable public contracts law, and despite the fact that the contractor’s bid was unbalanced .  In M.J. Paquet, Inc. v. NJ Dept of Transportation, 171 N.J. 378, 794 A.2d 141 (2002),  the NJDOT awarded a contract to Paquet for the rehabilitation of several highways and bridges.  A year later, OSHA revised regulations that affected Paquet’s bridge painting work.  When the NJDOT and Paquet could not agree on a increased price for the painting that resulted from the revision of the OSHA regulations, the NJDOT deleted bridge painting from Paquet’s work scope.

Paquet’s bid was unbalanced due to a last minute change in painting subcontracts that reduced the cost of bridge painting.  Paquet argued that due to time constraints it could not practicably adjust all of the pay items affected by the change in subcontractors in time to submit its bid to NJDOT.  Instead, Paquet reduced the price of several other items, like mobilization and layout costs, to offset the overstated bridge painting pay items.

After finding that NJDOT correctly deleted the painting work from the contract pursuant to the principle of impracticability, the Court held that Paquet was entitled to an equitable adjustment to compensate it for the non-painting work included in bridge painting pay items that NJDOT had deleted from the contract.  The court found that neither the contract nor the specifications contained a provision addressing equitable relief.  The court expressly rejected the argument that Paquet’s claims was barred by a specification prohibiting claims for additional compensation arising from pay items that inaccurately stated the cost or profit associated with that item.

The court noted that there was an established policy against unbalanced bids and front-end loading in public contracts.  But in examining the facts relating to Paquet’s bid, the court found Paquet had not violated that policy.

Although the court commented that its ruling was limited to the facts of the case, it changed two basic aspects of public contracting law in New Jersey and provided a basis for contractors to argue for the same changes elsewhere.  First, after canvassing federal law and the law of several states that recognize a contractor’s right to equitable adjustment by statute or contract, the court determined that New Jersey would permit such relief.  Thus, because there was no statutory or contractual basis for equitable relief in the Paquet contract, the court effectively created a common law right to equitable adjustment.

This common law right to equitable adjustment creates a potentially potent tool for contractors to use against public and private owners.  Second, rather than simply barring Paquet’s claim because of the policy against unbalanced bids, the court undertook an analysis of the reasons why the bid was unbalanced.  This gives aggrieved contractors a valuable tool for pressing their claims.

The court’s decision seemed driven by its finding that, absent an equitable adjustment, the NJDOT would be unjustly enriched at Paquet’s expense.  If the court denied relief to Paquet, the contractor would not have been compensated for substantial work that it performed.  Viewed expansively, the decision recognized the equitable principle that pricing for changes caused by the owner should be adjusted to make the contractor whole.
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About the Author:  Philip White is an attorney with Sills, Cummis, Radin, Tischman, Epstein & Cross, located at One Riverfront Plaza , Newark , NJ 07102 (973) 643-7000.  E-mail: pwhite@sillscummis.com.  This article was originally written by Mr. White for publication in the URS Claims Resource newsletter, Spring 2003 edition, published by URS Dispute Resolution Group, 100 California Street, Suite 500 , San Francisco , CA 94111-4529 . For more information on URS, contact Adam Winegard at 213-996-2579 or by e-mail at dispute_resolution@urscorp.com.

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ABOUT THIS NEWSLETTER & A DISCLAIMER

This newsletter Report is published and edited by J. Kent Holland, Jr., J.D., a construction lawyer and risk management consultant for environmental and design professional liability.  The Report is independent of any insurance company, law firm, or other entity, and is distributed with the understanding that ConstructionRisk.com, LLC, and the editor and writers, are not hereby engaged in rendering legal services or the practice of law.  Further, the content and comments in this newsletter are provided for educational purposes and for general distribution only, and cannot apply to any single set of specific circumstances. If you have a legal issue to which you believe this newsletter relates, we urge you to consult your own legal counsel. ConstructionRisk.com, LLC, and its writers and editors, expressly disclaim any responsibility for damages arising from the use, application, or reliance upon the information contained herein.

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