The Interplay Between Equitable Subrogation and The GIAs Assignment Rights

Matthew Bouchard
Lewis & Roberts, PLLC
AC I N a t i o n al A d v a n c e d Fo r um o n L i t i g a t in g C o n t r a c t S u r et y Bond & Fidelity Insurance Claims
P h i l a d el p h i a , PA O c t . 17 - 1 8 , 2 01 2

Mark Oertel
Lewis Brisbois Bisgaard & Smith LLP

EVERYONES FAVORITE SOURCE OF SALVAGE: EQUITABLE SUBROGATION

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:

Obligees right to apply earned but unpaid progress payments and retainage in Obligees hands to cost of completion Principals rights against subs and suppliers whose work was delayed, defective or otherwise deficient Subcontractors rights against contract balances, trust funds, other sureties, mechanics lien rights

Powerful stuff!

WHAT ABOUT ASSIGNMENT RIGHTS?

Assignment right seems to add nothing to the [equitable subrogation] rights here asserted.
Natl Sur. Corp. v. Allen-Codell Co., 70 F. Supp. 189, 191 (E.D. Ky. 1947)

DOESNT THE ASSIGNMENT CLAUSE DESERVE OUR RESPECT?

Some hypotheticals

ADVANTAGES OF ASSIGNMENT
Timing is everything!
Rights arise upon principals 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 principals 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

DISADVANTAGES OF ASSIGNMENT
Some assembly required -- filing 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 filing drying up potential sources of financing Industry practice dont file until signs of distress Could be too late vis--vis principals lender

Late filing of UCC = inferior priority v. other secured creditors Applicability to contract funds on federal projects limited

ADVANTAGES OF EQUITABLE SUBROGATION

No assembly required rights arise automatically as matter of equity
In most jurisdictions, UCC action not necessary to perfect suretys priority interest over proceeds of bonded contracts.
Natl Shawmut Bank of Boston v. New Amsterdam Cas. Co ., 411 F.2d 843 (1 st Cir. 1969)

Relation back to date of issuance of bonds Avoiding privity/non-assignability problems

DISADVANTAGES OF EQUITABLE SUBROGATION

Performance of bonded obligation is a condition precedent to effectiveness no performance, no right
Although some jurisdictions recognize contingent equitable subrogation

Right may not reach principals equipment or personal property

Potential argument for job-related material and equipment based on prime contract language Virtually no argument for principals 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

RIGHTS T YPICALLY ASSIGNED

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 T YPICALLY 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

TRIGGER
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

COMPLEMENTARY PROVISIONS OF GIA

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 affirmative claims Indemnity and collateral security provisions

PUTTING IT ALL TOGETHER: THE HUTTON DECISION

Hutton Constr. Co., Inc. v. County of Rockland , 52 F.3d 1191 (2d Cir. 1995)
Obligee disputed principals 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 principals 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 affirmative 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 affirmative claims against the obligee

STRATEGIC CONSIDERATIONS
What af fect might UCC filing have on principals operations and financing?
Often times the Bank or Other Lenders have already filed.

STRATEGIC CONSIDERATIONS
What af fect might UCC filing have on principals 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), revd, 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-ofAttorney Clause

QUESTIONS?