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When the Shoes Don't Fit: Defenses of the Principal That Are Unavailable to the Surety
By: Joseph C. Kovars
In troubled economic times like these, construction companies struggle, and bond claims rise in number. The need to consider both sides of the equation—the rights of the claimants and the defenses of the sureties—grows in importance. Regarding the surety's defenses, it is a cliché of surety law that a surety "stands in the shoes of its principal."1 This expression is shorthand for the well-established concept that the obligations of the surety are derived from those of its principal, and that the surety's liability is measured by, and coextensive with, the liability of the principal.2
When a claim is made on a payment or performance bond, the fact that the surety stands in the shoes of its principal means that, as a general rule, the surety can raise all the defenses of the principal. Under this general rule, if the principal is not liable for the claim, the surety sidesteps liability under the bond. However, like any rule, this one has exceptions.
There are several categories of defenses that, like a wrong-sized pair of shoes, simply do not fit the surety. Other defenses have been precluded by recent cases and statutes, which the surety industry is attempting to overcome via revised bond language or changes in the governing law. In either case, a surety attempting to stand in the shoes of its principal by relying solely on one of these defenses could well find itself "barefoot" before a claimant.
This article considers and surveys those defenses of the principal that are beyond the surety's reach. The last two categories discussed—"pay if paid claims" and surety inaction in processing claims—are in the vanguard of the developing law.
Defenses Personal to the Principal
To begin with, a surety cannot assert defenses that are "purely personal" to its principal. Defenses that clearly fall within this category are those relating to the capacity of the principal, such as insanity or infancy.3 According to the Restatement (Third) of Suretyship and Guaranty (Restatement), such defenses cannot be asserted by the surety because "lack of capacity to enter into the underlying obligation is often one of the risks that the obligee is trying to protect against by insisting on a secondary obligation."4 Consequently, while the principal's lack of capacity may discharge his liability, the surety usually remains bound.5
In the typical construction case, the unavailability of an insanity or infancy defense has little impact on a payment or performance bond surety because it is highly unlikely for a bond principal to raise one of these defenses. A "personal defense" that is much more commonly encountered in the construction industry, especially in these difficult economic times, is the bankruptcy of the principal.6 This defense, however, is also one not available to the surety. Two reasons underlie the unavailability of this defense. First, the bankruptcy code provides that the discharge of a debt is personal to the debtor and does not affect the liability of other entities for the debt. As one court put it, "In essence, the debtor's liability for the debt is excused, but the debt is still 'due and owing.' . . . Hence, the liability of a person who is a co-debtor with, or a guarantor or surety for, a bankrupt is not altered by the discharge of such bankrupt."7
Second, bonds are obtained precisely to protect against events such as the principal's bankruptcy. It has been said that "the insolvency or bankruptcy of the principal obligor is a chief risk against which the creditor seeks to protect itself by requiring a surety."8 Assertion of the principal's discharge defense would negate "the very purpose of suretyship," which is to "shift the risk of this event from the creditor to the surety."9
Other defenses that judicial decisions have characterized as "personal" to the principal, and hence not available to the surety, include fraud in the inducement, duress, forgery of the signature of the maker, and lack of corporate authority.10
Defenses Arising in Operation of Law
In addition to those defenses personal to the principal, a surety cannot argue defenses "arising by operation of law."11 Unfortunately, the cases and treatises that repeatedly state this proposition do not define what constitutes the specific elements of a defense "arising by operation of law." Theoretically, every defense asserted by a bond principal arises in some manner by application of law, be it the common law, a statute, or a contract clause. Obviously, barring the surety from raising all these defenses would conflict with the general rule that the surety may plead the defenses that are available to its principal.
Defenses "arising by operation of law" are best understood as procedural defenses of the principal, which do not relate to the underlying merits of the dispute. The most frequently cited such defense (other than discharge in bankruptcy, which is a hybrid in the sense that it is a personal defense that arises by operation of law) is the statute of limitations. The weight of authority holds that a surety is not discharged by the running of the statute of limitations against the principal, and therefore cannot assert the expiration of the statute as a surety defense.12
How does this rule apply in practice? Say the owner terminates a contractor for default. This may trigger the surety's liability under the performance bond. But if the owner waits to file suit against the surety until the statute of limitations has run for a contract action against the principal contractor (which varies by state from two to six years), is the surety off the hook as well? The answer given by the majority of jurisdictions is "no," so long as suit on the bond is still timely.
A different view is taken by the Restatement, which provides that if the obligee fails to take action against the surety until after expiration of the statute of limitations against the principal, the surety is discharged.13 The Restatement's approach follows that of jurisdictions like Texas, which, in Lawyers Surety Corp. v State of Texas,14 held that a surety whose bond guaranteed the principal's payment of state taxes was released by the state's failure to sue the principal within the three-year limitations period. The court stated that allowing recovery on the bond would effectively repeal the statute of limitations because the surety would seek to recover any loss on the bond froth its principal; this would, in effect, force the principal to defend the suit beyond the three-year period, which is contrary to the statute.15 Courts in Alabama and Iowa also have held that a surety may assert as a defense the running of the statute of limitations against its principal.16
Another example of a principal's defense that arises by operation of law and, accordingly, may not be asserted by the surety is lack of personal jurisdiction. In Biltmore Construction Co., Inc. v. National Union Fire Insurance Co.,17 the Florida District Court of Appeals denied summary judgment in favor of a surety, which argued that the obligees failure to properly serve the principal discharged its liability. The court held that although the principal may not be liable, the principals defense was not available to the surety.
Because a surety cannot assert a defense personal to the principal, or a defense that arises by operation of law, it does not benefit from a judgment on the merits in favor of the principal based on these defenses. The surety is not discharged and remains liable under the bond.18
Release of the Principal
Under the Restatement, an obligee's release of the principal also releases the surety unless (1) by its terms, the release reserves the obligee's recourse against the surety or (2) "the language or circumstances of the release otherwise show the obligee's intent to retain its claim against the secondary obligor."19 In either situation, the defense of release asserted by the principal is not available to the surety, whose liability to the obligee is not discharged.
The obligee's reservation of rights against the surety was the subject of the Eleventh Circuit's decision in Hardaway Co. v. Amwest Surety Insurance Co.20 In that case, the prime contractor and subcontractor agreed to release their claims against each other, but the prime contractor reserved its right to proceed against the subcontractor's performance bond surety. The surety argued that, notwithstanding the reservation of rights, the release of its principal also released the surety because, otherwise, the surety would be prejudiced by the inability to assert the counterclaims of its principal. The court ruled:
[T]he creditor's release of the principal debtor without the consent of the surety does not discharge the surety if the creditor, in the instrument of release, reserved its rights against the surety. However, the debtor's waiver of its claims in consideration of that release may not defeat the surety's right to assert those claims to reduce its liability to the creditor.21
Thus, while the reservation of rights prevented the surety from relying on the release as a complete defense to any liability, the surety retained the right to raise its principal's other defenses.22
In order to foreclose the surety from raising the release as a defense, broad exclusionary language is sufficient, In Axess International, Ltd. v. Intercargo Insurance Co.,23 the Ninth Circuit held that a release that reserved the right to proceed against "any other parties" was sufficient to reserve a claimant's rights against the surety, which was not a party to the release. Although the release did not mention the surety by name, it was held sufficient to manifest the intent of the obligee.
Waiver of Principal's Defenses
As set forth in the Restatement, a surety can consent to actions that would otherwise result in a discharge of its obligations or can contractually waive a discharge.24 Although the Restatement arguably restricts the waiver to certain specified defenses, in Data Sales Co., Inc. v. Diamond Z Manufacturing,25 the Arizona Court of Appeals held that given the general policy that parties may contractually waive defenses, the defenses that may be waived by a surety extend beyond those mentioned in the Restatement; the waiver is limited only by "principles of contract law such as unconscionability, good faith and fair dealing, and the statute of frauds."
Second-Tier Payment Bond Claims
On federal construction projects, the general contractor is required to post a payment bond because of the federal law known as the Miller Act.26 The Miller Act payment bond covers persons having "a direct relationship with the principal or a subcontractor of the principal." Many states have similar laws for state and local public construction projects. These are commonly called Little Miller Acts. In some states, the Little Miller Act extends the class of claimants to include subcontractors of the principal's subcontractors (so-called sub-subcontractors of the principal). Similarly, the AIA bonds define a claimant as an individual or entity having a direct contract with the principal or with a subcontractor of the principal for labor, materials, or equipment.
To the extent the lower-tier subcontractor is expressly covered by the bond, it makes sense that the lack of privity between the general contractor and the claimant is not a defense that can be asserted by the surety. Likewise, the principal's defense of payment to the first-tier subcontractor does not discharge the surety, who has a "higher duty" of guaranteeing that payment is received by a lower tier.27 Put another way, even if the principal pays the one with whom it has a contract, the surety may still have to pay a lower-tier claimant if that party is covered by the bond.
Setting Off the Principal's Claims
A claim that a bond principal has against a bond claimant is available to the surety as a setoff, provided that the claim is related to the underlying bonded obligation. In the most typical scenario, a principal's (typically, a general contractor's) claim of costs incurred to repair deficient work of a payment bond claimant (typically, a subcontractor) can be set off by the surety against the amounts claimed due by the claimant on the very same project.29
The situation is more complicated when the setoff defense is unrelated to the bonded obligation. Primarily in cases involving a surety that is the sole defendant, courts have historically been reluctant to allow such a defense in order to avoid prejudice to the principal."30 The Restatement addresses these concerns by allowing the surety to set off its principal's defense unrelated to the underlying obligation, even though the principal is not a party to the action, if (a) the claim is uncontested by the obligee; (b) the principal consents to the use of its claim by the surety; or (c) the principal is charged with notice of the surety's claim, and the surety gives the principal notice of its intent to assert the claim and an opportunity to join in the assertion.31
In addition, some courts allow a surety, when sued without its principal, to set off unrelated claims if the principal is insolvent32 because, in such a situation, the concerns regarding the potential unfairness to the principal of litigating the setoff do not exist. The surety sued alone also can set off the claims of its principal by taking an assignment of the principal's claims.33 As a further condition to asserting the setoff claim, at least one court imposes the requirement that the setoff amount "must be due and be a liquidated demand."34
Contingent Payment Clauses
"Pay-if-paid" and "pay-when-paid" clauses condition payment by the general contractor to its subcontractors upon the receipt of payment by the general contractor from the owner for the subcontractor's work. A pay-when-paid clause sets the timing for payment by providing that payment of the subcontractor is due when the general contractor is paid by the owner. Typically, if the owner does not pay after a "reasonable time," the contractor must still pay the subcontractor.35 A pay-if-paid clause, by contrast, provides that the subcontractor will be paid only if the general contractor is paid by the owner for the subcontractor's work. Such clauses make the general contractor's receipt of payment a condition precedent to the general contractor's obligation to pay the subcontractor."36 During the last decade or so, several states have struck down pay-if-paid clauses, either by statute or by case law, holding them unenforceable as a matter of public policy.37
Assuming no statutory or public policy prohibition of the contract clause itself, the authorities are divided on whether a surety can rely on a conditional payment clause as a defense to a payment bond claim. There is a trend to reject the defense in disputes involving federal construction projects. The Ninth Circuit, for example, ruled that a subcontractor's right of recovery under a Miller Act bond "accrues ninety days after the subcontractor has completed its work, not 'when and if' the prime contractor is paid by the government."38 The court reasoned that allowing the surety to avoid payment based upon a contingent payment clause would bar the subcontractor from asserting its Miller Act rights in cases where the government does not pay the prime within the one-year statute of limitations period, resulting in an implied waiver of the subcontractor's rights under the Miller Act. The court said this result is not permitted "in the absence of a 'clear and explicit' waiver of those rights." Similar conclusions have been reached by the Fifth Circuit, and by several federal district courts.39
In the context of private bonds, most courts addressing the issue have followed the federal Miller Act cases, and denied to the surety the contingent payment defense. In Moore Brothers Construction Co. v. Brown & Root, Inc.,40 the U.S. District Court for the Eastern District of Virginia stated:
[I]n the context of construction payment bonds, the surety must explicitly include within the language of its bond any claim to the defenses of the prime as against the subcontractor. Absent such clear language or clear incorporation of the subcontracts, the surety cannot rely on the prime's defenses to payment.
Affirming, the Fourth Circuit said that, absent an express pay-when-paid clause in the bond, "to suggest that the non-payment by the [owner] absolves the surety of its liability is nonsensical, for it defeats the very purpose of a payment bond."41 Likewise, the federal court in Brown & Kerr Inc. v. St. Paul Fire and Marine Insurance Co. held that allowing the surety to rely on a contingent payment provision "runs counter to the underlying purpose of the payment bond, i.e., the assurance of payment to subcontractors."42
The minority position is reflected in several state court decisions allowing a surety to raise a conditional payment clause as a defense to a claim on a Little Miller Act bond. For instance, in Wellington Power Corp. v. CNA Surety Corp.,43 the court ruled that a pay-if-paid "condition precedent clause" could be asserted by a surety to avoid paying a claim on a Little Miller Act bond. It concluded that "the public policy of freedom of contract outweighs the public policy found in the public bond statutes in cases involving a subcontractor's action on a surety bond." The court reasoned that because the liability of the surety was commensurate with that of its principal, no cause of action existed against the surety when the principal had no liability by virtue of the contingent payment clause. The court rejected the federal cases as inapposite because they dealt with the federal Miller Act and because "we simply do not find their reasoning compelling." Courts in Connecticut and Georgia also have recognized the right of a Little Miller Act surety to assert a contingent payment clause as a defense to a payment bond claim.44
Loss of Defenses Due to Surety Inaction
The failure of a surety to respond to payment bond claims in the manner and within the time limits prescribed by the bond can result in a loss of all defenses. This is the lesson imparted by three recent decisions involving the AIA A312 payment bond. The A312 bond provides that within 45 days of receiving a claim, the surety must (1) send an answer to the claimant, (2) state the amounts that are undisputed and the basis for challenging any amounts that are disputed, and (3) pay any undisputed amounts.
In National Union Fire Insurance Co. v Bramble,45 payment bond sureties acknowledged receipt of claims, requested additional information, and acknowledged receipt of the supporting documentation but took no further action. Though not contesting that they breached the requirements of the bond, the sureties argued that their inaction rendered the entire claim in dispute. The Maryland Court of Appeals ruled that the plain language of the bond necessarily required the sureties to communicate to the claimants within 45 days the amounts in dispute, and the basis for the disputes, and that allowing the sureties, through inaction, to dispute the entire claim would negate the 45-day time requirement and "greatly undermine the bond's purpose." The court held that the effect of the sureties' failure to comply strictly with the bond was to render the entire amount of the claim undisputed, and, accordingly, the sureties were required to pay the $1.2 million claim promptly. A similar result was reached by the U.S. District Court for the Middle District of Florida in J. C. Gibson Plastering Co., Inc. v. XL Specialty Insurance Company.46
The reasoning and holding of National Union was adopted and extended by the U.S. District Court for the Eastern District of Virginia in Casey Industrial, Inc. v. Seaboard Surety Co.47 Citing National Union, the Casey court stated that the surety was required, within the 45-day period provided for in the bond, to delineate which portions of the claim were disputed, and the bases for the dispute. Moreover, the court ruled that the plain meaning of the bond precluded the surety from developing or asserting new bases for disputing the claim outside the 45-day contractual period. Thus, any bases for dispute not expressly raised by the surety within the 45-day period were waived by the surety (the only exceptions being "legal defenses," which may be raised by the surety even if not asserted within the 45-day period).
These recent cases have created a firestorm in the surety world. The surety industry has mobilized to change the standard language in the A312 bond. As of this writing, it is unclear if the other industry participants in the AIA document process, such as the American Subcontractors Association, will consent to making the change official. The negotiations are ongoing. Some sureties are refusing to issue A312 bonds without modification.48
Three Categories of Defenses
The defenses of the principal that the surety cannot assert can be placed into three categories.
First are the defenses that, from the surety's perspective, are unavoidable in the sense that no action on the part of the surety can make the defenses available. Falling into this category are the defenses that are personal to the principal, the defenses that arise by operation of law, and a release of the principal that excludes the surety. These "shoes" will never fit the surety.
Second are the defenses of the principal that (though typically unassertable) can be made available by a proactive surety. These include the setoff defense, which is assertable with the principal's consent; and the contingent payment clause, which (in those jurisdictions that permit such clauses) is assertable if incorporated into the bond. Like a skilled cobbler, the surety can make these "shoes" fit.
Third are the defenses that are lost solely as a result of the behavior of the surety, such as the surety's waiver of a defense, or the surety's forfeiture of defenses by failing to timely meet its obligations under the bond, and that can be secured simply by the surety avoiding such behavior. Whether or not these "shoes" fit lies solely within the power of the surety.
1United States ex rel. Fireman's Fund Ins. Co. v. Frank Briscoe Co., 462 F. Supp. 114, 116 (E.D. La. 1978).
2Justice v. Rose, 144 N.E.2d 303, 304 (Ohio Ct. App. 1957).
3Among the many cases stating this proposition are Simmons v. Clark, 64 So. 2d 520 (La. Ct. App. 1953); Burner v. Nutter, 87 S.E. 359 (W. Va. 1915); and Gates v. Tebbetts, 119 N. W. 1120 (Neb. 1909).
4RESTATEMENT (THIRD) OF SURETYSHIP AND GUARANTY § 34, cmt. c (1996).
5Unless the principal, in disaffirming the contract, tenders back to the creditor any consideration received under the contract. McKee v. Harwood Automotive Co., 183 N.E. 646 (Ind. 1932); LAURENCE P. SIMPSON, HANDBOOK ON THE LAW OF SURETYSHIP § 59, at 286 (1950) [hereinafter Simpson on Suretyship].
6RESTATEMENT (THIRD) OF SURETYSHIP AND GUARANTY § 34 (1996).
7Sharon Reg'l Physician Servs. v. Gainnim, 2001 WL 315231 (Ohio Ct. App. Mar. 28, 2001).
823 SAMUEL WILLISTON & RICHARD A. LORD, A TREATISE ON THE LAW OF CONTRACTS § 61:8 (4th ed. 2002) [hereinafter WILLISTON ON CONTRACTS].
9Cadle Co. of Connecticut, Inc. v. C.F.D. Dev. Corp., 689 A.2d 1166, 1169 (Conn. App. Ct. 1997).
10Alien Inc. v. Futterman, 924 P2d 1063 (Colo. Ct. App. 1995); Rhode Island Hosp. Trust Nat'l Bank v. Ohio Cas. Ins. Co., 789 F.2d 74 (1st Cir. 1986); Florida Sch. Book Depository v. Liddon, 153 So. 902, 903 (Fla. 1934); Farmers' & Traders' Bank of Auxvasse v. Harrison, 12 S.W.2d 755 (Mo. 1928); Birken v. Tapper, 189 N.W. 698 (S.D. 1922); Mitchell v. Zurn, 221 S.W. 954 (Tex. Comm'n App. 1920).
11C. Arena & Co. v. St. Paul Fire & Marine Ins. Co, 1992 WL 368455 (E.D. Pa. Dec. 3, 1992).
12WILLISTON ON CONTRACTS, supra note 8, § 61:7; Rhode Island Hosp. Trust Nat'l Bank, 789 F.2d at 74: Bloom v. Bender, 313 P.2d 568 (Cal. 1957); Skinner v. Graham, 542 N.E.2d 642 (Ill. 1988); Presidents & Directors of Georgetown Coll. v. Madden, 505 F. Supp 557 (D. Md. 1980); Am. Oil Co. v. Valenti, 426 A.2d 305 (Conn. 1979). See also Annotation, Bar of Statute of Limitations as Against Primary Debtor as Release or Discharge of, or Defense Available to, Guarantor, 58 A.L.R.2d 1272 (1958).
13RESTATEMENT (THIRD) OF SURETYSHIP AND GUARANTY § 43 (1996).
14825 S. W. 2d 802 (Tex. Ct. App. 1992).
15The court in Lawyers Surety Corp. took note of the fact that the bond at issue was statutorily mandated, and that, in Texas, the terms of the statute were deemed incorporated into the bond. The question is whether the court would reach the same conclusion in a case involving the running of the statute of limitations against a principal covered by a private bond.
16Hous. Auth. of Huntsville v. Hartford Accident & Indem. Co., 954 So. 2d 577 (Ala. 2006); State v. Bi-States Constr. Co., 269 NW 2d 455 (Iowa 1978).
17572 So. 2d 532 (Fla. Dist. Ct. App. 1990).
18SIMPSON ON SURETYSHIP, supra note 5, § 71, at 326. The general rule that a judgment on the merits in favor of the principal is a defense to the surety is also inapplicable where the surety's promise is made unconditionally in the bond, so that the surety promises to pay no matter how valid the reason for the principal's failure Id. at 327; WILLISTON ON CONTRACTS, supra note 8, § 1255; Rhode Island Hosp. Trust Nat'l Bank v. Ohio Cas. Ins. Co., 789 F.2d 74 (1st Cir. 1986).
19RESTATEMENT (THIRD) OF SURETYSHIP AND GUARANTY § 39(b) (1996).
2015 F.3d 172 (11th Cir. 1994).
21Id. at 175.
22See also Allen v. Yates, 870 A.2d 39 (D.C. 2005); Chicago Title Ins. Co. v. Lumbermen's Mut. Las. Co., 707 A.2d 913 (Md. Ct. Spec. App. 1998). In situations where the release fails to expressly or implicitly reserve claims against the surety, Restatement § 39(c) provides that the surety is still discharged to the extent "(i) of the value of the consideration for the release; (ii) that the release of a duty to pay money pursuant to the underlying obligation could otherwise cause the secondary obligor a loss: and (iii) that the release discharges a duty of the principal obligor other than the payment of money."
23183 F.3d 935 (9th Cir. 1999).
24RESTATEMENT (THIRD) OF SURETYSHIP AND GUARANTY § 48 (1996).
2574 P.3d 268 (Ariz. 2003).
2640 U.S.C. § 270(a)(2).
27See Naylor Pipe Co. v. Murray Walter, Inc., 421 A.2d 1012, 1013 (N.H. 1980); United States ex rel. Bergen v. DeMatteo Constr. Co., 467 F. Supp 22, 24 n.5 (D. Conn. 1979).
28RESTATEMENT (THIRD) OF SURETYSHIP AND GUARANTY § 36 (1996).
29Whether a principal – and, by implication, the surety – can assert a setoff defense against the claims of a sub-subcontract IS Unclear. In United States ex rel. Martin Steel Constructors v. Avanti Constructors, Inc., 750 F.2d 759, 762 (9th Cir. 1984), the Ninth Circuit held that the principal can assert a setoff defense in situations "limited to those in which the plaintiff is a subcontractor or materialman of the general contractor and thus is in direct contractual relations with the counterclaimant." This approach was rejected by the First Circuit in United Structures of Am. v. G.R.G. Eng'g SE, 9 F.3d 996 (1st Cir. 1993), which held that counterclaims arising out of the same transaction constitute recoupment, not setoff, which may be asserted by the general contractor even in the absence of privity.
30The absent principal could be prejudiced by being bound by a court decision on the setoff defense, which the surety fails to zealously and effectively assert, or by being forced to litigate the setoff issue a second time after the case involving solely the surety is concluded.
31RESTATEMENT (THIRD) OF SURETYSHIP AND GUARANTY § 35 (1996).
32Saxis S.S. Co. v. Multifacs Int'l Traders, Inc., 375 F.2d 577, 583 n.8 (2d Cir. 1967); Tidewater Coal Exchange, Inc. v. New Amsterdam Cas. Co., 20 F.2d 951 (D. Del. 1927); Nat'l Sur. Co. v. George E. Breece Lumber Co., 60 F.2d 847 (10th Cir. 1932); SIMPSON ON SURETYSHIP, supra note 5, § 70, at 317.
33WILLISTON ON CONTRACTS, supra note 8, § 61:14; SIMPSON ON SURETYSHIP, supra note 5, § 70, at 317.
34Thornton Constr. Co., Inc. v. USF&G, 154 N.W2d 532 (Mich. Ct. App. 1967). The court held in Thornton that the condition that the setoff "be due and be a liquidated demand" had not been satisfied because the setoff amount was the subject of a separate suit between the principal and the claimant.
35See James A. Knox Jr., Defenses, in THE LAW OF PAYMENT BONDS (Kevin L. Lybeck & H. Bruce Shreves eds., American Bar Ass'n 1998), at 263, nn. 128 & 129.
36AIA A401 (Contractor-Subcontractor Agreement) provides that the contractor shall pay the subcontractor each progress payment within three working days after the contractor receives payment from the owner. However, in the event that the contractor does not receive payment for causes that are not the fault of the subcontractor, the contractor is obligated to pay the subcontractor on-demand. AGC Doc. No. 655, STANDARD FORM OF AGREEMENT BETWEEN CONTRACTOR AND SUBCONTRACTOR, provides that receipt of payment by the contractor from the owner for the subcontract work is a condition precedent to payment by the contractor to the subcontractor.
37Conditional payment clauses are prohibited by statute in North Carolina (N.C. GEN. STAT. § 22C-2 (2008)) and Wisconsin (WIS. STAT ANN. § 779.135(3) (2008)), and have been ruled unenforceable by the state courts in California (Wm. R. Clarke Corp. v. Safeco Ins. Co., 938 P2d 372, 376 (Cal. 1997)) and in New York (West-Fair Elec. Contractors v. Aetna Cas. & Sur. Co., 661 N.E.2d 967, 971 (N.Y. 1995)). In Maryland, provisions in public or private construction contracts, which condition payment to the subcontractor on receipt by the contractor of payment from the owner or any other third party, cannot abrogate or waive the right of the subcontractor to claim a mechanic's lien or sue on a payment bond. See MD. CODE ANN., REAL PROP., § 9-113 (2008); MD. CODE ANN., STATE FIN. & PROC.§ 17-108 (2008).
38United States ex ref. Walton Tech., Inc. v. Weststar Eng'g, Inc., 290 F.3d 1199 (9th Cir. 2002).
39See United States ex rel. TMS Mech. Contractors, Inc. v. Millers Mut. Fire Ins. Co. of Texas, 942 F.2d 946, 949 n.6 (5th Cir. 1991); United States ex rel. DDC Interiors, Inc. v. Dawson Constr. Co., Inc., 895 F. Supp. 270 (D. Colo. 1995); United States ex rel. Straightline Corp. v. Am. Cas. Co., 2007 WL 2050323 (N.D. W Va. July 12, 2007); United States ex rel. W .R. Ackerman v. Holloway Co., 126 F. Supp. 347 (D.N.M. 1947).
40962 F. Supp. 838, 841-42 (E. D. Va. 1997).
41Moore Bros. Co. v. Brown & Root, Inc., 207 F3d 717, 723 (4th Cir. 2000).
42940 F. Supp. 1245, 1249 (N.D. Ill. 1996). See also Shearman & Assocs., Inc. v. Cont'l Cas. Co., 901 F Supp. 199 (D.V.I. 1995); OBS Co. v. Pace Constr. Corp., 558 So. 2d 404 (Fla. 1990).
43614 S.E.2d 680 (W Va. 2005).
44See Star Contracting Corp. v. Manway Constr. Co., 337 A.2d 669 (Conn. Super. Ct. 1973); St. Paul Fire & Marine Ins. Co. v. Georgia Interstate Elec. Co., 370 S.E.2d 829 (Ga. Ct. App. 1988). For a recent, detailed discussion of this issue, see Steven J. Koprince, The Slow Erosion of Suretyship Principles: An Uncertain Future for "Pay-When-Paid" and "Pay-If-Paid" Clauses in Public Construction Subcontracts, 38 PUB. CONT. L.J. 47 (Fall 2008).
45863 A.2d 347 (Md. Ct. Spec. App. 2004), aff'd, 879 A.2d 101 (Md. 2005).
462007 WL 2916399 (M.D. Fla. Oct. 8, 2007).
472006 WL 3299932 (E. D. Va. Oct. 25, 2006).
48In reaction to these cases, the AIA and the surety industry have released a proposed amendment to the A312 payment bond that lengthens the surety's response time from 45 to 60 days and provides that the surety's failure to respond in a timely manner "shall not be deemed to constitute a waiver of defenses the Surety or Contractor may have or acquire as to a claim." See Daniel Toomey, Bonanza for Bond Claimants? Surety Industry Seeks to Stem the A312 Bleeding, CONSTRUCT! Summer/Fall 2008, at 3-6.