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January 2007

Legal Issues

A Blow to the Surety Industry

A series of recent decisions ruling in favor of our client in a case involving a payment bond claim may herald greatly increased pressure against surety companies. The most important ruling in the case held that a surety must assert all factual defenses in its initial 45-day bond response letter. The court ruled that any additional factual defenses were waived.

If you are seeking recovery on a payment bond, you may have similar arguments. This type of issue can have a dramatic impact on whether you recover and, if so, your damages. Accordingly, you need to understand the rulings, the terms of your bond, and the law that applies to your case.

Payment Bond Basics
Most mason contractors are somewhat familiar with payment bonds. As we discussed in our April 2006 Masonry "Legal Issues" article ("Understanding Nuts and Bolts of Surety Bonds"), the express terms of such payment bonds are critical. In particular, you need to be intimately familiar with the limitation on when claims must be presented, when a suit needs to be filed, and compliance with notice provisions. Similarly, the surety has obligations regarding the nature and timing of its response that also are governed by the terms of the bond.

Each of these elements of the bond must be placed in the context of surrounding law. The law that governs may be the place of the project, or it may be another state law, depending on the terms of the bond and the specific facts. The main issue is that you need to understand what law governs and whether there are any specific nuances to that state's law with respect to your bond claim.

The Casey v. Seaboard Case
In Casey Industrial Inc. v. Seaboard Surety Company, an unpaid subcontractor filed a claim against a payment bond in a Virginia court. The surety denied the claim in a response letter, asserting certain limited and specific grounds for denying the claim. The surety attempted to preserve additional possible defenses by claiming it reserved its rights to assert other defenses at a later point. The subcontractor filed suit to enforce its payment bond claim.

In the suit, the subcontractor alleged that it had performed its contractual services in a timely and workmanlike manner. It also claimed that it performed additional work beyond the scope of its subcontracts and gave proper notice of its claims for compensation in accordance with the terms of the payment bond. It was swiftly apparent that the surety intended to raise factual defenses not included in the bond response letter, including challenges to specific damages and whether the claimed damages were in fact extras. The subcontractor argued to the court that the surety should be barred from raising any additional defenses not raised in its bond response letter. The subcontractor's argument was that the language of the bond required the surety to respond to the claim within 45 days and state "the amounts disputed and the basis for challenging the amounts that are disputed."

The court agreed with the subcontractor. Applying typical contract construction rules, the court held that the bond should be interpreted according to its plain meaning. Further, Virginia law required that the bond be construed strictly against the surety. Given that the bond specifically required the surety to assert the basis for denial in its initial response letter, the court held that the surety was foreclosed permanently from raising any additional factual defenses not contained in the bond response letter.

The court specifically rejected the surety's argument that the surety should be permitted to conduct discovery to flesh out additional possible defenses that were not contained in the original letter. The court stated that the bond's language spoke for itself and, while the surety might believe the result was "draconian," to hold otherwise would violate both Virginia law and the plain meaning of the bond. In reaching its conclusion, the court relied heavily on a 2005 Maryland Court of Appeals case, National Union Fire Ins. v. Bramble, in which the Maryland court found that a surety's failure to timely raise any defense in its bond response letter foreclosed the surety from denying the payment bond claim.

Implications
The Casey decision is the natural outgrowth of the logic in the National Union v. Bramble case. While Casey involved a surety who had asserted some defenses, the same reading of the same bond language naturally required a surety to assert all available factual defenses in its bond response letter. Thus, the court in Casey saw the extension of the same argument as reasonable, and held that the surety was barred from developing any further factual defenses not previously raised in the bond response letter.

Perhaps most importantly, both the Casey and National Union cases involve construction and interpretation of the American Institute of Architect's performance and payment bonds. These bonds are used nationally and on a wide variety of projects. Accordingly, potential claimants on the national stage should pay close attention to these two cases and understand that, while they are only Maryland state and Virginia federal courts, these decisions have national implications. If you are considering or have presented a bond claim, these decisions may have an enormous impact on your case.







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