The Interplay Between Equitable Subrogation and The GIA’s 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

EVERYONE’S 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:
 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!

WHAT ABOUT ASSIGNMENT RIGHTS?
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)

DOESN’T THE ASSIGNMENT CLAUSE DESERVE OUR RESPECT?
Some hypotheticals

ADVANTAGES OF ASSIGNMENT
 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

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 – don’t file until signs of distress  Could be too late vis-à-vis principal’s 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 surety’s priority interest over proceeds of bonded contracts.
 Nat’l 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 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

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 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 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 principal’s operations and financing?
 Often times the Bank or Other Lenders have already filed.

STRATEGIC CONSIDERATIONS
 What af fect might UCC filing 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

QUESTIONS?

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