By: Thomas S. Tripodianos Published: January 2015

Proper Sureties Claim

Question.        Sureties issued a performance bond to the Public Owner in connection with Contractor's contract. The Sureties claim the Public Owner made an improper post-termination payment to Contractor to the detriment of their rights as potential subrogees. The sureties neither performed the contract themselves nor financed the project's completion.  Is the Sureties claim proper?

Answer. Not at this time.

The Sureties issued a performance bond in connection with a public improvement project. The Contractor has alleged the Public Owner is in material breach of the contract seeks to withdraw from the same.  The Public Owner has declared the Contractor in default and asserts that the Sureties have breached their obligations under the performance bond. The Contractor contests the Public Owner's claims of default. The Sureties assert that the Public Owner improperly made a post-termination payment to Contractor to the detriment of the Sureties' rights as potential subrogees.

In the Bond, the Sureties agreed,

if requested to do so by the [Public Owner], to fully perform and complete the Project to be performed under the Contract, pursuant to the terms, conditions and covenants thereof, if for any cause the Contractor fails or neglects to so fully perform and complete such Project…. [and] to commence the work of completion within twenty (20) days after written notice thereof from the [Public Owner] and to complete such Project within such time as the [Public Owner] may fix.

At the conclusion of the 20-day period, the Sureties notified the Public Owner that they have been unable to conclude that Contractor is, in fact, in material breach of the subject Contract such that it could properly be terminated for default under the terms and conditions of that Contract. Therefore, the Sureties have been unable to conclude that the conditions triggering any obligation under the Bond have been met.

The Sureties further contend that the Public Owner made a post termination payment to the Contractor and in doing so the Public Owner failed to mitigate its damages, to the ultimate detriment of the Sureties.  The Sureties never notified the Public Owner that it should not make further payments to Contractor or that doing so would impair their interests.

The Sureties assert that the Public Owner's post-termination payment to Contractor was improper, notwithstanding that the payment was approved before Contractor's termination. They argue that any balance the Public Owner owes Contractor under the Contract serves as the Sureties' collateral in the event that they are required to pay or otherwise perform under the Bond. According to the Sureties, if the Public Owner is correct that Contractor materially breached the Contract, then payment was an overpayment that impaired their interests in the unpaid balance of the contract price. The Sureties further contend that, in the event that Contractor is found liable and they are compelled to fulfill their obligations under the Bond, they are entitled to a damages offset under the doctrine of equitable subrogation.

Subrogation is the right one party has against a third party following payment, in whole or in part, of a legal obligation that ought to have been met by the third party. The doctrine of equitable subrogation allows insurers to "stand in the shoes" of their insured to seek indemnification by pursuing any claims that the insured may have had against third parties legally responsible for the loss. In short, one party known as the subrogee is substituted for and succeeds to the rights of another party, known as the subrogor. The doctrine of subrogation, which is based upon principles of equity, has a dual objective as stated by New York courts: It seeks, first, to prevent the insured from recovering twice for one harm, as it might if it could recover from both the insurer and from a third person who caused the harm, and second, to require the party who has caused the damage to reimburse the insurer for the payment the insurer has made.

Generally in a public improvement contract, the contractor is required to find a surety that will secure the performance of his contract. Upon default by the contractor, the surety, pursuant to a performance bond, completes the contract, at its own cost and expense. It then becomes equitably subrogated to the rights of the contractor and certain of the rights of the owner in the unpaid balance of the contract price.

Here, it is undisputed that the Sureties have neither undertaken performance of the Contract themselves nor financed the project's completion. The Sureties' lack of performance to date precludes them from asserting an equitable subrogation claim at this time for any improper payments that the Public Owner purportedly made to Contractor.

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