|
In the recent case of RLI Insurance Company v. Indian River
School District, et al., 2008 U.S. Dist. LEXIS 43303, the
U.S. District Court for the District of Delaware addressed the
scope of coverage of a performance bond where an owner’s
failure to properly supervise the work of the general contractor
resulted in overpayment.
In August of 2002, the Indian River School District
(“Owner”), hired McDaniel Plumbing and Heating, Inc.
(“General Contractor”) to perform certain mechanical work
for the New Sussex Central High School (the “Project”).
General Contractor secured payment and performance bonds
in favor of Owner from RLI Insurance Company (“Surety”),
in accordance with the Delaware
State Procurement Act (the
“Procurement Act”). Owner also
hired Becker Morgan Group, Inc.
(“Architect”) and EDiS Company
(“Construction Manager”) to work
on the Project. Pursuant to the
prime contract (the “Contract”),
payments to General Contractor
were contingent upon the review
and approval of both Architect and
Construction Manager.
Over the course of two years after commencement of the
Project, General Contractor fell behind schedule. Architect
and Construction Manager, however, continued to approve
payment applications. Consequently, Owner continued to pay
General Contractor all amounts requested. Eventually, Owner
terminated the Contract and submitted a claim to Surety for
completion of the Project under the performance bond.
Surety denied the bond claim, asserting that Owner did not
comply with its contractual obligations when it issued payments
to General Contractor in excess of the work actually
performed. Subsequently Surety filed a declaratory action
alleging breach of fiduciary duty and negligent misrepresentation
by Owner.
Surety raised two arguments for judgment in its favor. First,
Surety argued that overpayment by Owner to General Contractor
|
discharged Surety from its obligations under the performance
bond. The Court observed that older cases have
held that “sureties should be granted a total discharge from
their obligations in the event of overpayment” (citations
omitted); however, the Court noted that the modern rule provided
that “where there has been a material departure from
contractual provisions relating to payments and the security
of retained funds a compensated surety is discharged from its
obligations on the performance bond to the extent that such
unauthorized payments result in prejudice or injury.”
(Emphasis added). Additionally, the court stated “the
defense does not apply when the owner has in good faith relied
upon the certifications of its architects or engineers”
(citations omitted).
In order to prevail on its theory, therefore, Surety would need
to prove (a) Owner’s bad faith in relying on the certifications
from Architect and Construction Manager and (b) that Surety
was injured by the overpayments. The Court rejected
Surety’s argument, as it did not find any evidence of bad faith
on the part of Owner. Moreover, the Court cited Surety’s
actual knowledge of the overpayments and inaction at the
time they occurred as evidence of no injury.
Surety’s second argument pertained to the terms and conditions
of the bond, which provided, in relevant part, that
Owner was required to arrange a pre-default conference with
Surety and General Contractor prior to terminating General
Contractor. Surety argued that, by failing
to comply with the terms of the bond,
Owner was precluded from asserting a
claim thereunder. As the Procurement
Act does not provide for a pre-default
conference, however, the Court held that
Surety’s defense to the bond claim based
on Owner’s failure to schedule a predefault
conference was invalid, and
Owner’s Motion for Summary Judgment
as to that point was granted.
As illustrated in RLI Insurance, Owners must be vigilant to
act in good faith in the administration of construction contracts,
avoiding overpayments that might limit their right to
assert a claim under a performance bond. Although the
Owner was absolutely absolved of its poor project management
in RLI Insurance, a slightly different set of facts could
have proved fatal to its bond claim.
|
